The Impact of Basel IV on Consumers and Investors
(Last Updated On: 11. January 2023)
Good investing decisions require ample research and staying up-to-date with regulations. My previous post on “Investing in Commodity ETFs” highlights how certain investments may change with regional regulations. The European Union (EU) doesn’t allow pure commodity ETFs as all ETFs must include a minimum level of diversification. This is unlike the US, which allows pure commodity ETFs that are in direct relation with said commodity. Considering these stricter requirements in the EU, investors must take heed of other changes in the system.
In the case of banks and investors, one of the most recent significant changes was the implementation of Basel IV. This system was created in response to the global financial crisis in 2009 and has expanded to mitigate risk by increasing the minimum of maintained bank assets.
What is Basel IV?
Basel IV is an informal name for a set of proposed international banking reforms built on the existing Basel I to III accords developed by the Basel Committee on Banking Supervision (BCBS). This framework was put into effect on January 1, 2023, although some countries may already have implemented portions of the Basel III agreement into regular compliance.
Before its implementation, the Basel Committee proposed several changes that would place banks in a better position to deal with financial distress, such as:
- Setting a higher minimum capital ratio of 10.5%
- Limiting the use of internal risk models and relying on standardised models
- Introducing a leverage ratio buffer
With a five-year deadline, Basel compliance poses a challenge for banks as they would need to collect a higher volume and variety of data to apply the required calculations. Moreover, there are increased demands on external and internal reporting, data governance, and other technological considerations. When done correctly, these demanding processes can ultimately enhance an organisation’s growth, competitiveness, and profitability.
How does Basel IV affect banks?
Basel IV is meant to level the playing field by prioritising standardised risk models by moving them away from internal risk models. In a study by the Journal of Finance on German banks, loan-level data showed that banks “optimised” model-based regulation by lowering capital requirements. If standardised risk models were followed instead of internal ones, capital requirements would have been 64% higher — showcasing underreported risk. As a result, Basel IV would force banks heavily reliant on internal risk models, such as the European banking sector, to increase liquid assets. Reuters’ report on capital rules notes that banks in the EU need a further €1.2 billion (£1.06 billion) euros to meet the set capital requirements.
How will Basel IV impact consumers and investors?
Investing always carries a risk that could be disastrous without proper regulation. With Basel IV, assets are made much safer as banks are forced to keep liquidity ratios. The liquidity coverage ratio mandates that banks must expand their shortfall and hold liquid assets for a minimum of 30 days in the event of a financial crisis. However, this would mean less capital put into investments — reducing the bank’s earning power.
Despite losses during financially stable times, these safeguards have been implemented to protect consumers and investors during an economic downturn. As mentioned earlier, banks must collect more data for proper calculation and compliance. This can improve financial institutions’ disclosure requirements and market transparency, providing greater confidence to consumers and investors. In return, they are more likely to engage with banks for any loans or funding, ensuring that banks can still invest and reinvest their assets.
Through the banking framework Basel IV, banks can follow more standardised capital requirements and loan pricing — keeping the market more resilient to economic shocks.
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