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The long ‘journey’ of banks from Basel I to Basel IV: has the banking system become more sound and resilient than it used to be?

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Abstract

The amount of capital that banks have to hold has been raised over time due to the adoption of the increasingly demanding standards issued by the Basel Committee on Banking Supervision. Accordingly, in December 2017, the so-called Basel IV standards have been published with the final aim of further increasing the capital of banking institutions. Despite the criticisms, capital requirements are an effective tool to enhance the soundness of banks and in turn to help maintain financial stability. Nevertheless, the need still arises to make the legal framework increasingly less ‘one-size-fits-all-driven’, more conscious of the subjective differences among market participants and thereby more efficient.

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Notes

  1. Additionally, capital is also a means to fund the on-going operations of a firm.

  2. Lastra, R.: International Financial and Monetary Law, 2nd Edn., p. 113. Oxford University Press, Oxford, (2015) [25].

  3. Walker, G.: Banks and Banking. In: Walker, G., Purves, R.: Financial Services Law, 4th Edn., p. 720. Oxford University Press, Oxford, (2018) [36].

  4. See Cranston, R., Avgouleas, E., Van Zwieten, K., Hare, C., Van Sante, T.: Principles of Banking Law, 3rd Edn., p. 28. Oxford University Press, Oxford, (2017), [21], underlining that this arises from the fact that common equity is perpetual and irredeemable and ranks last in the event of insolvency.

  5. See Bodellini, M.: From Systemic Risk to Financial Scandals: the Shortcomings of US Regulation on Hedge Funds. Brooklyn Journal of Corporate, Financial & Commercial Law, 11, 443 (2017) [13].

  6. See Cranston, R., Avgouleas, E., Van Zwieten, K., Hare, C., Van Sante, T.: Principles of Banking Law, 3rd Edn., Oxford University Press, Oxford, (2017), 28 [21], underlining that ‘the risk of individual institution failure and of a systemic collapse is mostly addressed through prudential regulation in the guise of capital and liquidity requirements …’.

  7. See Bodellini, M.: To Bail-in, or To Bail-out, That Is the Question. European Business Organization Law Review, 19, 371 (2018) [16]; Bodellini, M.: Greek and Italian ‘Lessons’ on Bank Restructuring: Is Precautionary Recapitalisation the Way Forward?. Cambridge Yearbook of European Legal Studies, 19, 149 (2017) [14]; Brierley, P.: Ending Too-Big-To-Fail: Progress Since the Crisis, the Importance of Loss-Absorbing Capacity and the UK Approach to Resolution. European Business Organization Law Review, 18, 457 (2017) [17].

  8. Since January 2013 it has its own ‘charter’ available at http://www.bis.org/bcbs/charter.htm. As stated in the Charter, the internal organisational structure of the BCBS comprises: (a) The Committee; (b) Groups, working groups and task forces; (c) the Chairman; (d) The Secretariat. The Committee’s Secretariat is provided by the Bank for International Settlements (BIS) in Basel.

  9. See Lastra, R., Bodellini, M.: Soft Law and Sovereign Debt. Intergovernmental Group of Experts on Financing for Development. United Nations, (2018), 7 [26].

  10. See Jones, E., Zeitz, A.: The Limits of Globalizing Basel Banking Standards. Journal of Financial Regulation, 3, 89 (2017) [24].

  11. Basel Committee on Banking Supervision, International Convergence of Capital Measurement and Capital Standards, (1988). Available at www.bis.org [6].

  12. See Cranston, R., Avgouleas, E., Van Zwieten, K., Hare, C., Van Sante, T.: Principles of Banking Law, 3rd Edn., p. 28. Oxford University Press, Oxford, (2017), [21], underlining that typically capital is considered more expensive than debt.

  13. See Bank for International Settlements: History of the Basel Committee. Available at https://www.bis.org/bcbs/histiry.htm [3]; see also Shakdwippe, P., Mehta, M.: From Basel I to Basel II to Basel III. International J. New Tech. & Res., 3, 66 (2017) [33]; Balthazar, L.: From Basel 1 to Basel 3: The Integration of State of Art Risk Modelling in Banking Regulation, Palgrave Macmillan, New York, (2006) [2].

  14. On the risk weight attributed to Government debt in the Basel framework and on its consequences see Gleeson, S.: Bank Capital Regulation and Sovereign Debt restructuring. Capital Markets Law Journal, 13, 467 (2018) [22].

  15. Basel Committee on Banking Supervision, Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework, (2006) [7]. Available at www.bis.org.

  16. See Walker, G.: Basel III Market and Regulatory Compromise. Journal of Banking Regulation, 12, 95 (2011) [35].

  17. Cornford, A.: Basel II: The Revised Framework of 2004, United Nations Conference on Trade and Development (UNCTD). Discussion Paper No. 178, (2005) [20]; Belratti, A., Paladino, G.: Basel and Regulatory Arbitrage. Evidence from Financial Crises. J. Empirical Fin., 39, 180 (2016) [11].

  18. Greenspan, A.: Speech Given at the Federal Reserve of Chicago Bank Structure Conferences. 7 May 2010. Available at www.chicagofed.org [23].

  19. Avgouleas, E., Governance of Global Financial Markets: The Law, the Economics, the Politics. Cambridge University Press, Cambridge (2012) [1].

  20. See Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?, 39, Business Law Review, 176 (2018) [37].

  21. Basel Committee on Banking Supervision: Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems, (2011). Available at www.bis.org [8].

  22. Barr, M., Jackson, H., Tahyar, M.: Financial Regulation: Law and Policy. Foundation Press, Eagan, (2016) [5]; Cannata, F., Quagliariello, M.: Basel III and Beyond: A Guide to Banking Regulation After the Crisis. Risk Books, London, (2011) [18].

  23. See Walker, G.: Basel III Market and Regulatory Compromise. Journal of Banking Regulation, 12, 95 (2011) [35], underlining that ‘The final arrangements are more remarkable in terms of their balance and moderation rather than for the time that they took to agree’.

  24. Id., underlining that ‘Banks operating between 4.5 and 7 per cent will be subject to restrictions on dividend and bonus payments to protect capital from short-term dilution’.

  25. See Miles, D., Yang, J., Marcheggiano, G.: Optimal Bank Capital. Bank of England. External MPC Unit. Discussion Paper No. 31, (2011) [29], arguing that the amount of capital to hold should be 20% of unweighted assets.

  26. See Gleeson, S.: Bank Capital Regulation and Sovereign Debt restructuring. Capital Markets Law Journal, 13, 470 (2018) [22].

  27. About this specific issue see Bodellini, M.: Corporate Governance of Banks and Financial Stability: Critical Issues and Challenges Ahead. Business Law Review, 39, 162 (2018) [15].

  28. Basel Committee on Banking Supervision: Finalising Post-Crisis Reforms, (2017). Available at www.bis.org [9].

  29. Id.

  30. See Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?. 39, Business Law Review, 181 (2018) [37].

  31. Magnus, M., Margerit, A., Mesnard, B., Korpas, A.: Upgrading the Basel Standards: From Basel III to Basel IV?. Economic Governance Support Unit, European Parliament Briefing Paper PE 587.361 (2017). Available at https://www.europari.europa.eu/RegData/etudes/.../IPOL_BRI%282016%29587361_EN.pdf [27].

  32. Basel Committee on Banking Supervision: High Level Summary of Basel III Reforms, (2017). Available at www.bis.org [10].

  33. Basel Committee on Banking Supervision: Finalising Post-Crisis Reforms, (2017). Available at www.bis.org [9].

  34. Id.

  35. Basel Committee on Banking Supervision: High Level Summary of Basel III Reforms, (2017). Available at www.bis.org [10].

  36. See Sands, P., Liao, G., Ma, Y.: Rethinking Operational Risk Capital Requirements. Journal of Financial Regulation, 4, 20 (2018) [31].

  37. Basel Committee on Banking Supervision: Finalising Post-Crisis Reforms, (2017). Available at www.bis.org [9].

  38. Basel Committee on Banking Supervision: High Level Summary of Basel III Reforms, (2017). Available at www.bis.org [10].

  39. See Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?. 39, Business Law Review, 176 (2018) [37].

  40. Basel Committee on Banking Supervision: High Level Summary of Basel III Reforms, (2017). Available at www.bis.org [10].

  41. Bank for International Settlements: Governors and Heads of Supervision Finalise Basel III Reforms. (2017). Available at https://www.bis.org/press/p171207.htm [4].

  42. Basel Committee on Banking Supervision: High Level Summary of Basel III Reforms, (2017). Available at www.bis.org [10].

  43. Id., stating that ‘a G-SIB subject to a 2% risk-weighted higher-loss absorbency requirement would be subject to a 1% leverage ratio buffer requirement’.

  44. Id.

  45. See accordingly Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?. 39, Business Law Review, 177 (2018) [37].

  46. Basel Committee on Banking Supervision: High Level Summary of Basel III Reforms, (2017). Available at www.bis.org [10].

  47. Basel Committee on Banking Supervision: Finalising Post-Crisis Reforms, (2017). Available at www.bis.org [9].

  48. Id.

  49. See Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?. 39, Business Law Review, 181 (2018) [37].

  50. Basel Committee on Banking Supervision: Finalising Post-Crisis Reforms, (2017). Available at www.bis.org [9].

  51. Id.

  52. With regard to such output floor, a phase-in period has been agreed as follows: 1 January 2022: 50%; 1 January 2023: 55%; 1 January 2024: 60%; 1 January 2025: 65%; 1 January 2026: 70%; 1 January 2027: 72.5%; see Basel Committee on Banking Supervision: Finalising Post-Crisis Reforms, (2017). Available at www.bis.org [9].

  53. See McHenry, P.: Letter sent to the Chair of the Board of Governors of the Federal Reserve System, 31 January 2017. Available at www.ftalphaville-cdn.ft.com [28].

  54. VÖB, DekaBank, DZ BANK, BayernLB, Helaba, LBB, LBBW, NORD/LB, ApoBank: The Consequence of ‘Basel IV’—A Quantitative Impact Study. 25 May 2018 [34].

  55. Id.

  56. Id.

  57. Id.

  58. PricewaterhouseCoopers: ‘Basel IV’: Big Bang—or the Endgame of Basel III? BCBS finalises on Risk Weighted Assets (RWA). December 2017 [30]; see also Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?. 39, Business Law Review, 181 (2018) [37], underlining that ‘research findings suggest, if banks do nothing to mitigate their impact, the reform measures would require about EUR 120 billion in additional capital, while reducing the banking sector’ s return on equity by 0.6% points’; see Schneider, S., Schiock, G., Koch, S., Schneider, R.: Basel ‘IV’: What’s Next for Banks?: Implications of Intermediate Results of New Regulatory Rules for European Banks. McKinsey Global Risk Practice Paper. (2017) [32].

  59. See Miles, D., Yang, J., Marcheggiano, G.: Optimal Bank Capital. Bank of England. External MPC Unit. Discussion Paper No. 31, (2011) [29], arguing for un-weighted capital ratios of up to 20%. This is mainly based on the assumption that the higher the capital, the lower the risk of needing a public bail-out to rescue the bank in question.

  60. See Yeoh, P.: Basel IV: International Bank Capital Regulation Solution or the Beginning of a Solution?. 39, Business Law Review, 181 (2018) [37].

  61. See Bodellini, M.: Attività Bancaria e Impresa Cooperativa, Cacucci Editore, Bari, (2017) [12].

  62. Accordingly see Carney, M.: To G20 Leaders, Financial Stability Board (FSB) Chairman’s Memo to G20 Leaders. (2017). Available at https://www.fsb.org/wp-content/uploads/P030717-1.pdf [19], underlining that the largest banks are now required to have ten times more of the highest quality capital than before the crisis and are subject to greater market discipline as a result of globally agreed standards to resolve TBTF entities.

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  1. Queen Mary University of London, London, UK

    Marco Bodellini

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This paper was presented at the ‘Annual Conference on Financial Supervision in the EU 2018’ organised by the Academy of European Law in Brussels on 6 and 7 December 2018.

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Bodellini, M. The long ‘journey’ of banks from Basel I to Basel IV: has the banking system become more sound and resilient than it used to be?. ERA Forum 20, 81–97 (2019). https://doi.org/10.1007/s12027-019-00557-x

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