The development of Basel Accords, its European translation, and future directions

Development of the Basel Accords

The development of the Basel Accords can be traced back to the 1980s when banks began to use sophisticated risk management techniques and capital measurement methodologies to assess their financial risks. In response to this, the BCBS developed Basel I, in 1988. This accord set out a framework for banks and introduced regulatory capital requirements to cover risks. This included the risk weighted asset framework and the 8% regulatory capital rule. .

In 2004, the BCBS released a revised version of the Basel Accord, known as Basel II, which introduced more risk-sensitive capital requirements and enhanced disclosure and supervisory standards. With this the three-pillar framework and in general more model options for the three main risk categories (credit, market, and operational risk) were introduced. Basel II was implemented in Europe through the Capital Requirements Directive (CRD), which was adopted by the European Union in 2006 and implemented in 2008.

In the wake of the global financial crisis in 2008, the BCBS began work on a new framework, known as Basel III, to strengthen the regulation, supervision, and risk management of banks. Basel III for instance introduced higher capital and liquidity requirements, leverage ratio rules, and new standards for systemically important banks. Basel III was transposed into European law through the Capital Requirements Regulation (CRR) and the CRD IV, which were adopted by the European Union in 2013 and implemented in 2014. Through updates in the European banking framework different iterations of the CRD were introduced.

Translation of Basel into European Law

The Basel Accords are not binding laws for banks or national authorities but rather serve as a framework for the development of national regulations and standards. In Europe, the Basel Accords have been translated into European law through the CRD and the CRR, which set the regulatory requirements that banks must comply with.

The CRR is directly applicable in all EU member states, where as the CRD needs to be translated into national laws. The regulations are enforced by competent national authorities, which are responsible for supervising and monitoring the compliance of banks with the regulatory requirements.

And what about the Basel IV you might have heard of? 

Basel IV is not a new version of the Basel Accords but rather a term used to refer to the ongoing updates and revisions to the Basel III framework. The BCBS has continued to review and revise the Basel III framework since its adoption in 2010, and these ongoing updates are commonly referred to as Basel IV or Basel III finalization.

Some of the key updates and revisions under Basel IV include the following:

• A revised standardized approach for credit risk: The BCBS proposed to introduce risk-sensitive capital requirements for low-default portfolios.
• Output floor: The BCBS introduced an output floor, which will limit the extent to which banks can use internal models to calculate their capital requirements. The floor should ensure that banks do not reduce their capital requirements through advanced modelling approaches.
• Revised operational risk framework: The BCBS proposed revisions, which would replace the current standardized operational risk approach with a new standardized one.

The implementation of these updates and revisions under Basel IV is expected to have a significant impact on banks and the regulatory environment. In Europe, the European Commission recently published its legislative package, with an application date of 1 January 2025. However, it is essential to note that the updates are still being developed, and although there are some fixed dates, their final form and timing of implementation can vary.

What is the future of Basel?

The future of Basel is likely to involve continued updates and revisions to the regulatory framework for banks, as well as ongoing efforts to strengthen the resilience and stability of the global financial system. Some of the key trends and developments that are likely to shape the future of Basel include:

• Climate change and sustainability: There is growing recognition of the need to incorporate environmental, social, and governance (ESG) considerations into banking regulation and supervision. The BCBS has established a task force to explore the implications of climate change for banking supervision and is expected to release further guidance on climate risk management in the coming years.
• Digital transformation: The rapid pace of technological innovation is transforming the financial industry and is likely to have significant implications for banking regulation and supervision. The BCBS has established a working group to explore the regulatory and supervisory implications of fintech and other digital innovations.
• International cooperation and coordination: The global nature of the financial system means that effective regulation and supervision require international cooperation and coordination. The BCBS is expected to continue to work closely with national regulators and other international organizations to develop a common framework for banking regulation and supervision.
• Ongoing updates to the Basel framework: As noted earlier, the ongoing updates and revisions to the Basel framework are likely to continue in the coming years. These updates will likely address emerging risks and vulnerabilities in the financial system and may incorporate new developments in risk management and supervision.