Outline Basel II/III, Solvency II and CRD IV:

What is Basel II & III?

Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision (BCBS). The purpose of Basel II, which was initially published in June 2004, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Advocates of Basel II believe that such an international standard can help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse.

In practice, Basel II attempts to accomplish this by setting up rigorous risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.

Basel III (or the Third Basel Accord) is a global, voluntary regulatory standard on bank capital adequacy, stress testing and market liquidity risk. It was agreed upon by the members of the BCBS in 2010–11, and was scheduled to be introduced from 2013 until 2015; however, changes from April 1, 2013 extended implementation until March 31, 2018. The third instalment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the late 2000s financial crisis. Basel III was supposed to strengthen banks capital requirements by increasing bank liquidity and decreasing bank leverage.

Unlike Basel I and Basel II which are primarily related to the required level of bank loss reserves that must be held by banks for various classes of loans and other investments and assets that they have, Basel III is primarily related to the risks for the banks of a run on the bank by requiring differing levels of reserves for different forms of bank deposits and other borrowings. Therefore contrary to what might be expected by the name, Basel III rules do not for the most part supersede the guidelines known as Basel I and Basel II but work alongside them.

What is Solvency II?

Solvency II is the updated regulatory requirements for insurance firms that operate in the European Union. It is scheduled to come into effect on 31 Dec 2012. FSA's website states that the EU directive is due to be implemented on 1 November 2012.  Sometimes referred to as Basel for the Insurance Sector.

The rationale for European Union insurance legislation is to facilitate the development of a Single Market in insurance services in Europe, whilst at the same time securing an adequate level of consumer protection. The third-generation Insurance Directives established an "EU passport" (single licence) for insurers based on the concept of minimum harmonization and mutual recognition.

Many Member States have concluded that the current EU minimum requirements are not sufficient and have implemented their own reforms, thus leading to a situation where there is a patchwork of regulatory requirements across the EU. This hampers the functioning of the Single Market.

Solvency II will be based on economic principles for the measurement of assets and liabilities. It will also be a risk-based system as risk will be measured on consistent principles and capital requirements will depend directly on this. While the Solvency I Directive was aimed at revising and updating the current EU Solvency regime, Solvency II has a much wider scope.

A solvency capital requirement may have the following purposes:

To reduce the risk that an insurer would be unable to meet claims;To reduce the losses suffered by policyholders in the event that a firm is unable to meet all claims fully;To provide early warning to supervisors so that they can intervene promptly if capital falls below the required level; andTo promote confidence in the financial stability of the insurance sector.  Often called "Basel for insurers," Solvency II is somewhat similar to the banking regulations of Basel II.

For example, the proposed Solvency II framework has three main areas (pillars):

Pillar 1 consists of the quantitative requirements (for example, the amount of capital an insurer should hold).Pillar 2 sets out requirements for the governance and risk management of insurers, as well as for the effective supervision of insurers.Pillar 3 focuses on disclosure and transparency requirements.

What is CRD IV?  

The aim of CRD IV is to minimise the negative effects of firms failing by ensuring that firms hold enough financial resources to cover the risk associated with their business similar to Basel lll.

CRD IV is divided into two legislative instruments:

·         the Capital Requirements Directive (CRD), which the PRA (Prudential Regulation Authority) must transpose into is Handbook, and

·         the Capital Requirements Regulation (CRR), which is directly binding on firms, so the PRA do not need to implement it via the handbook.

The firms we regulate that are subject to CRD IV will need to comply with the CRR, supplemented by technical standards and guidelines from the European Banking Authority (EBA)