Primer: Basel III Endgame Impact on Consumer Lending

2nd Order Solutions
10 min readApr 2, 2024

Authors: Mikhal Ben-Joseph, Mara Albaugh, and Scott Barton

On March 6th, Federal Reserve Chair Jerome Powell confirmed that “broad and material” changes will be made to the current U.S. proposal for Basel III Endgame. This primer provides background on the original proposal — which would have significantly changed how most large banks calculate their capital requirements — and highlights a select number of key components that lenders should be aware of moving forward.

Background and Global Context of the American Proposal for Basel III Endgame

Large American financial institutions had been preparing for a July 2025 launch of an American version of “Basel III Endgame,” the latest capital framework established by the Basel Committee on Banking Supervision (BCBS).

Origins of the Proposal

The BCBS is the primary international forum for banking regulation and supervision, comprised of representatives from the central banks and regulatory bodies of internationally significant economies. Towards its goal of promoting stability in the international banking arena, and especially after the 2008–2009 financial crisis, BCBS has been iterating on a comprehensive regulatory capital framework to be implemented by all its member nations.

Between 2017 and 2019, it completed a version of these regulations with a colloquial nickname that reflected the rule makers’ finalizing intent: “Basel III Endgame.”

“Gold-Plating” Basel III

Basel III Endgame (B3E) is the framework at the heart of the latest proposed Regulatory Capital Rule for Large Banking Organizations (hereon, “proposal”) for the US. The proposal was produced in a joint effort by the Federal Reserve, FDIC, and OCC to reflect the enhanced risk mitigation policies of B3E.

However, the American proposal intensified many of the regulations set forth in the international version, partially in response to the three large American bank failures (see pg. 3) that occurred during its drafting in 2023. Critics called this augmented restrictiveness “gold-plating.”

While this “gold-plating” may be beneficial in mitigating the systemic risks uniquely posed by American banks, it potentially allows international banks to undercut their American peers and is one of the major concerns of the proposal’s opponents.

Two other major concerns with this proposal are the reduction of regulatory tailoring for certain large banks and the potential constraining of credit for marginal consumers due to increased lending costs. A few of the most pertinent changes related to these concerns, but not a comprehensive compilation, comprise the remainder of this post.

Key Changes to the Capital Ratio Calculation for Lenders

While the proposal would not change most of the capital ratio requirements directly, it would significantly affect the definitions and methodologies used to calculate the ratio.

Formula to calculate capital ratio

There are several types of capital metrics applicable to large banks in the US, and the proposal leaves most of the numerical requirements wholly unchanged. However, the proposal does substantially redefine the component parts of the calculation. The key changes detailed below are organized into two main sections based on whether their primary impact is in the numerator or denominator of the capital ratio.

What Counts as Capital — Reduction of Tailoring

Tailoring is a strategy wherein each bank is subject to regulations that are proportionate to the risk it faces and poses to the rest of the system.

Under the Enhanced Prudential Regime Categories, banks are split into four groups based on their size and systemic importance. In the proposal, many rules which formerly applied only to the largest banks (Category I and II) would now apply to all banks with greater than $100 billion in assets (Categories I-IV). This move would subject regional banks that exist in a few American states to the same regulations that the largest financial institutions in the world — global systemically important banks (GSIBs) — grapple with. Critics argue this reduction of tailoring may skirt congressional mandates and be unfair.

Enhanced prudential regime (EPR) categories (Source: 2OS Internal, Federal Reserve)

(1) Unrealized Gains and Losses

One of the most significant proposed tailoring changes was the elimination of a policy called the Accumulated Other Comprehensive Income (AOCI) opt-out (see pg. 9). This opt-out filter has allowed Category III and IV banks to avoid including certain unrealized gains and losses from their trading book in their Common Equity Tier 1 (CET1) capital, effectively shielding their capital war chest from fluctuations in the value of Available-for-Sale (AFS) securities. While the AOCI opt-out has been controversial since its initial implementation in 2013, the removal of this filter in the recent American proposal might have been inspired by the drastic unrealized losses that hastened the fall of Silicon Valley Bank in 2023. It’s worth noting, however, that the new policy would not have changed requirements surrounding the category of securities (Held-to-Maturity, or HTM) that were most influential in the SVB spiral.

If included in the final rule, the elimination of the AOCI opt-out would add volatility to the capital requirements for Category III and IV banks. Depending on its trading portfolio performance, the inclusion of AOCI could increase or decrease CET1 totals in any given period for a bank. This may incentivize some banks to explore reclassifying their AFS securities as HTM, a strategy that could help circumvent some of the fluctuations but comes with its own challenges (see pg. 9) and precautions.

(2) Less of a Bank’s “Hard to Calculate” Assets

The American B3E proposal included a variety of edits to the ways that certain “intangible and higher-risk” assets (see pg. 64036) are included in the capital summation for Category III and IV banks. The rationale for these changes is that certain assets have capital values that are hard to gauge, especially in stressful market conditions. By reducing the extra allowances that Category III and IV banks have for these assets, the proposal aligns all the large banks with capital standards that more closely reflect the riskiness of the assets rather than that of the institutions.

Unrealizable temporary deferred tax assets, mortgage servicing assets, and investments in the capital of other unconsolidated financial institutions are a few of the main instruments that would be affected by the proposal. Whereas Category III and IV banks can currently maintain up to 25% of their CET1 capital requirements in any of these categories, under the proposal this threshold would drop (see page 64036–7) to 10% in alignment with the rules for Category I and II banks. A variety of other assets would see similar reductions in their threshold deductions for regulatory capital, such as minority interest and certain unsecured debt instruments.

The impact of these rules would vary greatly with the investment and asset portfolios of the banks subject to them. Banks with assets in these categories above the specified threshold would see higher deductions in their capital totals and require augmentation from other sources.

Regardless of portfolio-dependent exposure, all banks subject to the proposal would need to ensure their procedural/data governance practices can identify the subtle differences between these categories. This might entail finding and refining new data attributes, potentially from sources outside of the bank itself.

Changing the RWA Methodology — Credit Access and Compliance Burdens

Perhaps the most broadly publicized concern with the proposal is its potential to reduce the availability of credit for marginal consumers. While the impact of the proposal on any financial institution would vary widely with the composition and behavior of its portfolio, the agencies estimate an average 16% increase (see pg. 13) in CET1 capital requirements across the industry.

When considered in tandem with the multitude of other recent banking regulations which have the potential to make credit more expensive (such as new laws on late fee reductions and proposal for long-term debt requirements), the proposal amplifies concerns that marginal consumers will face increasing challenges in meeting their capital needs.

Moreover, the extensiveness of the proposed changes would almost certainly raise compliance costs, which may be passed on to consumers.

(1) Dual Approaches for All

Currently, Category I and II banks calculate their Risk Weighted Assets (RWA) using two methods: a standard approach and an advanced approach. The latter can rely on a bank’s internal models, which regulators previously accepted to appropriately capture the unique risk profile of each institution. Category III and IV banks only need to use the standard approach.

Under the proposal, the advanced approach method would be replaced by an Expanded, Risk-Based Approach (ERBA) which mostly eliminates the use of internal models. In addition, all banks in Categories I-IV would be required to use both the standard and ERBA approaches in a dual system (see summary page). If internal models are a potential source for impropriety in risk calculation, then standardizing the advanced approach mitigates the risk of banks “gaming” their numbers.

(Source: Federal Reserve, see pg. 3)

Category III and IV banks have argued that this shift would pose a major compliance burden by essentially doubling the work needed to establish risk ratios. If this component of the proposal were to be finalized, banks would need to invest significant resources into compliance functions and potentially strategy adaptations as well.

(2) Risk Weights for Retail Lending

Under current regulation, all retail assets (such as credit cards, auto loans, or student loans) receive a simple 100% risk weight on drawn line under the standard approach.

Under the new proposal, retail loans to individuals or small businesses would be categorized (see pg. 64051–2) into one of three groups: transactors (credit cards paid in full every month for past 12 months), regulatory retail (any term loan such as student and auto loans and credit card revolvers with an aggregate credit limit under $1 million), and other retail (exposures that do not fall in any of the above categories). The risk weights on the drawn line for these categories would be 55%, 85%, and 110% respectively; importantly, there would also be a credit conversion factor (CCF) of 10% applied to any undrawn line on credit cards. Thus, whether the capital requirement for a retail loan will be larger or smaller under the proposal than the current regulation depends on utilization rate and category.

This new framework will potentially motivate lenders to reconsider the optimal mix of transactors and revolvers in their portfolios, as well as examine credit line decreases to maintain their capital ratios. There is concern that certain products and customer segments might become altogether too costly to maintain capital lines against, such as charge cards or small businesses which fall into the “other retail” category.

(Source: 2OS Internal)

The above demonstrates a simulated bank portfolio with 30% transactors, 30% light revolvers, and 40% heavy revolvers (light and heavy revolvers carried a balance in fewer than 6 or more than 6 of the last 12 months, respectively. We do not consider assets which would fall into the “other retail” category). Using approximate distributions of credit score and utilization rates from a 2020 Federal Reserve report and Experian, we estimated the potential impact on RWA as a percent of the original line assigned to each group under the proposal. We also simulated a 30% decrease in unused credit line to demonstrate one example of how banks might attempt to keep their RWA in equilibrium if the proposal is finalized. As illustrated above, the direction and magnitude of the effects of the weighting depend on the borrower subtype and utilization.

(3) Operational Risk

One last element of the proposal which has garnered significant concern — especially from the retail lending sector but even from regulators (see slide 8) — is the new operational risk add-on to RWA.

The rule is viewed by industry advocates as particularly punitive towards fee-based income (see pg. 13), which includes annual and interchange credit card fees among other service fees. While the contribution of income from interest- and trading-based assets towards the operational risk weights for a bank is capped at some percentage of the assets’ total value, the income from fee-based activities is not capped at all. Moreover, while interest- and trading-based assets’ contributions are calculated net of expenses, fee-based assets are calculated on a gross basis (see pg. 19–20). In practice, this different treatment for the fee category may lead the industry to shift away (see pg. 97) from such lending products. All else equal, affected lenders may want to examine opportunities to implement or enhance interest-based revenue strategies while winding down fee-based revenue streams.

Conclusion: Uncertainty Lies Ahead for America’s B3E

Concerns about the American B3E proposal range beyond those touched on here. Nearly every aspect of the American large bank system would have been touched by these rule changes. In his congressional testimony, Federal Reserve Chairman Powell indicated his belief that revision of the proposal will be completed within the year. As new versions are released to the public and further information is shared, financial institutions across the country will calculate the impact and prepare for the final ruling.

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