Widespread but selective: Cross-country variation in Basel standards adoption

What are Basel standards and why do they matter?

The Basel Committee on Banking Supervision has established itself as the global standard setter for banks. Since its creation in 1974, it has developed four global standards that are of relevance not only for its 27 member jurisdictions, but for countries around the globe.

The Basel Core Principles (BCP) have become the de facto minimum standard for the sound prudential regulation and supervision of banks systems around the world. Developed in 1997 and revised several times since, the Basel Core Principles apply to banks and financial supervisors. They set out minimum standards in a range of areas including regulatory independence, risk management procedures, and capital buffers. There is surprisingly little empirical evidence that compliance with the Core Principles actually improves the financial stability or the wider performance of the banking system. Nevertheless, countries are routinely assessed by the World Bank and IMF regarding their compliance with the Basel Core Principles.

Basel I is the original standard for internationally-active banks that are headquartered in member countries of the Basel Committee. Published in 1988, it set minimum capital requirements for internationally active commercial banks commensurate to the credit risk they face. Critics of Basel I argued that it did not sufficiently differentiate the risk associated with individual loans, and it did not cover all types of assets.

In response to these concerns, the Basel Committee developed Basel II. Finalised in 2004, the revised standard features differentiated requirements for a wider range of financial risks. Moreover, it allows banks to use internal risk models to calculate capital buffers. Basel II has been widely criticised for dramatically increasing the complexity of the capital framework, and for being woefully inadequate in ensuring bank resilience, as evidenced in the global financial crisis of 2008.

Basel III seeks to address these concerns by raising the bar of prudential banking standards. Developed in 2012-17, it combines tougher capital requirements with new rules to cover a wider range of financial risks, including liquidity and systemic risks. Basel III is also the first standard to be negotiated with developing country representatives from the G20 at the table, although their degree of influence is unclear.

While many financial regulators around the world recognize the relevance of the Basel Core Principles and Basel I, the benefits and costs of Basel II and III adoption among LMICs are disputed.

The implementation of Basel II and III poses specific challenges for regulators and banks in LMICs. An immediate challenge arises from the sheer complexity of Basel II and III since supervisory capacity is a particularly acute constraint in developing countries. Weaknesses in financial sector infrastructure, particularly gaps in the availability of credit ratings and credit information, can also frustrate efforts to implement these standards.

 

How are LMICs responding to such challenges?

The results of our research using data from the Financial Stability Institute (FSI) and in-depth case studies show that adoption is both widespread and highly selective. Among all jurisdictions that are not Basel Committee members and thus not obliged to adhere to its standards, 71 were nevertheless implementing at least one component of Basel II, and 41 at least one component of Basel III. Among our sample of eleven cases, only one LMICs (Ethiopia) eschews Basel II and III in its entirety.

Basel adoption: widespread
Basel II adoption worldwide
Source:
Financial Stability Institute (2015)

 

At the same time, regulators are taking a highly selective approach, implementing an average of 4 out of 10 Basel II and 1 out of 8 Basel III components. For Basel II, the most striking trend from the FSI data is that there is a clear split, revealed in the figure below, between jurisdictions that do and do not allow the use of advanced approaches that rely on internal risk models. The majority of regulators have decided against them, and the number of countries using internal model-based approaches has not increased since 2010, possibly reflecting the widespread criticism of these approaches in the wake of the 2008 global financial crisis.

 

Adoption of Basel II Pilar I

 

Basel III implementation beyond Basel Committee members has started more recently, and it may be too early to discern global patterns. Many jurisdictions have adopted the micro-prudential components of Basel III, including a stricter definition of capital and the capital conservation buffer. In contrast, the macro-prudential components such as the counter-cyclical buffer and requirements for domestic systemically important banks (D-SIB) have been less popular so far. No LMICs had to adopt the component for global systemically important banks (G-SIB) since they are not home regulators for these institutions. Regulators in the majority of our case study countries are only just beginning to contemplate Basel III implementation.

Basel III implementation
Basel III adoption worldwide
Source:
Financial Stability Institute (2015)

 

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The graphs above and the results of our quantitative research on the drivers of Basel adoption in ca. 100 countries using can be found in the following article:

Emily Jones and Alexandra O. Zeitz (2017). The Limits of Globalizing Basel Banking Standards. Journal of Financial Regulation, 3(1), 89-124.