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What is the Basel framework?
Also known as the ‘Basel Accords’, ‘Basel Standards’, ‘Basel Regulations’, or just plain ‘Basel’, the Basel framework is the full set of standards for the international banking system.
Set by the Basel Committee on Banking Supervision (BCBS), which comprises the world’s top banking regulators, the standards’ aim is to shore up the global financial system and set a level playing field for banking regulation.
At the heart of the framework lies the requirement for banks to maintain enough capital reserves to meet their obligations and absorb unexpected losses.
The first set of standards was the ‘Basel Capital Accord’, established in 1988. Today, this is known as ‘Basel I’, as there have been two subsequent sets of revisions — Basel II, issued in 2004, and Basel III, issued in 2010.
What is the scope of the Basel framework?
While capital requirements lie at the heart of the Basel accords, with each revision the standards have been extended. They now cover how banks are supervised and the market disclosures they are required to make. Basel II introduced new aspects to regulation and supervision structured around three pillars:
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Pillar 1, minimum capital requirements: This first pillar sets out the minimum regulatory capital requirement and contains rules for calculating more refined risk weights for different kinds of loans. In addition, it outlines that capital should be held against so-called operational risk.
The level has been increased in the two successive revisions. Under the latest standard, Basel III, banks have a capital requirement of 4.5% of common equity Tier 1, as a percentage of the bank’s risk-weighted assets. There is also an extra 2.5% buffer capital requirement, bringing the total minimum requirement to 7%. Importantly, the minimum Tier 1 capital ratio is set at 6%.
- Pillar 2, supervisory review process: Risk management best practice is at the core of pillar 2. Banks must undertake an Internal Capital Adequacy Assessment Process; it then falls to national supervisors to evaluate how well banks assess their capital needs relative to their risk. Supervisors are then required to take remedial measures if necessary, but the exact nature of the measures is left to their discretion.
- Pillar 3, market discipline: This pillar aims to ensure market discipline by making it mandatory to disclose relevant market information. Banks are required to disclose credit risk, operational risk, the leverage ratio and credit valuation adjustment risk. It also requires the disclosure of risk-weighted assets as calculated by both the bank’s internal models and a standardised model.
In Europe, the European Central Bank is responsible for assessing banks’ compliance with the Pillar 3 disclosure requirements. In 2022, the exercise focused on the following data: solvency, leverage, liquidity coverage and net stable funding ratios. It also looked at selected disclosure templates covering counterparty credit risk, or CCR.
What were the key revisions announced in Basel III?
The need for a revision to Basel II came as a result of the financial crisis of 2007–09, to address some key failings in the pre-crisis regulations.
In the BCBS’s own words, Basel III “provides a foundation for a resilient banking system that will help avoid the build-up of systemic vulnerabilities”.
Basel III has been introduced in two phases: an initial phase, introduced in 2010; and a final phase, introduced in 2017. This final phase is also known interchangeably as the ‘Basel III final reforms’, ‘Basel 3.1’ and ‘Basel IV’.
The 2017 reforms seek to restore credibility in the calculation of risk-weighted assets (RWAs) and improve the comparability of banks’ capital ratios.
Basel 3.1 at a glance
- Revisions to the standardised approaches for calculating credit risk, market risk, credit valuation adjustment and operational risk. This means greater risk sensitivity and comparability.
- Constraints on using internal models. The aim is to reduce unwarranted variability in banks’ calculations of RWAs.
- An output floor aims to reduce variability in RWAs and to improve comparability of capital ratios among banks.
- Global systemically important banks, or G-SIBs, are subject to higher leverage ratio requirements.
These final reforms introduce changes in the calculation of capital requirements for all risk types, for both standard and internal models and will mean higher capital needs for most banks.
How far are we in terms of implementation?
The target timelines for implementation of the final Basel III reforms vary significantly worldwide.
Following a one-year deferral to increase the operational capacity of banks and supervisors to respond to Covid-19, the reforms took effect in January 2023 and will be phased in over five years.
Around a third of the 28 member jurisdictions have implemented all or most of the Basel III standards, the BCBS reported in its latest update in early October.
A number of regulators worldwide have pushed forward implementation of the rules. In September 2023, for example, the Bank of England moved the implementation date of the Basel 3.1 policies by six months to July 1, 2025, aiming to ensure full implementation by 2030.
Member jurisdictions reiterated their expectation to implement all aspects of the Basel framework in full, consistently, and as soon as possible, though implementation in many cases is being pushed to 2024 or later.
The Bank for International Settlements maintains an interactive monitoring dashboard that reports on individual countries’ progress in adopting the standards.
While the standards are set by the BCBS, it falls on national supervisors to incorporate the Basel standards into their own regulations by an agreed deadline. It is only when the standards are incorporated into national regulations that they become binding rules for banks to follow.
This means there is variation in how national supervisors choose to incorporate the standards into national regulations.
Will Basel 3.1 prevent another global financial crisis?
Not necessarily. As Latin America editor Barbara Pianese reported in September, some academics and civil society organisations argue that Basel III standards, as implemented, do not remove the risk that the largest US banks are still ‘too big to fail’.
In particular, the post-2008 reforms increased capital relative to risk, but stopped short of requiring sufficient capital to minimise bail-out risks, academics argued during the 15th Anniversary Lehman Collapse Conference.
