| Basel Framework International regulatory standards for banks |
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| Background |
| Pillar 1: Regulatory capital |
| Pillar 2: Supervisory review |
| Pillar 3: Market disclosure |
| Business and Economics Portal |
The Basel Accords [lower-alpha 1] refer to the banking supervision accords (recommendations on banking regulations) issued by the Basel Committee on Banking Supervision (BCBS). [1]
Basel I was developed through deliberations among central bankers from major countries. In 1988, the Basel Committee published a set of minimum capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992. A new set of rules known as Basel II was developed and published in 2004 to supersede the Basel I accords. Basel III was a set of enhancements to in response to the financial crisis of 2007–2008. It does not supersede either Basel I or II but focuses on reforms to the Basel II framework to address specific issues, including related to the risk of a bank run.
The Basel Accords have been integrated into the consolidated Basel Framework, which comprises all of the current and forthcoming standards of the Basel Committee on Banking Supervision. [2] [3]
Formerly, the Basel Committee consisted of representatives from central banks and regulatory authorities of the Group of Ten countries plus Luxembourg and Spain. Since 2009, all of the other G-20 major economies are represented, as well as some other major banking locales such as Hong Kong and Singapore. [lower-alpha 2]
The Committee does not have the authority to enforce recommendations, although most member countries as well as some other countries tend to implement the Committee's policies. This means that recommendations are enforced through national (or EU-wide) laws and regulations, rather than as a result of the committee's recommendations - thus some time may pass and, potentially, some unilateral changes may be made, between the international recommendations for minimum standards being agreed and implementation as law at the national level.
The regulatory standards published by the committee are commonly known as Basel Accords.They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there. The Basel Accords is a set of recommendations for regulations in the banking industry.
Deliberations by central bankers from major countries resulted in the Basel Capital Accord, which was published in 1988 and covered capital requirements for credit risk. The Accord was enforced by law in the Group of Ten (G-10) countries in 1992.
The Basel Accord was augmented in 1996 with a framework for market risk, which included both a standardised approach and a modelled approach, the latter based on value at risk. [1]
Published in 2004, Basel II was a new capital framework to supersede the Basel I framework. It introduced "three pillars": [1]
Capital requirements for operational risk were introduced for the first time. The ratio of equity and credit is 8% under Basel II. The standards were revised several times during subsequent years. [1]
Bank regulators in the United States took the position of requiring a bank to follow the set of rules (Basel I or Basel II) giving the more conservative approach for the bank. Because of this it was anticipated that only the few very largest US banks would operate under the Basel II rules, the others being regulated under the Basel I framework. However Basel II standards were criticised by some for allowing banks to take on too much risk with too little capital. This was considered part of the cause of the US subprime mortgage crisis, which started in 2008.
The Basel 2.5 revisions introduced stressed VaR and IRC for modelled market risk in 2009-10. [1]
Following the financial crisis of 2007–2008, the Basel III reforms were published in 2010/11. The standards set new definitions of capital, higher capital ratio requirements, and a leverage ratio requirement as a "back stop" measure. Risk-based capital requirements (RWAs) for CVA risk and interest rate risk in the banking book were introduced for the first time, along with a large exposures framework, a revised securitisation framework, and a standardised approach to counterparty credit risk (SA-CCR) to measure exposure to derivative transactions. A specific framework for exposures to central counterparty clearing was introduced. [4]
The BCBS also published regulatory standards for the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR); [5]
In subsequent years, the Basel Committee updated the standards for market risk, based on a “Fundamental Review of the Trading Book” (FRTB). [6] In addition, further reforms of the framework were published by the Basel Committee in 2017 under the title Basel III: Finalising post-crisis reforms. [2] These reforms were sometimes referred to as "Basel IV". However, the secretary general of the Basel Committee said, in a 2016 speech, that he did not believe the changes are substantial enough to warrant that title and the Basel Committee refer to only three Basel Accords. [7] [1] These new standards came into effect on 1 January 2023, although national implementation of the standards is generally running behind this schedule and still ongoing.
The framework's approach to risk which is based on risk weights derived from the past was criticised for failing to account for the uncertainty in the future. [8] A recent OECD study suggest that bank regulation based on the Basel accords encourage unconventional business practices and contributed to or even reinforced adverse systemic shocks that materialised during the financial crisis. According to the study, capital regulation based on risk-weighted assets encourages innovation designed to circumvent regulatory requirements and shifts banks' focus away from their core economic functions. Tighter capital requirements based on risk-weighted assets, introduced in the Basel III, may further contribute to these skewed incentives. New liquidity regulation, notwithstanding its good intentions, is another likely candidate to increase bank incentives to exploit regulation. [9]
In an October 24, 2020 speech at the Bund Financial Summit in Shanghai, Jack Ma described the Basel Accords as a "club for the elderly." [10] : 50
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.
Banking regulation and supervision refers to a form of financial regulation which subjects banks to certain requirements, restrictions and guidelines, enforced by a financial regulatory authority generally referred to as banking supervisor, with semantic variations across jurisdictions. By and large, banking regulation and supervision aims at ensuring that banks are safe and sound and at fostering market transparency between banks and the individuals and corporations with whom they conduct business.
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.
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.
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.
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.
Valuation risk is the risk that an entity suffers a loss when trading an asset or a liability due to a difference between the accounting value and the price effectively obtained in the trade.
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:
Macroprudential regulation is the approach to financial regulation that aims to mitigate risk to the financial system as a whole. After the 2007–2008 financial crisis, there has been a growing consensus among policymakers and economic researchers about the need to re-orient the regulatory framework towards a macroprudential perspective.
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".
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.
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.
Liquidity regulations are financial regulations designed to ensure that financial institutions have the necessary assets on hand in order to prevent liquidity disruptions due to changing market conditions. This is often related to reserve requirement and capital requirement but focuses on the specific liquidity risk of assets that are held.
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.
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