Basel III Endgame: The 2024-2026 Saga and What It Means

Introduction

The Basel III Endgame (sometimes called Basel IV) is the final chapter of the post-crisis bank capital reform saga, and its outcome will determine the capital backdrop for FIG investment banking for the next decade. The July 2023 Notice of Proposed Rulemaking (NPR) from the Fed, OCC, and FDIC proposed sweeping changes to how the largest US banks calculate risk-weighted assets, with an estimated aggregate capital increase of approximately 19% for the largest institutions. The proposal triggered the most intense industry lobbying campaign since Dodd-Frank, a leadership change at the Fed, and a fundamental shift in the expected outcome: from significant capital increases to a capital-neutral reproposal under the current administration. For FIG analysts and bankers, the Endgame is not an abstract regulatory topic; it directly affects bank ROE (higher capital requirements dilute returns), P/TBV multiples (lower ROE compresses valuations), M&A capacity (more capital tied up in requirements means less available for deals), and competitive positioning (US banks could face different requirements than European peers).

The NPR proposed four major changes to the capital framework for banks with over $100 billion in assets.

Standardized credit risk approach: Replacing the Advanced Internal Ratings-Based (AIRB) approach with a more granular standardized methodology. Under AIRB, banks used their own models to estimate risk weights, which critics argued allowed them to systematically underestimate risk. The standardized approach would assign risk weights based on observable characteristics (LTV for mortgages ranging from 40% to 125%, borrower type for corporate exposures) rather than bank-derived estimates.

Fundamental Review of the Trading Book (FRTB): A new market risk framework replacing Value-at-Risk with expected shortfall, incorporating stressed liquidity horizons and reducing the benefit of diversification across trading desks. This would have significantly increased capital charges for banks with large capital markets operations (Goldman Sachs, Morgan Stanley, JPMorgan's CIB).

Standardized operational risk: Replacing internal model approaches for operational risk with a standardized formula calibrated to each bank's historical loss experience. The prior internal model approach had been criticized for producing inconsistent results across banks.

Output floor: Setting a minimum floor requiring that total RWA from any combination of internal models cannot fall below 72.5% of what the standardized approach would produce. This prevents banks from gaming the model framework to achieve artificially low capital requirements.

The Output Floor

The output floor is the single most consequential element of the Basel III Endgame. It states that regardless of what a bank's internal models produce, total risk-weighted assets cannot be lower than 72.5% of the amount calculated under the standardized approach. For banks that have optimized their internal models to achieve low RWA density, the output floor can be binding, meaning the standardized calculation (not the internal model) effectively determines their capital requirement. The floor phases in gradually: 50% in the first year, increasing to 72.5% by the end of the transition period. The EU has already begun this phase-in as of January 1, 2025, while the US has not yet finalized its approach. The output floor directly addresses the RWA density comparability problem: two banks with identical portfolios should not have materially different capital requirements simply because one bank's models are more aggressive.

The estimated impact was substantial: approximately 19% aggregate capital increase for Category I and II banks (the eight G-SIBs and other large firms), with 9% for Category III and IV banks ($100-250 billion in assets). The original implementation timeline targeted July 1, 2025, with a three-year phase-in to June 30, 2028.

The opposition was unprecedented in scale and intensity. The Bank Policy Institute (representing the largest US banks) launched a "Stop Basel Endgame" campaign. The American Bankers Association (ABA) criticized the operational risk methodology. The US Chamber of Commerce engaged in public advocacy. Center Forward ran television advertisements arguing the proposal would restrict credit availability for consumers and small businesses.

The core arguments centered on four themes. First, the capital increase was unnecessary given that US banks were already among the best-capitalized in the world, with CET1 ratios of 11-16% against requirements of 10-14%. Second, the proposal would raise the cost of lending, particularly for mortgages, auto loans, and credit cards, passing regulatory costs to consumers. Third, it would create competitive disadvantages versus European banks (whose CRR3 implementation includes national discretions that soften the impact) and versus non-bank lenders (which face no comparable capital requirements). Fourth, the proposal was overly complex and would take years to implement correctly.

In September 2024, Fed Vice Chair Michael Barr announced a revised framework that would reduce the aggregate capital increase from approximately 19% to approximately 9%, responding to the volume and substance of industry comment letters (over 400 received).

The practical outcome for FIG advisory is becoming clearer. The original 19% capital increase is dead. The revised 9% increase under Barr is also unlikely to survive in its proposed form. The expected capital-neutral reproposal means that any new standardized approaches will be calibrated so that aggregate required capital remains approximately unchanged.

For bank valuation, this is materially positive. The original proposal would have reduced aggregate ROE by an estimated 1-2 percentage points (more capital in the denominator without proportional earnings growth), which would have compressed P/TBV multiples across the sector via the justified P/BV formula. A capital-neutral outcome preserves current ROE levels and removes a significant source of uncertainty from bank equity valuations.

For M&A, the resolution of Endgame uncertainty is a catalyst. Banks that had been hoarding excess capital as a buffer against potential Endgame increases (JPMorgan's 15.7% CET1 versus an 11.5% requirement reflects this caution in part) may begin deploying that excess through acquisitions, buybacks, or dividend increases. The regional bank consolidation wave is expected to accelerate as capital certainty improves.

The Basel III Endgame saga illustrates a broader truth about FIG: regulatory outcomes are not static background conditions. They are dynamic, politically influenced, and capable of shifting the entire valuation framework for the sector. The transition from a 19% capital increase to capital neutrality over two years changed the earnings capacity, M&A outlook, and equity valuation of every large US bank. FIG professionals who tracked this evolution in real time had a material analytical advantage.