US banks are expected to adopt more sophisticated credit valuation adjustment (CVA) capital rules, while many EU banks are opting for simpler methods due to regulatory differences and operational costs. This divergence highlights growing gaps in bank capital regulations between the two regions.
The divergence in how US and EU banks are implementing new capital rules for derivatives risks could lead to uneven playing fields and potentially impact global financial stability. Different capital charges may influence banks' risk-taking behavior and their ability to manage exposures across borders.
Bank capital rules in the European Union and the United States are increasingly diverging, with the latest example being the capital charges for credit valuation adjustments (CVA), which measure risks from deteriorating derivatives counterparties.
Following reforms by the Basel Committee on Banking Supervision in 2017, the standardized approach (SA-CVA) became the most sophisticated option, intended to reward banks for investments in risk measurement. However, many EU banks opted for the simpler fallback approach (BA-CVA) when the new rules took effect last year. This choice was often driven by the realization that BA-CVA, when combined with internal models for counterparty credit risk, could result in lower capital requirements and operational expenses compared to SA-CVA.
Further complicating the EU's adoption of SA-CVA was the decision to retain existing exemptions for CVA capital charges on exposures to corporates, sovereigns, and pension funds. These exemptions reduced the capital benefits of SA-CVA, particularly for uncollateralized trades with larger market risk exposures.
In contrast, US banks are anticipated to largely adopt the SA-CVA. This expectation is fueled by US regulators' plans to phase out internal models for credit risk, compelling banks to use the more punitive standardized approach (SA-CCR) within BA-CVA, making it less appealing. Additionally, proposed changes to remove the 'Collins Floor' in the US would ensure CVA always plays a role in capital requirements, incentivizing banks to invest in capital-efficient SA-CVA approaches.
This divergence highlights a growing gap in regulatory approaches between the US and EU, with US banks being pushed towards sophisticated CVA methods while EU banks are leaning towards simpler ones, partly due to regulatory choices and cost considerations. US regulators are still finalizing their Basel III implementation, with compliance not expected until 2028 at the earliest.