The Basel Committee’s (BCBS) proposal to apply higher capital charges for “unconditionally cancelable lines of credit” (UCCs) could impact internationally active US credit card banks CET1 ratios on average by 375 basis points, absent any remedial measures from affected institutions.
Fitch Ratings says, if implemented by the US authorities, the measures will encourage US banks to reduce unused lines of credit to avoid lowering their capital ratios. This follows the publication of written feedback on the December 2015 consultative proposals to revise the Standardized Approach for credit risk.
Capital rules require banks to convert undrawn credit lines to credit exposures by multiplying the committed but undrawn amount by a credit conversion factor (CCF).
UCCs to both retail and corporate clients are currently subject to a 0% CCF under the standardized approach to credit risk (SA). US bank holding companies with total assets in excess of $250bn, with regulatory approval to use models for calculating their capital requirements, remain subject to a capital floor based on 100% of their SA capital requirements.
At year-end 2015, UCC totaling about $3 trillion were subject to an SA 0% CCF for a select range of the largest US bank holding companies and credit card banks, based on regulatory disclosures.
The BCBS believes that consumer protection laws and reputational risk considerations may constrain banks’ ability to cancel such commitments. For this reason, the Committee believes a 0% CCF is inappropriate and proposes a new CCF of between 50% and 75% for wholesale UCCs and 10% and 20% CCFs for retail UCCs, i.e. credit cards and personal overdraft facilities. The Basel Committee proposals would impact large internationally active banks operating under the Advanced approach.
For large internationally active credit card banks, the implications could be material if adopted and could change the competitive position for affected firms.
Fitch estimates end-2015 CET1 ratios for select credit card banks could fall by an average of 3.75% if a 20% UCC CCF is applied to retail credit card exposures and a 75% CCF applied to wholesale credit card exposures. In contrast, estimated average CET1 ratios for the large universal banks would drop by just 0.78%. As such, if the US regulatory authorities adopt the BCBS UCC proposal in its current form, Fitch expects credit card issuers will seek to reduce the amount of UCC by trimming credit lines for active accounts and/or closing inactive accounts.
In contrast to US institutions, banks in other major jurisdictions are not currently subject to a 100% capital floor, where the internal ratings-based model approach is often used to calculate capital charges for credit card exposures. Based on a Fitch review of 105 medium-to-large EU banks at end-1H15, only a few individual German, Dutch, Finnish, and UK banks appear to benefit significantly from the application of the SA 0% CCF for UCCs.
The revised SA proposals for UCCs are possibly influenced by parallel studies undertaken by the Committee on how banks use internal models to estimate credit risk capital requirements for UCCs. In a study released on April 1, 2016, the Committee found that some banks do not assign CCFs (zero or otherwise) to UCCs, while some banks assign a 0% CCF to commitments that are only conditionally cancelable. The study also found that assigned non-zero CCFs usually do not differ materially between UCCs and other facilities.
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