Basel Committee identifies key lessons from 2023 banking turmoil
The Basel Committee on Banking Supervision (BCBS) has published a report assessing the causes and lessons from the 2023 banking turmoil. This period of stress, which began in March 2023, was the most significant since the Great Financial Crisis.
Supervisory gaps in business models and liquidity
The BCBS report highlights critical lessons for supervision, focusing on weaknesses in business strategies, governance, and risk management practices among the failed banks.
Despite diverse models, these institutions shared common vulnerabilities and were outliers compared to their peers.
Supervisors are urged to assess the short- and medium-term viability of business models, moving beyond mere regulatory ratios to incorporate forward-looking, risk-adjusted profitability measures.
The report also stresses the need for proactive engagement with outlier banks, ensuring they understand and can manage their risks, with engagement intensity aligned to the significance of identified issues.
Furthermore, the turmoil exposed challenges in liquidity risk supervision, calling for enhanced monitoring, increased frequency of data collection, and comprehensive stress testing across banking groups, including entity-level oversight to account for limitations in liquidity transfers during stress periods.
The BCBS is pursuing initiatives to strengthen supervisory effectiveness, including developing practical tools and additional global guidance.
Regulatory framework under scrutiny
While most failed banks in 2023 were not subject to Basel III, the turmoil raised important regulatory questions, particularly regarding liquidity standards.
The observed liquidity outflows far exceeded levels assumed under the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR), influenced by deposit characteristics, negative media, and digital banking.
This prompts questions about broadening the LCR's scope and recalibrating regulatory outflow rates.
Issues also arose concerning trapped liquidity within banking groups and inadequate operational capacity to monetize high-quality liquid assets (HQLAs).
The treatment of held-to-maturity (HTM) securities, which can accumulate large unrealized losses during rate hikes, also came under scrutiny, as their liquidity during stress periods is questionable.
The failures of three US regional banks, largely driven by concentrated interest rate risk in the banking book (IRRBB), underscore the importance of supervisory challenge to key modeling assumptions and practices, as IRRBB is addressed via Pillar 2 and 3, not Pillar 1 requirements.
Beyond rules: The imperative of judgment
The 2023 banking turmoil starkly revealed the limitations of purely rules-based supervision, emphasizing the critical need for timely and forceful interventions even when regulatory requirements are technically met.
While the Basel Framework provides a robust foundation, its effectiveness hinges on proactive supervisory judgment and the ability to anticipate and address outlier risks before they escalate.
The ongoing initiatives to strengthen guidance and tools are welcome, but the core challenge remains the consistent and decisive application of supervisory powers to ensure financial stability.