In this interview, David Laugier, Managing Director at Redbridge, discusses some of the key terms and principles linked to the new prudential regulation that treasurers need to know and how they may apply to their financing strategies.
Why do treasurers need to understand the impact of finalized Basel III?
David Laugier: The finalized Basel III framework aims to make capital requirements more consistent and comparable across banks by limiting the advantage some banks derive from using internal models to calculate their capital requirements that produce much more favorable results than standardized approaches. In particular, the new regulation introduces a safeguard – the output floor – that ensures the capital requirement calculated by a bank’s internal model must be at least 72.5% of that calculated using standardized approaches. This floor has applied since January 1 2025 and will be gradually phased in, reaching its final impact by 2033. Several studies project that, all else being equal, banks’ risk-weighted assets (RWAs) will increase by around 15% over the long term as a result of finalized Basel III, requiring them to set aside more capital.
Banks could respond to these new rules in three ways. First, they could choose to reduce their risk limits, lending volumes and appetite for exposures that are more capital-intensive. Second, they could accept absorbing the increase in RWAs without earning additional revenue, although this scenario of reduced profitability is likely to be difficult to sustain over the long term. Finally, they may seek to offset the impact by generating more revenue by applying higher margins and / or taking on additional side business in areas including cash management, foreign exchange and deposits.
What should treasurers expect as a result of the changes?
The output floor is intended to bring banks whose RWAs are structurally low relative to regulatory standards back into line. Banks that have long followed conservative approaches, such as through lower-risk portfolios or by assigning risk weights closer to standardized approaches, or that have moved in this direction in recent years in anticipation of prudential changes, will need to make much smaller adjustments – and in some cases none at all. This means that the impact of finalized Basel III will not be the same for all banks in a company’s banking pool.
Beyond that, some types of financing have become more capital-efficient relative to others as a result of the new regulation. For example, in syndicated loans, committed but undrawn facilities (such as revolving credit facilities used as back-up liquidity) may remain attractive in some cases, particularly for large groups that rarely draw them. By contrast, commitments that were historically underestimated (in terms of risk) or inexpensive may see their cost of capital increase. An example of such a commitment would be unused authorized overdrafts.
How is all this likely to affect companies’ relationships with their banks?
– Overall, the impact will be limited for many companies but potentially significant for those whose financing needs consume more bank capital. Under finalized Basel III, the dynamics of the banking relationship are being refocused on capital consumption, share of wallet and net profitability per client.
From a treasury perspective, it makes sense to ask each bank for the internal rating assigned to their company and to compare, lender by lender, the drivers of their assessment of this risk profile. It could also be a good idea to follow the example of Trafigura, which asked its core banks for an analysis of how the implementation of finalized Basel III would affect each bank’s risk appetite, the structure of their relationship with Trafigura and its profitability. How does the new framework affect the bank’s lending capacity, maturities, margins, covenants and requirements for ancillary revenues? It’s also important to clarify the frameworks used in prudential calculations. Such topics are rarely mastered in detail by relationship managers, often requiring detailed discussions with risk and credit teams.
How will finalized Basel III affect companies’ financing strategies?
Diversifying funding sources can genuinely make a company more resilient. The challenge is to objectively identify, instrument by instrument and entity by entity, where capital costs are likely to increase and which alternatives are genuinely available. From this perspective, some asset-backed financing may prove more sensitive than “unsecured” financings depending on their prudential treatment, the structure of the commitments and how banks consider risk.
In the background, the growth of private debt and, more broadly, non-bank intermediation (shadow banking) raises the prospect of rebalancing between bank and non-bank financing as balance-sheet constraints and return-on-capital pressures on banks intensify.
Over the past 18 months, Redbridge has observed companies paying greater attention to the possibility of issuing bonds, mainly via the public markets when they have a credit rating, but also through private debt when bank capacity tightens. With this in mind, it is becoming important for companies to incorporate finalized Basel III in their plans for the next five by setting out how they intend to diversify their sources of funding, specifying rating targets (at the group level and for major entities) and readying themselves for a possible reduction in reliance on bank credit over the medium term. Factoring also fits into this logic of diversification. By improving working capital requirements, it helps reduce the pressure on some of a company’s facilities and strengthens its financial flexibility.