Output Floor

30 August 2024

One of the centrepieces of the revised Basel proposals is the updated Output Floor. The main aim of the Output Floor is to bring greater alignment between the capital requirements for the credit risk Standardised and Internal Models approaches.

Overview

Under the revised Output Floor, firms with internal modelling permissions, will be required to calculate Risk Weighted Assets as the higher of:

Total RWAs using all approaches they have the supervisory approval to use, including IM approaches
72.5% of RWAs calculated using only standardised approaches

The aim of the Output Floor is to:

Reduce undercapitalisation due to uncaptured model risk.
Enhance comparability of RWAs amongst firms.
Support competition by narrowing the gap in risk weights between SA and IM firms.

Implementation

Since the PRA moved implementation of Basel 3.1 by twelve months from the original proposals to 1 January 2026, the output floor will now be implemented over a transition period of 4 years.

What banks should consider

Under the current proposals, UK subsidiaries of third-country firms will not be subject to the output floor in the UK. This is to avoid ‘double counting’ as the expectation is that the output floor will be applied at the level of the Parent, in their home jurisdiction.

This means that subsidiaries of third-country firms with internal models may have an advantage against their domestic counterparties if their HQ is in jurisdictions with divergent approaches on the Output Floor. In order to ensure international firms continue to align with domestic banks the PRA have made high level statements but there has been no concrete information produced by the regulator. International firms will need to monitor this on an ongoing basis to understand what specific output floor expectations they will be required to meet, if any, in the UK.

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If you have any further questions regarding Basel 3.1, please contact us via the button below and a member of our team will be in touch.

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