On the Verge of Basel IV: What’s New in the Package for Banks?
Basel Norms and Their Key Facts
Basel norms in banking are an internationally agreed set of measures developed by the Basel Committee on Banking Supervision (BCBS) in response to the numerous challenges faced by the financial and capital markets. As the Bank for International Settlements (BIS) explained, the measures aim at setting minimum standards and requirements that apply to internationally active banks and financial institutions.
The BCBS regulations and requirements have no legal force. The Basel Accords are recommendations expected to be implemented by member countries. The first Basel Capital Accord was supported by G10 Governors and central banks. Today, there are 28 jurisdictions and 45 institutions, consisting of central banks and authorities responsible for banking supervision in their home countries.
|Members and representatives responsible for supervision in the banking sector|
|Argentina||Central Bank of Argentina|
|Australia||Reserve Bank of Australia|
|Australian Prudential Regulation Authority|
|Belgium||National Bank of Belgium|
|Brazil||Central Bank of Brazil|
|Canada||Bank of Canada|
|Office of the Superintendent of Financial Institutions|
|China||People’s Bank of China|
|China Banking Regulatory Commission|
|European Union||European Central Bank|
|European Central Bank Single Supervisory Mechanism|
|France||Bank of France|
|Prudential Supervision and Resolution Authority|
|Federal Financial Supervisory Authority (BaFin)|
|Hong Kong SAR||Hong Kong Monetary Authority|
|India||Reserve Bank of India (RBI)|
|Indonesia Financial Services Authority|
|Italy||Bank of Italy|
|Japan||Bank of Japan|
|Financial Services Agency|
|Korea||Bank of Korea|
|Financial Supervisory Service|
|Luxembourg||Surveillance Commission for the Financial Sector|
|Mexico||Bank of Mexico|
|Comisión Nacional Bancaria y de Valores|
|Russia||Central Bank of the Russian Federation|
|Saudi Arabia||Saudi Arabian Monetary Agency|
|Singapore||Monetary Authority of Singapore|
|South Africa||South African Reserve Bank|
|Spain||Bank of Spain|
|Switzerland||Swiss National Bank|
|Swiss Financial Market Supervisory Authority (FINMA)|
|Turkey||Central Bank of the Republic of Turkey|
|Banking Regulation and Supervision Agency|
|United Kingdom||Bank of England|
|Prudential Regulation Authority|
|USA||Board of Governors of the Federal Reserve System|
|Federal Reserve Bank of New York|
|Office of the Comptroller of the Currency|
|Federal Deposit Insurance Corporation|
|Chile||Central Bank of Chile|
|Banking and Financial Institutions Supervisory Agency|
|Malaysia||Central Bank of Malaysia|
|United Arab Emirates||Central Bank of the United Arab Emirates|
|Supervisory groups, international agencies and other bodies|
|Bank for International Settlements|
|Basel Consultative Group|
|European Banking Authority|
|International Monetary Fund|
|Bank for International Settlements|
Basel Committee membership, institutions, and representatives responsible for supervision in the banking sector
All the members, groups, agencies, and bodies responsible for supervision have played a vital part in formulating the BCBS’s core principles. These form a basis for the supervisory system and standards that are further explained and embodied in the Basel norms in banking.
The BCBS has already published three Basel Accords.
The Basel Accords and Their Principles
issued in 1988
|This Accord aimed to tackle credit risk. With this Accord the BCBS established a bank asset classification and lowered many risk profiles, which boosted investments. This paved the way for the best practices and regulations in the banking sector.|
issued in 2004
|The major aim of this Accord was to strengthen capital requirements and set up the regulatory review framework. This Accord and its updates and amendments aimed to make bank’s capital more risk-sensitive, promote risk management for large banks, and establish standardized techniques and approaches to evaluating banks in non-EU countries.|
issued in 2009
|This Accord came as a response to the global financial crisis. It aimed at reforming and enhancing the regulation, supervision, and risk management within the entire banking sector. Based on the two previous Basel Accords, Basel III focused on individual banks’ ability to withstand financial stresses and mitigate system-wide shocks.|
Evolution of Basel norms in banking: Basel I, Basel II, Basel III
The Basel Accords have continued to develop. Thus, from 2012 through 2017, the Committee addressed the issues of banks’ exposure to central counterparties, margin requirements, measurement of counterparty credit risk exposures, and calculation of capital requirements for securitizations by introducing Fundamental Review of the Trading Book (FRTB) capital requirements and enhancement of the framework for disclosure requirements. In 2017, new standards were put in place for the calculation of capital requirements for credit risk, credit valuation adjustment risk, and operation risk. One of the objectives of these new standards was to reduce the excessive variability of risk-weighted assets (RWA), which we will discuss further below.
The Basel III norms addressed a number of shortcomings and provided a foundation for more resilient banking. But the ongoing reform of Basel III and its implementation aims to reveal further systemic vulnerabilities.
Basel III Norms and More
The reasons for the global financial crisis are quite complex. Before the crisis in 2008, there was a period of excess liquidity, which became partially invisible for many banks and supervisors. Subsequently, the banks discovered they had insufficient liquidity reserves to meet their obligations, while the quality of their capital was also inadequate. Basel III, being the biggest regulatory change to date, allowed the reform of the entire banking sector landscape.
Basel III retained the three pillars from Basel II, i.e.,
- Pillar 1 establishes regulatory capital requirements for calculating credit, operational, and market risks
- Pillar 2 sets out a process for reviewing the overall capital adequacy by banks and a process for supervisors to evaluate how banks assess their risks
- Pillar 3 outlines disclosure requirements
However, in addition, Pillar 1 was reinforced with capital and liquidity requirements.
Moreover, Basel III introduced two liquidity ratios: the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). These two ratios ensure a sufficient level of high-quality liquid assets and promote resilience over a longer time horizon, respectively.
We should also mention that changes to Pillar 1 introduced the Capital Adequacy Ratio (CAR), and in particular the definition of capital and minimum CAR requirements, under which the BCBS issued a consultative document on the FRTB, which outlines market risk requirements such as
- Stricter definition of tools and instruments applied to the trading book
- Longer periods for value-at-risk calculations
- Use of correlations under the standardized approach
According to the OECD Journal, Basel II never came properly into effect due to the crisis. Under Basel III, the Basel Committee introduced changes to capital requirements, such as raising the quality, consistency, and transparency of the capital base, enhancing risk coverage, introducing the leverage ratio, and considering the role of procyclical factors, though it failed to address some major concerns, particularly about the changes to the risk-weighted asset framework.
From Basel III to Basel IV: A Journey through Risk-Weighted Assets
Basel I offered quite simple risk weights focusing on credit risk and offering a market risk component. However, in 2012, according to the European Parliament briefing, the BCBS initiated a comprehensive review of the risk-weighted capital framework to finalize the Basel III norms and strengthen the resilience of the global banking system.
In 2017, the Basel Committee published finalized rules covering major issues associated with RWAs. These rules outline fundamental changes to calculating capital ratio and RWA by all banks, no matter their size or the complexity of their banking model. Such changes were deemed to be the “finalization” of the Basel III package of reforms. Nevertheless, many experts consider this the beginning of the new Basel IV Accord, due to the scale of the modifications.
We will not look into the changes in any depth here. However, it is worth saying that the impact of Basel IV may vary by location as well as by the type and business model of certain banks. It is time for banks to work out their own capital management strategies in order to be ready for Basel IV. The development of such strategies requires extensive knowledge and expertise.
At CompatibL, we deliver support to our customers in adjusting their strategies in line with the forthcoming requirements and understanding the evolving regulatory requirements. In addition, we offer risk management software that covers such regulatory frameworks as Basel III, FRTB, ISDA SIMM, IRRBB, and SA-CCR.
The winds of change regarding Basel IV have already forced some larger banks to apply advanced modeling and optimization approaches and even review their legal entity set up. There are many areas to consider while maintaining the pace of capital efficiency: product offerings, policies on collateral and guarantees, repricing, management of costs, etc. What is more, the technical side may become the major challenge. How to calculate RWA accurately? How to ensure the data is complete and used appropriately? At CompatibL, we strongly recommend considering investing in technical tools and implementing efficient capital management approaches.