Basel III Endgame: Are stricter capital rules strengthening banks or following the economy?

Written by Sarah Virk & Researched by Rebecca Stevens

“Basel III could choke lending in this country,” Warned JP Morgan Chase CEO Jamie Dimon in a 2024 Senate hearing. His remarks captured a rising concern across the finance sector.

Originally developed as a response to the 2008 global financial crisis, the Basel III reforms were designed to strengthen the resilience of banks by requiring higher levels of capital and tighter risk management. Now, more than a decade later, they are finding reproductions and are pushing to implement the final measures. Supporters argue that this is an essential part to safeguarding the financial stability, yet critics warn that imposing stricter capital requirements during a fragile economic recovery may constrain lending, reduce profitability, and slow investment. Yet, as this implementation approaches, the debates regarding the Basel III Endgame are intensifying, and the arguments surrounding it are growing.

The Basel III endgame refers to the final implementation of the phase of post-crisis reforms introduced but the Basel Committee on Banking Supervision. Initially, this idea was conceived in the aftermath of the 2008 financial crisis. The broader Basel III framework was designed to strengthen the global banking system by enhancing capital adequacy, improving risk management, and increasing transparency. The Endgame package now seeks to finalise these measures through a series of more perspective standards.

Central to these changes is the introduction of the output floor, a mechanism that limits the extent to which banks are able to use internal models to calculate risk-weighted assets, also known as RWA. Under this new rule, banks must hold capital equal to at least 72.5% of the requirements calculated using standardised models, regardless of whether internal assessments indicated a lower exposure. Regulators argue that the addresses model risk, promotes consistency across jurisdictions, and prevents undercapitalization. Critics, however, warn that these measures could disproportionately increase capital burdens for institutions with historically low risk portfolios, constraining credit supply and compressing returns on equity.

Whilst the Basel III Endgame aims to establish a global standard for bank capital, its implication varies significantly across major economies, reflecting differing regulatory priorities and economic conditions. This divergence can carry an important implication for internal banking and cross-border differences. In the United States, regulators have proposed some of the strictest spatial requirements, with large banks potentially needing to hold up to 16% more capital under the new rules. The Federal Reserve’s approach emphasises robust buffers for systemically important institutions, raising the common equity Tier 1 ratio to around 13%. This, in turn, reflects a cautious stance aimed at minimising systemic risk in a market that experienced severe strain during the 2008 crisis. However, US banks warn that such heightened requirements could reduce lending capacity, particularly to small and other enterprises that alone rely heavily on bank credit.

In contrast, the EU has adopted a more measured and controlled path. The European Banking Authority supports the reforms with an impact assessment that suggests that stricter spatial rules may lead to up to a 15% contraction in mortgage lending, which is a key sector for many European economies. With this, policymakers are balancing the need for financial stability with concerns about affordability and growth in the housing market. However, the EU’s phased implementation plan has allowed banks more time to adjust, reflecting an effort to avoid sudden shocks to credit ability. The EU, in this regard, has the strongest outcome of this difficulty, with the US having the more difficult outcome.

Meanwhile, in the UK, it occupies a middle ground in this situation. Post Brexit regularity autonomy has allowed the UK’s Prudential Regulation Authority to tailor Basel III standards to the national priorities, blending aspects of both the UK’s stringent capital buffers and the EU’s cautious rollout. This strategy aims to protect financial stability whilst supporting economic recovery, particularly in sectors vulnerable to credit tightening.

Yet, what does this mean for us today? At the centre of the issue, the Basel III Endgame is an excursive in crisis prevention. By curbing reliance on overly optimistic internal risk models and enforcing more continent spatial floors, the framework is designed to mitigate systemic risk and avoid a repeat of the 2008 collapse. These reforms enhance transparency, increase loss-absorbing capacity, and reduce the likelihood of taxpayer-funded bailouts. In conclusion, the Basel III Endgame represents a pivotal balancing act between financial resilience and economic vitality.