brainbytes-dev Basel III/IV Framework
Capital requirements, liquidity ratios, leverage — comprehensive Basel regulatory framework for banking supervision.
When to Activate
- Capital adequacy calculations (CET1, Tier 1, Total Capital)
- Risk-weighted asset computation (credit, market, operational risk)
- Liquidity ratio analysis (LCR, NSFR)
- Leverage ratio assessment
- Capital buffer requirements
- FRTB (Fundamental Review of the Trading Book) implementation
- Basel IV output floor impact analysis
- Regulatory capital planning and stress testing
Core Concepts
Capital Structure
Common Equity Tier 1 (CET1) — highest quality:
- Common shares, retained earnings, accumulated OCI (with adjustments)
- Deductions: goodwill, intangible assets, deferred tax assets (threshold), investments in financial institutions
- Minimum requirement: 4.5% of RWA
Additional Tier 1 (AT1):
- Perpetual instruments with loss-absorption features (CoCos — contingent convertibles)
- Write-down or conversion trigger at CET1 ratio of 5.125% (or higher)
- AT1 + CET1 minimum: 6.0% of RWA
Tier 2 Capital:
- Subordinated debt (minimum 5-year original maturity, amortized in last 5 years)
- Eligible provisions (up to limit)
- Total Capital minimum: 8.0% of RWA
Capital Requirements Summary
Minimum + Conservation + Countercyclical + G-SIB
CET1 4.5% 7.0% 7.0-9.5% 8.0-10.5%
Tier 1 6.0% 8.5% 8.5-11.0% 9.5-12.0%
Total Capital 8.0% 10.5% 10.5-13.0% 11.5-14.0%
Capital Buffers
| Buffer | Size | Trigger | Effect when breached |
|---|---|---|---|
| Conservation buffer | 2.5% CET1 | Always on | Restrictions on dividends, buybacks, bonuses |
| Countercyclical buffer | 0-2.5% CET1 | Set by national authority based on credit cycle | Restrictions on distributions |
| G-SIB surcharge | 1.0-3.5% CET1 | Systemically important banks (buckets 1-5) | Restrictions on distributions |
| D-SIB surcharge | Varies | National authority designation | Restrictions on distributions |
Risk-Weighted Assets (RWA)
Credit Risk — Standardized Approach:
- Sovereign: 0% (AAA-AA), 20% (A), 50% (BBB), 100% (BB-B), 150% (below B), 100% (unrated)
- Banks: Based on External Credit Assessment or SCRA (Standardized Credit Risk Assessment)
- Corporate: 20-150% based on rating; SME support factor available
- Retail: 75% (regulatory retail), Residential mortgage: 20-70% (based on LTV)
- Commercial real estate: 60-150% (based on LTV and income-producing)
Credit Risk — IRB Approaches:
- Foundation IRB (F-IRB): Bank estimates PD; LGD, EAD, M prescribed by supervisor
- Advanced IRB (A-IRB): Bank estimates PD, LGD, EAD, M
- Key parameters: PD (Probability of Default), LGD (Loss Given Default), EAD (Exposure at Default), M (Maturity)
- RWA = K x 12.5 x EAD, where K is the capital requirement from the IRB formula
Market Risk — FRTB:
- Standardized Approach (SA): Sensitivities-based method (delta, vega, curvature) + Default Risk Charge + Residual Risk Add-on
- Internal Models Approach (IMA): Expected Shortfall (replaces VaR), with liquidity horizons, P&L attribution test, backtesting
- Boundary between banking book and trading book: stricter rules, reduced arbitrage
Operational Risk — Basel IV:
- New Standardized Approach replaces all previous approaches (BIA, TSA, AMA)
- Business Indicator Component (BIC) = Business Indicator x marginal coefficient (alpha)
- Internal Loss Multiplier (ILM) based on historical losses (optional, jurisdictional discretion)
Liquidity Ratios
Liquidity Coverage Ratio (LCR):
LCR = High Quality Liquid Assets (HQLA) / Total net cash outflows over 30 days >= 100%
- HQLA Level 1: Cash, central bank reserves, sovereign bonds (0% risk weight) — no haircut
- HQLA Level 2A: 20% RW sovereign/PSE bonds, covered bonds (AA-) — 15% haircut, max 40% of HQLA
- HQLA Level 2B: Corporate bonds (A+ to BBB-), RMBS (AA), equities — 25-50% haircut, max 15% of HQLA
- Cash outflows: Retail deposits (3-10%), unsecured wholesale (5-100%), secured funding, derivative obligations
- Cash inflows: Contractual inflows capped at 75% of outflows
Net Stable Funding Ratio (NSFR):
NSFR = Available Stable Funding (ASF) / Required Stable Funding (RSF) >= 100%
- ASF: Weighted liabilities and equity (weight 0-100% based on stability)
- RSF: Weighted assets and off-balance sheet exposures (weight 0-100% based on liquidity)
- Ensures stable funding for assets over 1-year horizon
Leverage Ratio
Leverage Ratio = Tier 1 Capital / Total Exposure Measure >= 3%
- Exposure measure: On-balance sheet items + derivative exposures (SA-CCR) + SFT exposures + off-balance sheet items
- Non-risk-based backstop to risk-weighted capital requirements
- G-SIB leverage ratio buffer: 50% of G-SIB surcharge
Basel IV — Output Floor
- IRB banks: RWA cannot be less than 72.5% of standardized approach RWA
- Phase-in: 50% (2023) rising to 72.5% (2028) — timelines vary by jurisdiction
- Significant impact for banks with low-risk portfolios (e.g., residential mortgages)
Methodology
Capital Adequacy Assessment
- Classify capital instruments: CET1, AT1, Tier 2 — apply deductions and adjustments
- Calculate credit risk RWA: Standardized or IRB approach for each exposure class
- Calculate market risk RWA: SA or IMA under FRTB rules
- Calculate operational risk RWA: New Standardized Approach (BIC x coefficient)
- Apply output floor: Max(IRB RWA, 72.5% x SA RWA)
- Compute capital ratios: CET1%, Tier 1%, Total Capital%
- Assess buffer requirements: Conservation + countercyclical + systemic
- Identify shortfall or surplus: Actual ratios vs. requirements including buffers
LCR Calculation Steps
- Inventory HQLA: Classify Level 1, 2A, 2B; apply haircuts and caps
- Calculate cash outflows: Apply run-off factors to each liability/commitment category
- Calculate cash inflows: Apply inflow rates to maturing assets (cap at 75% of outflows)
- Net cash outflows: Outflows - min(inflows, 75% x outflows)
- LCR: HQLA / net cash outflows
Stress Testing Integration
- Capital ratios under adverse scenarios (GDP decline, interest rate shock, credit losses)
- Supervisory stress tests (EBA, Fed CCAR/DFAST)
- Internal stress tests informing capital planning
- Reverse stress testing: What scenarios would breach minimum requirements?
Templates
Capital Ratio Computation
Amount (EUR m)
CET1 Capital
Common shares __________
Retained earnings __________
AOCI adjustments __________
(-) Goodwill and intangibles __________
(-) Other regulatory deductions __________
= CET1 Capital __________
AT1 Capital __________
Tier 1 Capital (CET1 + AT1) __________
Tier 2 Capital __________
Total Capital __________
RWA — Credit Risk __________
RWA — Market Risk __________
RWA — Operational Risk __________
RWA — Output Floor Adjustment __________
Total RWA __________
CET1 Ratio: ____% (min 4.5% + buffers)
Tier 1 Ratio: ____% (min 6.0% + buffers)
Total Cap Ratio: ____% (min 8.0% + buffers)
LCR Summary
Amount Weight Weighted
HQLA Level 1 _____ 100% _____
HQLA Level 2A _____ 85% _____
HQLA Level 2B _____ 50-75% _____
Total HQLA _____
Cash Outflows
Retail deposits (stable) _____ 3-5% _____
Retail deposits (less stable) _____ 10% _____
Unsecured wholesale _____ 5-100% _____
Secured funding _____ varies _____
Total Outflows _____
Cash Inflows (capped at 75%) _____
Net Cash Outflows _____
LCR = HQLA / Net Outflows = ____%
Quality Gate
- Capital instruments correctly classified (CET1/AT1/T2) with all deductions applied
- Credit risk RWA uses correct approach (SA or IRB) per exposure class
- Market risk captured under FRTB framework (SA or IMA)
- Operational risk uses new standardized approach with correct BIC calculation
- Output floor applied (72.5% of SA RWA, or phase-in percentage)
- All applicable buffers identified (conservation, countercyclical, systemic)
- LCR HQLA composition respects caps (Level 2A: 40%, Level 2B: 15%)
- NSFR available and required stable funding weighted correctly
- Leverage ratio includes all exposure categories (derivatives via SA-CCR)
- Capital planning incorporates stress test results