Economic impact of the Final Basel III output floor

Macro & Finance

9 Apr

Economic impact of the Final Basel III output floor

The Final Basel III Framework introduces the concept of an output floor, which impacts the minimum level of capital banks are required to hold for each type of asset. In this context, the European Commission has put forward two main options for implementing the output floor: 1) the single stack approach, which is the preferred approach by the European Banking Authority (EBA), and 2) the parallel stack approach, which is preferred by several member states, including Denmark, Germany and France.

On this basis, the Swedish Bankers’ Association has asked Copenhagen Economics to analyse the impact of the different options on the Swedish banking sector and the real-economy.

We find that:

Implementing the output floor according to the single stack approach will de facto entail a significant increase in capital requirements for low-risk assets. As the Swedish banks have historically had low credit losses, Sweden is one of the most affected countries with an increase in capital requirements of 28%, against 18% for the EU average.
The increase in capital requirements for Swedish banks is particularly pronounced for unrated corporates (i.e. almost all corporates except for some of the largest), which will de facto all be subject to the same capital requirements, no matter the underlying risk.
We expect that, in time, the increase in capital requirements for low-risk assets will translate into higher borrowing costs for end-customers. We estimate that annual borrowing costs for Swedish banking customers will increase by some SEK 18 bn.
We expect this to reduce investments in the Swedish economy, which will eventually impact productivity and GDP. We estimate a permanent reduction in the level of Sweden’s GDP by around 0.7%, corresponding to around SEK 40 bn.
Implementing the output floor according to the parallel stack approach is more consistent with economic considerations as well as the original spirit behind the Final Basel III framework. This would lead to a much smaller total impact on capital requirements (around 6% increase in Sweden).

We conclude that imposing fixed global international standards on banks with highly different structures can reduce economic welfare. Hence, Sweden, as well as the EU, would be best served with an implementation that reflects this variation hereby adhering to the original aim of the Basel proposals.

The study is commissioned by the Swedish Bankers’ Association.

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