Basel Committee on Banking Supervision

Proportionality in financial system regulation and supervision may ensure that the applicable rules and supervision practices are consistent with banks’ systemic importance and risk profile, and are appropriate for the broader characteristics of a particular financial system. The Core principles for effective banking supervision (BCPs),1 which are applicable to all banks in all jurisdictions, embed proportionality as a principle. The Basel Framework,2 which sets minimum requirements for internationally active banks in Committee member jurisdictions, also allows for a degree of proportionality by providing options to implement simpler standardised approaches. While the simpler standardised approaches in the Basel Framework may also be suitable for banks that are not internationally active, in some cases regulation might require even further adaptation. This chapter aims to provide support to authorities seeking to implement proportionality in these situations in their domestic frameworks.

In line with its mandate to strengthen the regulation, supervision and practices of banks worldwide to enhance financial stability, the Committee has conducted work on proportionality over a number of years through surveys, discussions and other initiatives.3 This work has revealed that proportionality has been widely adopted and implemented in different ways, while also highlighting many practical policy challenges as authorities seek to balance the regulatory requirements in a way that supports financial stability.

The Committee has developed voluntary high-level considerations to assist authorities with these practical policy challenges. They aim to support the decision-making process of proportionality in a broad variety of jurisdictions, in a way that would not undermine financial stability and/or the safety of financial institutions. These considerations build upon the Committee’s work on proportionality, domestic experiences from across the world, international discussions and academic work, and the broad exchange of views across the supervisory community.

Importantly, these high-level considerations are not a standard and do not contain any prescriptive requirements. They should not be understood as a modification to the Basel Framework, the BCPs or any of the Committee’s standards, guidelines or sound practices. Neither these considerations nor the technical annexes should be utilised in formal assessments of regulation or supervisory practices. For example, they will not be used by the Committee to assess proportionality in member or non-member jurisdictions and will not be used in the Committee’s Regulatory Consistency Assessment Programme (RCAP).

Financial systems are heterogeneous. Characteristics that tend to vary across financial systems include the distribution of banks’ size, international activity, level of sophistication and predominance of domestically owned (including government-owned) versus foreign-owned banks. Some financial systems include both large internationally active banks and small banks serving local communities. Other financial systems consist primarily of small local institutions, some of which might undertake bank-like activities without themselves being banks.

The distribution of banks within a financial system may influence the approach to proportionality. In a number of jurisdictions, simpler rules are implemented for less complex banks in banking systems that also include large, internationally active banks subject to the Basel Framework. For some non-Committee members with simple and homogenous banking systems, applying simpler rules to all banks may be appropriate. However, such simplifications may not be necessarily appropriate for small banks operating in more complex financial markets.

Like financial institutions, supervisory authorities also differ across jurisdictions. For example, supervisory authorities may have different legal powers, organisational arrangements, availability of resources and levels of independence. In general, these factors tend to influence the design and implementation of proportionate regulation and supervision frameworks.

In addition to these overarching issues, authorities are invited to bear in mind the following considerations to help ensure the proportionality approach being considered is consistent with financial system robustness, safeguards financial stability and limits regulatory arbitrage opportunities across and within jurisdictions.

1. Proportionality approaches that are consistent with the BCPs preserve financial stability. The BCPs were designed to be applicable globally, across a range of jurisdictions, financial systems and banking institutions. The BCPs establish the minimum criteria for an effective regulatory and supervisory framework and underpin any proportionate approach. Regardless of the proportionality approach adopted, the BCPs require that all banks have prudent policies and processes to identify, measure, evaluate, monitor, report and control or mitigate risk on a timely basis.
2. The Basel Framework is the standard for internationally active banks. The Framework already embeds a menu of options with various elements of proportionality and flexibility that could be authorities’ first choice whenever appropriate and possible. Alignment with international standards promotes trust in the financial system and prevents regulatory arbitrage and fragmentation. It also streamlines cross-border supervision and facilitates transparency, comparability and understanding of the regulatory framework by international stakeholders.
3. Depending on local circumstances, it might be appropriate to tailor regulation for non-internationally active banks. This includes potentially applying the Basel Framework in its current form (ie Basel III), or earlier or modified forms, for jurisdictions that have simpler banking systems, implemented in a way that is consistent with the underlying objective of the international standard. Such proportionate approaches preserve financial stability through bank safety and soundness. For some banks and banking systems, this might be achieved with rules that are even simpler than the Basel Framework while remaining broadly aligned with the international standards.
4. Effective proportionate approaches strive to be both conservative and simple to understand and implement. The objective of proportionality is to reflect jurisdictions’ circumstances and supervisory capacity, not to dilute the robustness of the standards. This means that any simpler proportionate approaches would be more conservative to compensate for their lower risk sensitivity. As the Basel Framework establishes minimum requirements, more conservative requirements and thresholds may be more suitable in some cases.
5. Proportionality can help authorities achieve an appropriate intensity of supervision for all banks. As per the BCPs, all banks should be subject to supervision commensurate to their risk profile and systemic importance. This is achieved when supervisors maintain sufficient awareness and surveillance of the overall risk profiles, risk management and governance practices of banks, including those that are under simpler proportionate regulatory requirements.
6. Proportionate approaches provide regulatory certainty, without being overly static. Regulatory stability and predictability tend to create favourable operating environments for both banks and supervisors. As with any other regulation, it may be necessary for authorities to revise the scope and range of proportionate approaches as the financial system evolves, banks’ business models change and supervisors’ powers, skills and capabilities improve. In any case, it is important that proportionality is seen as a stepping stone in the implementation of international standards, and that the design of a proportionate approach can facilitate potential future implementation of the Basel Framework, where appropriate.
7. Proportionality approaches that include supervisory discretion allow supervisors to respond to bank behaviours and financial system developments. Supervisors are encouraged to ensure that proportionality approaches do not create opportunities for regulatory arbitrage or particular (dis)incentives for any group of banks. In general, simple segmentation rules work well for most, but not necessarily all, banks. In addition, financial systems may evolve in ways that are not foreseen when a proportionality approach is first designed. These situations can generally be addressed by supervisors if they retain discretions under the proportionality approach.

The High-level considerations on proportionality (July 2022) include technical annexes which set out illustrative elements. These annexes aim to support jurisdictions in addressing specific policy challenges related to proportionality, such as segmentation of banks, capital definitions, risk-weighted asset calculations, leverage ratios, liquidity requirements, large exposures, supervisory review processes, disclosure requirements, and corporate governance, while maintaining financial stability and aligning with the Basel Core Principles. Additionally, the annexes feature self-guided itineraries, which consist of targeted questions designed to assist authorities in conducting internal discussions and tailoring proportionality approaches to their unique financial system characteristics and supervisory capacities.