Basel III: Finalising post-crisis reforms

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Basel III: Finalising post-crisis reforms, sometimes called the Basel III Endgame, Basel 3.1 or CRR3, are changes to international standards for bank capital requirements that were agreed by the Basel Committee on Banking Supervision (BCBS) in 2017 and are due for implementation in January 2023. They amend the international banking standards known as the Basel Accords. [1]

Contents

The Basel Committee describes these changes as completing the Basel III reforms, published in 2010–11, [2] and calls them "finalised Basel III post-crisis reforms". [3] These remaining reforms to prudential regulation of banks are known by various names in BCBS member jurisdictions (often including other Basel III reforms that remain to be implemented – in particular, FRTB). In the US, implementation of these reforms is the main part of what is being called the Basel III "Endgame". [4] [5] The UK calls the changes "Basel 3.1". [6] In the European Union, it is typically known as CRR3. [7] Others have referred to them as Basel IV; however, the secretary general of Basel Committee said in a 2016 speech he did not view the changes as substantial enough to describe them in such a way. [8]

Critics of the reforms, in particular those from the banking industry, argue that the standards lead to a significant increase in capital requirements, when the stated intention of the Basel Committee was for the changes to the standards to be capital neutral in terms of their aggregate impact, although not necessarily neutral for individual banks. [1]

History

Basel III is an international regulatory framework for banks, developed by the Basel Committee on Banking Supervision (BCBS) in response to the financial crisis of 2007-08. It contains various rules on capital and liquidity requirements for banks. The 2017 reforms complement the initial Basel III. This set of rules was adopted on 7 December 2017 with an intended implementation date of January 2022 (including a phase-in period for the output floor until 2027). [9] [10] As the BCBS does not have the power to issue legally binding regulation, the Basel standards have to be implemented by national authorities. [11]

The secretary general of the Basel Committee said, in a 2016 speech, that he did not believe the changes are substantial enough to warrant a new Roman numeral. [8] The Basel Committee refer to only three Basel Accords. [12]

In response to the COVID-19 pandemic, the BCBS agreed to delay implementation by one year until January 2023. [13]

Requirements

The reforms revise the standardised approach for credit risk (SA-CR), the internal ratings-based approach for credit risk (IRB), the credit valuation adjustment (CVA) framework, the calculation of operational risk RWAs, the leverage ratio, and introduce an aggregate output floor for risk weighted assets (RWAs).

The BCBS press release summarised the reforms as follows: [14]

These reforms will take effect from January 2023, with exception of the output floor, which is phased in, taking full effect only on 1 January 2028. [15]

Capital impact

The standards are expected to increase capital requirements for British banks alone by £50bn. [16] The average Common Equity Tier 1 (CET1) capital ratio for major European banks is estimated to fall by 0.9%, with the biggest impact on banks in Sweden and Denmark of 2.5–3%. [17] The December 2020 assessment by the European Banking Authority (EBA) of the capital impact of implementing Basel 3.1 in the EU is an increase of 18.5% in minimum required capital with the impact for some national banking sectors forecast to be much higher (based on figures as of 31 December 2019). [18]

Implementation

The Basel Committee set 1 January 2023 as the (revised) date for implementation of the new rules. However, in October 2021 the European Commission proposed an implementation date of 1 January 2025. [19] In March 2022, the UK's Bank of England also announced that they will propose an implementation date of January 2025. [20]

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Operational risk is the risk of losses caused by flawed or failed processes, policies, systems or events that disrupt business operations. Employee errors, criminal activity such as fraud, and physical events are among the factors that can trigger operational risk. The process to manage operational risk is known as operational risk management. The definition of operational risk, adopted by the European Solvency II Directive for insurers, is a variation adopted from the Basel II regulations for banks: "The risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal processes, people and systems, or from external events, differ from the expected losses". The scope of operational risk is then broad, and can also include other classes of risks, such as fraud, security, privacy protection, legal risks, physical or environmental risks. Operational risks similarly may impact broadly, in that they can affect client satisfaction, reputation and shareholder value, all while increasing business volatility.

The Basel Accords refer to the banking supervision accords issued by the Basel Committee on Banking Supervision (BCBS).

Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. It is now extended and partially superseded by Basel III.

<span class="mw-page-title-main">Basel Committee on Banking Supervision</span> International financial regulatory body

The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten (G10) countries in 1974. The committee expanded its membership in 2009 and then again in 2014. As of 2019, the BCBS has 45 members from 28 jurisdictions, consisting of central banks and authorities with responsibility of banking regulation.

Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves, but may also include non-redeemable non-cumulative preferred stock. The Basel Committee also observed that banks have used innovative instruments over the years to generate Tier 1 capital; these are subject to stringent conditions and are limited to a maximum of 15% of total Tier 1 capital. This part of the Tier 1 capital will be phased out during the implementation of Basel III.

Basel I is the first Basel Accord. It arose from deliberations by central bankers from major countries during the late 1970s and 1980s. In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks. It is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992.

Advanced measurement approach (AMA) is one of three possible operational risk methods that can be used under Basel II by a bank or other financial institution. The other two are the Basic Indicator Approach and the Standardised Approach. The methods increase in sophistication and risk sensitivity with AMA being the most advanced of the three.

The term Advanced IRB or A-IRB is an abbreviation of advanced internal ratings-based approach, and it refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions.

The term Foundation IRB or F-IRB is an abbreviation of foundation internal ratings-based approach, and it refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions.

The term standardized approach refers to a set of credit risk measurement techniques proposed under Basel II, which sets capital adequacy rules for banking institutions.

In the context of operational risk, the standardized approach or standardised approach is a set of operational risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions.

Exposure at default or (EAD) is a parameter used in the calculation of economic capital or regulatory capital under Basel II for a banking institution. It can be defined as the gross exposure under a facility upon default of an obligor.

<span class="mw-page-title-main">Capital Requirements Directives</span>

The Capital Requirements Directives (CRD) for the financial services industry have introduced a supervisory framework in the European Union which reflects the Basel II and Basel III rules on capital measurement and capital standards.

Risk-weighted asset is a bank's assets or off-balance-sheet exposures, weighted according to risk. This sort of asset calculation is used in determining the capital requirement or Capital Adequacy Ratio (CAR) for a financial institution. In the Basel I accord published by the Basel Committee on Banking Supervision, the Committee explains why using a risk-weight approach is the preferred methodology which banks should adopt for capital calculation:

Basel III is the third Basel Accord, a framework that sets international standards for bank capital adequacy, stress testing, and liquidity requirements. Augmenting and superseding parts of the Basel II standards, it was developed in response to the deficiencies in financial regulation revealed by the financial crisis of 2007–08. It is intended to strengthen bank capital requirements by increasing minimum capital requirements, holdings of high quality liquid assets, and decreasing bank leverage.

During the financial crisis of 2007–2008, several banks, including the UK's Northern Rock and the U.S. investment banks Bear Stearns and Lehman Brothers, suffered a liquidity crisis, due to their over-reliance on short-term wholesale funding from the interbank lending market. As a result, the G20 launched an overhaul of banking regulation known as Basel III. In addition to changes in capital requirements, Basel III also contains two entirely new liquidity requirements: the net stable funding ratio (NSFR) and the liquidity coverage ratio (LCR).

A systemically important financial institution (SIFI) is a bank, insurance company, or other financial institution whose failure might trigger a financial crisis. They are colloquially referred to as "too big to fail".

Under the Basel II guidelines, banks are allowed to use their own estimated risk parameters for the purpose of calculating regulatory capital. This is known as the internal ratings-based (IRB) approach to capital requirements for credit risk. Only banks meeting certain minimum conditions, disclosure requirements and approval from their national supervisor are allowed to use this approach in estimating capital for various exposures.

The Fundamental Review of the Trading Book (FRTB), is a set of proposals by the Basel Committee on Banking Supervision for a new market risk-related capital requirement for banks.

The standardized approach for counterparty credit risk (SA-CCR) is the capital requirement framework under Basel III addressing counterparty risk for derivative trades. It was published by the Basel Committee in March 2014. See Basel III: Finalising post-crisis reforms.

References

  1. 1 2 Davies, Howard (2017-12-21). "The Last Basel Round? by Howard Davies". Project Syndicate. Retrieved 2017-12-27.
  2. ↑ "Regulators look ahead to 'Basel 4'". ICAEW. Archived from the original on 5 October 2018. Retrieved 18 May 2014.
  3. ↑ "Sixteenth progress report on adoption of the Basel regulatory framework". BCBS. 7 May 2019. Retrieved 31 May 2019.
  4. ↑ Anton, Austin (2022-01-10). "Basel III Endgame and the Cost of Credit for American Business". Bank Policy Institute. Retrieved 2023-07-11.
  5. ↑ "How the Basel III "Endgame" Reforms Will Transform US Capital Requirements". SIFMA. Retrieved 2023-06-28.
  6. ↑ "Prudential standards in the Financial Services Bill Policy statement" (PDF). UK Government. 2020-03-11. Retrieved 2020-03-12.
  7. ↑ "CRR3". www.afme.eu. Retrieved 2023-06-28.
  8. 1 2 Coen, William (2016-04-05). "The global policy reform agenda: completing the job".{{cite journal}}: Cite journal requires |journal= (help)
  9. ↑ "Finalising Basel III - in brief" (PDF). BCBS. Retrieved 16 July 2019.
  10. ↑ "Basel III Website". BCBS. 7 December 2017. Retrieved 16 July 2019.
  11. ↑ "Policy development and implementation review". www.bis.org. 30 October 2015. Retrieved 8 April 2019.
  12. ↑ "History of the Basel Committee". 2014-10-09.{{cite journal}}: Cite journal requires |journal= (help)
  13. ↑ "Governors and Heads of Supervision announce deferral of Basel III implementation to increase operational capacity of banks and supervisors to respond to Covid-19". 2020-03-27.{{cite journal}}: Cite journal requires |journal= (help)
  14. ↑ "Governors and Heads of Supervision finalise Basel III reforms". 2017-12-07.{{cite journal}}: Cite journal requires |journal= (help)
  15. ↑ Basel Committee on Banking Supervision. "Basel III transitional arrangements, 2017–2028" (PDF).
  16. ↑ "KPMG: UK Banks Facing New £50bn Capital Hole as 'Basel IV' Emerges". International Business Times. September 12, 2013. Retrieved 18 May 2014.
  17. ↑ Nicolaus, David (2017-12-19). "Basel IV – capital and strategic planning". KPMG. Retrieved 2018-01-10.
  18. ↑ European Banking Authority. "Basel III Reforms: Updated Impact Study" (PDF).
  19. ↑ Implementing Basel 4 - European Commission proposal for CRR3, KPMG , October 2021
  20. ↑ Implementation of Basel standards, Bank of England, 21 March 2022

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