Overview
The Basel Norms form the core of international banking regulation designed to strengthen bank capital, liquidity, leverage constraints, and market discipline to safeguard global financial stability. This article outlines Basel I–III, prudential norms, the effects of liberalization and globalization on stability, linkages to international standards and codes, and the supervisor’s role under the Basel framework.
Basel norms: an outline
Basel I introduced minimum capital requirements focused on credit risk with an 8% capital adequacy ratio against risk-weighted assets, creating a common baseline for internationally active banks. Basel II expanded to a three-pillar structure—minimum capital (Pillar 1), supervisory review (Pillar 2), and market discipline (Pillar 3)—adding operational risk and enhancing risk sensitivity in measurement and disclosure. Basel III, developed post‑2007–09 crisis, strengthened common equity Tier 1 buffers, introduced a leverage ratio backstop, standardized liquidity requirements via LCR and NSFR, added capital conservation and countercyclical buffers, and reformed market risk and securitization frameworks.
Prudential norms
Prudential norms translate Basel principles into implementable requirements on capital adequacy, asset classification and provisioning, concentration limits, and risk aggregation across credit, market, operational, and interest rate risk in the banking book. Liquidity risk standards require robust high-quality liquid asset buffers for 30‑day stress survival (LCR) and stable funding over one year (NSFR), supported by internal stress testing, early-warning indicators, and contingency funding plans. Governance and control norms cover board oversight, risk culture, model risk management, remuneration alignment, and comprehensive disclosures to support market discipline and comparability.
Liberalization, globalization, and stability
Liberalization broadens intermediation, competition, and access to capital, while globalization increases cross-border capital flows, market integration, and risk transmission channels. These forces can improve efficiency and risk sharing but may also raise procyclicality, reliance on volatile wholesale funding, and exposure to global shocks, requiring macroprudential buffers and robust resolution frameworks. Sound prudential and conduct regulation, combined with market infrastructure resilience and crisis-management arrangements, mitigates spillovers from capital flow reversals, asset price corrections, and foreign-currency funding stresses.
Linkage to international financial stability
The Basel framework underpins cross-border consistency, level playing fields, and transparency, supporting the mandates of bodies such as the BIS, FSB, and IMF in monitoring systemic risks and promoting coordinated responses. Harmonized capital, liquidity, and disclosure standards facilitate comparability of bank resilience across jurisdictions, reducing regulatory arbitrage and strengthening global confidence. Mutual recognition and periodic peer assessments encourage consistent implementation, while data standards and public disclosures enhance surveillance and market discipline internationally.
International standards and codes
The Basel Core Principles for Effective Banking Supervision provide the baseline for supervisory independence, powers, methodologies, and enforcement, complemented by capital, liquidity, large exposures, market risk, operational risk, and interest rate risk standards. The FSB’s Key Attributes of Effective Resolution Regimes define resolution planning, bail‑in, and cross-border cooperation to handle systemic failures without taxpayer bailouts. Additional global codes—on disclosures, accounting, payment and settlement systems, and AML/CFT—integrate with prudential standards to strengthen the broader financial stability architecture.
Role of the supervisor under Basel
Supervisors assess banks’ risk profiles and capital adequacy beyond minimums through Pillar 2, set institution‑specific capital and liquidity add‑ons, and require remediation where governance or risk controls are weak. They conduct risk-based supervision, thematic reviews, and system-wide stress tests, and evaluate internal models, validation practices, and model risk governance. Supervisors enforce robust public disclosures, ensure credible recovery and resolution plans, and coordinate with domestic and cross-border authorities to manage crises and maintain stability under stress.
Capital, leverage, and buffers
Common equity Tier 1 forms the highest-quality loss-absorbing capital, supplemented by additional Tier 1 and Tier 2 instruments, with minimum ratios reinforced by conservation and countercyclical buffers. A non-risk-based leverage ratio constrains balance-sheet expansion and model risk, limiting excessive build-up of exposures during benign periods. Systemically important banks face additional capital surcharges and heightened supervisory expectations, reflecting their potential externalities in a stress event.
Liquidity standards and funding
The Liquidity Coverage Ratio requires a stock of high-quality liquid assets sufficient to withstand severe short-term outflows, while the Net Stable Funding Ratio promotes stable, longer-term funding profiles. Supervisors emphasize diversified funding, collateral management discipline, intraday liquidity controls, and contingency funding plans tested through regular fire drills and reverse stress scenarios. Disclosure of liquidity metrics and funding concentrations supports market scrutiny and early corrective market signals.
Market risk and trading book reforms
Post-crisis reforms revised market risk capital through the Fundamental Review of the Trading Book, enhancing risk sensitivity, boundary definitions, and the treatment of default and curvature risk. Counterparty credit risk and CVA frameworks were strengthened, and margin and central clearing requirements for derivatives improved resilience to market–funding spirals. Supervisors evaluate trading risk governance, model performance, backtesting and P&L attribution, and the adequacy of stress scenarios capturing illiquidity and basis risks.
Operational resilience and conduct
Operational risk capital moved toward standardized frameworks while supervisors intensified scrutiny of risk and control self-assessments, loss data, and scenario analysis. Heightened expectations cover cyber resilience, third‑party and cloud concentration risk, data governance, and incident response with clear recovery time objectives. Conduct supervision complements prudential goals by addressing product suitability, fair treatment, and disclosure quality, reducing misconduct-driven losses and reputational contagion.
Macroprudential integration
Macroprudential tools—countercyclical capital buffers, sectoral risk weights, and borrower-based constraints—are used to temper credit cycles and concentration risks. System-wide stress tests incorporate funding, market, and second-round effects, with results feeding into buffer calibration and supervisory priorities. Cross-border coordination aligns activation and release of buffers and enhances transparency during global shocks.
Implementation and proportionality
Jurisdictions tailor Basel implementation to their financial structures and development stages, applying proportionality to smaller or less complex banks while preserving core resilience. Clear transition paths, impact assessments, and capacity building support effective adoption without undue credit disintermediation. Ongoing reviews, public consultations, and peer assessments sustain consistency and credibility of the framework over time.
Policy implications for stability
- Preserve risk-sensitive capital and liquidity standards while retaining simple backstops to constrain model and measurement risk.
- Strengthen cross-border crisis preparedness through resolution colleges, funding in resolution options, and operational continuity planning.
- Expand systemic oversight to significant nonbank intermediaries and critical third parties, aligning prudential, conduct, and operational resilience expectations.
- Enhance disclosures and data standards to improve comparability, market discipline, and early detection of systemic vulnerabilities.
A disciplined application of Basel standards—anchored by vigilant supervision, robust governance, and credible resolution—provides a durable foundation for financial stability in an increasingly liberalized and globalized financial system.
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