In next couple of years there will be sweeping changes to existing Basel III Accord what will pave way for a new game changing regime called Basel 4. In obvious intent, the new Accord will raise risk-based capital ratio, revise risk weighting and move away from too much emphasis on model-based approach. One of key measures will be leverage Ratio.
It will stay ahead of 3% ratio as a front-stop measure. Another key measure will be balancing risk sensitivity with simplicity in the new regime. The Basel Committee has already come out a consultation paper on the advantages of greater simplicity which gives the directions how to move out of current high level of complexity.
Another area is addressing complexity of risk weights by internal model which is also an important issue during financial crisis. To address the same, the Basel committee has come out with a paper on Fundamental Review of Trading Book which talks about considerable difference of risk weighting between banking book and trading book and the way forward. In respect of capital buffers, many countries like Australia and the UK are proposing to require Pillar 2 capital through CET1 capital, rather than through a combination of tier 1 and tier 2 capital.
This gives more loss absorbing capability of core capital paving the way for more financial stability. In liquidity measures, there have been enhancements by regulators in different geographies. In the UK, Prudential Regulatory Authority is proposing additional liquidity requirement from systemic point of view for Liquidity Coverage Ratio. So LCR and NSFR will be stabilised further. more in new regime. Furthermore, the Macro-prudential issues like surcharge for global systemically important banks will be an add on to the new Basel regime.
This will reduce contagion risk. This will tighten the large exposure measures for appropriate oversight. The bailing out of banks by government has been issue during and post financial crisis. There are astute possibilities to include the recovery and resolution issues in new Basel Accord. EU Bank Recovery and Resolution Directive (BRRD) and FSB guidance will have impact in new regime. Another change be more stringent risk disclosure the of the use of internal models on a bank’s regulatory capital.
This will create more transparency. In summary, the Basel 4 will address the above issue increasing stability and transparency of financial system, with sweeping changes, pre-empting chances of government bail out of banks or sovereign default.