Topic:

Basel
Summary

Basel III

Originally published in 2010, Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision (BCBS), to strengthen the regulation, supervision and risk management of the banking sector following the 2008 financial crisis. These measures aim to:

-improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source

-improve risk management and governance

-strengthen banks' transparency and disclosures.

The Basel III framework builds on and enhances the regulatory framework set out under Basel II and Basel 2.5. The Basel III framework covers both the quality and quantity of banks’ capital, setting higher levels of capital requirements and increasing the quality of capital to ensure that capital is genuinely loss-absorbing and will be implemented on a phased-in basis. Basel III introduces:

-the leverage ratio;

-the Liquidity Coverage Ratio (LCR)

-net stable funding ratio (NSFR).

The introduction of the leverage ratio, a non-risk based "backstop" measure will restrict the build-up of excessive leverage in the banking sector. Basel III's leverage ratio is defined as the "capital measure" (the numerator) divided by the "exposure measure" (the denominator) and is expressed as a percentage. The capital measure is defined as Tier 1 capital which is mostly Common Equity and some additional Tier 1 Capital (AT1) with a 3% minimum leverage ratio requirement with a view to migrating to a binding Pillar 1 (minimum capital requirement) treatment on 1 January 2019. This was further revised in December 2017 and will come into effect on 1 January 2022.

-Basel III phase-in arrangements

The Liquidity Coverage Ratio (LCR) (revised in January 2014) aims to promote short-term resilience of a bank’s liquidity risk profile by requiring banks to have sufficient high quality liquid assets (HQLA) to withstand a 30-day stressed funding scenario that is specified by supervisors. The liquidity framework includes a common set of monitoring metrics to assist supervisors in identifying and analysing liquidity risk trends at both the bank and system-wide level.

The Net Stable Funding Ratio (NSFR) complements the LCR and is designed to promote prudent funding structures by banks. It is a longer-term structural ratio designed to address liquidity mismatches. The NSFR covers the entire balance sheet and provides incentives for banks to use prevent over-reliance on short-term wholesale funding. The BCBS issued the final requirements for banks' NSFR-related disclosures in June 2015 and it became a minimum standard on 1 January 2018.

The Basel III framework also differentiates the three pillar architecture:

-Pillar 1 covers capital, risk coverage and leverage provisions;

-Pillar 2 comprises all aspects of risk management and supervision; and

-Pillar 3 sets guidelines for market discipline

Basel III/CRD IV/CRR

The Basel III rules are implemented in the European Union by means of Capital Requirements Directive 2013/36/EU (CRD IV) and Regulation 575/2013/EU (CRR)

-Capital Requirements Directive (CRD IV) 2013/36/EU

-Capital Requirements Regulation (CRR) 575/2013/EU

Basel IV

In 2012 a comprehensive review of the risk-weighted capital framework was initiated by the BCBS. Having analysed separately the banking book, the trading book and operational risk, the BCBS proposed several amendments to the Basel III framework. The refinements and additions to the Basel III framework have been termed “Basel IV” by some.

On 7 December 2017, the Group of Governors and Heads of Supervision (GHOS) endorsed a package of amendments to the Basel framework,  with the intention of finalising the outstanding post-crisis reforms known as the "Basel III" reforms. The agreement is the result of a strategic review of those international reforms with a view to improving the balance between simplicity, comparability and risk-sensitivity.

The package completes the global reform of the regulatory framework and includes the following key elements:

1. a revised standardised approach for credit risk, which will improve the robustness and risk sensitivity of the existing approach;

2. revisions to both internal ratings-based (IRB) approaches for credit risk to reduce unwarranted variability in banks' calculations of risk-weighted assets (RWAs);

3. an overhaul of the credit valuation adjustment (CVA) framework consisting of the removal of the use of an internally modelled approach and the introduction of a new basic approach (BA-CVA) as well as revisions to the standardised approach (SA-CVA), to enhance the risk sensitivity, strengthen the robustness and improve the consistency of the framework;

4. a new revised standardised approach for operational risk (SA-OR), replacing all the existing standardised and advanced measurement approaches for this risk to simplify the framework and increase comparability;

5. revisions to the measurement of the leverage ratio and a leverage ratio buffer for global systemically important banks (G-SIBs), which will take the form of a Tier 1 capital buffer set at 50% of a G-SIB's risk-weighted capital buffer;

6. refinements to the leverage ratio exposure measure, include modifying the way including which derivatives are reflected in the exposure measure; and

7. an aggregate output floor, which will ensure that banks' risk-weighted assets (RWAs) generated by internal models are no lower than 72.5% of RWAs as calculated by the Basel III framework's standardised approaches. Banks will also be required to disclose their RWAs based on these standardised approaches.

A short description of the agreed reforms is set out in an accompanying summary document. The final standards text detailing the reforms and the Committee's assessment of their quantitative impact have also been published. The revised standards will take effect from 1 January 2022 and will be phased in over five years.

In March 2018 the Basel Committee published a Consultative Document proposing revisions to the minimum capital requirements for market risk/the “Fundamental Review of the Trading Book” (FRTB). The proposal aims to address industry concerns and recommendations arising from the 2016 framework, Minimum capital requirements for market risk and responses received to the follow-up 2017 consultation, Simplified alternative to the standardised approach to market risk capital requirements.

The revisions will be implemented in the EU as part of the Revised Capital Requirements Regulation (CRR II), published in November 2016.