Impact of Basel IV on capital efficiency and factoring
Fausto Galmarini, Chairman of the EUF, discusses the significant changes represented by the introduction of the Basel IV reforms.
The output floor, which aims to reduce variability in Risk-Weighted Assets (RWAs) and improve the comparability of capital ratios among banks, will have major effects on banks’ business models, capital efficiency, and the factoring industry.
The output floor sets a minimum level of RWAs calculated under internal models at 72.5% of those required under standardised approaches for calculating capital requirements for all Pillar 1 risks. Due to the potential impact of the floor, the implementation is progressive: from the initial 50%, it reaches the final 72.5% in 2027.
Many banks are strategically re-evaluating their business models. The output floor will force all banks to critically assess the capital consumption and profitability of different business lines and determine their viability over the medium term.
For example, the RWA for factoring operations under the Advanced Internal Ratings-Based (AIRB) model is estimated to be in the range of 20% to 30%. The introduction of the output floor will penalise banks that are using internal models because they will see a consistent increase in capital absorption for a business that historically has a very low level of risk.
To avoid this, an important step is to ask the regulators for specific treatment for factoring. This implies the need to gather data at a European level that can demonstrate the real level of risk, the lower Loss Given Default (LGD), and the minimal relevance of past due payments as an early indicator of insolvency in factoring activity.
The EUF is negotiating with the European Banking Authority (EBA) to change the New Definition of Default (NDOD) guidelines. The current rule, which states that a receivable 90 days past due automatically represents a default, is far from the reality, creating many false positive cases.
The EBA is now open to discussing this topic and has requested further data to examine the proposal to change the rule. The EUF is committed to gathering this data by the end of July and aims to launch a project for collecting much more data in a structured way. This will support the request to the EBA for specific treatment for factoring in line with its real risk, which will benefit all banks and intermediaries, whether they use the internal ratings-based model or standardised methods for calculating capital consumption. This would help avoid the negative impact of the output floor.
