Basel IV implementation in the EU: what banks need to prepare for

This article is for informational purposes only and does not constitute legal advice. Consult a qualified legal professional for advice specific to your situation.

What Basel IV is and why it matters

Basel IV is the informal name for the final set of reforms to the Basel III framework agreed by the Basel Committee on Banking Supervision in December 2017. The official Basel Committee designation is “Basel III: finalising post-crisis reforms,” which explains why the term Basel IV does not appear in EU legislation. Within the EU, Basel IV is implemented primarily through the Capital Requirements Regulation 3 (CRR3, Regulation (EU) 2024/1623, CELEX: 32024R1623), which amends the original Capital Requirements Regulation (CRR, Regulation (EU) 575/2013, CELEX: 32013R0575).

CRR3 entered into force on 9 July 2024 and applies from 1 January 2025, with a phased implementation schedule for the most significant changes running through to 2030. The accompanying Capital Requirements Directive 6 (CRD6, Directive 2024/1619/EU, CELEX: 32024L1619) makes parallel amendments to the supervisory and governance framework and had a transposition deadline of 10 January 2026.

The reforms address a specific problem that regulators identified in the post-crisis period. Banks using internal models to calculate their capital requirements were producing risk-weighted asset figures that varied widely from bank to bank for economically similar exposures. The variation reflected genuine differences in modelling methodology, but also gaming and optimistic model assumptions. The result was that the risk-weighted asset floors implied by internal models had diverged so far from what standardised approaches would produce that the comparability of capital ratios across institutions had broken down.

Basel IV responds to this by constraining how much capital benefit banks can derive from internal models, strengthening the standardised approaches that act as the floor, and introducing a new framework for market risk. For banks that have relied heavily on internal models to minimise their capital requirements, the reforms represent a material increase in required capital. For banks already operating close to standardised approaches, the impact is more modest.

For a broader overview of how EU financial regulation is structured, see EU financial regulation in 2026: what it covers, who it affects, and why horizon scanning matters. For an explanation of how regulatory technical standards interact with the parent regulation, see what are regulatory technical standards and why they matter more than the regulation itself.

Who CRR3 applies to

CRR3 applies to credit institutions and investment firms within the scope of the original CRR. In practice, this means EU-incorporated banks and their subsidiaries, branches of non-EU banks operating within the EU, and certain investment firms that have not migrated to the Investment Firms Regulation (IFR) regime.

The regulation applies on a consolidated basis at the level of the EU parent undertaking, and on an individual basis at the level of each entity within the group. The supervisory authority for consolidated supervision is determined by the location of the EU parent, and the European Central Bank (ECB) assumes direct supervisory responsibility for significant institutions within the Single Supervisory Mechanism (SSM).

Non-EU banks with EU branches should note that CRR3 applies to those branches in specific respects, and that CRD6 introduces new requirements for third-country branches that go beyond what the original CRD IV framework required. The third-country branch provisions under CRD6 are a material change for US, UK, and Asian banks with EU branch presences, and they interact with the national implementation of CRD6 by individual member states.

The output floor: the central constraint

The output floor is the single most consequential element of Basel IV for banks that use internal models. It establishes that a bank’s internal model-derived risk-weighted assets (RWA) cannot fall below 72.5% of what the standardised approaches would produce for the same portfolio. In other words, internal models can reduce capital requirements relative to standardised approaches, but only down to a floor of 72.5% of the standardised calculation.

The floor applies at the consolidated level and is phased in under CRR3. The phasing schedule is as follows: 50% from 1 January 2025, 55% from 1 January 2026, 60% from 1 January 2027, 65% from 1 January 2028, 70% from 1 January 2029, and 72.5% from 1 January 2030. Banks need to monitor their floor position throughout this transition period, not only at the final destination.

For banks whose internal models produce RWA significantly below the standardised floor, the output floor acts as a binding constraint that overrides the internal model result. The bank must hold capital as if its RWA were the floored figure. The practical consequence is that some banks will need to hold more capital than their internal models would otherwise require, and the benefit of model sophistication is bounded.

The output floor calculation requires banks to compute two parallel RWA figures simultaneously: the internal model figure and the standardised figure. This is a material operational requirement. Banks that have not historically maintained a live standardised approach calculation alongside their internal model calculations need to build that capability into their risk infrastructure.

What the output floor does not do

The output floor constrains the aggregate capital benefit of internal models at the consolidated level. It does not eliminate internal models or require banks to use standardised approaches for individual exposure calculations. A bank can still use an internal ratings-based (IRB) approach for credit risk, an internal model approach for market risk, and an advanced measurement approach for operational risk. The output floor limits the aggregate capital reduction those models can produce relative to the standardised baseline, but the models themselves remain in use for risk management and pricing purposes even where the floor binds.

Revised standardised approaches for credit risk

The standardised approach for credit risk is significantly revised under CRR3. The changes affect how risk weights are assigned to different exposure classes and how external credit ratings are used in the standardised calculation.

Exposures to institutions and corporates

The revised standardised approach introduces more granular risk weight differentiation for exposures to credit institutions and corporates. For exposures to credit institutions, the risk weight now depends on the credit quality step of the institution, derived from its external credit rating where available, with a due diligence requirement that prohibits mechanical reliance on ratings.

For unrated corporate exposures, the revised approach introduces an investment grade (IG) category that allows banks to apply a 65% risk weight to unrated corporates that meet specified criteria, including credit quality characteristics and the absence of financial distress. This is lower than the previous 100% risk weight that applied to most unrated corporate exposures under the standardised approach. The criteria for the IG classification must be applied consistently and documented as part of the bank’s credit risk framework.

Retail exposures

The retail exposure category is restructured under CRR3. The new framework distinguishes between regulatory retail exposures, which qualify for a 75% risk weight, and transactor exposures, which are a subset of revolving retail facilities where the borrower pays in full each cycle and qualifies for a 45% risk weight. The rationale for the transactor category is that borrowers who consistently pay in full exhibit materially lower credit risk than those who carry balances.

Banks need to identify which retail exposures qualify under each sub-category and build the classification into their risk weight assignment process. The transactor classification requires evidence that the borrower has paid in full for the most recent twelve months, which means the supporting data infrastructure must capture payment behaviour at the account level.

Real estate exposures

The real estate exposure framework is substantially revised, with the most significant change being the introduction of loan-splitting for residential real estate exposures. Under the revised approach, the portion of a residential real estate loan up to 55% of the property value receives a 20% risk weight, and the portion above that threshold receives the risk weight of the counterparty under the standardised approach (typically 75% for retail or 100% for corporate). This produces a blended risk weight that is more sensitive to loan-to-value ratios than the previous approach.

Commercial real estate exposures are also revised, with income-producing real estate now treated as a distinct sub-category with risk weights ranging from 70% to 110% depending on loan-to-value. Land acquisition, development, and construction exposures face a 150% risk weight unless specific criteria for a lower 100% weight are met.

The loan-splitting methodology requires banks to track property valuations and loan balances at the exposure level and to apply the split calculation correctly at each reporting date. For banks with large real estate portfolios, this is a meaningful data and systems requirement.

Changes to the IRB approach

CRR3 imposes significant constraints on the use of the internal ratings-based approach for credit risk. The most consequential are the permanent partial use requirements and the removal of the advanced IRB approach for certain exposure classes.

Permanent partial use

Under the original CRR, banks could apply for permission to use the standardised approach permanently for certain exposure classes (permanent partial use), while using IRB for the rest of their portfolio. CRR3 effectively mandates partial use for specific categories by removing the option to use the advanced IRB (A-IRB) approach for those exposures.

Banks can no longer apply A-IRB to exposures to large corporates (defined as entities with consolidated revenues above EUR 500 million), exposures to credit institutions, and exposures to financial institutions. For these categories, banks using IRB must use the foundation IRB (F-IRB) approach, which uses supervisory estimates of loss given default (LGD) and credit conversion factors rather than bank-internal estimates. Banks that have previously used A-IRB for these exposure classes need to transition to F-IRB or the standardised approach.

Revised minimum requirements for IRB models

CRR3 introduces tighter requirements for IRB model development, validation, and use. The minimum number of years of data required for probability of default (PD) estimation is revised, and the criteria for the classification of obligors into rating grades are tightened. The treatment of defaulted exposures under IRB is also revised, with the introduction of a best estimate of expected loss (BEEL) concept that affects how banks calculate LGD for defaulted exposures.

Banks using IRB need to review their model documentation against the revised minimum requirements and assess whether their current models satisfy the new criteria. Where models do not satisfy the revised standards, they must be updated or replaced. The timeline for model updates needs to account for supervisory approval processes, which can take twelve to twenty-four months for material model changes.

The Fundamental Review of the Trading Book

The Fundamental Review of the Trading Book (FRTB) is the market risk component of Basel IV. Under CRR3, it replaces the previous market risk framework with a revised standardised approach (SA) and a revised internal models approach (IMA) for market risk capital.

FRTB applies to banks with significant trading book activity. The thresholds for significance are defined in CRR3, and banks below those thresholds may use a simplified standardised approach rather than the full FRTB framework.

The revised standardised approach under FRTB is more risk-sensitive than its predecessor. It requires banks to calculate a sensitivities-based method (SBM) component, a residual risk add-on (RRAO) for exposures with complex risk profiles, and a default risk charge (DRC). Each of these components requires detailed position-level data and calculation infrastructure.

The revised internal models approach introduces a new concept, the expected shortfall (ES) measure, replacing the previous value-at-risk (VaR) approach. ES is a more conservative risk measure that captures tail losses more completely than VaR. Banks that received approval to use internal models under the previous framework cannot automatically carry over that approval to the FRTB IMA; they must apply for new approval from their supervisory authority.

The FRTB rules under CRR3 apply from 1 January 2025 for capital reporting purposes, but the transition from the legacy market risk framework involves a parallel-run period during which banks must report both legacy and FRTB figures. The operational burden of running two parallel market risk calculations simultaneously is significant for banks with complex trading books.

Operational risk: the new standardised approach

CRR3 replaces all previous operational risk capital approaches, including the basic indicator approach, the standardised approach, and the advanced measurement approach, with a single new standardised approach (SA) for operational risk.

The new SA calculates operational risk capital as the business indicator component (BIC), derived from the bank’s income and expense data across three components: an interest, leases, and dividends component; a services component; and a financial component. Each component uses absolute values of income and expense items to ensure that the measure reflects business volume regardless of accounting presentation.

The Basel IV international standard also introduced an internal loss multiplier (ILM) that adjusts capital based on a bank’s historical operational loss experience. CRR3 does not implement the ILM. The EU exercised the discretion available under the Basel framework to disregard historical operational loss data for all institutions, so the own funds requirement under CRR3 equals the BIC alone. This simplification was chosen to ensure a level playing field within the EU and to avoid the competitive disadvantages that could arise from different institutions’ loss history data having different quality and coverage.

The removal of the advanced measurement approach (AMA) is significant for banks that had invested heavily in sophisticated operational risk models. Those models no longer produce capital benefit under CRR3, though they may retain value for internal risk management purposes. Banks need to recalculate their operational risk capital under the new SA and assess the impact relative to their previous AMA or standardised approach figures.

Credit valuation adjustment risk

Credit valuation adjustment (CVA) risk is the risk of loss arising from changes in the credit valuation adjustment applied to over-the-counter derivatives. CRR3 introduces a substantially revised framework for CVA capital, replacing the previous standardised and advanced approaches with a new structure that includes a basic approach (BA-CVA), a standardised approach (SA-CVA), and a full internal models approach.

The revised CVA framework applies to all OTC derivatives exposures and is closely related to the FRTB market risk framework in its methodology. Banks that currently benefit from exemptions from the CVA capital charge for transactions with non-financial counterparties or sovereigns should note that the scope of exemptions is narrowed under CRR3, and some previously exempt exposures will now be subject to CVA capital.

Leverage ratio and NSFR

The leverage ratio, which requires banks to maintain Tier 1 capital of at least 3% of total exposures regardless of risk weighting, is retained in CRR3 with some adjustments to the exposure measure calculation. The net stable funding ratio (NSFR), which requires banks to maintain stable funding against illiquid assets over a one-year horizon, is also retained. Neither is fundamentally changed by the Basel IV reforms, but both interact with the revised risk-weighted asset calculations in ways that banks need to model explicitly.

What banks need to do now

The phased implementation schedule does not reduce the urgency of preparation. Banks that deferred detailed impact assessment should be working on it now.

The first priority is quantitative impact assessment. Banks need to model their capital position under CRR3 across the full phase-in schedule, identifying where the output floor binds, where the revised standardised approaches produce higher risk weights than current approaches, and where FRTB changes the market risk capital figure. This assessment needs to be granular enough to identify the exposure classes and portfolios driving the largest impacts.

The second priority is model review. Banks using IRB need to assess whether their models satisfy the revised minimum requirements, identify where models need to be updated or replaced, and plan the timeline for supervisory approval of material changes. Banks that need to transition from A-IRB to F-IRB for large corporates and institution exposures need to build the F-IRB calculation into their capital reporting infrastructure.

The third priority is data and systems. The output floor requires a parallel standardised RWA calculation. The FRTB requires position-level data for the sensitivities-based method. The revised real estate risk weights require loan-to-value data at the exposure level. Many of these data requirements will expose gaps in existing risk data infrastructure that need to be addressed as part of the implementation programme.

The fourth priority is capital planning. Banks whose capital position is materially affected by the output floor or revised standardised approaches need to assess whether their current capital buffers are adequate across the full phase-in schedule and develop a capital plan that addresses any projected shortfalls.

Monitoring the regulatory pipeline

CRR3 itself is published, but the implementing framework continues to develop. The European Banking Authority is developing regulatory technical standards and implementing technical standards under CRR3 across several areas, including the output floor calculation methodology, the treatment of securitisation positions in the output floor, and FRTB implementation details. These technical standards add specificity to obligations that CRR3 sets out at a higher level of abstraction.

Supervisory authorities are also issuing Q&A guidance as banks submit interpretive questions during the early phase of implementation. These Q&As are not legally binding in the same way as RTS, but they are authoritative guidance on supervisory expectations and need to be tracked as part of ongoing compliance monitoring.

For the complete picture of EU financial regulation milestones relevant to banks, see the EU financial regulation calendar 2025 to 2026. For an explanation of how EBA technical standards relate to the parent regulation, see what are regulatory technical standards and why they matter more than the regulation itself.

Forseti monitors CRR3 and the Basel IV implementing framework continuously, including EBA technical standards and supervisory Q&As as they are published, anchored to verified official sources with full CELEX traceability. Start for free.