Basel III

Basel III
Basel III (or the Third Basel Accord) is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 201011, and scheduled to be introduced from 2013 until 2018.[1][2] The third installment of the Basel Accords (see Basel I, Basel II) was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. The OECD estimates that the implementation of Basel III will decrease annual GDP growth by 0.050.15%.[3][4] Critics suggest that greater regulation is responsible for the slow recovery from the late-2000s financial crisis,[5][6] and that the Basel III requirements will increase the incentives of banks to game the regulatory framework and further negatively affect the stability of the financial system.[7]

Overview
Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum leverage ratio and two required liquidity ratios.[8] The leverage ratio is calculated by dividing Tier 1 capital by the bank's average total consolidated assets;[9] the banks area expected to maintain the leverage ratio in excess of 3%. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.[10]

Summary of proposed changes

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 instruments will be harmonised Tier 3 capital will be eliminated.[11] Second, the risk coverage of the capital framework will be strengthened. Promote more integrated management of market and counterparty credit risk Add the CVA (credit valuation adjustment)-risk due to deterioration in counterparty's credit rating Strengthen the capital requirements for counterparty credit exposures arising from banks' derivatives, repo and securities financing transactions Raise the capital buffers backing these exposures Reduce procyclicality and Provide additional incentives to move OTC derivative contracts to central counterparties (probably clearing houses) Provide incentives to strengthen the risk management of counterparty credit exposures Raise counterparty credit risk management standards by including wrong-way risk Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework. The Committee therefore is introducing a leverage ratio requirement that is intended to achieve the following objectives: Put a floor under the build-up of leverage in the banking sector

Basel III Introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simpler measure that is based on gross exposures. Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers"). The Committee is introducing a series of measures to address procyclicality: Dampen any excess cyclicality of the minimum capital requirement; Promote more forward looking provisions; Conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and Achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth. Requirement to use long term data horizons to estimate probabilities of default, downturn loss-given-default estimates, recommended in Basel II, to become mandatory Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements. Banks must conduct stress tests that include widening credit spreads in recessionary scenarios. Promoting stronger provisioning practices (forward looking provisioning): Advocating a change in the accounting standards towards an expected loss (EL) approach (usually, EL amount := LGD*PD*EAD).[12] Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio called the Net Stable Funding Ratio. (In January 2012, the oversight panel of the Basel Committee on Banking Supervision issued a statement saying that regulators will allow banks to dip below their required liquidity levels, the liquidity coverage ratio, during periods of stress.[13]) The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions. As on September 2010, proposed Basel III norms ask for ratios as: 79.5% (4.5% + 2.5% (conservation buffer) + 02.5% (seasonal buffer)) for common equity and 8.511% for Tier 1 capital and 10.513% for total capital.[14]

US implementation
The US Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules.[15] It summarized them as follows, and made clear they would apply not only to banks but to all institutions with more than US$50 billion in assets: "Risk-based capital and leverage requirements" including first annual capital plans, conduct stress tests, and capital adequacy "including a tier one common risk-based capital ratio greater than 5 percent, under both expected and stressed conditions" see scenario analysis on this. A risk-based capital surcharge Market liquidity, first based on the US's own "interagency liquidity risk-management guidance issued in March 2010" that require liquidity stress tests and set internal quantitative limits, later moving to a full Basel III regime see below. The Federal Reserve Board itself would conduct tests annually "using three economic and financial market scenarios." Institutions would be encouraged to use at least five scenarios reflecting improbable events, and especially those considered impossible by management, but no standards apply yet to extreme scenarios. Only a summary of the three official Fed scenarios "including company-specific information, would be made public" but one or more internal company-run stress tests must be run each year with summaries published. Single-counterparty credit limits to cut "credit exposure of a covered financial firm to a single counterparty as a percentage of the firm's regulatory capital. Credit exposure between the largest financial companies would be subject to a tighter limit."

Basel III "Early remediation requirements" to ensure that "financial weaknesses are addressed at an early stage". One or more "triggers for remediationsuch as capital levels, stress test results, and risk-management weaknessesin some cases calibrated to be forward-looking" would be proposed by the Board in 2012. "Required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales."[16] It was unclear as of December 2011 how these rules would apply to insurance, hedge funds and other large financial players. The announced intent was "to limit the dangers of big financial firms being heavily intertwined."[15]

Macroeconomic Impact of Basel III

An OECD study[3] released on 17 February 2011, estimates that the medium-term impact of Basel III implementation on GDP growth is in the range of 0.05% to 0.15% per year. Economic output is mainly affected by an increase in bank lending spreads as banks pass a rise in bank funding costs, due to higher capital requirements, to their customers. To meet the capital requirements effective in 2015 (4.5% for the common equity ratio, 6% for the Tier 1 capital ratio), banks are estimated to increase their lending spreads on average by about 15 basis points. The capital requirements effective as of 2019 (7% for the common equity ratio, 8.5% for the Tier 1 capital ratio) could increase bank lending spreads by about 50 basis points. The estimated effects on GDP growth assume no active response from monetary policy. To the extent that monetary policy will no longer be constrained by the zero lower bound, the Basel III impact on economic output could be offset by a reduction (or delayed increase) in monetary policy rates by about 30 to 80 basis points.[3]

Key dates
Capital Requirements
Date Milestone: Capital Requirement

2014 Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital requirements. 2015 Minimum capital requirements: Higher minimum capital requirements are fully implemented. 2016 Conservation buffer: Start of the gradual phasing-in of the conservation buffer. 2019 Conservation buffer: The conservation buffer is fully implemented.

Leverage Ratio
Date Milestone: Leverage Ratio

2011 Supervisory monitoring: Developing templates to track the leverage ratio and the underlying components. 2013 Parallel run I: The leverage ratio and its components will be tracked by supervisors but not disclosed and not mandatory. 2015 Parallel run II: The leverage ratio and its components will be tracked and disclosed but not mandatory. 2017 Final adjustments: Based on the results of the parallel run period, any final adjustments to the leverage ratio. 2018 Mandatory requirement: The leverage ratio will become a mandatory part of Basel III requirements.

Basel III

Liquidity Requirements
Date Milestone: Liquidity Requirements

2011 Observation period: Developing templates and supervisory monitoring of the liquidity ratios. 2015 Introduction of the LCR: Introduction of the Liquidity Coverage Ratio (LCR). 2018 Introduction of the NSFR: Introduction of the Net Stable Funding Ratio (NSFR).

Studies on Basel III

In addition to articles used for references (see References), this section lists links to recent high-quality publicly available studies on Basel III. This section may be updated frequently as Basel III is currently under development.
Date Feb 2012 Dec 2011 Jun 2011 Source BNP Paribas Fortis Article Title / Link Basel III for dummies [17] Video Systemically Important Banks [18] Basel III: no Achilles' spear [19] Comments "All you need to know about Basel III in 10 minutes."

OECD: Economics Department BNP Paribas: Economic Research Department Georg, Co-Pierre

OECD analysis on the failure of bank regulation and markets to discipline systemically important banks. BNP Paribas' Economic Research Department study on Basel III.

Feb 2011

Basel III and Systemic Risk Regulation What Way [20] Forward? Macroeconomic Impact of [21] Basel III Thinking Beyond Basel III

An overview article of Basel III with a focus on how to regulate systemic risk.

Feb 2011 May 2010

OECD: Economics Department OECD Journal: Financial Market Trends Bloomberg BusinessWeek

OECD analysis on the macroeconomic impact of Basel III.

[22] OECD study on Basel I, Basel II and III.

May 2010

Bair said regulators around the world need to work together on the next round of FDIC's Bair Says Europe Should Make Banks Hold More capital standards for banks ... the next round of international standards, known as [23] Basel III, which Bair said must meet "very aggressive" goals. Capital FACTBOX-G20 progress on [24] financial regulation Finance ministers from the G20 group of industrial and emerging countries meet in Busan, Korea, on June 45 to review pledges made in 2009 to strengthen regulation and learn lessons from the financial crisis. "The most important bit of reform is the international set of rules known as "Basel 3", which will govern the capital and liquidity buffers banks carry. It is here that the most vicious and least public skirmish between banks and their regulators is taking place."

May 2010

Reuters

May 2010

The Economist

The banks battle back A behind-the-scenes brawl over new capital and liquidity rules [25]

Basel III

References
[1] "Group of Governors and Heads of Supervision announces higher global minimum capital standards" (http:/ / www. bis. org/ press/ p100912. pdf) (pdf). Basel Committee on Banking Supervision. 2010-09-12. . [2] Financial Times report Oct 2012 (http:/ / ftalphaville. ft. com/ 2012/ 10/ 24/ 1225821/ and-now-for-some-basel-3-inspired-deleveraging/ ) [3] Patrick Slovik; Boris Cournde (2011). Macroeconomic Impact of Basel III. OECD Economics Department Working Papers. OECD Publishing. doi:10.1787/5kghwnhkkjs8-en. [4] Jones, Huw (September 2010). "Basel rules to have little impact on economy" (http:/ / www. reuters. com/ article/ 2011/ 02/ 16/ oecd-basel-idUSLDE71E23Q20110216) (pdf). . [5] John Taylor (September 2012). "Regulatory Expansion Versus Economic Expansion in Two Recoveries" (http:/ / johnbtaylorsblog. blogspot. sk/ 2012/ 09/ regulatory-expansion-versus-economic. html). . [6] Philip Suttle (2011-03-03). "The Macroeconomic Implications of Basel III" (http:/ / www. iif. com/ download. php?id=dzL6w4GP8AQ=). Institute of International Finance. . Retrieved 2012-11-17. [7] Patrick Slovik (2012). Systemically Important Banks and Capital Regulations Challenges. OECD Economics Department Working Papers. OECD Publishing. doi:10.1787/5kg0ps8cq8q6-en. [8] http:/ / www. bis. org/ publ/ bcbs189. pdf [9] http:/ / www. investopedia. com/ terms/ t/ tier-1-leverage-ratio. asp#axzz2FJchzgOy [10] Hal S. Scott (2011-06-16). "Testimony of Hal S. Scott before the Committee on Financial Services" (http:/ / financialservices. house. gov/ UploadedFiles/ 061611scott. pdf) (pdf). Committee on Financial Services, United State House of Representatives. pp.1213. . Retrieved 2012-11-17. [11] "Strengthening the resilience of the banking sector" (http:/ / www. bis. org/ publ/ bcbs164. pdf) (pdf). BCBS. December 2009. p.15. . "Tier 3 will be abolished to ensure that market risks are met with the same quality of capital as credit and operational risks." [12] "Basel II Comprehensive version part 2: The First Pillar Minimum Capital Requirements" (http:/ / www. bis. org/ publ/ bcbs128b. pdf) (pdf). November 2005. p.86. . [13] Susanne Craig (2012-01-08). "Bank Regulators to Allow Leeway on Liquidity Rule" (http:/ / www. nytimes. com/ 2012/ 01/ 09/ business/ bank-regulators-to-allow-leeway-on-capital-rule. html?). New York Times. . Retrieved 2012-01-10. [14] Proposed Basel III Guidelines: A Credit Positive for Indian Banks [15] Edward Wyatt (December 20, 2011). "Fed Proposes New Capital Rules for Banks" (http:/ / www. nytimes. com/ 2011/ 12/ 21/ business/ fed-proposes-new-capital-rules-for-banks. html). New York Times. . Retrieved 6 July 2012. [16] "Press Release" (http:/ / www. federalreserve. gov/ newsevents/ press/ bcreg/ 20111220a. htm). Federal Reserve Bank. December 20, 2011. . Retrieved 6 July 2012. [17] http:/ / player. vimeo. com/ video/ 45431290. [18] http:/ / dx. doi. org/ 10. 1787/ 5kg0ps8cq8q6-en [19] http:/ / economic-research. bnpparibas. com/ applis/ www/ RechEco. nsf/ ConjonctureByDateEN/ 81391A165B85FB54C12578C00042E75A/ $File/ C1105_06_A1. pdf?OpenElement [20] http:/ / www. gfinm. de/ images/ stories/ workingpaper17. pdf [21] http:/ / dx. doi. org/ 10. 1787/ 5kghwnhkkjs8-en [22] http:/ / www. webcitation. org/ 5q4GU5WGw [23] http:/ / www. webcitation. org/ 5pylqZc12 [24] http:/ / www. webcitation. org/ 5q2JSEJlP [25] http:/ / www. webcitation. org/ 5q2g8umPx

External links
Basel III capital rules (http://www.bis.org/publ/bcbs189.pdf) Basel III liquidity rules (http://www.bis.org/publ/bcbs188.pdf)

Article Sources and Contributors

Article Sources and Contributors

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