Basel Framework Overview and Regulatory Impact

The Basel Framework is a set of international banking regulations aimed at ensuring the stability of the global financial system. These regulations were first introduced in 1988 by the Basel Committee on Banking Supervision.

The Basel Framework has undergone several revisions, with the most significant update being Basel III, which was implemented in 2013. Basel III introduced stricter capital requirements, liquidity standards, and risk management guidelines for banks.

The primary goal of the Basel Framework is to prevent bank failures and maintain financial stability. To achieve this, it sets minimum capital requirements for banks, which vary depending on the type of assets held.

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The Basel Accords were developed over several years beginning in the 1980s by the Basel Committee on Bank Supervision (BCBS). The BCBS was founded in 1974 as a forum for regular cooperation between its member countries on banking supervisory matters.

The BCBS describes its original aim as the enhancement of "financial stability by improving supervisory knowhow and the quality of banking supervision worldwide." This goal is still relevant today as the BCBS continues to play a crucial role in shaping the global banking landscape.

The Basel Accords were originally organized by central bankers from the G10 countries, who were working toward building new international financial structures to replace the recently collapsed Bretton Woods system. This marked the beginning of a new era in international banking regulation.

The Basel Accords are named after the city of Basel, Switzerland, where the Bank for International Settlements (BIS) is headquartered. The BIS serves as the secretariat for the BCBS and provides administrative support for the committee's activities.

The Basel Accords have undergone several revisions, with the most recent being Basel III, which was released in 2010 in response to the financial crisis of 2007-09. Basel III builds on the three pillars of Basel II and introduces new regulatory requirements on bank liquidity and bank leverage.

Here are the three Basel Accords, listed in chronological order:

The Basel framework is a set of rules designed to ensure the stability of the global banking system. It's been around since 1988, but it's undergone significant changes over the years.

Basel I was the first framework, but it was eventually replaced by Basel II in 2004. Basel II introduced three pillars: minimum capital requirements, supervisory review, and effective use of disclosure.

Basel II introduced capital requirements for operational risk for the first time, and the ratio of equity to credit is 8%. This framework was revised several times, with the Basel 2.5 revisions introducing stressed VaR and IRC for modelled market risk in 2009-10.

The ECCB is moving from Basel I to Basel II/III to address the lack of risk sensitivity in Basel I. Basel II/III allows for more flexibility and tailoring to meet the ECCU's unique circumstances.

Some of the key features of the Basel framework include:

These features are designed to promote a more stable and resilient financial system, and to prevent the kind of risk-taking that contributed to the US subprime mortgage crisis in 2008.

The Basel framework has undergone several reforms and updates over the years, each introducing new components to strengthen banking regulations. Basel II, published in 2004, introduced three pillars: minimum capital requirements, supervisory review, and effective use of disclosure.

The Basel II framework also introduced capital requirements for operational risk, with a ratio of equity and credit set at 8%. This framework was revised several times, with the Basel 2.5 revisions introducing stressed VaR and IRC for modelled market risk in 2009-10.

Basel III, which began being rolled out in 2025, will force banks to hold more capital, giving them an extra cushion in times of stress. The rules will be phased in over three years, with full compliance starting on July 1, 2028.

The Basel III framework covers further reforms in six areas, including a standardised approach for credit risk, internal ratings based approach for credit risk, and a standardised approach for operational risk based on income and historical losses.

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The Basel framework is crucial for maintaining a safe and stable global banking system. It sets standards for banks to have enough capital to survive unexpected losses.

The Basel Accords, including Basel III, require banks to maintain a minimum amount of common equity and a minimum liquidity ratio. This ensures that banks have a sufficient cushion to absorb losses and prevent governments from bailing them out with taxpayers' money.

A study by PwC projected that implementing the Basel III Endgame requirements would reduce economic growth in the U.S. by 56 basis points via reduced returns to bank shareholders and increased costs to consumers and businesses.

The projected macroeconomic impact of Basel III implementation is a topic of interest. An OECD study found that the medium-term impact on economic growth would be in the range of -0.05% to -0.15% per year due to increased bank lending spreads.

This impact can be mitigated by a decrease in monetary policy rates of 30 to 80 basis points. A study by PwC projected that the implementation of the Basel III Endgame requirements would reduce economic growth in the U.S. by 56 basis points.

Higher capital requirements resulted in contractions in trading operations and the number of personnel employed on trading floors in the United States.

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The Basel I regulations failed to prevent the 2007 to 2009 financial crisis and Great Recession, leading to even tighter controls.

Basel I made less capital available for lending, which limited the amount of money banks could lend to customers.

It adopted a simple approach to risk weighting, focusing solely on credit risk and overlooking other critical risks.

This simplistic approach was a major criticism of Basel I, highlighting the need for a more comprehensive risk assessment.

The Basel Regulatory Framework is overseen by the Basel Committee on Banking Supervision (BCBS), which is headquartered at the Bank for International Settlements. The BCBS updates the framework periodically, with the most recent information available on their website.

The BCBS uses systemic indicators, known as GSIB denominators, to calculate an aggregate global indicator amount for each systemic indicator. This data is used to determine the Board's GSIB risk-based capital surcharge.

The BCBS has released several proposals and notices for revising the Basel framework, including a 2012 notice of proposed rulemaking to modify the regulatory capital minimums and a 2016 proposal to require more granular disclosures on market risk.

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Basel II is an extension of the regulations for minimum capital requirements as defined under Basel I. It's designed to provide a more comprehensive framework for banks to manage their risk.

Basel II operates under three key pillars, which are mutually reinforcing. These pillars are the foundation of the framework.

Pillar 1 focuses on establishing minimum capital requirements for three major components of risk: credit risk, market risk, and operational risk. This ensures that banks have sufficient capital to cover potential losses.

Pillar 2 requires supervisory oversight to assess whether banks are adequately managing their risk. This involves reviewing a bank's risk management activities and ensuring they are meeting the required standards.

Pillar 3 improves transparency by requiring banks to publicly disclose details of their risk management activities. This provides greater insight into a bank's capital adequacy and helps to promote market discipline.

Here's a brief overview of the three pillars of Basel II:

The Basel Committee on Banking Supervision is responsible for setting global banking regulations, and their framework is crucial in ensuring the stability of the financial system. The most recent information from the BCBS can be found on the website for the Bank for International Settlements.

The Basel Committee operates under a three-pillar framework: Pillar 1 focuses on minimum capital requirements, Pillar 2 emphasizes supervisory review, and Pillar 3 promotes transparency and market discipline. This framework is designed to ensure that banks maintain sufficient capital to absorb potential losses.

The Basel II framework, introduced in 2004, introduced three pillars: minimum capital requirements, supervisory review, and effective use of disclosure. The ratio of equity and credit under Basel II is 8%. The Basel 2.5 revisions introduced stressed VaR and IRC for modelled market risk in 2009-10.

In the United States, bank regulators took a conservative approach by requiring banks to follow the more stringent Basel II framework. However, Basel II standards were criticized for allowing banks to take on too much risk with too little capital, which was seen as a contributing factor to the 2008 subprime mortgage crisis.

Here is a brief overview of the Basel regulatory framework:

The Basel Committee has released several proposals and guidelines to strengthen the regulatory framework. For example, in 2014, they introduced the Supervisory Framework for Measuring and Controlling Large Exposures, and in 2016, they proposed more granular disclosures on market risk.

The Liquidity Coverage Ratio (LCR) is a crucial regulation for U.S. banks, and it's essential to understand its specific requirements.

In 2014, the Federal Reserve Board of Governors approved a U.S. version of the LCR, which has more stringent definitions of High-Quality Liquid Assets (HQLA) and total net cash outflows compared to the Basel III standard.

The U.S. rule excludes certain privately issued mortgage-backed securities from HQLA, whereas they are included under Basel III. This is a key difference to note.

Bonds and securities issued by financial institutions are also not eligible under the U.S. rule, which is a modification to the Basel III standard.

Banks with at least $250 billion in total assets or at least $10 billion in on-balance sheet foreign exposure are subject to the standard U.S. rule. Smaller banks may have different requirements.

Here's a summary of the key differences between the U.S. rule and Basel III:

Understanding these differences is essential for U.S. banks to comply with the LCR requirements.

Banks have a crucial role to play in implementing the regulatory framework. To do this, they must commit to the implementation process.

A good corporate governance framework is essential for effective board and senior management oversight, as well as robust risk management systems. This includes having a strong board that oversees the bank's operations and a senior management team that can effectively manage risk.

Banks must also have a Basel II/III implementation plan in place, including a dedicated implementation team and budgetary allocation for investment in human and technological resources. This plan should be tailored to the bank's specific needs and goals.

Here are the key components of a Basel II/III implementation plan:

Risk Management is a crucial aspect of the Basel framework. A framework for limiting large exposure to external and internal counterparties was implemented in 2018.

The Bank of England is in the process of implementing the Basel III framework on large exposures as of 2024. This will help in managing risks associated with large exposures.

The Fundamental Review of the Trading Book has led to a change in minimum capital requirements for market risk in the trading book. Minimum capital requirements are now based on a better calibrated standardised approach or internal model approval (IMA) for an expected shortfall measure rather than value at risk.

Counterparty risk is a significant concern for financial institutions. It refers to the risk of financial loss due to the failure of a counterparty to meet its obligations.

A new framework for exposures to Central Counterparties (CCPs) was introduced in 2017. This framework aims to provide a more accurate measurement of potential future exposure.

The standardised approach for counterparty credit risk (SA-CCR) replaced the Current exposure method in 2017. SA-CCR is used to measure the potential future exposure of derivative transactions.

In 2018, a framework for limiting large exposure to external and internal counterparties was implemented. This framework helps to mitigate the risk of large losses due to counterparty default.

The Bank of England is in the process of implementing the Basel III framework on large exposures in the UK, as of 2024. This framework will further strengthen the regulations on large exposures.

Interest Rate Risk in the Banking Book is a crucial aspect of risk management in the banking industry. New rules for interest rate risk in the banking book became effective in 2018.

Banks are required to calculate their exposures based on "economic value of equity" (EVE) under a set of prescribed interest rate shock scenarios. This means that banks need to assess their potential losses under different interest rate scenarios.

The EVE approach helps banks to identify and manage their interest rate risk more effectively. This is a significant change from the previous methods used by banks.

Banks must now consider a range of interest rate shock scenarios when calculating their EVE. This includes scenarios where interest rates rise or fall significantly.

The new rules aim to improve the accuracy of interest rate risk calculations and reduce the risk of bank failures. By requiring banks to use the EVE approach, regulators are promoting a more robust risk management framework.