The final piece of the Basel III jigsaw fits - Banks and unrated corporates can handle the output floor

The European Commission has proposed implementing the outstanding elements of the international banking reforms agreed in the wake of the global financial crisis. The final Basel III rules are designed to curb any underestimating of risks by banks when using internal models. The introduction of the output floor as lower bound for determining banks’ capital requirements will foster fair competition between banks using internal models and those that do not. The output floor will predominantly affect loans to large unrated corporates. Sebastian Mack assumes that the resulting capital increase will be digestible for the banks with only limited effects on the real economy.

Requiring all EU corporates to seek an external credit rating would not reduce the impact of the output floor as only a fraction of these firms demonstrates high creditworthiness. However, increasing the rating coverage of EU corporates would provide banks with additional information on borrowers and thus improve their risk management capabilities. In the absence of any public European rating agency, national central banks should follow the example of the Banque de France and establish public rating registers for large EU corporates.

Image: CC Ashkan Forouzani, Source: Unsplash