Neil Esho: Stick to the Core Principles

18 September 2023
Knowledge Base

On 13 September, Neil Esho, Secretary General of the Basel Committee on Banking Supervision, at the Eurofi Financial Forum 2023, Santiago de Compostela. When asked how he went bankrupt, Mike Campbell, a Scottish war veteran who features in Hemingway’s novel, The Sun Also Rises, responded: “two ways: gradually and then suddenly”. This description of financial failure – clearly not new – is also an apt description that sums up many an episode of banking distress. This includes the failure of a number of US regional banks earlier this year, and the merger of two large Swiss G-SIBs.

In the US case, there was a build-up of excessive interest rate risk and a concentration of unstable funding sources, before the sharp rise in interest rates triggered a realisation that the banks’ tech-focused business models were particularly susceptible and the capital and liquidity resources available to cover such risks were inadequate. In the case of Credit Suisse, the gradual build-up of issues was perhaps even longer and more public. They included large losses linked to Archegos and Greensill Capital, fundamental weaknesses in risk management and governance, various scandals, reporting weaknesses, and repeated changes in management and strategy. The final loss of confidence in the viability of the business model was also sudden.

Strong capital and liquidity buffers can buy bank managers and supervisors time to rectify weaknesses. But, unless weaknesses are addressed with sufficient urgency, that time can suddenly run out. So gradually then suddenly has been a common theme throughout the history of banking crises – the gradual build-up of vulnerabilities, followed by the sudden materialisation of losses. While the specific causes of banking crisis may differ, they drive home the same set of lessons: the need for strong and effective supervision and a comprehensive regulatory framework for banks.

The Chair of the Basel Committee, Pablo Hernández de Cos, will speak on Thursday about the implications of the banking turmoil for the work of the Basel Committee. Today I will focus my remarks on the Core principles for effective banking supervision, better known as the “Basel Core Principles”. For supervisors around the world, the journey to compliance with the Basel Core Principles is something of a pilgrimage. Like the Camino de Santiago, it can be a long journey, but one which is well worth the effort.

The Committee issued a consultative document proposing revisions to the Core Principles in July this year. Originally published in 1997, the Core Principles are the de facto minimum standards for the sound prudential regulation and supervision of all banks and banking systems. Their rationale, a recognition that weaknesses in the banking system of a country, whether developing or developed, can threaten financial stability both within that country and internationally, remains highly relevant given the turmoil earlier this year.

The Core Principles provide a framework for strengthening prudential supervision in all countries, and so are designed to be universally applicable – that is, unlike the Basel Framework, which is intended for internationally active banks, the Core Principles accommodate a broad spectrum of banks and range of different banking systems. To be capable of universal application, the principles aim to be simple, flexible and outcome-oriented rather than prescriptive on process.

In total, there are 29 core principles, which are broadly grouped according to the expectations of supervisory authorities (CPs 1–13) and those of banks (CPs 14–29).

The Core Principles are comprehensive, and so are used as a minimum standard by which banking supervisors can assess the effectiveness of their regulatory and supervisory frameworks. The International Monetary Fund (IMF) and World Bank also use them as part of their Financial Sector Assessment Program (FSAP) to evaluate the effectiveness of countries’ banking supervisory systems and practices. Over 100 different jurisdictions have undergone assessment against the Basel Core Principles as part of FSAPs – and so they are a truly global standard.

The proposed amendments to the Core Principles

Why are the Core Principles being reviewed now and what are the proposed changes?

The Core Principles are intended to be a “living” standard that evolves over time in response to global financial developments, emerging risks and trends, and changes to the global regulatory landscape. Since their introduction, the Core Principles have been revised twice: first in 2006 and most recently in 2012. Given that over a decade has passed since the last update, the Committee considered that it was time to comprehensively review the standard and started the current review about a year ago.

To ensure that the revised standard reflects the global experience of banking supervision, a Task Force comprising both Committee and non-Committee member jurisdictions, as well as the IMF and World Bank was formed to carry out the review.

The current review has been informed by a range of inputs, including:

  • the effect of recent structural changes affecting the banking system;
  • supervisory and regulatory developments over the past 10 years;
  • lessons learnt in implementing the 2012 update to the Core Principles; and
  • experiences gained from the IMF and World Bank’s FSAPs since 2012.

A careful examination and consideration of these inputs has resulted in proposed changes to the standard that can be grouped into six thematic topics.

First, financial risks and macroprudential supervision, where the Core Principles have been strengthened to reflect key elements of many of the post-global financial crisis reforms. These include, in particular, the introduction of a leverage ratio to complement the risk-weighted framework; enhancements to credit risk management practices; the introduction of expected credit loss approaches to provisioning; and more stringent requirements for managing large exposures and related party transactions.

The last 10 years have also reaffirmed the importance of applying a system-wide macro perspective to the supervision of banks. As a broad financial system perspective is integral to many of the principles, the existing requirements have been strengthened based on lessons learnt. This includes the importance of cooperation between supervisors and authorities with responsibility for macroprudential policy, having a process to identify domestic systemically important banks, and the value of having flexible buffers that can be used in periods of stress.

Given that the Core Principles are outcomes-focused, the proposed adjustments do not require non-Committee member jurisdictions to implement the Basel III Framework in order to comply with the principles. Rather, the changes are intended to reflect key elements of the Basel III reforms, such as the leverage ratio and capital buffers, but they allow for these to be implemented in a simpler and proportionate manner.

The second thematic topic is operational resilience, where significant supervisory efforts have focused on ensuring that banks are better able to withstand, adapt to and recover from severe operational risk-related events. For example, disruption from pandemics, cyber attacks, technology failures and natural disasters. The proposed revisions aim to incorporate elements from the Committee’s Principles for operational resilience and revised Principles for the sound management of operational risk. This includes enhancements to governance, business continuity planning and testing, third-party dependency management and resilient cyber security.

Third are climate-related financial risks, where changes have been proposed to improve supervisory practices and banks’ risk management, reflecting elements of the Committee’s Principles for the effective management and supervision of climate-related financial risks. We expect banks to understand how climate-related risk drivers may manifest themselves through financial risks, recognise that these risks could materialise over varying time horizons, and implement appropriate measures to mitigate these risks. Supervisors are also expected to consider climate-related financial risks in their supervision of banks and should be able to assess banks’ risk management processes.

Fourth is the digitalisation of finance and non-bank financial intermediation (NBFI). Financial intermediation has evolved significantly since the last update to the Core Principles, prompted by rapid advances in financial technology and the proliferation of NBFIs. While the Core Principles are designed to apply to banks, supervisors should also remain alert to the risks arising from NBFI activities and their potential impact on the banking system.

The proposed revisions reinforce the group-wide approach to supervision by ensuring that supervisors can access all relevant information (wherever records are located) and review the overall activities of the banking group, including those that may be undertaken by service providers. The proposals also recognise that risks can arise from a range of different NBFIs, and strengthen requirements for supervisory monitoring and for banks to manage their counterparty risks.

The fifth thematic topic is risk management practices, where the proposed revisions aim to reinforce the importance of banks instituting a sound risk culture, maintaining strong risk management practices, and adopting and implementing sustainable business models. This includes amendments to enhance corporate governance, including board independence, renewal and diversity, and to give greater emphasis to risk appetite frameworks and risk data aggregation.

And finally, the sixth thematic topic is lessons learnt since the last review, which has informed several of the proposed changes. Here, the proposed amendments seek to enhance supervisory transparency, decision-making and legal protections. We have also proposed a broader strengthening of the standard by upgrading several existing additional criteria to essential criteria, including those relating to corrective and sanctioning powers, consolidated supervision, corporate governance, interest rate risk in the banking book and liquidity risk.

This proposal reflects our understanding that these requirements are no longer aspirational, but rather that practices have evolved sufficiently enough for these expectations to be reasonably embedded within the minimum standard.

Underpinning all the principles is the concept of proportionality. Here it is important to clarify – and we have also tried to do so in the standard itself – that proportionality does not mean lower or less conservative standards. Rather, it reflects the idea that rules and supervisory practices are commensurate with banks’ systemic importance and risk profiles, and that they are appropriate for the broader characteristics of a particular financial system.


The public consultation on the Basel Core Principles will close early next month. I encourage you to take advantage of the opportunity to provide feedback to the Committee. Given that the Core Principles are a global standard, the Committee is keen to hear from a broad range of stakeholders. After carefully reviewing all the comments received, we hope to publish the final revised standard around the middle of next year.

As I mentioned at the start, the banking turmoil of March 2023 has reinforced the importance of effective risk management and supervision. Despite the Core Principles now being in effect for over 25 years, some principles consistently receive weak ratings across jurisdictions. This is seen across institutional arrangements and supervision – for example, independence, accountability, resourcing and legal protection for supervisors (CP2) and corrective actions and sanctioning powers (CP11) – and banks’ governance and risk management practices, including transactions with related parties (CP20) and problem assets, provisions and reserves (CP18).

Our objective – and also our challenge throughout this process – is to raise the bar for supervisory and bank practices, while also keeping the principles universally applicable. While full implementation of the Core Principles by all countries is not a guarantee against bank failure, it provides a good basis for developing effective supervisory systems, and it would be a significant step towards improving banking system resilience and financial stability both domestically and internationally.

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