BASEL REGULATORY GOVERNANCE

THE BASEL FRAMEWORK

The framework comes under the Bank of International Settlements (BIS) regulations. The most recent update Basel III accord, an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision and risk management within the banking sector. Overseen by the Basel Committee on Banking Supervision (BCBS) a committee of banking supervisory authorities to ensure market compliance.
The Basel Framework addresses several shortcomings in the pre-crisis regulatory framework and provides a foundation for a resilient banking system that will help avoid the build-up of systemic vulnerabilities.
The Base accords are developing after several consultative papers, redrawing the landscape by a complete overhaul of the trading process practices to refine capitalization market risk rules. This review covers all aspects of minimum capital requirements for market risk such as the trading book, banking book, the standardized and internal models approaches. Likely to develop into Basel IV accord but currently designated as the Base Framework.

THE FINANCIAL CRISIS

More than a decade since the onset of the financial crisis, triggered by the US subprime mortgage market in 2007, mostly over a huge housing and mortgage bust in the US. This caused a severe impact to market liquidity and credit crunch, spreading over to all credit lines and financial markets. This caused an unprecedented economic panic that wasn’t predicted to be this adverse.   This triggered a major recession in the US which impacted global and trade investments, affecting other global regions and economies. At this stage Governments across the world, didn’t appreciate the impact this would have on their own and the global economy and were slow to intervene.

This crisis caused a severe sovereign debt crisis and consequently an international banking crisis.  The internal unregulated excessive risk-taking by Lehman Brothers and other banks helped to magnify the financial impact globally. Leading to the actual collapse of the too big to fail Lehman Brothers. The domino effect of the intertwined banking sector lead to one of the worst recessions seen.  The Great Recession in 2008-09, a complete global economic downturn, this now forms a key stress scenario in the banking system, followed by the European banking system debt crisis scenarios. Towards the end of 2009 there were signs of recovery, nonetheless a period of very slow growth in countries with the biggest debt burden.

TACKLING THE PROBLEM

The continual weakness of the banking system is its exposure to worldwide events and the global economy. Events can be micro or macroeconomic shocks, the recent Coronavirus is a testament that non-financial shocks can have an immense impact where supply chain shortages trigger an effect in the marketplace, risk factors are not only financial triggers. Paraphrasing JFK, banks might be forgiven for thinking “ask not what we are doing to the economy, but what is the economy doing to us”.  The knock-on effects of failures in the banking sector can ripple into a tsunami. The challenges have been addressed by

• regulating more in order to prevent crises and prepare for repeat events.

• bailout institutions that are deemed too important to fail

• resolve failing banks where possible by bailing in creditors.

On the surface banks that appeared to be well-capitalized weren’t and lack of transparency to safeguard all parties in the equation. Turbulent times and the unknown are complex to model so expectations about potential losses can and do change at short notice.  Finding the “optimal” capital ratio seems to be non-existent, and there was no clear answer to how the banks could demonstrate clear backed up funds.  At this time, leverage was very high; yet spreads on unsecured loans to banks were negligible. Following the crisis, it was difficult to persuade lenders to risk unsecured lending to the banking sector. Which led to a mass bailout.

REGULATION TO SUPPORT

The constraint on banks came not from regulators but from the market. As time has passed, we have returned to a more normal state. Regulators have to decide on the appropriate amount of equity capital to cope with a future crisis.
The amount of loss-absorbing capital today is greater than before the crisis, the simple leverage ratio of UK banks, for example, has improved by a factor of around two. This may not be enough, banks consistently denied that they were undercapitalized.  We’ve seen across European Banks, the market value of equity is less than book value. The concept that it is possible to finance long-term risky lending by short-term safe borrowing is the alchemy in our present financial system.
After what happened to Lehman's, solvency concerns led to a liquidity problem for banks in the crisis, but it was the resulting runs on the banking and shadow banking systems that led to the sudden collapse of the system. Two important lessons emerged from that experience. First, in a crisis, the central bank is the only ultimate source of liquidity. Second, liquidity regulation cannot be designed without its being integrated into the framework for central bank liquidity provision.

BASEL REGULATION

The complex nature of the recent financial crisis brought light to the lack of regulation in a highly complex market and the lack of sensible reporting measures to ensure risk-taking is backed by sufficient funds and
due process. These post-crisis concerns were captured into the Basel III charter regulatory reform. Representing a significant milestone with a view to ensure a sensible capital framework of holdings. Several regulatory reforms have been brought in to counter the financial crisis, constituting a global regulatory framework, overlapping other frameworks in the US and Far East Markets   These reforms will eventually fall into a global programme, but for now, each market is responding it is own way to safeguard but global nature of finance may require cross border reform.
Current regulation is built upon previous accords, Basel I, II, III and is part of a continuous process to enhance regulation in the banking industry. The accord ensures banks have sufficient means to protect the economy when they take more risks than they can actually absorb.
The Basel III reforms also ensure the excessive variability in risk-weighted assets are addressed and improve the comparability and transparency of banks' risk-based capital ratios. Since the Basel III regulatory reforms have been factored into a comprehensive framework, the task remains of ensuring the standards are implemented consistently around the world. This can be achieved by working as the responsible regulatory body to ensure a strengthened form of global standards.