Basel III: international regulatory framework for banks

What is Basel III?

The Basel accords refer to a series of three sequential international banking regulation agreements (Basel I, II and III) set by the Basel committee on bank supervision (BCBS).

The BCBS has drawn up standards to ensure that banks and other credit institutions maintain enough capital and liquidity to meet their obligations and absorb unexpected losses.

The latest accord, Basel III, was agreed at international level to address the fall-out from the global financial crisis of 2007–2008.

To allow time for banks to adjust to the new standards and for jurisdictions to implement them in their legal frameworks, Basel III has been phased in over a number of years, and large parts of the accord are now in force in the EU. 

On 30 May 2024, the Council adopted new rules that draw to a close the implementation of the international Basel III agreements into EU law. In practice, the new rules amend the capital requirements regulation and the capital requirements directive.

• Basel III reforms: new EU rules to increase banks’ resilience to economic shocks (press release, 30 May 2024)
• The Basel committee (bank of international settlements)

The completion of Basel III in a nutshell

The Basel framework requires banks to meet risk-based capital ratios, with a focus on a bank’s risk-weighted assets (RWAs). Banks need to hold a certain amount of regulatory capital against their RWAs:

The final elements of Basel III now being implemented are:

• changes to the standardised approach to determining RWAs: using parameters that are clearly defined and calibrated in the capital rules
• changes to the internal ratings-based (IRB) approach, allowing banks themselves to estimate the parameters used in the calculation of RWAs (namely the introduction of input floors on the parameters of the IRB approach)
• the option to use the IRB approach has been removed for certain types of exposures
• the output floor (measure that sets a lower limit (floor) on the RWAs (output)), calculated by the banks using their internal models, is set at 72.5% of the standardised approach 
• a new operational risk framework: refers to the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events

What else has been agreed?

In addition to implementing the final part of the Basel III accord, other amendments to regulation 575/2013 (the CRR) and to directive 2013/36/EU (the CRD) have been agreed to:

How does the EU ensure banking stability and pragmatism?

The EU seeks to balance regulation and innovation and, at the same time, deal with new disruptive factors, such as the climate crisis and cryptocurrencies.

Regulating without suffocating

There is a need to implement global standards while ensuring that the specific features of the EU banking system are respected. Regulation and innovation need to coexist to avoid stifling the banking sector. 

To achieve this, the EU is phasing in a number of exemptions to the Basel III output floor requirement. These exemptions focus on, among others:

• the treatment of certain ‘low risk’ immovable property loans
• loans to unrated corporates
• object financing

The EU has also decided to ensure that the output floor is applied at the individual entity level. Capital must be held at all levels of a group (parent company and subsidiaries alike), rather than only at the parent level (group application).

This protects member states hosting foreign operations through subsidiaries of banking groups as, in this way, subsidiaries need not rely on support from their parent bank to weather a crisis. 

Overview of the banking sector

In 2020, there were 5 441 banks in the EU. The member state with the largest number of banks was Germany (28% of the EU total), followed by Poland (11%), Austria and Italy (both 9%), this means that over half of all EU banks were located in these four member states.

Managing cross-border banking: third-country branches

The EU has also agreed on  a minimum-harmonising framework for the authorisation and supervision of branches established in member states by banks incorporated in third countries (third-country branches). 

This common EU framework requires a delicate balancing act between the necessary authorisation requirements and the importance of the EU’s integration in global markets, financing sources and banking products for EU citizens and firms. 

The framework includes: 

• strict but proportionate licensing and supervisory requirements
• limited exemptions for certain types of firms and transactions
• a sufficiently long transitional period for the industry to adjust to the new framework and for the continuation of existing contractual relationships

Mitigating against uncharted risks 

The EU takes into consideration global emerging challenges, such as climate-related financial risks, cyber risks, and operational resilience. Important aspects of the agreement concern environmental and crypto risks.

Banks have a key role in mitigating climate change. The EU requires banks to integrate environmental, social and governance (ESG) risks into their governance structures, risk management frameworks and strategic planning processes. This involves identifying, assessing, monitoring, and managing ESG risks as part of overall risk management practices.

Banks are encouraged to consider the impact of their lending and investment activities on environmental and social factors, as well as governance issues. Furthermore, banks will be required to:

• take account of the EU’s aim to reach carbon neutrality by 2050 objective and the relevant agreed EU sustainability goals when conducting internal risk management and compliance tasks
• have a lower risk weight for exposure to the EU emissions trading system (40%) to fight climate change and to support the role of banks in financing the green transition

In parallel, to safeguard against potential cryptocurrency instability, capital charges for banks’ investments in crypto-assets have been introduced. Aligned with the EU’s markets in crypto assets regulation (MiCA) these charges will operate on a transitional basis until the international standards on the prudential treatment of crypto-assets – currently being finalised under Basel – are to be implemented in the EU.

Crypto-assets (infographic)

Crypto-assets (infographic)

Transparency of banking leaders

The agreement also includes provisions to avoid unsuitable persons being appointed to banks’ management boards, while also promoting diversity and gender balance.

Large banking entities will need to share information with their supervisor on the suitability assessment of candidates for their board’s executive member and chair positions at least 30 days before the appointee takes up the position.

Where members of the management body do not meet suitability requirements, member states must ensure that the competent authorities have the necessary powers to prevent their appointment or to remove such members from the management body.

What are the advantages for EU citizens ?