VIDEO | A brief history of Basel regulation, and what this means for bank guarantees

VIDEO | A brief history of Basel regulation, and what this means for bank guarantees - Trade Treasury Payments

At ICC Austria’s Trade Finance Week in Vienna, Trade Treasury Payments (TTP) spoke with Mireille Troosters, Trade Finance Specialist at KBC Bank, to better understand the regulatory journey behind Basel and how its evolution is reshaping the treatment of trade finance instruments.

Troosters said, “Basel regulations began in 1988 with two main objectives: to create a level playing field for banks globally, and to ensure that banks were robust enough to absorb losses in a crisis and continue supporting the economy.”

While the original Basel framework helped set the foundation for international capital standards, subsequent global financial shocks revealed major shortcomings. The 2008 crisis in particular exposed deep inconsistencies in how banks calculated capital, prompting regulators to rein in model variability.

Troosters said, “Banks had too much lenience in developing internal models, which led to uneven capital requirements. Institutions that could afford to build complex models often benefited from lower capital charges, undermining both the level playing field and systemic stability.”

In response, regulators introduced a more standardised and risk-sensitive framework, widely referred to in Europe as Basel IV (or Basel 3.1). The new rules aim to narrow the gap between internal models and standardised approaches by imposing stricter capital floors and recalibrating how different exposures are treated.

One key change affects how bank guarantees and letters of credit are reflected on a bank’s balance sheet.

Troosters said, “When a bank issues a guarantee or letter of credit, it’s not an asset, it’s a contingent liability. The vast majority of these instruments never result in an actual payout, but banks still need to set aside capital in case something does go wrong.”

Under the updated framework, the credit conversion factor (CCF) for trade-related contingent liabilities is increasing. This means that instruments historically recognised as low risk (like bank guarantees) will now require more capital to be held against them, despite decades of performance data showing exceptionally low default rates in trade finance.

Troosters said, “It’s a frustrating outcome, because trade finance has proven to be low risk for over 25 years. But the new modelling makes it more expensive for banks and, ultimately, their clients.”

With implementation timelines drawing nearer, the discussion around Basel’s impact on trade finance is likely to intensify. Institutions will need to revisit how they price, structure, and support guarantees in a more capital-sensitive environment.