The Basel III Accord | Basel iii Compliance Professionals Association (BiiiCPA)

The Basel III Accord

The Basel III Accord is a comprehensive set of reforms developed by the Basel Committee on Banking Supervision ("BCBS", "Basel Committee") to enhance the stability and resilience of the global financial system. It aims not only to strengthen regulation, supervision, and risk management within the banking sector, but also to reduce systemic risks.

Systemic risk refers to the danger that the failure or distress of a single financial institution, market segment, or infrastructure component could trigger a chain reaction, leading to widespread instability or collapse of the entire financial system. It goes beyond the problems of individual banks or firms and threatens the functioning of the financial system as a whole.

This risk arises from the interconnected nature of financial institutions and markets. When one major institution fails, it can cause panic, liquidity shortages, or losses that spread rapidly to others, disrupting the normal flow of credit and capital. A clear example of systemic risk was the 2008 global financial crisis, where the collapse of Lehman Brothers led to severe disruptions in financial markets worldwide.

Regulators and standard-setting bodies like the Basel Committee work to identify and mitigate systemic risks through stricter capital and liquidity requirements, enhanced supervision, and measures that limit excessive interconnections and leverage in the banking sector. The goal is to ensure that the financial system remains stable, even when individual institutions face difficulties.

By addressing both microprudential and macroprudential concerns, Basel III contributes to safeguarding the financial system against future crises and maintaining confidence in global markets. It was introduced in response to the deficiencies in financial regulation revealed by the global financial crisis of 2007–2008.

Basel III builds upon the Basel II framework. It strengthens all Basel II Pillars (capital requirements, supervisory review, market discipline) and introduces new regulatory standards to address systemic risk and improve the resilience of financial institutions.

Microprudential and macroprudential supervision

Microprudential supervision refers to the regulatory approach that focuses on the health and stability of individual financial institutions. The aim is to ensure that each bank, insurance company, or investment firm operates in a sound and prudent manner, minimizing the risk of failure. This involves close oversight of capital adequacy, liquidity management, risk controls, and governance structures. By ensuring that each institution is financially resilient and well-managed, microprudential supervision helps protect depositors, investors, and other stakeholders from losses arising from poor practices or excessive risk-taking at the firm level.

In contrast, macroprudential supervision is concerned with the stability of the financial system as a whole. It looks beyond the soundness of individual institutions to examine how risks can accumulate and interact across the financial sector, potentially leading to systemic crises. This approach takes into account interconnectedness among financial institutions, common exposures, and the amplification of risk through procyclical behavior, such as excessive credit growth in booms and sharp contractions in downturns. Macroprudential policy uses tools like the countercyclical capital buffer and sectoral capital requirements to limit the build-up of systemic risks and enhance the resilience of the financial system during periods of stress.

While both approaches aim to promote financial stability, they differ in focus. Microprudential supervision addresses the risk of failure at the firm level, whereas macroprudential supervision addresses risks that could disrupt the entire financial system. However, they are complementary and increasingly integrated in regulatory frameworks, as the stability of individual firms contributes to systemic stability, and systemic vulnerabilities can, in turn, threaten the solvency of individual institutions. A balanced approach that combines both perspectives is essential to ensure a robust and resilient financial system.

The Basel Committee on Banking Supervision (BCBS)

The BCBS was founded in 1974 by the central bank governors of the G10 countries, in response to disruptions in international financial markets, to improve the quality of banking supervision globally, enhance cooperation among banking regulators, and develop guidelines to promote financial stability.

The Basel Committee, operating under the Bank for International Settlements (BIS) in Basel, Switzerland, is not a supranational authority. Its guidelines and standards are not legally binding, but they are widely adopted by national authorities in many countries.

The Basel Committee develops global regulatory frameworks to ensure the soundness of the banking system (like Basel I, Basel II, and Basel III), and promotes consistent implementation across jurisdictions. It conducts peer reviews and assessments, and issues guidance on topics such as credit risk, market risk, operational risk, governance, and capital adequacy.

Even though the Basel Committee’s decisions are not legally binding, its frameworks set the global standards that shape national regulations and influence how banks operate in every country. It plays a vital role in ensuring cross-border consistency, resilience of financial systems, and trust in international banking.

The Basel Committee is composed of representatives from 28 jurisdictions, including both central banks and supervisory authorities.

From Argentina, the Central Bank of Argentina participates. Australia is represented by the Reserve Bank of Australia and the Australian Prudential Regulation Authority. Belgium contributes through the National Bank of Belgium. Brazil is represented by the Central Bank of Brazil, and Canada by both the Bank of Canada and the Office of the Superintendent of Financial Institutions.

China participates through the People's Bank of China and the National Financial Regulatory Administration. The European Union is represented by the European Central Bank and its Single Supervisory Mechanism. France contributes through the Bank of France and the Prudential Supervision and Resolution Authority, while Germany is represented by the Deutsche Bundesbank and BaFin (Federal Financial Supervisory Authority).

Hong Kong SAR is represented by the Hong Kong Monetary Authority. India participates through the Reserve Bank of India. Indonesia is represented by Bank Indonesia and the Indonesia Financial Services Authority. Italy participates via the Bank of Italy. Japan contributes through the Bank of Japan and the Financial Services Agency. Korea is represented by the Bank of Korea and the Financial Supervisory Service.

Luxembourg participates through the Commission de Surveillance du Secteur Financier. Mexico is represented by the Bank of Mexico and the National Banking and Securities Commission. The Netherlands contributes through the Netherlands Bank, while Russia is represented by the Central Bank of the Russian Federation.

Saudi Arabia is represented by the Saudi Central Bank. Singapore participates through the Monetary Authority of Singapore. South Africa is represented by the South African Reserve Bank. Spain participates via the Bank of Spain. Sweden contributes through both Sveriges Riksbank and Finansinspektionen.

Switzerland is represented by the Swiss National Bank and the Swiss Financial Market Supervisory Authority (FINMA). Türkiye participates through the Central Bank of the Republic of Türkiye and the Banking Regulation and Supervision Agency. The United Kingdom is represented by the Bank of England and the Prudential Regulation Authority. The United States participates through the Board of Governors of the Federal Reserve System, the Federal Reserve Bank of New York, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation.

The Basel Committee reports to the Group of Governors and Heads of Supervision (GHOS), which is its oversight body and the primary decision-making group for the Committee's work. The GHOS is composed of the central bank governors and heads of banking supervisory authorities from the jurisdictions represented on the Basel Committee. It provides strategic direction, endorses major decisions, and approves the publication of key regulatory standards, including the Basel framework updates.

The Basel Committee develops proposals, consults with stakeholders, and prepares final standards. These are submitted to the GHOS, which reviews, modifies if necessary, and approves them for implementation across member jurisdictions. This governance structure ensures accountability, legitimacy, and alignment with national authorities’ priorities, while maintaining a coordinated international approach to banking regulation. By reporting to the GHOS, the Basel Committee ensures that its decisions are supported at the highest levels of financial policy-making, promoting consistent adoption of its standards globally and reinforcing the credibility and influence of its work.

What has led to Basel III?

One of the primary reasons the economic and financial crisis became so severe was the excessive build-up of leverage, both on and off the balance sheet, across the banking sectors of many countries. This high level of leverage left banks highly vulnerable to even modest shocks, amplifying losses and triggering a rapid erosion of confidence in financial institutions. As asset prices fell and funding conditions tightened, over-leveraged banks were forced into abrupt deleveraging, which further exacerbated the downturn and contributed to a vicious cycle of declining credit availability and deepening economic contraction.

On-balance sheet leverage refers to the use of borrowed funds to finance assets that appear directly on a bank’s balance sheet, such as loans, securities, and physical assets. It is commonly measured by comparing total assets to the bank’s capital. A higher ratio indicates that a bank is funding a larger portion of its activities with debt rather than equity, which increases its exposure to potential losses.

Off-balance sheet leverage involves exposures that do not appear fully on the balance sheet but still carry risk and can lead to future obligations. These include derivatives contracts, guarantees, letters of credit, and lending commitments. Off-balance sheet activities can significantly increase a bank’s risk profile without an immediate or transparent reflection in its financial statements, making it more difficult to assess the true level of leverage and risk.

The excessive build-up of leverage was accompanied by a gradual erosion of the level and quality of the capital base. At the same time, many banks were holding insufficient liquidity buffers. The banking system therefore was not able to absorb the resulting systemic trading and credit losses nor could it cope with the reintermediation of large off-balance sheet exposures that had built up in the shadow banking system.

The shadow banking system refers to a network of financial institutions, activities, and instruments that perform bank-like functions (such as lending and maturity transformation) but operate outside the traditional banking regulatory framework.

These entities include investment funds, money market funds, hedge funds, structured investment vehicles (SIVs), and finance companies. They raise funds through wholesale funding markets and short-term instruments, and use those funds to invest in longer-term or riskier assets—similar to what banks do.

Because they are not subject to the same capital and liquidity requirements as regulated banks, shadow banking entities can take on higher levels of risk and leverage. This lack of oversight can create vulnerabilities in the financial system. For example, during the 2007–2008 financial crisis, parts of the shadow banking system experienced severe distress, leading to liquidity shortages and contagion across markets.

While the shadow banking system can provide useful alternative sources of credit and support market liquidity, its opacity and interconnectedness with traditional banks can pose systemic risks, especially in times of stress.

The crisis was made worse by the high level of interconnectedness between large, systemically important financial institutions. These institutions were linked through a dense web of complex financial transactions, including derivatives, interbank lending, securitizations, and repurchase agreements. This meant that the distress or failure of one major institution could quickly spread to others, as losses, defaults, or liquidity problems in one firm could trigger similar issues in its counterparties. Because many of these transactions were opaque and difficult to unwind, it was challenging for market participants and regulators to assess the full extent of the risk. As a result, trust in the financial system rapidly deteriorated, and contagion spread, further deepening the crisis.

The vulnerabilities in the banking sector quickly affected the broader financial system and the real economy. As banks began to incur large losses and face liquidity shortages, they reduced lending to other financial institutions, businesses, and households. This created a chain reaction: funding markets froze, confidence collapsed, and credit became increasingly scarce. The contraction of liquidity meant that financial institutions had difficulty meeting short-term obligations, while the decline in credit availability made it hard for companies to invest and for consumers to borrow and spend. Together, these dynamics led to a sharp slowdown in economic activity, job losses, and a deep recession.

As the crisis deepened and the financial system teetered on the edge of collapse, governments and central banks were forced to intervene on an unprecedented scale. They injected large amounts of liquidity into the banking system to keep financial markets functioning and to prevent a total freeze in lending. In many cases, they also provided capital directly to struggling banks to shore up their balance sheets and restore confidence. Additionally, they issued guarantees on bank liabilities, such as deposits and interbank loans, to stabilize the system.

These emergency measures were necessary to prevent a complete meltdown, but they came at a high cost. Taxpayers were effectively put at risk, as public funds were used to absorb losses and support failing institutions. The impact of the crisis was immediate and severe in the countries most affected: major banks were nationalized or restructured, financial systems underwent dramatic changes, and entire economies entered deep recessions with rising unemployment and falling output. The crisis exposed structural weaknesses and led to widespread calls for regulatory reform.

The recent and past financial crises have shown how quickly and widely economic and financial shocks can spread across countries and regions. In today’s interconnected global economy, problems that begin in one part of the world—whether due to a banking failure, a market collapse, or a geopolitical event—can rapidly affect financial systems and economies elsewhere. Moreover, the exact causes and timing of future crises are difficult to predict.

Because of this, it is essential that all countries take steps to strengthen the resilience of their banking sectors. This means ensuring that banks are well-capitalized, have robust risk management practices, maintain adequate liquidity buffers, and are subject to strong supervision. A resilient banking system is better able to absorb shocks—whether they originate domestically or abroad—without triggering broader instability. By reinforcing the soundness of their banks, countries can protect their economies, preserve financial stability, and reduce the need for costly public interventions in future crises.

---

December 2017 - Finalization of the Basel III post-crisis regulatory reforms

The Basel III reforms complement the initial phase of the Basel III reforms announced in 2010.

The 2017 reforms seek to restore credibility in the calculation of risk weighted assets (RWAs) and improve the comparability of banks’ capital ratios.

RWAs are an estimate of risk that determines the minimum level of regulatory capital a bank must maintain to deal with unexpected losses.

A prudent and credible calculation of RWAs is an integral element of the risk-based capital framework.

The revisions seek to restore credibility in the calculation of risk-weighted assets (RWAs) and improve the comparability of banks’ capital ratios by:

• enhancing the robustness and risk sensitivity of the standardised approaches for credit risk, credit valuation adjustment (CVA) risk and operational risk;

• constraining the use of the internal model approaches, by placing limits on certain inputs used to calculate capital requirements under the internal ratings-based (IRB) approach for credit risk and by removing the use of the internal model approaches for CVA risk and for operational risk;

• introducing a leverage ratio buffer to further limit the leverage of global systemically important banks (G-SIBs); and

• replacing the existing Basel II output floor with a more robust risk-sensitive floor based on the Committee’s revised Basel III standardised approaches.

Credit risk

Credit risk accounts for the bulk of most banks’ risk-taking activities and hence their regulatory capital requirements. The standardised approach is used by the majority of banks around the world, including in non-Basel Committee jurisdictions. The Committee’s revisions to the standardised approach for credit risk enhance the regulatory framework by:

• improving its granularity and risk sensitivity. For example, the Basel II standardised approach assigns a flat risk weight to all residential mortgages. In the revised standardised approach mortgage risk weights depend on the loan-to-value (LTV) ratio of the mortgage;

• reducing mechanistic reliance on credit ratings, by requiring banks to conduct sufficient due diligence, and by developing a sufficiently granular non-ratings-based approach for jurisdictions that cannot or do not wish to rely on external credit ratings; and

• as a result, providing the foundation for a revised output floor to internally modelled capital requirements (to replace the existing Basel I floor) and related disclosure to enhance comparability across banks and restore a level playing field.

In summary, the key revisions are as follows:

• A more granular approach has been developed for unrated exposures to banks and corporates, and for rated exposures in jurisdictions where the use of credit ratings is permitted.

• For exposures to banks, some of the risk weights for rated exposures have been recalibrated. In addition, the risk-weighted treatment for unrated exposures is more granular than the existing flat risk weight. A standalone treatment for covered bonds has also been introduced.

• For exposures to corporates, a more granular look-up table has been developed. A specific risk weight applies to exposures to small and medium-sized enterprises (SMEs). In addition, the revised standardised approach includes a standalone treatment for exposures to project finance, object finance and commodities finance.

• For residential real estate exposures, more risk-sensitive approaches have been developed, whereby risk weights vary based on the LTV ratio of the mortgage (instead of the existing single risk weight) and in ways that better reflect differences in market structures.

• For retail exposures, a more granular treatment applies, which distinguishes between different types of retail exposures. For example, the regulatory retail portfolio distinguishes between revolving facilities (where credit is typically drawn upon) and transactors (where the facility is used to facilitate transactions rather than a source of credit).

• For commercial real estate exposures, approaches have been developed that are more risk sensitive than the flat risk weight which generally applies.

• For subordinated debt and equity exposures, a more granular risk weight treatment applies (relative to the current flat risk weight).

• For off-balance sheet items, the credit conversion factors (CCFs), which are used to determine the amount of an exposure to be risk-weighted, have been made more risk-sensitive, including the introduction of positive CCFs for unconditionally cancellable commitments (UCCs).

Operational risk

The financial crisis highlighted two main shortcomings with the existing operational risk framework.

First, capital requirements for operational risk proved insufficient to cover operational risk losses incurred by some banks.

Second, the nature of these losses – covering events such as misconduct, and inadequate systems and controls – highlighted the difficulty associated with using internal models to estimate capital requirements for operational risk.

The Committee has streamlined the operational risk framework. The advanced measurement approaches (AMA) for calculating operational risk capital requirements (which are based on banks’ internal models) and the existing three standardised approaches are replaced with a single risk-sensitive standardised approach to be used by all banks.

The new standardised approach for operational risk determines a bank’s operational risk capital requirements based on two components:

(i) a measure of a bank’s income; and

(ii) a measure of a bank’s historical losses.

Conceptually, it assumes:

(i) that operational risk increases at an increasing rate with a bank’s income; and

(ii) banks which have experienced greater operational risk losses historically are assumed to be more likely to experience operational risk losses in the future.

The leverage ratio complements the risk-weighted capital requirements by providing a safeguard against unsustainable levels of leverage and by mitigating gaming and model risk across both internal models and standardised risk measurement approaches.

The leverage ratio

To maintain the relative incentives provided by both capital constraints, the finalised Basel III reforms introduce a leverage ratio buffer for G-SIBs. Such an approach is consistent with the risk-weighted G-SIB buffer, which seeks to mitigate the externalities created by G-SIBs.

The leverage ratio G-SIB buffer must be met with Tier 1 capital and is set at 50% of a G-SIB’s risk weighted higher-loss absorbency requirements. For example, a G-SIB subject to a 2% risk-weighted higher-loss absorbency requirement would be subject to a 1% leverage ratio buffer requirement.

The leverage ratio buffer takes the form of a capital buffer akin to the capital buffers in the risk weighted framework. As such, the leverage ratio buffer will be divided into five ranges.

As is the case with the risk-weighted framework, capital distribution constraints will be imposed on a G-SIB that does not meet its leverage ratio buffer requirement. The distribution constraints imposed on a G-SIB will depend on its CET1 risk-weighted ratio and Tier 1 leverage ratio.

A G-SIB that meets:

(i) its CET1 risk-weighted requirements (defined as a 4.5% minimum requirement, a 2.5% capital conservation buffer and the G-SIB higher loss-absorbency requirement) and;

(ii) its Tier 1 leverage ratio requirement (defined as a 3% leverage ratio minimum requirement and the G-SIB leverage ratio buffer) will not be subject to distribution constraints.

A G-SIB that does not meet one of these requirements will be subject to the associated minimum capital conservation requirement (expressed as a percentage of earnings). A G-SIB that does not meet both requirements will be subject to the higher of the two associated conservation requirements.

What is next?

The finalisation of Basel III in December 2017 represents an important milestone for the Basel Committee’s response to the global financial crisis. The full set of Basel III reforms will help enhance the resilience of the banking system.

The Basel Committee will continue to exercise its mandate to strengthen the regulation, supervision, and practices of banks worldwide. The agenda changes, but the purpose is constant – to safeguard and enhance financial stability.

The Basel Committee has agreed that jurisdictions may exercise national discretion in periods of exceptional macroeconomic circumstances to exempt central bank reserves from the leverage ratio exposure measure on a temporary basis.

Jurisdictions that exercise this discretion would be required to recalibrate the minimum leverage ratio requirement commensurately to offset the impact of excluding central bank reserves, and require their banks to disclose the impact of this exemption on their leverage ratios.

The Committee continues to monitor the impact of the Basel III leverage ratio’s treatment of client-cleared derivative transactions. It will review the impact of the leverage ratio on banks’ provision of clearing services and any consequent impact on the resilience of central counterparty clearing.

---

The scope of Basel III (a difficult exercise).

The scope of Basel III is broad and ambitious. This wide scope makes Basel III a difficult exercise for several reasons.

First, it requires banks to make significant adjustments to their capital structures, funding models, and internal risk management systems.

Second, it demands major changes in supervisory practices, data reporting, and compliance efforts, both at the firm level and across jurisdictions.

Third, the global nature of Basel III requires consistent implementation and coordination among countries with diverse banking systems, economic conditions, and regulatory traditions.

Achieving uniform implementation across all jurisdictions has proven to be a challenge. National regulators sometimes adapt or delay certain components of the framework based on domestic considerations, which can lead to inconsistencies and regulatory arbitrage. Additionally, Basel III's complexity, including its reliance on advanced risk models and detailed calculations, has raised concerns about transparency, comparability, and the burden placed on smaller banks.

The Basel iii framework must be applied on a consolidated basis to internationally active banks. Consolidated supervision is the best means to provide supervisors with a comprehensive view of risks and to reduce opportunities for regulatory arbitrage.

The scope of application of the framework will include, on a fully consolidated basis, any holding company that is the parent entity within a banking group to ensure that it captures the risk of the whole banking group.

Banking groups are groups that engage predominantly in banking activities and, in some countries, a banking group may be registered as a bank.

A holding company that is a parent of a banking group may itself have a parent holding company. In some structures, this parent holding company may not be subject to this framework because it is not considered a parent of a banking group.

The framework will also apply to all internationally active banks at every tier within a banking group, also on a fully consolidated basis.

As an alternative to full sub-consolidation, the application of this framework to the stand-alone bank (ie on a basis that does not consolidate assets and liabilities of subsidiaries) would achieve the same objective, providing the full book value of any investments in subsidiaries and significant minority-owned stakes is deducted from the bank’s capital.

Further, to supplement consolidated supervision, it is essential to ensure that capital recognised in capital adequacy measures is adequately distributed amongst legal entities of a banking group. Accordingly, supervisors should test that individual banks are adequately capitalised on a stand-alone basis.

Banking, securities and other financial subsidiaries.

To the greatest extent possible, all banking and other relevant financial activities (both regulated and unregulated) conducted within a group containing an internationally active bank will be captured through consolidation. Thus, majority -owned or -controlled banking entities, securities entities (where subject to broadly similar regulation or where securities activities are deemed banking activities) and other financial entities should generally be fully consolidated.

“Financial activities” do not include insurance activities and “financial entities” do not include insurance entities.

Examples of the types of activities that financial entities might be involved in include financial leasing, issuing credit cards, portfolio management, investment advisory, custodial and safekeeping services and other similar activities that are ancillary to the business of banking.

There may be instances where it is not feasible or desirable to consolidate certain securities or other regulated financial entities. This would be only in cases where such holdings are acquired through debt previously contracted and held on a temporary basis, are subject to different regulation, or where non-consolidation for regulatory capital purposes is otherwise required by law. In such cases, it is imperative for the bank supervisor to obtain sufficient information from supervisors responsible for such entities.

If any majority-owned securities and other financial subsidiaries are not consolidated for capital purposes, all equity and other regulatory capital (or, if applicable, other total loss-absorbing capacity) investments in those entities attributable to the group will be deducted, and the assets and liabilities, as well as third-party capital investments in the subsidiary will be removed from the bank’s balance sheet.

Supervisors will ensure that an entity that is not consolidated and for which the capital investment is deducted meets regulatory capital requirements. Supervisors will monitor actions taken by the subsidiary to correct any capital shortfall and, if it is not corrected in a timely manner, the shortfall will also be deducted from the parent bank’s capital.

Significant minority investments in banking, securities and other financial entities, where control does not exist, will be excluded from the banking group’s capital by deduction of the equity and other regulatory investments. Alternatively, such investments might be, under certain conditions, consolidated on a pro rata basis.

For example, pro rata consolidation may be appropriate for joint ventures or where the supervisor is satisfied that the parent is legally or de facto expected to support the entity on a proportionate basis only and the other significant shareholders have the means and the willingness to proportionately support it. The threshold above which minority investments will be deemed significant and be thus either deducted or consolidated on a pro-rata basis is to be determined by national accounting and/or regulatory practices. As an example, the threshold for pro-rata inclusion in the European Union is defined as equity interests of between 20% and 50%.

---