Core Path · L1.2.09

Regulators and supervisors

12 minRegulationInstitutions

Math Atoms

By the end you will be able to

  1. 1Map who sets global standards (BCBS, IAIS, IOSCO, CPMI, FSB, IASB) and explain why they need national authorities to act.
  2. 2Match the main standards to the bodies that write them.
  3. 3Name the main supervisors in the US, EU, UK and Asia-Pacific, and the models they follow.
  4. 4Calculate a bank's basic Basel III capital requirements.

Why it matters

A rule agreed in a meeting room in Basel, Switzerland, decides how much capital a bank in São Paulo, Sydney or Seoul must hold. The committee that writes it has no legal power at all. How does that work?

Core explanation

Who writes the rules, who checks them

Every institution in this module, from banks and insurers to CCPs and fund managers, works under rules. Those rules come from two very different kinds of body, and telling them apart is the key to the whole system.

Standard setters (global)

International committees where national authorities agree common rules. They have no legal power over firms: a standard setter relies on its members to put the rules into national law. They are like a recipe that every member promises to cook.

Regulators and supervisors (national)

Authorities with powers in law. A regulator writes binding rules; a supervisor checks each firm, visits it, and can fine it, limit its business or close it. Often one authority does both.

The global standard setters.

BodyCoversBest-known standards
BCBS (Basel Committee on Banking Supervision)BanksBasel III: capital, leverage, LCR, NSFR
IAIS (International Association of Insurance Supervisors)InsurersInsurance Core Principles; Insurance Capital Standard
IOSCO (International Organization of Securities Commissions)Securities marketsObjectives and Principles of Securities Regulation
CPMI (Committee on Payments and Market Infrastructures)Payments, CCPs, depositoriesPFMI, written jointly with IOSCO
FSB (Financial Stability Board)The whole system; coordinates the others for the G20Key Attributes of Effective Resolution Regimes; list of global systemically important banks
IASB (International Accounting Standards Board)Company accountsIFRS, including IFRS 9 and IFRS 17

The BCBS, CPMI and FSB are hosted in Basel by the Bank for International Settlements (BIS), the central banks' own bank. The IASB is different: it is a private, independent board, overseen by the IFRS Foundation, whose standards are adopted by law in many countries. The US uses its own accounting rules, US GAAP, set by the FASB.

TimelineHow the global rulebook grew

1 / 9

1974

Basel Committee founded

After the failure of Bankhaus Herstatt, G10 central bank governors set up the BCBS.

ExploreFrom a meeting in Basel to a bank in your town

Click a box to see what happens there.

G20

Leaders of the largest economies agree what must change, for example after the 2008 crisis: more and better bank capital, central clearing of derivatives, an end to “too big to fail”.

Sort itWho wrote it?

Match each standard to the body that sets it.

  • The Liquidity Coverage Ratio (LCR)

  • IFRS 9: how firms account for financial instruments

  • The Insurance Capital Standard

  • Key Attributes of Effective Resolution Regimes

  • Objectives and Principles of Securities Regulation

Three jobs, three ways to organise them. Supervision covers three jobs: prudential (is the firm safe?), conduct (does it treat customers and markets fairly?) and macroprudential (is the whole system safe?). Countries split these jobs in different ways:

  • Sectoral: one authority per type of firm (banks, insurers, securities), as in the US, Hong Kong and mainland China.
  • Integrated: one authority for everything, as in Japan and Singapore.
  • Twin peaks: one authority for prudential safety, another for conduct, as in the UK, Australia and the Netherlands.

ExploreWho supervises what

Pick a region, then a sector to see who is responsible.

Sectoral and layered: many agencies, split by type of firm, with states as well as federal bodies.

  • Fed

    Federal Reserve

    Bank holding companies and many banks; also the central bank.

    BanksSystem

  • OCC

    Office of the Comptroller of the Currency

    Charters and supervises national banks.

    Banks

  • FDIC

    Federal Deposit Insurance Corporation

    Insures deposits, supervises some state banks, resolves failed banks.

    Banks

  • SEC

    Securities and Exchange Commission

    Securities markets, broker-dealers, funds and their managers.

    MarketsConduct

  • CFTC

    Commodity Futures Trading Commission

    Futures, options on futures and most swaps.

    Markets

  • States + NAIC

    State insurance regulators

    Each state regulates insurers; the NAIC coordinates standards.

    InsurersConduct

  • CFPB

    Consumer Financial Protection Bureau

    Consumer protection for loans, cards and payments.

    Conduct

  • FSOC

    Financial Stability Oversight Council

    Brings the agencies together to watch system-wide risk.

    System

The formal version

The best-known Basel standard is a precise ratio. A bank's common equity tier 1 (CET1) capital is divided by its risk-weighted assets (RWA), in which a safe government bond might count for nothing and a business loan for its full amount:

CET1 ratio=CET1 capitalRWA  ≥  4.5%+2.5% buffer\text{CET1 ratio} = \frac{\text{CET1 capital}}{\text{RWA}} \;\ge\; 4.5\% + 2.5\% \text{ buffer}

A second, simpler test ignores risk weights altogether, as a backstop:

Leverage ratio=Tier 1 capitaltotal exposure  ≥  3%\text{Leverage ratio} = \frac{\text{Tier 1 capital}}{\text{total exposure}} \;\ge\; 3\%

Both are shown in full: they are simple percentages. How risk weights are set is a large topic of its own, covered in later levels.

Try it

A bank with A$300.0bn of risk-weighted assets holds A$36.0bn of CET1: a ratio of 12.0%. Lower its capital until it enters the buffer, then below the minimum, and read what happens at each stage. Then raise its risk-weighted assets, as if it had made riskier loans.

Try itCheck a bank against Basel III

A$300.0bn
A$36.0bn
CET1 ratio12.0%
Minimum (4.5%)A$13.5bn
With buffer (7%)A$21.0bn
0%minimum · buffer16%

Above the buffer: no Basel restrictions apply, though supervisors may ask for more.

Worked example

One rule, from Basel to Sydney

Follow Basel III's capital rule to a made-up Australian bank with A$300.0bn of risk-weighted assets, A$700.0bn of leverage exposure and A$36.0bn of CET1 capital.

Tracing the rule

Step 1 of 5
  1. 1

    The global standard

    The BCBS agrees minimum CET1 of 4.5% of RWA, a 2.5% conservation buffer, and a 3% leverage ratio. Australia, as a member, commits to apply them.

Regulatory lens · looking ahead

This lesson is the map for the rest of the course. You will meet these bodies again and again:

  • BCBS: Basel III capital and liquidity rules, the market risk framework (FRTB) and IRRBB.
  • IAIS and EU law: Solvency II and the Insurance Capital Standard for insurers (L1.2.03).
  • CPMI-IOSCO: the PFMI for CCPs and payment systems (L1.2.07).
  • FSB: resolution regimes, the list of global systemically important banks, and work on non-bank finance (L1.2.04, L1.2.06).
  • IASB and FASB: IFRS 9 and CECL for credit losses, IFRS 17 for insurers.

The final Basel III reforms, agreed in 2017, have been adopted on different timetables around the world; the BCBS publishes progress reports. Later levels study the rules themselves.

Sparks

SparkThe bank that closed at lunchtime
On 26 June 1974, German regulators closed Bankhaus Herstatt at the end of the German business day. Banks that had already paid it Deutsche marks in currency trades never received the US dollars due to them later that day in New York. The shock led central bank governors of the G10 to set up the Basel Committee later that year. The risk of paying one leg of a trade and not receiving the other is still called Herstatt risk.
SparkTwin peaks began as a paper
The “twin peaks” idea was set out by Michael Taylor in a 1995 paper for the Centre for the Study of Financial Innovation in London. Australia adopted it first, in 1998; the UK moved to it in 2013.

Key takeaways

  • Global standard setters (BCBS, IAIS, IOSCO, CPMI, FSB, IASB) agree rules but have no legal power over firms.
  • National regulators write the rules into law; supervisors check individual firms and enforce them.
  • The FSB coordinates the others for the G20; the BIS hosts the Basel-based committees; the IASB writes IFRS.
  • Countries organise supervision sectorally (US, Hong Kong, China), in one integrated body (Japan, Singapore) or as twin peaks (UK, Australia).
  • Basel III's core test: CET1 ≥ 4.5% of RWA plus a 2.5% buffer, backed by a 3% leverage ratio.

Reaction

Check what stuck

Question 1 · objective 4

A bank has US$500bn of risk-weighted assets. Under Basel III, how much CET1 capital must it hold to meet the 4.5% minimum plus the 2.5% conservation buffer, in US$ billions?

US$bn

Question 2 · objective 4

The same bank's leverage exposure (all its assets, unweighted, plus some off-balance-sheet items) is US$800bn. What is the minimum Tier 1 capital under the 3% leverage ratio, in US$ billions?

US$bn

Question 3 · objective 1

What legal power does the Basel Committee have over banks?

Question 4 · objective 2

Which body issues IFRS 17, the accounting standard for insurance contracts?

Question 5 · objective 3

Under the UK's twin peaks model, who supervises how a bank treats its customers?

Glossary

Standard setter
A body that agrees common rules among its members but has no legal power to enforce them.
Regulator
An authority that writes binding rules for firms under powers given by law.
Supervisor
An authority that checks, day to day, that individual firms follow the rules, and can act if they do not.
Prudential
Supervision aimed at the safety and soundness of firms: capital, liquidity and risk management.
Conduct
Supervision of how firms treat customers and behave in markets.
Macroprudential
Policy aimed at the stability of the financial system as a whole, rather than single firms.
Twin peaks
A model with one regulator for prudential safety and another for conduct.
Risk-weighted assets
Risk-weighted assets: a bank's assets, each scaled by a weight for how risky it is.
CET1
Common equity tier 1: the highest-quality capital, mainly ordinary shares and retained profits.
Resolution
Handling a failing firm in an orderly way, so that its critical services continue and taxpayers do not pay.

Deep Dives & Origins

Deep Dives

  • Goodhart, The Basel Committee on Banking Supervision: A History of the Early Years, 1974–1997, Cambridge University Press, 2011. Intermediate.
  • Bank for International Settlements, Financial Stability Institute, FSI Connect tutorials and the online Basel Framework. Intermediate.

Origins

  • Basel Committee on Banking Supervision, The Basel Framework (consolidated standards), BIS.
  • Basel Committee, “History of the Basel Committee”, BIS website.
  • Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions, 2011 (updated 2014).
  • IOSCO, Objectives and Principles of Securities Regulation; IAIS, Insurance Core Principles.
  • Taylor, Twin Peaks: A Regulatory Structure for the New Century, CSFI, 1995.

Module complete

You have met every kind of institution in the financial system and the bodies that regulate them. Try the Lab Test for Module 1.2 →

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Central banks

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The time value of money