Basel III is a global regulatory standard that aims to strengthen bank capital requirements and introduce new regulatory requirements on bank liquidity and leverage. It was developed in response to deficiencies in previous regulations that contributed to the global financial crisis. The goals of Basel III include improving the banking sector's ability to absorb shocks from financial and economic stress, reducing risks, and strengthening transparency. Key changes under Basel III include higher and better quality capital buffers, introduction of leverage ratio, liquidity coverage ratio, net stable funding ratio, and capital surcharges for systemically important banks.
2. OVERVIEW
Meaning of Basel III
Why Basel III
Aims
Objectives
Major Changes
Implementation of the Changes
3. What is "Basel III":
" A global regulatory standard on:
bank capital adequacy
stress testing and
market liquidity risk
4. Also a set of reform measures to
improve:
Regulation
Supervision
Risk management
5. Reasons for Basel III Formulation:
Failures of Basel II being:
A. Inability to strengthen financial stability.
B. Insufficient capital reserve.
C. Inadequate comprehensive risk management approach.
D. Lack of uniformed definition of capital .
6. Aims & Objectives of Basel III
To minimize the probability of recurrence of crises to
greater extent.
To improve the banking sector's ability to absorb
shocks arising from financial and economic stress.
To improve risk management and governance.
To strengthen banks' transparency and disclosures .
7. Targets:
Bank-level or micro prudential which will
help raise the resilience of individual
banking institutions in periods of stress.
Macro prudential system wide risks that
build up across the banking sector as
well as the pro-cyclical amplification of
these risk over time.
8. Key Elements of Reforms…
Increasing the quality and quantity capital
Enhancing risk coverage of capital
Introducing Leverage ratio
Improving liquidity rules
Establishing additional buffers
Managing counter party risks
10. Pillar 1:Minimum Capital
Requirements
• Pillar 1 aligns the minimum capital requirements
more closely to actual risks of bank's economic
loss.
• revised risks:
√ Credit risk
√ Operational risk
√ Market risk
12. Pillar 2:Supervisory Review Process
• Pillar 2 requires banks to think about the whole spectrum
of risks they might face including those not captured at all
in Pillar 1 such as interest rate risk.
• Coverage in Pillar 2:
√ risks that are not fully covered by Pillar 1
√ Credit concentration risk
√ Counterparty credit risk
√ Risks that are not covered by Pillar 1
√ Interest rate risk in the banking book
√ Liquidity risk
√ Business risk
√ Stress testing
13. Pillar 3:Market Discipline
Pillar 3 is designed to increase the
transparency of lenders' risk profile by
requiring them to give details of their
risk management and risk distributions.
14. Weaknesses of Basel II
The quality of capital.
Pro-cyclicality.
Liquidity risk.
Systemic banks.
15. Basel III: Strengthening the global capital
framework
A. Capital reform.
B. Liquidity standards.
C. Systemic risk and interconnectedness.
16. A. Capital Reform
A new definition of capital.
Capital conservation buffer.
Countercyclical capital buffer.
Minimum capital standards.
17. A new definition of capital
Total regulatory capital will consist of the sum of
the following elements:
1. Tier 1 Capital (going-concern capital)
a. Common Equity Tier 1
b. Additional Tier 1
2. Tier 2 Capital (gone-concern capital)
For each of the three categories above (1a, 1b and
2) there is a single set of criteria that instruments
are required to meet before inclusion in the
relevant category.
18. Capital conservation buffer
The capital conservation buffer is designed to ensure
that banks build up capital buffers outside periods of
stress which can be drawn down as losses are incurred.
A capital conservation buffer of 2.5%, comprised of
Common Equity Tier 1, is established above the
regulatory minimum capital requirement.
Outside of periods of stress, banks should hold buffers
of capital above the regulatory minimum.
19. Countercyclical capital buffer
The countercyclical buffer aims to ensure that banking
sector capital requirements take account of the macro-
financial environment in which banks operate.
It will be deployed by national jurisdictions when excess
aggregate credit growth is judged to be associated with a
build-up of system-wide risk to ensure the banking system
has a buffer of capital to protect it against future potential
losses.
21. B. Liquidity Standards:
1. Short-term: Liquidity Coverage
Ratio(LCR)
2. Long-term: Net Stable Funding
Ratio(NSFR)
22. 1.Short-term:LCR
The LCR is a response from Basel committee
to the recent financial crisis. The LCR proposal
requires banks to hold high quality liquid
assets in order to survive in emergent stress
scenario.
23. Short-term:LCR
Must be no lower than 1.
The higher the better.
high quality liquid: liquid in markets during a time of
stress and, ideally, be central bank eligible.
Banks are still expected to conduct their own stress tests
to assess the level of liquidity they should hold beyond
this minimum, and construct scenarios that could cause
difficulties for their specific business activities.
24. 2. Long-term:NSFR
Objectives:
To promote more medium and long-term funding
activities of banking organizations.
Ensure that the investment activities are funded by
stable liabilities.
To limit the over-reliance on wholesale short-term
funding(money market)
25. Long-term:NSFR
Available stable funding (ASF) is defined as the total
amount of an institution’s:
capital.
preferred stock with maturity of equal to or greater than
one year.
liabilities with effective maturities of one year or greater.
deposits and/or term deposits with maturities of less than
one year that would be expected to stay with the
institution for an extended period a stress event.
26. Required Stable Funding:
The required amount of stable funding is
calculated as the sum of the value of the assets
held and funded by the institution, multiplied by a
RSF factor, added to the amount of OBS activity
(or potential liquidity exposure) multiplied by its
associated RSF factor.
27. Required Stable Funding
These components of required stable funding are not
equally weighted.
100% of loans longer than one year.
85% of loans to retail clients with a remaining life shorter
than one year.
50% of loans to corporate clients with a remaining life
shorter than one year.
and 20% of government and corporate bonds.
off-balance sheet categories are also weighted.
28. C. Systemic risk and
interconnectedness (Counterparty
risk)
Capital incentives for using CCPs for OTC.
Higher capital for systemic derivatives.
Higher capital for inter-financial exposures.
Contingent capital.
Capital surcharge for systemic banks.
29. CONCLUSION
Basel III introduces a paradigm shift in capital
and liquidity standards.
It was constructed and agreed in relatively
record time which leaves many elements
unfinished.
The final implementation date a long way off.
30. HOWEVER,
Market pressure and competitor pressure
already driving considerable change at a
range of firms.
Firms therefore should ensure to engage with
Basel III as soon as possible to be
competitively advantaged in the new post-
crisis financial risk and regulatory landscape.
31. References:
Basel II: a guide to capital adequacy standards for Lenders.
[Available at: http://www.cml.org.uk/cml/policy/issues/748]
Basel III regulations: a practical overview. [Available at:
www.moodysanalytics.com] [Accessed on 30/11/12].
Basel III: Issues and implications. [Available at: www.kpmg.com]
[Accessed on 30/11/12].
Federal Reserve Proposes Revised Bank Captial Rules.
[Available at:
http://blogs.law.harvard.edu/corpgov/2012/06/12/federal-
reserve-proposes-revised-ba...] [Accessed on 30/11/12].
Introduction to Basel II: [Available at:
http://www.rcg.ch/papers/basel2.pdf]
Introduction to Basel II. [Available at:
http://www.horwathmak.com/Literature/Introduction_to_basel_ii.
pdf]
