Basel reforms’ effectiveness during the COVID-19 pandemic

This is my sixth post for “Risk Insights”, entitled “Basel reforms’ effectiveness during the COVID-19 pandemic”.

I came across an insightful paper published in July 2021 by the Basel Committee of Banking Supervision (BCBS) titled “Early lessons from the Covid-19 pandemic on the Basel reforms” (link here). So, following my last three posts, “Overview of Basel I: the Capital Accord” (link here), “Overview of Basel II: the New Capital Framework” (link here) and “Overview of Basel III: responding to the 2007–9 financial crisis” (link here), the story of the Basel Accords continues.

Disclaimer: This post is not designed to provide a comprehensive summary of the paper; instead, it will cover a few findings using a simplistic explanation, so that someone with no, or a limited, background in risk will be able to quickly grasp a few concepts in risk management.

The BCBS report is an interim preliminary report assessing the effectiveness of the post-global 2007–9 financial crisis Basel reforms in the context of the COVID-19 pandemic on a global scale. This report contributes to the BCBS's broader work programme to evaluate the adoption of Basel reforms by its member states against its main objectives of strengthening the resilience of the global banking system. This review uses various public and private data, case studies and the supervisory survey result in conducting various empirical analyses.

To sum up, the initial finding reveals that the better and higher-quality capital and liquidity level required by the Basel reforms since 2009 has contributed positively to the ability of global financial institutions to absorb and cushion the significant impact of the COVID-19 shock. The study has so far seen a positive value of a robust regulatory framework. In comparison with the 2007-9 financial crisis, banks can absorb the unprecedented negative economic shocks caused by the COVID-19 pandemic rather than amplifying them through the financial system, resulting in a systemic risk. Various combinations of capital buffers, such as capital conservation buffer, countercyclical capital buffer, global systemically important bank buffer, domestic systemically important bank or other systemic buffers, have been introduced or used to absorb losses in times of stress, as well as helping to maintain the provision of key financial services. The report states that the global banking system has remained resilient overall throughout the COVID-19 pandemic, which is partly evident by banks continuing to provide credit to the real economy and other critical financial services.

This interim report states that it is still too early to draw a strong conclusion regarding buffer usability, and further study will be required to better understand why banks are reluctant to use capital buffers. Such reluctance could be driven by the wider market stigma of a negative impression, uncertainty about future profitability, supervisory response, and so on.

The above has highlighted a few key insights. Several inconclusive areas identified in this interim report will continue to be monitored by the BCBS and further reviews when additional data becomes available. The final report, with more in-depth analysis and comprehensive evaluation, is currently scheduled for 2022. As mentioned in my last post (link here), the Basel Accords allow us to enhance risk management practice collectively, and the BCBS work programme is testing the Basel reform efforts on a global scale.?

If you want to read the detailed analysis, the BCBS paper can be found at the link shared earlier. Also, the Bank of England made a short speech titled “Emerging prudential lessons from Covid stress” (link here), and the Financial Stability Board (FSB) published an interim report titled “Lessons Learnt from the COVID-19 Pandemic from a Financial Stability Perspective” (link here). The paper from the FSB not only covered capital and liquidity resilience but also gave some insights into operational and cyber resilience, among other things. Both publications provide additional insights into the Basel reforms’ effectiveness during the COVID-19 pandemic and some initial lessons learnt.

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?All the best and have a good day!