The document outlines the Basel Committee's finalization of the Basel III framework, aimed at enhancing the resilience of the banking system following the global financial crisis. It seeks to reduce excessive variability in risk-weighted assets (RWAs) and improve the transparency of banks' capital ratios. The proposed revisions aim to strengthen the robustness of standardized approaches for credit risk and…
Subject: Finalization of the Basel III Framework
Author: Basel Committee on Banking Supervision
Date: December 2017
Scope: Post-crisis reforms of the banking regulatory framework, including credit risk, operational risk, CVA risk, leverage ratio and output floor for risk-weighted assets (RWA).
Target population: international banks and regulators
Sector: banking sector
Period covered: phased implementation from 2018 to 2027
The document covers approximately the first 52 pages of the finalized standard, incorporating major revisions of standardized and internal approaches for credit risk.
- This document finalizes the Basel III framework, complementing the initial reforms adopted after the 2007-2009 global financial crisis (p. 5).
- The main objective is to address the loss of confidence among stakeholders in risk-weighted capital ratios (RWA) by reducing excessive variability of these risk-weighted assets (p. 5).
- The framework aims to strengthen the resilience of the banking system so it can support the real economy and foster sustainable economic growth (p. 5).
- Key revisions include:
- Enhancing the robustness and risk sensitivity of standardized approaches for credit and operational risk (p. 5).
- Limiting the use of internal modeling approaches, with jurisdictions allowed to rely solely on standardized approaches while remaining compliant (p. 5).
- Introducing a progressive output floor, ensuring that RWA calculated by internal models cannot be lower than a rising percentage (50% in 2022 to 72.5% in 2027) of RWA calculated under the standardized approach (p. 6).
- Finalizing the leverage ratio, with a revised exposure definition and a specific buffer for global systemically important banks (G-SIB) from 2022 (p. 6).
- Updating minimum capital requirements for CVA (Credit Valuation Adjustment) and operational risk (p. 6).
- The Committee conducted broad stakeholder consultation and rigorous macroeconomic impact analysis, ensuring no significant increase in overall capital requirements (p. 5).
- Recommendations include adopting the new standards according to a precise timetable, with main application dates from January 1, 2022 for most revisions, and a transitional phase until 2027 for the output floor (p. 6).
- Jurisdictions may impose more conservative requirements or accelerate implementation as needed; Basel III constitutes a minimum standard (p. 5).
- This document was developed to finalize Basel III regulatory reforms in response to weaknesses revealed by the global financial crisis (p. 5).
- The central issue is the loss of confidence among market participants, analysts and academics in banks' published risk-weighted capital ratios due to excessive variability in RWA calculation (p. 5).
- The pre-crisis framework showed shortcomings in simplicity, comparability and risk sensitivity, motivating a thorough revision (p. 5).
- Challenges include restoring credibility of RWA calculations, ensuring transparency and comparability of capital ratios, and guaranteeing banking system resilience to support the real economy (p. 5).
- Specific objectives are:
- Reduce excessive RWA variability.
- Strengthen robustness and risk sensitivity of standardized approaches.
- Limit use of internal models while allowing supervised use.
- Introduce an output floor to limit the gap between internal models and standardized approaches.
- Finalize the leverage ratio and strengthen requirements for operational and CVA risks (p. 5).
- The scope covers credit, operational, CVA risks, leverage ratio and output floor, with phased implementation between 2018 and 2027 (p. 6).
- Document limitations concern partial coverage of chapters (only first 52 pages provided), notably on internal approaches and some technical details (p. 3).
Standardized Approach for Credit Risk:
- Banks may choose between the standardized approach and the internal ratings-based (IRB) approach to calculate capital requirements for credit risk (p. 7).
- The standardized approach assigns fixed risk weights to different exposure classes, potentially relying on recognized external ratings (ECAI) where jurisdiction permits (p. 7).
- Exposures must be weighted net of specific provisions, including partial write-offs (p. 7).
- Exposures are classified into categories: sovereigns, non-central public sector entities, banks, corporates, SMEs, specialized exposures, residential and commercial real estate, securitizations, etc. (p. 7-27).
- For each category, precise weighting tables are defined according to external rating, credit quality, asset type, loan-to-value ratio (LTV), and other criteria (p. 8-27).
- Examples:
- Sovereign exposures weighted from 0% to 150% depending on rating (p. 8).
- Bank exposures weighted according to a hierarchy between external rating approach (ECRA) and standardized approach (SCRA) with three grades (A, B, C) and associated weights (p. 11-14).
- Corporate exposures weighted from 20% to 150% depending on external rating or 100% if unrated, with specific treatment for SMEs (p. 16-17).
- Specialized exposures (project finance, objects, commodities) weighted from 80% to 130% depending on phase and quality (p. 18).
- Residential real estate exposures weighted according to LTV, with thresholds ranging from 20% to 70% (p. 24-26).
- Commercial real estate exposures weighted according to LTV, with thresholds from 60% to 110% (p. 26-27).
- Due diligence requirements are imposed to ensure quality of risk assessment and correct application of risk weights (p. 8).
- A multiplier of 1.5 is applied to uncovered exposures with currency mismatch between loan currency and client income currency, capped at 150% (p. 28).
Capital Requirements for Operational Risk and CVA Risk:
- The framework introduces specific minimum requirements for CVA risk, related to changes in derivative values upon counterparty default (p. 6).
- Operational risk is also revised to enhance risk sensitivity and robustness of calculations (p. 6).
Output Floor:
- A floor is introduced to limit divergence between RWA calculated by internal models and those from the standardized approach (p. 6).
- This floor starts at 50% in 2022 and increases progressively each year to reach 72.5% in 2027 (p. 6).
Leverage Ratio:
- The leverage ratio is finalized with a revised exposure definition (based on the January 2014 definition and revised in 2022) (p. 6).
- A specific buffer is provided for global systemically important banks (G-SIB) from 2022 (p. 6).
Implementation Timeline:
- Standardized revisions for credit risk, CVA, operational risk: January 1, 2022 (p. 6).
- IRB approach revisions: January 1, 2023 (p. 6).
- Leverage ratio: existing definition since 2018, revised definition from 2022 (p. 6).
- Output floor: phased implementation from 2022 to 2027 (p. 6).
General Provisions:
- Jurisdictions may choose to apply only standardized approaches and remain compliant (p. 5).
- Stricter requirements or accelerated transition modalities may be adopted nationally (p. 5).
- The framework aims for a balance between simplicity, comparability and risk sensitivity (p. 5).
- Banks must implement internal policies, systems and controls to ensure correct application of risk weights and quality of risk analyses (p. 8).
- Findings:
- Excessive variability of risk-weighted assets (RWA) was observed, affecting confidence in banks' capital ratios (p. 5).
- Current standardized approaches lacked robustness and risk sensitivity, while internal models could be used too broadly and heterogeneously (p. 5).
- Exposures are now classified and weighted with precise criteria, notably by exposure type, external rating, loan-to-value ratio, and other characteristics (p. 7-28).
- Assumptions:
- Revisions are calibrated not to significantly increase overall capital requirements, according to rigorous macroeconomic impact analysis (p. 5).
- RWA variability will be reduced through improved standardized approaches and limiting internal models (p. 5).
- Interpretations:
- The introduction of the output floor guarantees a minimum capital based on the standardized approach, enhancing comparability (p. 6).
- The leverage ratio complements the risk-weighted ratio by providing an unweighted leverage measure (p. 6).
- Due diligence and internal controls are essential to ensure calculation quality and transparency (p. 8).
- Uncertainties:
- The real impact of revisions on banking system stability and the economy will be continuously monitored and assessed (p. 5).
- Effective implementation will depend on jurisdictions' and banks' capacity to apply new rules within deadlines (p. 6).
- The Committee recommends phased implementation according to the following schedule:
- January 1, 2022: entry into force of revisions to the standardized approach for credit risk, CVA framework, operational risk, and start of output floor at 50% (p. 6).
- January 1, 2023: application of IRB approach revisions and increase of output floor to 55% (p. 6).
- Annual progression of output floor up to 72.5% in 2027 (p. 6).
- Leverage ratio with revised definition applicable from 2022, and G-SIB buffer also from this date (p. 6).
- Banks must comply with new requirements, notably regarding RWA calculation, due diligence, and data transparency (p. 8).
- National authorities have latitude to adopt stricter requirements or accelerated transition modalities, depending on local specifics (p. 5).
- The Committee will continue monitoring and evaluating reform effectiveness, notably regarding RWA variability and financial stability (p. 5).
- The finalized framework constitutes an international minimum standard, aiming to strengthen banking sector resilience while supporting the real economy (p. 5).
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