Basel IV

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The Basel IV standards are changes to global bank capital requirements that were agreed in 2017 and are due for implementation in January 2023. They amend the international banking standards known as the Basel Accords. [1] Regulators argue that these changes are simply completing the Basel III reforms, agreed in principle in 2010–11, although most of the Basel III reforms were agreed in detail at that time. [2] The Basel Committee (BCBS) itself calls them simply "finalised reforms" [3] and the UK Government has called them "Basel 3.1". [4] Critics of the reform, in particular those from the banking industry, argue that Basel IV require a significant increase in capital and should be treated as a distinct round of reforms. [5]

Contents

Requirements

Basel IV introduces changes that limit the reduction in capital that can result from banks' use of internal models under the Internal Ratings-Based approach. This includes: [6] [7]

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 2027). [9]

Basel IV requirements are expected to increase capital requirements for British banks alone by £50bn. [10] 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%. [11]

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. The 2017 reforms complement the initial Basel III. This set of rules was adopted on 7 December 2017 (14 January 2019 for the adjustment to the market risk framework) with an intended implementation date of January 2022 (2027 for the output floor). [12] [13] As the BCBS does not have the power to issue legally binding regulation, the Basel standards have to be implemented by national authorities. [14]

In response to the COVID-19 pandemic, the BCBS agreed to delay implementation until January 2023. [15]

Implementation

The Basel Committee set 1 January 2023 as the date for implementation of the new rules. However, in October 2021 the European Commission proposed delaying the implementation until January 2025. [16] In March 2022, the UK's Bank of England also announced that they will propose an implementation date of January 2025. [17]

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Bank regulation is a form of government regulation which subjects banks to certain requirements, restrictions and guidelines, designed to create market transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things. As regulation focusing on key factors in the financial markets, it forms one of the three components of financial law, the other two being case law and self-regulating market practices.

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.

A capital requirement is the amount of capital a bank or other financial institution has to have as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity as a percentage of risk-weighted assets. These requirements are put into place to ensure that these institutions do not take on excess leverage and risk becoming insolvent. Capital requirements govern the ratio of equity to debt, recorded on the liabilities and equity side of a firm's balance sheet. They should not be confused with reserve requirements, which govern the assets side of a bank's balance sheet—in particular, the proportion of its assets it must hold in cash or highly-liquid assets. Capital is a source of funds not a use of funds.

Basel Committee on Banking Supervision Banking supervisory organization

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 countries in 1974. The committee expanded its membership in 2009 and then again in 2014. In 2019, the BCBS has 45 members from 28 Jurisdictions, consisting of Central Banks and authorities with responsibility of banking regulation. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee frames guidelines and standards in different areas – some of the better known among them are the international standards on capital adequacy, the Core Principles for Effective Banking Supervision and the Concordat on cross-border banking supervision. The Committee's Secretariat is located at the Bank for International Settlements (BIS) in Basel, Switzerland. The Bank for International Settlements (BIS) hosts and supports a number of international institutions engaged in standard setting and financial stability, one of which is BCBS. Yet like the other committees, BCBS has its own governance arrangements, reporting lines and agendas, guided by the central bank governors of the Group of Ten (G10) countries.

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.

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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 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.

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Capital Requirements Directives

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Basel III is a global, voluntary regulatory framework on bank capital adequacy, stress testing, and market liquidity risk. This third installment of the Basel Accords 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). On October 31, 2014, the Basel Committee on Banking Supervision issued its final Net Stable Funding Ratio.

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Capital Requirements Regulation 2013 EU banking law

The Capital Requirements Regulation(EU) No. 575/2013 is an EU law that aims to decrease the likelihood that banks go insolvent. With the Credit Institutions Directive 2013 the Capital Requirements Regulation 2013 reflects Basel III rules on capital measurement and capital standards.

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.

References

  1. ↑ 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. Retrieved 18 May 2014.
  3. ↑ "Sixteenth progress report on adoption of the Basel regulatory framework". BCBS. Retrieved 31 May 2019.
  4. ↑ "Prudential standards in the Financial Services Bill Policy statement" (PDF). UK Government. 2020-03-11. Retrieved 2020-03-12.
  5. ↑ Davies, Howard (2017-12-21). "The Last Basel Round? by Howard Davies". Project Syndicate. Retrieved 2017-12-27.
  6. ↑ "Basel 4 – Emerging from the mist". KPMG. Retrieved 18 May 2014.
  7. ↑ "South Africa: Basel 4 – Emerging From The Mist?". Mondaq. Retrieved 18 May 2014.
  8. 1 2 3 "Five things to remember about Basel III - Banking blog". blogs.deloitte.ch. Retrieved 2018-01-09.
  9. ↑ "Sixteenth progress report on adoption of the Basel regulatory framework". BCBS. Retrieved 31 May 2019.
  10. ↑ "KPMG: UK Banks Facing New £50bn Capital Hole as 'Basel IV' Emerges". International Business Times. September 12, 2013. Retrieved 18 May 2014.
  11. ↑ Nicolaus, David (2017-12-19). "Basel IV – capital and strategic planning". KPMG. Retrieved 2018-01-10.
  12. ↑ "Finalising Basel III - in brief" (PDF). BCBS. Retrieved 16 July 2019.
  13. ↑ "Basel III Website". BCBS. Retrieved 16 July 2019.
  14. ↑ "Policy development and implementation review". www.bis.org. 30 October 2015. Retrieved 8 April 2019.
  15. ↑ "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)
  16. ↑ Implementing Basel 4 - European Commission proposal for CRR3, KPMG , October 2021
  17. ↑ Implementation of Basel standards, Bank of England, 21 March 2022

Bibliography

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