2. Basel III
• Basel III is an international regulatory accord that introduced a set of
reforms designed to improve the regulation, supervision and risk
management within the banking sector.
• The 3 pillars of Basel III are :
Minimum capital requirement
Supervisory review process
Market discipline
3. 1st Pillar: Minimum capital Requirement
• The first pillar Minimum Capital Requirement is mainly for total risk
including the credit risk, market risk as well as operational risk .
• Banks' regulatory capital is divided into :
Tier 1 / Regulatory Capital
Tier 2 / Risk weighted assets
5. • Basel III introduced two additional capital buffers:
1. A mandatory "capital conservation buffer", equivalent to 2.5% of
risk-weighted assets. Considering the 4.5% CET1 capital ratio
required, banks have to hold a total of 7% CET1 capital ratio, from
2019 onwards.
2. A "discretionary counter-cyclical buffer", allowing national
regulators to require up to an additional 2.5% of capital during
periods of high credit growth. The level of this buffer ranges
between 0% and 2.5% of RWA and must be met by CET1 capital.
6. Implementation
• First, the quality, consistency, and
transparency of the capital base will be
raised.
Tier 1 capital: the predominant form of
Tier 1 capital must be common shares
and retained earnings
Tier 2 capital: supplementary capital,
however, the instruments will be
harmonised
Tier 3 capital will be eliminated
7. In Context Of Nepal
• According to the new capital adequacy framework 2007, Minimum
capital requirements for Commercial Banks are:
Tier I capital = 6% of RWE
Total Capital= 10% of RWE
• These ratios are already higher than the global standard for capital
adequacy prescribed by Basel II. Under Basel III, minimum Tier I
capital should be 6% of RWE and there will not be necessity of any
change in total capital requirements.
8. 2nd Pillar : Supervisory review process)
Piller II aims to ensure that the
banks board and senior
management retain the
responsibility for developing and
maintaining risk policies and internal
controls and that it encourages the
use of reporting tools and
mechanisms to monitor/supervise
institution-wide risks. Also central
bank should consistently monitor
the activities of every bank.
9. Principles of 2nd pillar
• Board and senior management
oversight
• Sound capital assessment
• Comprehensive assessment of risk
• Monitoring and reporting
• International control review
• Review of adequacy of risk assessment
• Assessment of capital adequacy
• Assessment of the control
environment
• Supervisory review of compliance with
minimum standards
• Supervisory response
10. 3rd Pillar: Market Discipline
Pillar 3 recognizes that market discipline has the potential to
reinforce minimum capital standards (Pillar 1) and the
supervisory review process (Pillar 2), and so promote safety
and soundness in banks and financial systems.
Market discipline refers to the way in which market
participants influence a financial institution’s behavior
through monitoring its risk profile and financial position.
Anybody providing funds to a financial institution is an
investor, from depositors to professional investors in
sophisticated debt instruments.
11. Investors can exercise market discipline through the price they charge
financial institutions for supplying funds, or simply by withdrawing
their funds.
12. Condition for effective market condition
• Effective market discipline requires certain conditions to be in
place.
• First, market participants need to have access to useful
information.
• Second, market participants must be able to process that
information, which means it must be accessible and meaningful.
• Third, market participants must have incentives to monitor banks.
Some aspects of the regulatory framework, such as the Open Bank
Resolution Policy (OBR) and no deposit insurance, reinforce these
incentives. Measures to encourage greater financial education and
awareness will also assist.
13. • Finally, there must be the right mechanisms available for market
participants to exercise market discipline.
• For most industries and in most circumstances within the financial
services industry, market discipline will deliver, and historically has
delivered, good outcomes. Very few people would wish to revert to a
world where the banking system was directly controlled
14. • Principle 1 – Disclosures should
be clear
• Principle 2 - Disclosures should
be comprehensive
• Principle 3 - Disclosures should
be meaningful
• Principle 4: Disclosures should be
consistent over time
• Principle 5: Disclosures should be
comparable across banks
Guiding principle