Abstract
PurposeIntroducing radical changes to the methodologies for the determination of capital requirements, the final stage of the Basel III standards, which is referred to as “Basel IV” by the industry, will be a significant challenge for the global banking sector. This article reviews the main components of the new framework, analyses its ongoing implementation in the European Union and discusses its potential impact on banks, putting forward policy recommendations.Design/methodology/approachThis article uses primary sources such as the publications by the Basel Committee for Banking Supervision and the European Commission. It also reviews the secondary sources, including both academic articles and analyses by various stakeholders. However, this article does not undertake any empirical analysis.FindingsThis article discusses that Basel IV will introduce strategic, operational and regulatory challenges for banks in scope. It also identifies a number of areas which are subject to further debate in the European Union such as the enhanced due diligence requirements under the new credit risk framework; governance, reporting and control rules under the operational risk framework; exemptions for certain derivative transactions under the credit valuation adjustment framework and the level of application of the capital floors within banking groups. This article concludes that the global implementation of the reforms by all jurisdictions and transposition into national banking laws concurrently with the European Union in line with the Basel Committee's implementation timeline is important from a financial stability standpoint.Originality/valueThe article presents an up-to-date and comprehensive review of the practical implications of Basel IV standards. It analyses the implementation of the standards in the case of the European Union, reviews the potential policy implications and presents recommendations for risk management practitioners.
Highlights
In response to the global financial crisis, the Basel Committee for Banking Supervision (BCBS) introduced Basel III standards to address shortcomings of the pre-crisis regulatory framework
In the case of the latter, respective risk weight buckets have become more granular based on the loan-to-value ratios (LTV) ratio and depending on whether the exposure is to income-producing real estate (IPRE) or general residential real estate
Conclusion and policy implications This article has reviewed the Basel IV standards which complement Basel III reforms by improving the robustness and risk sensitivity of the standardised approaches (SA) approaches for credit risk, credit valuation adjustment (CVA) risk and operational risk; removing the use of the internal modelling approaches for CVA risk and for operational risk; placing parameter input floors under the internal ratings-based (IRB) approach for credit risk; imposing a leverage ratio buffer on Global Systemically Important Banks (G-SIBs) and introducing a capital floor based on the revised SA approaches
Summary
Legislative progress towards the implementation of Basel IV across different jurisdictions is moving slower than anticipated, with the European Union (EU) being an exception where those standards are being implemented through the revised Capital Requirements Regulation (CRR 2) and Directive (CRD 5) [3] This is partially driven by the European Banking Authority’s (EBA) reports, recommending the full implementation of the final Basel III framework in the EU in response to the European Commission’s (EC) call for technical advice in May 2018 (EBA, 2019b). This article makes three main contributions to the literature on financial regulations: firstly, it provides a comprehensive and up-to-date review of theoretical and practical implications of Basel IV in the context of banking risk management principles It undertakes an in-depth examination of the implementation of Basel IV in the case of the EU. The last section will highlight the conclusions and policy implications that emerge from this article
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