Basel IV in Banking
Introduction
Basel IV, often referred to as the “finalization of Basel III”, is the latest set of international banking regulations developed by the Basel Committee on Banking Supervision (BCBS). While regulators officially avoid the term Basel IV, many in the financial industry use it to highlight the scale of changes compared to earlier frameworks.
The reforms, finalized in December 2017, represent the most comprehensive update to global banking standards since the aftermath of the financial crisis. Basel IV seeks to restore credibility to banks’ capital ratios, reduce variability in risk-weighted assets (RWAs), and ensure that banks across jurisdictions are measured by more consistent standards.
Why Basel IV Was Introduced
The Global Financial Crisis (2007–2009) exposed flaws in the Basel II and early Basel III frameworks. Even as Basel III was rolled out, regulators identified three key issues:
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Excessive reliance on internal models – Large banks could use complex internal models to calculate RWAs, often underestimating risk compared to smaller banks using standardized approaches.
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Inconsistency across banks – The same type of risk exposure produced very different capital requirements depending on the bank and jurisdiction.
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Incomplete coverage of risks – Certain credit, market, and operational risks were not fully captured under existing rules.
Basel IV was designed to close these gaps.
Core Elements of Basel IV
1. Credit Risk Reforms
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Stricter standardized approaches for credit risk, with more risk sensitivity.
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Revised risk weights for exposures such as residential real estate, commercial property, and corporates.
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Removal of the option for banks to use internal models for low-default portfolios (e.g., certain corporates, banks, and equity exposures).
2. Operational Risk
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Replacement of multiple existing approaches (Basic Indicator, Standardized, Advanced Measurement) with a single Standardized Measurement Approach (SMA).
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Capital requirements now link more directly to banks’ income and historical operational loss experience.
3. Market Risk (FRTB – Fundamental Review of the Trading Book)
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Introduces stricter definitions of the trading book vs. banking book.
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New standardized approach and internal models approach for market risk.
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More sensitivity to liquidity horizons and risk factors.
4. Output Floor
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The most controversial element:
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Banks using internal models must maintain RWAs at least 72.5% of what they would be under the standardized approach.
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Designed to limit variability in RWAs between banks and increase comparability.
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5. Leverage Ratio Adjustments
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Introduction of a leverage ratio buffer for Global Systemically Important Banks (G-SIBs).
Basel IV Timeline of Key Dates
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December 2017 – Basel Committee finalizes Basel III reforms, unofficially called Basel IV.
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January 2023 – Basel IV implementation begins in most jurisdictions (delayed by one year from the original 2022 schedule due to COVID-19).
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January 2025 – EU and other jurisdictions align their local Capital Requirements Regulation (CRR3) and Directive (CRD VI) with Basel IV.
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January 2028 – Full global implementation of Basel IV expected, including the 72.5% output floor and all revised risk frameworks.
Expected Impact of Basel IV
For Banks
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Higher capital requirements for certain exposures, particularly real estate and large corporates.
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Reduced reliance on internal models, forcing banks to rely more on standardized approaches.
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Operational risk capital increases for banks with high historical loss profiles.
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Pressure on profitability, as stricter rules reduce return on equity (ROE).
For Regulators
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Greater comparability across banks globally.
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Reduced systemic risk and improved transparency.
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Stronger confidence in capital adequacy metrics.
For Markets
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Large, complex banks will face higher compliance and reporting costs.
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Smaller banks may benefit, as reliance on standardized approaches reduces competitive imbalances.
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Lending patterns may shift, with higher capital charges affecting real estate and corporate lending.
Criticisms of Basel IV
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Cost of compliance – Implementation requires major IT and reporting upgrades.
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Credit supply impact – Some argue stricter capital rules will reduce banks’ willingness to lend.
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Global inconsistencies – Different timelines in different regions (e.g., EU, US, Asia) could create competitive imbalances.
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Complexity – Despite simplification efforts, the reforms remain highly technical.
Basel III vs. Basel IV: What Changed
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Basel III: Focused on capital quality, buffers, leverage, and liquidity standards.
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Basel IV: Focuses on risk measurement consistency, model restrictions, and the output floor.
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Basel III made banks stronger; Basel IV makes their capital ratios more credible and comparable.
Conclusion
Basel IV represents a critical milestone in the global regulation of banks. While it is technically the finalization of Basel III, its scope and impact are profound enough to warrant its own identity. By 2028, when Basel IV is fully implemented, the international banking system will operate under a far stricter and more standardized regime.
The reforms may reduce profitability and lending flexibility, but they aim to restore trust, comparability, and resilience across the banking sector. For regulators, investors, and society, Basel IV is not just about numbers — it is about ensuring stability in an interconnected financial world.
