Eliminating the negative impacts of the Basel IV output floor by adjusting a bank’s business model

Abstract

The purpose of this paper is to show the interaction between the Basel IV output floor and business model management. Specifically, the paper analyses how banks can optimise the output floor by moderately adjusting the composition of their portfolio. The individual topics are explained based on simplified exemplary cases. The presented capital floor analysis may help a bank’s top management to allocate the available capital better, formulate a coherent internal risk appetite, including the cost of capital in their pricing models, and set explicit targets for key performance drivers directly linked to the desired shareholder returns. With a target business model in mind, our approach can therefore be used to determine target levels for the individual risk positions that contribute to the output floor. The paper presents a procedure for overall bank management, particularly for business model planning in the presence of the Basel IV floor. Managers, analysts and regulators can apply our approach to analyse the business model of an individual bank, as well as the output floor of the banking sector as a whole. To our knowledge, our paper is the first academic contribution on the impact of the new prudential floor approach on the banks’ business model.