US Banks Are Facing Major Regulatory Changes – What You Need to Know

The American financial system is set to undergo a major set of regulatory changes that are poised to significantly evolve key elements of how U.S. banks do business.

Called “Basel III Endgame,” the set of regulatory updates is part of a global push to ensure the financial system is as resilient as possible against the threat of crises.

These upcoming changes are already causing significant debate and could potentially lead to meaningful changes in how some banks do business. Given that significance, we sat down with Nasdaq Head of Regulatory Technology, Edward Probst, to discuss the new standards and what they mean for the industry.

“Regulators are aiming to increase resiliency by enhancing risk-weighted asset calculations, improving comparability across borders through rule harmonization and improved risk management practices,” he explained.

Here’s what you need to know about Basel III Endgame:

Where are these regulations coming from?

Based in Basel, Switzerland, the Basel Committee on Banking Supervision brings banking regulatory authorities from around the world together to develop the Basel Accords, a regulatory framework that BCBS members have agreed to adopt in their jurisdictions. In response to the Global Financial Crisis, this Committee released an extensive set of updated standards in 2010 known as Basel III that aimed to strengthen banks to make them more resilient against certain risks.

An additional series of regulatory reforms, called “Basel III: Finalising post-crisis reforms,” were agreed to by the Committee in 2017. These updates to the Accords are sometimes known as Basel 3.1, Basel IV, or Basel III Endgame, and, last year, American officials published their own draft rules for how they propose implementing the standards for U.S. banks.

What does Basel III Endgame change?

These reforms are primarily aimed at determining how much capital a bank should keep on its balance sheet. As opposed to customers’ deposits, this capital is money that shareholders have put into the bank and is an important measurement because it represents funds that are not owed to anyone and can, therefore, serve as a buffer against any sudden drawdowns or losses in the business. 

The Basel III Endgame framework seeks to update rules for how much capital a given bank should maintain, as well as the specific standards each bank must follow. The changes include revisions to measuring credit risk, changes to the credit valuation adjustment (CVA) framework, updates to assessing operational risk, and more.

The standards are highly complex and technical – the final text from the Committee is 162 pages – but the overall impact is that banks will need to track and report their operations and ledgers with significantly increased granularity to calculate how much capital is required for regulatory compliance.

In terms of the effect on banking businesses, holding additional capital theoretically reduces risk to some degree but also changes the economics of many kinds of transactions banks undertake. For banking customers, this may result in higher prices, although the degree to which the increased costs are passed on by banks remains a matter of debate.

Although these specific regulatory frameworks were written in response to the last financial crisis, they largely represent the continued progression of global regulation, Probst explained.

“Ever since the Basel Accords have been put into place, there’s been a progressively increasing set of regulations to govern the way the banks manage capital by calibrating the investments they make and the risks they take,” he said. “The frameworks are evolving over time as markets evolve, and those frameworks are getting smarter and more accurate and trying to strike the balance between constraining the economy but also enabling a healthy level of risk-taking.”

What’s the current state of play in the US?

The U.S. Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation jointly released a Notice for Proposed Rulemaking (NPR) for the U.S. implementation of Basel III Endgame in July 2023. These proposals adapted the Basel frameworks for the context of American banks, and the industry was given until January 2024 to submit comments ahead of a final rule.

The U.S. version of the updated capital rules clocks in at 316 pages – nearly double what the Basel Committee produced on the same framework. The overall impact, according to the U.S. regulators, increased “capital requirements for large firms by an estimated 16 percent.”

The proposed framework largely follows the Basel Committee’s standards. However, in some instances, Probst explained, American regulators have “taken a harsher stance on a few select areas.”

More than 300 comments were submitted about the proposed changes, and regulators are now in the process of going through them ahead of publishing their responses later this year. According to Probst, those responses will likely offer some “directional” guidance on any revisions coming to the U.S. rules – which would then be finalized and published at a later date.

While officials are targeting a July 1, 2025, implementation of the new requirements, Probst noted that there is potential scope for that deadline to move depending on the number of changes regulators deem necessary for their final rules.

The financial industry, meanwhile, is already making investments in response to the upcoming regulatory changes. That’s especially true, according to Probst, as the new rules significantly impact the end-to-end supply chain of information due to increased granularity and reference data required.

“Those that were relying on manual or semi-automated processes to deal with Basel III have recognized that they’re going to face scrutiny as they present their control environments to internal and external audit,” he explained. “The new rules are intensive in terms of the amount of information you have to process and the variety of calculation rules you have to run. The analysis to put this all together and get a holistic view is going to be a challenge without a systematic approach.”

What is the industry saying about Basel III Endgame?

Given that the new rules are likely to result in many banks needing to maintain higher levels of capital, the industry has questioned the extent to which the proposed changes are correctly balancing risk reduction with economic impact.

“Any time you increase capital requirements, you’re going to have questions,” Probst said. “And there are important questions being asked, top of mind being: Why does the U.S. need a harsher regime than the rest of the world?”

For one example, experts have questioned whether the proposed updates would do anything to address some of the current concerns about stability or whether they are effectively fighting yesterday’s battles.

“Many responses to Basel III Endgame have asked whether this regulation is fixing a problem we have, or fixing a problem that we used to have that is now already mitigated by other measures,” Probst explained. “And when you look at the Silicon Valley Bank incident, you ask yourself what in this new regulation would have mitigated it, if anything?”

Beyond the questions of whether the regulations are fit for the present, there are also doubts that the Basel frameworks, which were based on international studies and determined in contexts significantly different from the U.S. financial system, are appropriate for the American regulatory environment.

For instance, the Basel III Endgame standards require banks to set aside capital on the basis of operational risk – the idea that elements of how a bank operates (separate from its assets or trading activities) introduce risk. This is one key area where many U.S. banks are focusing their disagreement, arguing that the post-crisis regime that includes the Comprehensive Capital Analysis and Review (CCAR) stress-testing is more than adequate for guarding against this type of risk.

How is this going to affect the banking industry?

When they come into effect, the Basel III Endgame-based regulatory rules will have two major forms of impact on the banks.

Firstly, increased capital requirements will change the economics of decision-making around some banking activities. This could result in higher costs for customers, or it could lead banks to pursue certain business strategies over others. 

“The cost of doing certain trades will change, the cost of issuing certain loans will change,” Probst said. “So, a bank is going to have to view managing its balance sheet through a new lens: How much capital does it consume for me to issue a trade finance letter? How much does it take for me to issue a mortgage to a low-income borrower? What’s the implication of buying corporate bonds and keeping those on our balance sheet?”

“There will be a new paradigm based on these new risk ratings that affect how they optimize their business for the future,” he added, pointing to the example of how the new rules would require a bank to hold capital against a line of credit extended to a customer – even if it is never drawn upon – which would significantly impact decisions about the scale of operations for a credit card business.

Want to learn more? The Basel III Endgame rules will mean a host of changes for how banks measure market risk, credit risk, and credit valuation adjustment.

The other way that Basel III Endgame will increase the burden on banks is by requiring them to adopt new technologies, expertise, and processes in order to meet the tracking, calculating, and reporting demands of the updated regulations.

Banks will now need to monitor their activities at a much more granular level, running a large magnitude of complex calculations, connecting their systems, and producing highly detailed auditable reports.

“Compliance with Endgame requires cohesion across the bank, including risk, finance, treasury, and technology. And there is a lot we can do now to ensure a better outcome,” Probst explained. “The more time we spend now to improve data sourcing, controls, and to test the new methodologies and reporting, the more time we will have for value-add activities including balance sheet optimization and capital planning.”

What is Nasdaq doing to help?

For banks that want to avoid the complexity, challenges, and costs of building in-house yet another data storage and computational system across multiple business units, Nasdaq provides specialized fit-for-purpose tools to directly address regulatory requirements.

Adenza, the Nasdaq-owned provider of mission-critical risk management, regulatory reporting, and capital markets software to the financial services industry, has already been tapped by major banks to provide solutions to Basel III Endgame regulations in Australia and Canada, where the new international standards have already gone live.

While the U.S. version of those frameworks necessitates adjustments to the tracking and reporting programs, Adenza is already delivering updated solutions for its customers. “We’re giving customers the ability to get a good jump-start and to build a high-quality implementation,” Probst explained.

“We’re not waiting until the last rule is fully finalized: We want customers to be able to implement their systems with plenty of time: We have already delivered the product for operational risk, we have delivered the product for CVA risk, and more,” he added. “We expect there will be some changes, and we’re very adept at dealing with change because we manage over 5,000 regulatory reports across the world, and we deal with tens of thousands of updates throughout the year.”

In addition to its fit-for-purpose software that enables customers to meet the analytics, calculation, and reporting standards of Basel III Endgame, Adenza’s cloud-first systems mean a high-performance and ready-to-scale environment that can readily grow and update to new requirements.

Want to learn more? Adenza uniquely addresses the Basel-driven need for consolidated offerings of risk analytics, regulatory calculation and reporting, cloud-first approaches, and TCO optimization.