Basel IV sounds like the sequel to a bad action movie franchise, and in a way, it is. The action is the wild west of bankers trying to skirt rules to pad profits—a move that creates really bad externalities like the Great Recession of 2007-2009. Regulators need to work fast to combat this, and they do so by creating frameworks that banks must implement to ensure that they are abiding by the rules and not putting their investors, or the broader economy at large, at risk.
“Basel” refers to the Basel Committee on Banking Supervision, a supranational institution that controls the banking industry in Europe by giving it region-wide rules that all banks must follow. Basel IV is the latest iteration of their regulations and, as you would guess, it’s the fourth of a series of efforts (beginning in 1988) to regulate the banks.
Basel I and II are history, but Basel III was an incredibly important milestone in the history of modern banking. Established in 2010 and enacted initially in 2013, the standard still hasn’t been fully adopted, which makes it interesting that it’s already been superseded. Its primary rules relate to capital requirements (a ratio of common equity to risk-weighted assets, essentially ensuring that banks aren’t over-exposed to any type of risky bets) and leverage ratio, which ensures that banks aren’t over-levered. Additionally, liquidity requirements are established by the rules to ensure that a bank run doesn’t result in a freeze of funds that could put a gridlock in the economy and cause a cascade effect of bank failures.
Regulations are rarely praised by the regulated, but Basel III was largely lauded by banks and policymakers as sound policy that ensured the safety of banks without being too onerous. That may explain why Basel IV was established in 2016 (with a deadline to be fully implemented in 2027): it is much stricter, with a focus on a lower leverage ratio that ensures a blowup in one asset class will not cause the banks to fail and thus get bailed out. Critics argue that these rules are far too restrictive in Basel IV, but that doesn’t much matter, as it will be enacted. (A highly technical but still readable overview can be found here.)
Ultimately, these regulations will matter for consultants and accountants, and will not matter much to sales/traders, equity and debt analysts, and more so-called “front office” people in investment banking, asset management, and institutional investment. Nonetheless, the Basel Committee’s moves to handcuff the banking sector are important backdrop for understanding where the future of finance is going.