Basel Frameworks

The principles included in the documents issued by the Basel Committee (composed by the governors of national central banks) and that, for various reasons, are assimilated under the concept of ‘Basel Frameworks’ refer to principles for a sound and prudent management of the whole financial system.

A sound and prudent management, or rather the relavant operational principles, evolved over time, both due to the changes of finacial scenarios and in relation to the need of a refinement of the techniques used to identify and monitor corporate data (data governance).

The Basel Committee does not have any regulatory power relating to specific national regulations (or in case of European countries, at an EU level) but – considering the different issues addressed and the high-specialised input offered – over the years, Member States have implemented these regulations in ther national or Comminity Law (such as in the EU).

The first agreement, called Basel I, dated 1988, established that for each loan operation, banks or investment firms were required to set aside a certain percentage of the amount granted, to safeguard in case of default of the borrower.

In 2004, a second agreement was issued, called Basel II, with the aim of specifying and providing further details on specific issues and also introducing new ones, which were not included in the first one. These provisions were based on three pillars.

• First Pillar – Minimum capital requirements
• Second Pillar – Supervisory review process
• Third Pillar – Disclosure requirements

 

Crisis of 2008 and Basel III

With the onset of the financil crisis of 2007-2009, regulators had to deal with an unprecedented situation. Some financial intermedieries were too big and their financial leverage level too high. The framework introduced with the previous regulations was subject to strong critics and discussions, mainly due to its inappropriatness to ensure stability and its inability to address a system-wide financial crisis.

In this context, authorities implemented a set of reviews of the framework, based on stricter principles, which led to the publication of Basel III agreement, in 2014.

 

Key principles of Basel III

The main issues addressed by the regulatos were: adequate capitalisation, prudent liquidity and risk management and improved transparency of information.

 

1. ADEQUATE CAPITALISATION

The Capital Requirement Regulation (CRR) and Capital requirement Directive (CRD IV) establish that banks and investment firms must have sufficient capital to address unexpected losses (own funds requirement). This requirement is expressed as a percentage of risk-weighted assets, which means that the higher the risk of an asset is, the higher the amount of capital allocated will be. Regulators did not change the percentage of ‘regulatory capital’, i.e. the total capital needed to ensure stability, which is still equal to 8% of the capital used for risky activities. It consists in Tier 1 Capital, representing capital for going concern, and Tier 2 Capital, representing capital in case of gone concern.

 

2. LIQUIDITY MANAGEMENT

Similarly to the coverage of capital requirements, minimum liquidity requirements have also been introduced for the management of liquidity risk, differantiating between short-term liquidity risk profile (or LCR), which refers to the coverage level of net outflows in case of severe shocks over a 30-day interval, and longer-term liquidity, measuring a bank’s resilience (or Net Stable Funding Ratio).

Moreover, new reports have been introduced to measure the trend of liquidity flows (both inflows and outflows) on a quarterly basis (Additional Liquidity Monitoring Metrics). In detail, these new reports show the consideration given by the Basel Committee to liquidity, to maintain an adequate control (data governance).

3. RISK MANAGEMENT

Referring to risk management, following the crisis of 2008, when credit institutions reached an excessive level of financial leverage, regulators decided to introduce a reporting requirement for leverage ratio, to monitor the exposure of a bank and its assets. Financial leverage refers to the ratio between bank’s assets and share capital. The recourse to leverage exposes banks to large losses, since outstanding assets are higher than available capital.

 

4. IMPROVED TRANSPARENCY OF INFORMATION

At last, Basel III aims at improving transparency through new integrations to disclosure requirements. The Third Pillar deals with this issue, introducing the requirement of detailed disclosures on capital adequacy, risk exposure and relevant monitoring processes.

This is the content of the TIGREARM suite dedicated to regulatory analysis

On 21.06.2021 the new Basel agreement (so called ‘Basel IV’) will enter into force, implementing significant changes to the above-mentioned framework.

 

Basel Frameworks on TIGREARM suite

1. The ‘Ren+’ module allows for an analysis of Italian and European regulations, continuously updated.

2. The module related to ‘Harmonised Reporting’, starting from Basel frameworks, allows to produce specific bases or surveys related to requirements on the above-mentioned areas, carrying out a diagnostics analysis and offering innovative supporting instruments in the field of data quality.
   The main functions refer to:

• Possibility to acquire reporting, regardless of the provider used by the institution
• Management of validation rules (both European Banking Authority and European Central Banks ones)
• Possibility to adjust errors identified by validation rules and re-generation of the adjusted and corrected survey, ready to be sent to supervisory bodies

3. The ‘MidaBI’ module, starting from an historical analysis of harmonised bases, allows to check, with a cross-process involving specific bases, their overall consistency (data governance), as well as to produce, according to business intelligence principles, both qualitative reports (data mining) and an automatic generation of information required under Third Pillar of Basel (information disclosure).

All TigreArm modules are web-based and can be used also for remote working