What is Basel III

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Basel III, albeit delayed, is set to change the banking landscape. More capital and greater liquidity will change the way banks do business in the future. More interestingly, Basel III could well …

Basel III, albeit delayed, is set to change the banking landscape. More capital and greater liquidity will change the way banks do business in the future. More interestingly, Basel III could well lead a change in the financial services landscape globally. A "Shadow Banking Sector" is already a reality and Basel III opens up significant opportunities for capital rich emerging market banks.
This is a first in a series of presentations exploring Basel III, its impact on the global banking sector and most importantly possible response strategies banks could adopt to gain competitive advantage.

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  • Credit & counterparty credit riskIntroduces capital requirements to cover Credit Valuation Adjustments risHigher capital requirements for securitisation productsDerivatives and Repos cleared through CCPs are no longer risk-free and have 2% risk weightHigher correlation factor to risk weight large and unregulated financial institutionsLiquidityRegulatory liquidity risk reports produced at least monthlyWith ability to deliver weekly or daily reportsConsolidate clean exposures, liabilities, counterparties and market data in a centralisedLCR
  • Mexico's banks to adopt Basel III capital rules in September……the first worldwide to adopt the rules…..…."The reason for adopting (the rules) ahead of schedule is that really the system is very strong," Babatz said….Reuters August 21, 2012The central bank stated that the mandate would be "an interim measure to ensure banks hold sufficient liquid assets until Basel III LCR comes into effect" in January 2015, the media outlet reports.The banks in the UAE are currently well-positioned to cope with the standards as a result of them not having much exposure to sovereign debt, having substantial government support and being less connected to the global economy, according to the news source.Australian regulator moves to implement Basel III two years earlyAsia Risk, 7 Sep 2011…..Apra says it believes Australian authorised deposit-taking institutions (ADIs) are in a strong position to meet new minimum capital requirements and therefore has proposed accelerating the deadline……..Bangkok Central ng Pilipinas (BSP)BSP to Fully Implement Basel 3 Capital Adequacy Rules for U/KBs in 2014 01.06.2012…adopt the capital adequacy standards in full by January 2014 without recourse to a staggered implementation or a gradual phase-out of ineligible capital instruments. This recognizes the present strong capital position of the banking industry while providing for a reasonable transition period.This puts the Philippines alongside such jurisdictions as China, Australia, Hong Kong SAR and Singapore which have announced similar Basel III implementation plansJapan – Pillar 2 rules not in place.

Transcript

  • 1. What is Basel IIICopyright © Vedanvi 2012 1
  • 2. Evolution of Basel Requirements Pillar II Pillar I Pillar III Market Liquidity Ratios Leverage Ratio Supervisory Capital Ratios Discipline Review Capital RWA LCR NSFR Tier 1 Tier 2 Credit Market Operational Concentration (EU Large Exposure) Standard CCR BIA Derivative IRB F Exposure Standard IRB A CEM Standard VAR AMA CVA Brand new with Basel III Stress EPE IMA Updated with Basel III VAR WWR Updated with Basel 2.5Source: Moody’s Analytics IRC No Change from Basel 2 Copyright © Vedanvi 2012 2
  • 3. Basel 2.5 ChangesObjectives• Strengthen Market Risk Framework – capture key risksThe Changes• Higher capital charge for market risk• Regular VaR & Stressed VaR• Incremental Risk Charge• Securitisation Charge• Comprehensive Risk Model (Structured Credit)Impact• Significant increase in aggregated IV RWA• Increase in Attributed EquityCopyright © Vedanvi 2012 3
  • 4. Key Elements of Basel IIIObjectives• Strengthen global capital and liquidity rules to promote resilienceThe Changes• Higher Minimum Tier 1 Capital Requirement• New Capital Conservation Buffer• Countercyclical Capital Buffer• Higher Minimum Tier 1 Common Equity Requirements• Liquidity Standard• Leverage Ratio• Minimum Total Capital RatioCopyright © Vedanvi 2012 4
  • 5. Basel III Requirements Explored Basel III Objective Requirements Raising quality, consistency & • Tier 1 – common shares and retained earnings transparency of capital • Hybrid capital instruments phased out • Tier 3 capital eliminated • Deductions harmonised Enhancing risk coverage • Stressed VaR capital requirements based on 12 month period of significant financial stress • Higher capital for resecuritisation • Strengthen Pillar 2 and Pillar 3 • Stressed counterparty credit risk capital req. • CVA – capital charge for mark to market losses • Strengthening collateral management – longer margining period • Move to central counterparty over OTC • Treatment of wrong way risk & backtestingSource: Basel Committee on Banking Supervision, Bank of International Settlements Copyright © Vedanvi 2012 5
  • 6. Basel III Requirements Explored Basel III Objective Requirements Supplementing risk based capital • Constrain leverage requirement with leverage ratio • Non risk based backstop measure Reducing procyclicality and • Dampen cyclicality of the minimum requirements promoting countercyclical buffers • Long term data for PD and LGD • Stress test considering downward migration of credit portfolio in recession • FSA – scalar converting outputs of underlying PD models into through the cycle estimates • Forward looking provisioning • Capital conservation standards • Excess credit growthSource: Basel Committee on Banking Supervision, Bank of International Settlements Copyright © Vedanvi 2012 6
  • 7. Basel III Requirements Explored Basel III Objective Requirements Addressing systemic risk & • Move to central counterparties for OTC interconnectedness • High req for trading, derivative, complex securitization and off balance sheet activities • High req for inter-financial sector exposures • Liquidity requirements penalising excessive reliance on short term, interbank funding to support long dated assetsSource: Basel Committee on Banking Supervision, Bank of International Settlements Copyright © Vedanvi 2012 7
  • 8. Complex Phase In ArrangementSource: Basel Committee on Banking Supervision, Bank of International Settlements Copyright © Vedanvi 2012 8
  • 9. How Far are Banks in Implementation 9
  • 10. Basel III Implementation – Some take the leads…… Germany Pushes ahead Switzerland EU To impose stricter Final Rules delayed requirements to BIII Japan Weaker Rules to BIII Final rules published – Weaker rules UK Proposing stricterUSA requirements RussiaExtend comment Implementing Baselperiod for Basel II III in 2015rulesWeaker rules to BIII China Early adoption of BIII Philippines & higher capital Full implementation Mexico by 2014 for systemic First country in world India banks to implement Basel III Brazil Final rules issued (Sept 2012) Full implementation Early adoption of Higher capital req. Mar 2018- Higher Basel III and higher capital requirements capital requirements to BIII Australia UAE Capital rules issues Mar… creating a new world order and new Implement Basel III earlier – LCR 2015 2012 & Liquidity rules Nov 2011. Implementation 2arbitrage opportunities? years sooner Copyright © Vedanvi 2012 10
  • 11. Implementation Progress as at End May 2012 Basel II Basel 2.5 Basel III • 21 of 27 implemented • 20 out of 27 countries • India, Japan & Saudi Basel II have implemented Arabia – published final • Indonesia & Russia – • Russia & US – issued Regs. Pillar 1 implemented but draft Regs. on market • Europe – draft Directive not Pillar 2 & 3 risk & Regs published – final • Turkey – compliant by • US Regs modified in Dec Rules delayed to Oct 2012 2011 2012 • China – final Regs issued • Argentina, Indonesia, • Argentina, Hong • USA – Parallel run – Mexico, Saudi Arabia & Kong, SAR, Indonesia, Ko Basel 1 legal min Turkey – not rea, Russia, Turkey & US implemented Basel 2.5 – not issued Draft Regs.Source Report to G20 Leaders on Basel III Implementation.. Basel Committee on Banking Supervision, Bank of International Settlements. June 2012 11 Copyright © Vedanvi 2012
  • 12. Is Basel III set to avert future crisis? 12
  • 13. What’s Missing Financial crisis on Etc. etc. etc... eave of Is more Capital the only Basel III Answer? Libor Scandal Failed Money Laundering Controls Jamie Dimon, blamed “errors, sloppiness and bad judgment” for the loss. RBS Systems OutCopyright © Vedanvi 2012 13
  • 14. Unintended Consequences• Reduced lending & subsequent impact on economic growth (covered above)• Reduce appetite of investors to invest in banks – at a time when capital most needed• Inconsistent implementation – opening regulatory arbitrage opportunities• Incentives to move risks to “shadow banking sector”• End of free banking?• Increased cost of banking & loans• ………..Copyright © Vedanvi 2012 14
  • 15. Appendix 15
  • 16. Level of ImplementationMain Countries Basel II Basel Basel III Notes 2.5Belgium 4 4 2 Basel III Follow EU ProcessFrance 4 4 2 Basel III Follow EU ProcessGermany 4 4 2 Basel III Follow EU ProcessItaly 4 4 2 Basel III Follow EU ProcessLuxembourg 4 4 2 Basel III Follow EU ProcessThe Netherlands 4 4 2 Basel III Follow EU ProcessSpain 4 4 2 Basel III Follow EU ProcessSweden 4 4,1 2 Basel 2.5 – (4) Final rules for the Basel 2.5 agreement are in force. (1) A new national ICAAP guideline is still under development. Basel III Follow EU ProcessUnited Kingdom 4 4 2 Basel III Follow EU ProcessKeyNumber and colour code: 1 = draft regulation not published; 2 = draft regulation published; 3 = final rule published; 4 = final rule in force. Green = implementation completed; Yellow= implementation in process; Red = no implementation.Copyright © Vedanvi 2012 16
  • 17. Level of ImplementationMain Countries Basel II Basel Basel III Notes 2.5Australia 4 4 2 Basel III - Draft rules for capital requirements issued on 30 March 2012. Draft rules to implement liquidity requirements issued in November 2011 for public consultation until 17 February 2012.Brazil 4 4 2 Basel III - Draft regulation published for public consultation on 17 February 2012.Canada 4 4 2 Basel III - On 1 February 2011, banks were directed to meet the 7% CET1 standard as of January 2013. Regulations for (i) non-viability contingent capital and (ii) transitioning for non- qualifying instruments published August and October 2011 respectively. Draft regulation for definition of capital and counterparty credit risk issued to banks in March 2012.Source: Basel Committee on Banking SupervisionCopyright © Vedanvi 2012 17
  • 18. Level of ImplementationMain Countries Basel II Basel Basel III Notes 2.5China 4 4 2 Supervisory guidelines released between 2007 and 2010 which will be integrated into new capital regulation combining BII, B2.5 and BIII. Large banks submitted application for advanced approaches currently assessed by CBRC. Basel III - Draft regulation combines BII, B2.5 and BIII. Public consultation ended in 2011. Final rule expected to come into force in Q3 2012. Will be applied to all banking institutions.Hong Kong 4 4 1,3 Basel III - (3) Bill passed by the Legislative Council on 29 February 2012 and published for the purpose of creating rule-making powers for the implementation of Basel III. (1) Industry consultation underway on policy proposals for inclusion in rules. Consultation on draft text of rules scheduled for second half of 2012.India 4 4 2 Basel III - Draft regulation released for comments on 30 December 2011.Copyright © Vedanvi 2012 18
  • 19. Level of ImplementationMain Countries Basel II Basel Basel III Notes 2.5Japan 4 4 3 Basel III - Draft regulation published on 7 February 2012 – Final rules published on 30 March 2012Russia 1, 4 1,2 1 Basel II - 1) Pillar 2 expected to be implemented not earlier than in 2014. (4) Simplified standardised approach for credit risk, simplified approach for market risk and the Basic Indicator Approach for operational risk implemented. Basel 2.5 (1) Pillar 2 expected to be implemented not earlier than in 2014. (2) Final regulation (revision to the simplified approach for market risk) expected shortly - regulation expected to come into force during Q2 2012. Basel III - Draft regulations under development.Saudi Arabia 4 3 3 Basel III - Final regulation issued to banks.Singapore 4 4 2 Basel III - Public consultation on draft ended in February 2012. Final rule is expected to be published in mid-2012.Copyright © Vedanvi 2012 19
  • 20. Level of ImplementationMain Countries Basel II Basel Basel III Notes 2.5South Africa 4 4 1 Basel III - Draft amendments to legislation issued on 30 March 2012 for consultation.Switzerland 4 4 2 Basel III Public consultation on draft regulation on Basel III has been finished in January 2012. Decision on final rules text expected until mid-2012. Final SIFI regulation (level: Banking Act) adopted by Parliament on 30 September 2011 – Draft SIFI regulation (level: accompanying ordinances) was published in December 2011; decision on final rule text expected before end-2012.Copyright © Vedanvi 2012 20
  • 21. Level of ImplementationMain Countries Basel II Basel Basel III Notes 2.5United States 4 1.2 1 Basel II Parallel run on-going –Basel II mandatory institutions required to implement the advanced approaches to credit risk and operational risk. Those Banks have made significant progress in implementation efforts Basel 2.5 (2) Market risk capital requirements have been proposed and remain to be finalised. These proposed requirements were modified in December 2011 to incorporate restrictions on the use of credit ratings as set forth in the Dodd-Frank regulatory reform legislation. (1) Other Basel 2.5 revisions are under development as part of the proposed Basel III rule currently expected to be issued for comment during Q2 2012. Basel III Draft regulation for consultation planned during Q2 2012. Basel 2.5 and Basel III rulemakings in the United States must be coordinated with applicable work on implementation of the Dodd-Frank regulatory reform legislation.Copyright © Vedanvi 2012 21