Basel III – The Basel Committee on Banking Supervision (BCBS) issued a comprehensive reform package entitled “Basel III: The Basel III guidelines on strengthening the global capital framework and new regulatory requirements on liquidity and leverage were proposed in December 2010. This new accord is a set of new banking rules developed by Basel Committee on Banking Supervision to make the banks stronger and efficient enough to overcome any crisis by introducing extra capital and reserves.
It is aimed to enhance the individual banking institutions ability to deal with financial and economic stress, risk management and strengthen the transparency and disclosures with the objective of promoting a more resilient banking sector.
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Basel III – Meaning BASEL III Accord
Basel committee :
The Basel Committee is a group of international banking authorities and many experts in the banking sector who strive to strengthen the regulation, supervision and practices of banks and improve financial stability worldwide, by strengthening the banking sector all over world.Actually there is some history behind this Basel committee regarding which I will discuss in future.
The Basel III is a set of standards and practices created to ensure that international banks maintain adequate capital to sustain themselves during the times of economic adversity.
“Basel III” is a complete set of reform measures, that were developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector.
Major Features of Basel III
- Better Capital Quality: One of the key elements of Basel III is the introduction of much stricter definition of capital. Better quality capital means higher-loss absorbing capacity.
- Capital Conservation Buffer: Banks will be required to hold to hold a capital conservation buffer. The aim to build this buffer is to ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and economic stress.
- Countercyclical Buffer: It has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times. The buffer will range from 0% to 2.5%.
- Minimum Common Equity and Tier 1 Capital Requirements: The minimum requirement for common equity has been raised under Basel III from 2% to 4.5% of total risk weighted assets. The overall Tier I capital requirement will also increase from 4% to 6%.
- Leverage Ratio: This aims to put a cap on swelling of leverage in the banking sector on a global basis.
- Liquidity Ratios: A new Liquidity Coverage Ratio and Net Stable Funding Ratio are to be introduced in 2015 and 2018 respectively.
- Systemically Important Financial Institutions: Systemically important banks will be expected to have loss absorbing capability beyond the Basel III requirements.
It’s mainly aimed at :
- 1. Improving transparency and disclosures of banks and their activities.
- 2. Strengthen the practices related to risk management and governance in every unfavorable situation.
- 3. Improve the banking sector’s ability to face the shocks arising from financial and economic stress.
Example: In recent times the ruling governments in the states of telangana and Andhra Pradesh had come out with an oath of waiving the farmer’s loans if they could have been given power to form government before elections. This action has many adverse effects on banks.
Important points in BASEL 3 :
1. Capital requirements :
According to the Basel III rules, banks shall put their efforts to increase their tier-1 capital ratio from 2% to 4.5%. This should be completed by 2015. In addition to this, by 2019, banks will be required to add an additional conservation buffer of 2.5%. This indirectly means that they will have to hold core capital equal to 7% of their risk-weighted assets.All this reforms are intended to improve the quality and performance of capital norms of banks. “The minimum total capital requirements has increased from 8% to 10.5%”.
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Comparison of Capital Requirements under Basel III and Basel II :
|Requirements||Under Basel III||Under Basel II|
|Minimum Ratio of Total Capital To RWAs||10.50%||8%|
|Minimum Ratio of Common Equity to RWAs||4.50% to 7.00%||2%|
|Tier I capital to RWAs||6.00%||4%|
|Core Tier I capital to RWAs||5.00%||2%|
|Capital Conservation Buffers to RWAs||2.50%||None|
|Countercyclical Buffer||0% to 2.50%||None|
|Minimum Liquidity Coverage Ratio||TBD (2015)||None|
|Minimum Net Stable Funding Ratio||TBD (2018)||None|
|Systemically important Financial Institutions Charge||TBD (2011)||None|
2.Liquidity reforms :
Basel committee in its 3rd accord has developed two minimum standards for funding liquidity. They are :
A.Increased Long-term Balance Sheet Funding :
In order to improve the condition of banks from adverse effects of short term wholesale funding the “Net Stable Funding Ratio (NSFR)” has been designed to encourage banks to move towards achieving stability in their structure by using more stable sources to fund their activities.
B.Increased Short-term Liquidity Coverage :
Basel Committee assumed that many banking institutions will face a liquidity crunch, And in view of this it has introduced a new requirement for liquidity. A 30 days Liquidity Coverage Ratio is intended to ensure that banks have short-term resilience. Probably this can solve the problem of liquidity crisis to some extent.
The Basel Committee has also introduced a new non risk-weighted leverage ratio to prevent banks building-up excessive on and off balance sheet leverage. The Basel Committee is currently testing a minimum Tier 1 leverage ratio of 3% of bank exposure, which generally follows the accounting measure of exposure.