Basel Committee on Banking Supervision (BCBS)
The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities established by the central bank governors of the G10 countries in 1974. The committee expanded its membership in 2009 and then again in 2014. In 2019, the BCBS had 45 members from 28 Jurisdictions, consisting of Central Banks and authorities responsible for 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 several international institutions engaged in standard-setting and financial stability, one of which is BCBS. Yet like the other committees, BCBS has its governance arrangements, reporting lines and agendas, guided by the central bank governors of the G10 countries.
The Basel Committee on Banking Supervision (BCBS) is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the regulation, supervision, and practices to enhance financial stability.
The Committee is concerned with banking regulation, but regulators in many jurisdictions, for example, the UK, also apply similar rules to non-bank financial institutions such as investment management and securities firms. In other words, many of the banking regulations covered in the following sections may also apply, albeit in a modified form, to non-banks.
There was strong recognition within the Committee of the overriding need for a multinational accord to continually strengthen the international banking system’s stability and remove a source of competitive inequality arising from differences in national capital requirements.
The Basel Accord stipulates the minimum capital ratios that banks should maintain in member countries. The minimum set of risks for which capital ratios are to be maintained are credit, market and operational risks. In other words, the greater the level of credit, market and operational risk within a firm, the more capital the firm should hold. As we will see below, other risk types are also subject to regulatory capital requirements, but these tend to be firm-specific –. In contrast, the assumption within the Basel Accord is that all firms in the financial sector are subject to credit, market, and operational risks.
In recent years, enhancements to the Accord (now known as Basel III) have introduced several concepts beyond capital ratios, including:
- a countercyclical capital buffer, which places restrictions on participation by banks in system-wide credit booms intending to reduce their losses in credit busts
- a leverage ratio – a minimum amount of loss-absorbing capital relative to all of a bank’s assets and off-balance sheet exposures regardless of risk weighting, and
- a set of liquidity requirements/ratios
The capital adequacy requirements are grouped into three pillars:
Pillar 1: Minimum regulatory capital requirements – this involves applying ‘formulaic’ methods for
calculating the regulatory capital.
In simple terms, the basic Pillar 1 capital requirement for banks can be expressed as:
——————————————————- > 8%
credit risk + market risk + operational risk
Pillar 2: Supervisory review process – this involves firms submitting information, in addition to that
contained within Pillar 1 to enable the regulator to assess the amount of capital that should be held.
Typically, this ‘extra’ information would be concerned with:
- risks not covered under Pillar 1
- the way that risk is managed
- the quality of the control infrastructure
- how the calculated risk profile relates to the strategic and financial plans of the firm.
Pillar 3: Market discipline – firms are required to publish information about the way they manage the
risks they face
Basel IV is the informal name for proposed banking reforms building on Basel I, Basel II, and Basel III. It is also referred to as Basel 3.1. It is scheduled to begin implementation on Jan. 1, 2023.
How Basel I, II, and III Work
Basel I. Known as the Basel Capital Accord, Basel I was issued in 1988. Its purpose was to address what the central bankers perceived as a need for a “multinational accord to strengthen the international banking system’s stability and remove a source of competitive inequality arising from differences in national capital requirements.”3 Capital requirements refer to the number of liquid assets a bank must keep on hand to meet its potential obligations. Basel I called for banks to maintain a minimum ratio of capital to risk-weighted assets of 8% by the end of 1992.4
Basel II. In 2004, roughly a decade and a half after the first Basel accord, the committee released an update – Basel II.4 Basel II refined Basel I’s way of calculating the minimum ratio of capital to risk-weighted assets, dividing bank assets into tiers based on liquidity and risk level, with Tier 1 capital being the highest quality. Under Basel II, banks still had to maintain a reserve of 8%, but at least half of that (4%) now had to be Tier 1 capital.5
Basel III. After the subprime mortgage meltdown and worldwide financial crisis of 2007-2008 showed the risk-mitigation measures of Basel I and II to be inadequate, the committee got to work on Basel III. Begun in 2009, it was initially scheduled to begin implementation by 2015. Still, the deadline has been pushed back several times and is currently Jan. 1, 2023, although specific provisions are already in effect in some countries. Among other changes, Basel III increased the Tier 1 capital requirement from 4% to 6% while also requiring that banks maintain additional buffers, raising the total capital requirement to as much as 13%.6
What Would Basel IV Do?
As Basel III awaited its final implementation deadline, the BCBS continued to tweak its provisions. In parts of the financial community, those proposals have come to be known by the unofficial name of Basel IV. However, William Coen, then-secretary general of the Basel Committee, said in a 2016 speech that he didn’t believe the changes were substantial enough to merit their own Roman numeral.7
Whether it is merely the final phase of Basel III or a “Basel” in its own right, Basel IV is also set to begin implementation on Jan. 1, 2023. 8 Its principal goal, the committee says, is to “restore credibility in the calculation of risk-weighted assets (RWAs) and improve the comparability of banks’ capital ratios.”