Basel IV and the structural relationship between SA and IMA

Abstract

The current paper aims at ascertaining the massive overhaul of the Trading Book or Basel IV, comparing the capital requirements of the Standardized and Internal Models Approaches in market crisis context. Throughout an integral sequential analysis encompassing every step of both regimes -including several specifications for the latter-, the study finds that the radical revamp achieves its main objective: raising capital for market risks. Simultaneously, the Standardized Approach appears favored, establishing a high floor as a credible fall-back and penalizing the Internal Models with complex structures and stringent validation tests. With the general purpose apparently attained, it would be wise to review the whole process and grant some flexibility to local supervisors in its application. The investigation was focused on Mexican stock markets during Covid-19, and it is understood that extending it to more countries could bolster the results. The present article ranks among the first to study the effects of Basel IV and highlights some of its flaws, particularly the probably excessive capital levels and the crackdown on Internal Models, which could dent profits, restrict innovation and shrink credit.