What Basel IV Means for U.S. Banks

What Is Basel IV?

Basel IV is the informal name for a set of proposed banking reforms building on the international banking accords known as Basel I, Basel II, and Basel III. It is also referred to as Basel 3.1. It began implementation on Jan. 1, 2023, although its full adoption is expected to take until 2025 and the stages of implementation vary by country.

Basel IV is a package of banking reforms developed in response to the 2008-09 financial crisis. It is a comprehensive set of measures that will make significant changes to the way banks, including those in the U.S., calculate risk-weighted assets (RWAs).

Key Takeaways

  • Basel IV is the informal name for a set of proposed international banking reforms that began implementation on Jan. 1, 2023, and are expected to take five years to fully implement.
  • Basel IV builds on the earlier Basel Accords: Basel I, Basel II, and Basel III.
  • Basel IV grew out of the global financial crisis and changes the way risk-weighted assets are calculated.
  • The accords aim to strengthen the international banking system by standardizing rules from country to country, including those relating to risk.

Understanding the Basel Accords

Basel I, Basel II, and Basel III are international banking accords developed by the Basel Committee on Banking Supervision (BCBS), based in Basel, Switzerland. Committee members include central banks and other banking regulators from around the world. The U.S. is represented on the committee by the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp. (FDIC).

The overall objective of the Basel Accords, as they are collectively known, is to "improve supervisory understanding and the quality of banking supervision worldwide," according to the BCBS.  

The committee attempts to do that, it says, by "exchanging information on national supervisory arrangements; by improving the effectiveness of techniques for supervising international banking business; and by setting minimum supervisory standards in areas where they are considered desirable."

The standards established by the accords are voluntary. The BCBS has no enforcement powers but relies on each participating nation's regulators to implement them. Regulators can also impose more-stringent standards if they wish.

How Basel I, II, and III Work

Basel I: Known at the time 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 stability of the international banking system and to remove a source of competitive inequality arising from differences in national capital requirements."

Capital requirements refer to the amount 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 RWAs of 8%, by the end of 1992.

Basel II: In 2004, roughly a decade and a half after the first Basel accord, the committee released an update, Basel II. Basel II refined Basel I's way of calculating the minimum ratio of capital to RWAs, 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.

Basel III: After the subprime mortgage meltdown in the U.S. and worldwide financial crisis of 2007-2008 showed the risk-mitigation measures of Basels I and II to be inadequate, the committee got to work on Basel III. Begun in 2009, it was originally scheduled to begin implementation by 2015, but the deadline has been pushed back several times and started to roll out Jan. 1, 2023, although certain provisions are already in effect in some countries.

Among other changes, Basel III increased the Tier 1 capital requirement to 6% from 4%, while also requiring that banks maintain additional buffers, raising the total capital requirement to as much as 13%.

What Basel IV Will 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.

Whether it is merely the final phase of Basel III or a "Basel" in its own right, Basel IV began implementation on Jan. 1, 2023. Its principal goal, the committee says, is to "restore credibility in the calculation of RWAs and improve the comparability of banks' capital ratios."  

Toward that end, it proposes a number of changes, some highly technical. They include:

  • Improving the earlier accords' standardized approaches for credit risk, credit valuation adjustment (CVA) risk, and operational risk. These rules lay out new risk ratings for various types of assets, including bonds and real estate. Credit valuation risk refers to the pricing of derivative instruments.
  • Constraining the use of the internal model approaches used by some banks to calculate their capital requirements. Banks generally will have to follow the accords' standardized approach unless they obtain regulator approval to use an alternative. Internal models have been faulted for allowing banks to underestimate the riskiness of their portfolios and how much capital they must keep in reserve.
  • Introducing a leverage ratio buffer to further limit the leverage of global systemically important banks (banks considered so large and important that their failure could endanger the world financial system). The new leverage ratio requires them to keep additional capital in reserve.
  • Replacing the existing Basel II output floor with a more risk-sensitive floor. This provision refers to the difference between the amount of capital that a bank would be required to keep in reserve based on its internal model rather than the standardized model. The new rules would require banks by the start of 2027 to hold capital equal to at least 72.5% of the amount indicated by the standardized model, regardless of what their internal model suggests.

While Basel IV began implementation on Jan. 1, 2023, banks will have five years to fully comply. Based on recent history, it's still possible that the deadline will be extended, as well as that some provisions may be modified further before they go into effect.

What Are the Basel Accords?

The Basel Accords are a series of voluntary international banking regulations developed by the Basel Committee on Banking Supervision, which is part of the Bank for International Settlements in Basel, Switzerland.

What Is the Basel Committee on Banking Supervision?

The Basel Committee on Banking Supervision is an organization that brings together central bankers and bank regulators from around the world to discuss and formulate rules for more effective international bank supervision. It was formed in 1974 and is best known for creating the Basel Accords.

What Countries Are on the Basel Committee?

The Basel Committee's current membership comprises 45 members from 28 jurisdictions: Argentina, Australia, Belgium, Brazil, Canada, China, the European Union, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the U.K., and the U.S.

The Bottom Line

Basel IV, also known as Basel 3.1, is the latest in a series of international accords intended to bring greater standardization and stability to the worldwide banking system. It builds on the reforms begun by Basel I in 1988 that were later followed and supplemented by Basel II and Basel III.

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