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 is scheduled to begin implementation on Jan. 1, 2023.
- Basel IV is the informal name for a set of proposed international banking reforms, scheduled to go into effect on Jan. 1, 2022, and is expected to take five years to fully implement.
- Basel IV builds on the earlier Basel Accords: Basel I, Basel II, and Basel III.
- 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 United States is currently represented 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 Corporation.
The overall objective of the Basel Accords, as they are collectively known, is to "improve supervisory understanding and the quality of banking supervision worldwide," the BCBS says.
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 in order to meet its potential obligations. Basel I called for banks to maintain a minimum ratio of capital to risk-weighted assets (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 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 is currently Jan. 1, 2023, although certain 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%.
What Basel IV Would 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 is also set to begin implementation on Jan. 1, 2022. 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 will generally 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 as opposed to the standardized model. The new rules would require banks 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 is set to begin implementation on Jan. 1, 2023, banks will have five years to fully comply. Based on recent history, it is still possible that the deadline will be extended, as well as that some provisions may be further modified 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 consists of 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 United Kingdom, and the United States.
The Bottom Line
Basel IV 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 and followed up by Basel II and Basel III.