On 18 December 2015, we blogged that the Basel Committee on Banking Supervision (Basel Committee) published a consultation paper on the identification and measurement of step-in risk. The Basel Committee’s proposals focused on the identification of unconsolidated entities to which a bank may nevertheless provide financial support, in order to protect itself from any adverse reputational risk stemming from its connection to the entities. The proposals also included potential approaches that could be used to reflect step-in risk in prudential measures.
The Basel Committee has now published a second consultation paper on guidelines for the identification and management of step-in risk. The aim of the consultation paper is to mitigate potential spill-over effects from the shadow banking system to banks. This work is part of the G20 initiative to strengthen the oversight and regulation of the shadow banking system to mitigate systemic risk, in particular, risks arising due to banks’ interactions with shadow banking entities.
The proposed guidelines define the step-in risk that is potentially embedded in banks’ relationships with unconsolidated entities. Step-in risk is the risk that a bank might support entities beyond its contractual obligations in order to protect itself from any adverse reputational risk stemming from its connection to the entities. If not appropriately anticipated, the materialisation of step-in risk could affect a bank’s capital and liquidity positions.
The guidelines propose criteria for identification of step-in risk that cover the risk characteristics of the entities in addition to banks’ relationships with them. In terms of prudential response, the Basel Committee has recognised the necessity of a tailored approach as opposed to a standardised approach. To this end, this framework entails no automatic Pillar 1 capital or liquidity charge additional to the existing Basel III standards. Rather, the framework leverages existing prudential tools by informing or supplementing them.
The Basel Committee notes that the present framework should enter into force as soon as possible and no later than end-2019. The Basel Committee intends to monitor jurisdictions’ progress in implementing these guidelines in order to keep itself informed of the approaches taken to identify step-in risk and the range of supervisory responses employed.
The deadline for comments on the consultation paper is 15 May 2017.