Basel III

risk weighted);[4][5] The banks were expected to maintain a leverage ratio in excess of 3% under Basel III.
In July 2013, the U.S. Federal Reserve announced that
the minimum Basel III leverage ratio would be 6% for 8
Systemically important nancial institution (SIFI) banks
and 5% for their insured bank holding companies.[6]

Basel III (or the Third Basel Accord) is a global, voluntary regulatory framework on bank capital adequacy,
stress testing and market liquidity risk. It was agreed
upon by the members of the Basel Committee on Banking Supervision in 201011, and was scheduled to be
introduced from 2013 until 2015; however, changes
from 1 April 2013 extended implementation until 31
March 2018 and again extended to 31 March 2019.[1][2]
The third installment of the Basel Accords (see Basel I,
Basel II) was developed in response to the deciencies
in nancial regulation revealed by the nancial crisis of
200708. Basel III was supposed to strengthen bank
capital requirements by increasing bank liquidity and decreasing bank leverage.

2.3 Liquidity requirements

Basel III introduced two required liquidity ratios.[7] The
Liquidity Coverage Ratio was supposed to require a
bank to hold sucient high-quality liquid assets to cover
its total net cash outows over 30 days; the Net Stable
Funding Ratio was to require the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.[8]

Overview

Unlike Basel I and Basel II, which focus primarily on the

level of bank loss reserves that banks are required to hold,
Basel III focuses primarily on the risk of a run on the
bank by requiring diering levels of reserves for dierent forms of bank deposits and other borrowings. Therefore Basel III does not, for the most part, supersede the
guidelines known as Basel I and Basel II; rather, it will
work alongside them.

2
2.1

2.3.1 U.S. version of the Basel Liquidity Coverage

Ratio requirements
On 24 October 2013, the Federal Reserve Board of Governors approved an interagency proposal for the U.S.
version of the Basel Committee on Banking Supervision (BCBS)'s Liquidity Coverage Ratio (LCR). The ratio would apply to certain U.S. banking organizations and
other systemically important nancial institutions.[9] The
comment period for the proposal is scheduled to close by
31st January 2014

Key principles

The United States LCR proposal came out signicantly tougher than BCBSs version, especially for larger
bank holding companies.[10] The proposal requires nancial institutions and FSOC designated nonbank nancial
companies[11] to have an adequate stock of high-quality
liquid assets (HQLA) that can be quickly liquidated to
meet liquidity needs over a short period of time.

Capital requirements

The original Basel III rule from 2010 was supposed to require banks to hold 4.5% of common equity (up from
2% in Basel II) and 6% of Tier I capital (including
common equity and up from 4% in Basel II) of "riskweighted assets" (RWAs).[3] Basel III introduced two
additional capital buersa mandatory capital conservation buer of 2.5% and a discretionary countercyclical buer to allow national regulators to require up
to an additional 2.5% of capital during periods of high
credit growth.

2.2

The LCR consists of two parts: the numerator is the value

of HQLA, and the denominator consists of the total net
cash outows over a specied stress period (total expected
cash outows minus total expected cash inows).[12]
The Liquidity Coverage Ratio applies to U.S. banking operations with assets of more than $10 billion. The proposal would require:

Leverage ratio
Large Bank Holding Companies (BHC) those with
over $250 billion in consolidated assets, or more in
on-balance sheet foreign exposure, and to systemically important, non-bank nancial institutions;[11]

Basel III introduced a minimum leverage ratio. The

leverage ratio was calculated by dividing Tier 1 capital by the banks average total consolidated assets (not
1

3 IMPLEMENTATION
to hold enough HQLA to cover 30 days of net cash requirements to submit remediation plans to U.S. regulaoutow. That amount would be determined based tors to address what actions would be taken if the LCR
on the peak cumulative amount within the 30-day falls below 100% for three or more consecutive days.
period.[9]
Regional rms (those with between $50 and $250
3 Implementation
billion in assets) would be subject to a modied
LCR at the (BHC) level only. The modied LCR
requires the regional rms to hold enough HQLA 3.1 Summary of originally (2010) proto cover 21 days of net cash outow. The net cash
posed changes in Basel Committee lanoutow parameters are 70% of those applicable to
guage
the larger institutions and do not include the requirement to calculate the peak cumulative outows[12]
First, the quality, consistency, and transparency of
the capital base will be raised.
Smaller BHCs, those under $50 billion, would remain subject to the prevailing qualitative supervi Tier 1 capital: the predominant form of Tier
sory framework.[13]
1 capital must be common shares and retained
earnings

The U.S. proposal divides qualifying HQLAs into three

specic categories (Level 1, Level 2A, and Level 2B).
Across the categories the combination of Level 2A and
2B assets cannot exceed 40% HQLA with 2B assets limited to a maximum of 15% of HQLA.[12]
Level 1 represents assets that are highly liquid (generally those risk-weighted at 0% under the Basel
III standardized approach for capital) and receive
no haircut. Notably, the Fed chose not to include
GSE-issued securities in Level 1, despite industry
lobbying, on the basis that they are not guaranteed
by the "full faith and credit" of the U.S. government.
Level 2A assets generally include assets that would
be subject to a 20% risk-weighting under Basel
III and includes assets such as GSE-issued and guaranteed securities. These assets would be subject
to a 15% haircut which is similar to the treatment of
such securities under the BCBS version.
Level 2B assets include corporate debt and equity
securities and are subject to a 50% haircut. The
BCBS and U.S. version treats equities in a similar
manner, but corporate debt under the BCBS version
is split between 2A and 2B based on public credit
ratings, unlike the U.S. proposal. This treatment of
corporate debt securities is the direct impact of the
DoddFrank Act's Section 939, which removed references to credit ratings, and further evidences the
conservative bias of U.S. regulators approach to the
LCR.
The proposal requires that the LCR be at least equal to
or greater than 1.0 and includes a multiyear transition period that would require: 80% compliance starting 1 January 2015, 90% compliance starting 1 January 2016, and
100% compliance starting 1 January 2017.[14]
Lastly, the proposal requires both sets of rms (large bank
holding companies and regional rms) subject to the LCR

Tier 2 capital: supplementary capital, however, the instruments will be harmonised

Tier 3 capital will be eliminated.[15]
Second, the risk coverage of the capital framework
will be strengthened.
Promote more integrated management of market and counterparty credit risk
Add the credit valuation adjustmentrisk due
to deterioration in counterpartys credit rating
Strengthen the capital requirements for counterparty credit exposures arising from banks
derivatives, repo and securities nancing transactions
Raise the capital buers backing these exposures
Reduce procyclicality and
Provide additional incentives to move OTC
derivative contracts to qualifying central counterparties (probably clearing houses). Currently, the BCBS has stated derivatives cleared
with a QCCP will be risk-weighted at 2% (The
rule is still yet to be nalized in the U.S.)
Provide incentives to strengthen the risk management of counterparty credit exposures
Raise counterparty credit risk management
standards by including wrong-way risk
Third, a leverage ratio will be introduced as a
supplementary measure to the Basel II risk-based
framework. The ration was nalized on September
3, 2014 and is known as the Supplementary Leverage Ratio.[16]
intended to achieve the following objectives:
Put a oor under the buildup of leverage
in the banking sector

3.2

U.S. implementation
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.

3
As of September 2010, proposed Basel III norms asked
for ratios as: 79.5% (4.5% + 2.5% (conservation buer)
+ 02.5% (seasonal buer)) for common equity and 8.5
11% for Tier 1 capital and 10.513% for total capital.[19]

On 15 April, the Basel Committee on Banking Supervision (BCBS) released the nal version of its Supervisory
Fourth, a series of measures is introduced to proFramework for Measuring and Controlling Large Expomote the buildup of capital buers in good times
sures (SFLE) that builds on longstanding BCBS guidthat can be drawn upon in periods of stress (Reance on credit exposure concentrations.[20]
ducing procyclicality and promoting countercyclical
On September 3, 2014, the U.S. banking agencies (Fedbuers).
eral Reserve, Oce of the Comptroller of the Currency,
Measures to address procyclicality:
and Federal Deposit Insurance Corporation) issued their
Dampen excess cyclicality of the mini- nal rule implementing the Liquidity Coverage Ratio
(LCR).[21] The LCR is a short-term liquidity measure inmum capital requirement;
tended to ensure that banking organizations maintain a
Promote more forward looking provisucient pool of liquid assets to cover net cash outows
sions;
over a 30-day stress period.
Conserve capital to build buers at individual banks and the banking sector that
can be used in stress; and
3.2 U.S. implementation
Achieve the broader macroprudential goal of
protecting the banking sector from periods of The U.S. Federal Reserve announced in December 2011
that it would implement substantially all of the Basel III
excess credit growth.
rules.[22] It summarized them as follows, and made clear
Requirement to use long-term data horithey would apply not only to banks but also to all instituzons to estimate probabilities of default,
tions with more than US$50 billion in assets:
downturn loss-given-default estimates,
recommended in Basel II, to become
Risk-based capital and leverage requirements inmandatory
cluding rst annual capital plans, conduct stress
Improved calibration of the risk functests, and capital adequacy including a tier one
tions, which convert loss estimates into
common risk-based capital ratio greater than 5 perregulatory capital requirements.
cent, under both expected and stressed conditions
Banks must conduct stress tests that in see scenario analysis on this. A risk-based capital
clude widening credit spreads in recessurcharge
sionary scenarios.
Market liquidity, rst based on the United States
Promoting stronger provisioning practices
own "interagency liquidity risk-management guid(forward-looking provisioning):
ance issued in March 2010 that require liquidity
Advocating a change in the accountstress tests and set internal quantitative limits, later
ing standards towards an expected loss
moving to a full Basel III regime - see below.
(EL) approach (usually, EL amount :=
The Federal Reserve Board itself would conduct
LGD*PD*EAD).[17]
tests annually using three economic and nancial
Fifth,a global minimum liquidity standard for intermarket scenarios. Institutions would be encournationally active banks is introduced that includes
aged to use at least ve scenarios reecting improba 30-day liquidity coverage ratio requirement unable events, and especially those considered imposderpinned by a longer-term structural liquidity rasible by management, but no standards apply yet to
tio called the Net Stable Funding Ratio. (In January
extreme scenarios. Only a summary of the three of2012, the oversight panel of the Basel Committee
cial Fed scenarios including company-specic inon Banking Supervision issued a statement saying
formation, would be made public but one or more
that regulators will allow banks to dip below their
internal company-run stress tests must be run each
required liquidity levels, the liquidity coverage rayear with summaries published.
tio, during periods of stress.[18] )
Single-counterparty credit limits to cut "credit expo The Committee also is reviewing the need for
sure of a covered nancial rm to a single counteradditional capital, liquidity or other supervisory
party as a percentage of the rms regulatory capital.
measures to reduce the externalities created by
Credit exposure between the largest nancial comsystemically important institutions.
panies would be subject to a tighter limit.

4 ANALYSIS OF BASEL III IMPACT

Early remediation requirements to ensure that
nancial weaknesses are addressed at an early
stage. One or more triggers for remediation
such as capital levels, stress test results, and riskmanagement 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.[23]

As of January 2014, the United States has been on track

to implement many of the Basel III rules, despite dierences in ratio requirements and calculations.[24]

3.3

Key milestones

3.3.1

Capital requirements

3.3.2

Leverage ratio

3.3.3

Liquidity requirements

thus using public policy to strengthen anti-competitive

duopolistic practices.[27][28] The conicted and unreliable
credit ratings of these agencies is generally seen as a major contributor to the US housing bubble.
Opaque treatment of all derivatives contracts is also criticized. While institutions have many legitimate (hedging, insurance) risk reduction reasons to deal in derivatives, the Basel III accords:
treat insurance buyers and sellers equally even
though sellers take on more concentrated risks (literally purchasing them) which they are then expected
to oset correctly without regulation
do not require organizations to investigate correlations of all internal risks they own
do not tax or charge institutions for the systematic or
aggressive externalization or conicted marketing of
risk - other than requiring an orderly unravelling of
derivatives in a crisis and stricter record keeping

Since derivatives present major unknowns in a crisis these

are seen as major failings by some critics [29] causing several to claim that the too big to fail status remains with
respect to major derivatives dealers who aggressively took
4 Analysis of Basel III impact
on risk of an event they did not believe would happen but did. As Basel III does not absolutely require extreme
scenarios that management atly rejects to be included
4.1 Macroeconomic impact
in stress testing this remains a vulnerability. StandardAn OECD study released on 17 February 2011, estimated ized external auditing and modelling is an issue proposed
that the medium-term impact of Basel III implementa- to be addressed in Basel 4 however.
tion on GDP growth would be in the range of 0.05% to A few critics argue that capitalization regulation is inher0.15% per year.[25] Economic output would be mainly ently fruitless due to these and similar problems and - deaected by an increase in bank lending spreads, as banks spite an opposite ideological view of regulation - agree
pass a rise in bank funding costs, due to higher capi- that too big to fail persists.[30]
tal requirements, to their customers. To meet the capital requirements originally eective in 2015 banks were Basel III has been criticized similarly for its paper burden
estimated to increase their lending spreads on average and risk inhibition by banks, organized in the Institute
by about 15 basis points. Capital requirements eec- of International Finance, an international association of
tive as of 2019 (7% for the common equity ratio, 8.5% global banks based in Washington, D.C., who argue
for the Tier 1 capital ratio) could increase bank lending that it would hurt both their business and overall ecospreads by about 50 basis points.[26] The estimated eects nomic growth. The OECD estimated that implemenon GDP growth assume no active response from mone- tation of Basel III would decrease annual GDP growth
[25][31]
blaming the slow recovery from
tary policy. To the extent that monetary policy would no by 0.050.15%,
the
nancial
crisis
of
200708
on the regulation.[32][33]
longer be constrained by the zero lower bound, the Basel
III impact on economic output could be oset by a re- Basel III was also criticized as negatively aecting the
duction (or delayed increase) in monetary policy rates by stability of the nancial system by increasing incentives of banks to game the regulatory framework.[34] The
about 30 to 80 basis points.[25]
American Bankers Association,[35] community banks
organized in the Independent Community Bankers of
America, and some of the most liberal Democrats in the
4.2 Criticism
U.S. Congress, including the entire Maryland congresThink tanks such as the World Pensions Council have ar- sional delegation with Democratic Senators Ben Cardin
gued that Basel III merely builds on and further expands and Barbara Mikulski and Representatives Chris Van
the existing Basel II regulatory base without fundamen- Hollen and Elijah Cummings, voiced opposition to Basel
tally questioning its core tenets, notably the ever-growing III in their comments to the Federal Deposit Insurance
reliance on standardized assessments of credit risk mar- Corporation,[36] saying that the Basel III proposals, if imketed by two private sector agencies- Moodys and S&P, plemented, would hurt small banks by increasing their

5
capital holdings dramatically on mortgage and small business loans.[37]

[9] http://www.federalreserve.gov/FR_notice_lcr_
20131024.pdf

Others have argued that Basel III did not go far enough to [10] Fed Liquidity Proposal Seen Trading Safety for Costlier
regulate banks as inadequate regulation was a cause of the
Credit. Bloomberg.
nancial crisis.[38] On 6 January 2013 the global banking
sector won a signicant easing of Basel III Rules, when [11] Nonbank SIFIs: FSOC proposes initial designations
more names to follow. http://www.pwc.com/en_US/us/
the Basel Committee on Banking Supervision extended
financial-services/regulatory-services/publications/assets/
not only the implementation schedule to 2019, but broadfs-reg-brief-nonbank-sifi.pdf, June 2013.
ened the denition of liquid assets.[39]

4.3

Further studies

[12] Liquidity coverage ratio:

another brick in
http://www.pwc.com/en_US/us/
the
wall.
financial-services/regulatory-services/publications/assets/
fs-reg-brief-dodd-frank-act-basel-iii-fed-liquidity-coverage-ratio.
pdf, October 2013.

In addition to articles used for references (see References), this section lists links to publicly available highquality studies on Basel III. This section may be updated [13] http://www.federalreserve.gov/newsevents/press/bcreg/
frequently as Basel III remains under development.
20131024a.htm

See also
Basel I
Basel II
Basel 4
Systemically important nancial institution
Operational risk
Operational risk management

References

[14] http://www.ft.com/cms/s/0/
9f61345c-3cb1-11e3-a8c4-00144feab7de.html#
axzz2jWZZfSmH
[15] Strengthening the resilience of the banking sector
(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.
[16] First
take:
Supplementary
leverage
ratio.
http://www.pwc.com/us/en/
financial-services/regulatory-services/publications/
first-take-supplementary-leverage-ratio-basel-iii.jhtml''.
PwC Financial Services Regulatory Practice, September,
2014.
[17] Basel II Comprehensive version part 2: The First Pillar Minimum Capital Requirements (PDF). November
2005. p. 86.

[1] Group of Governors and Heads of Supervision announces higher global minimum capital standards (PDF).
Basel Committee on Banking Supervision. 12 September
2010.

[18] Susanne Craig (8 January 2012). Bank Regulators to Allow Leeway on Liquidity Rule. New York Times. Retrieved 10 January 2012.

[2] Financial Times report Oct 2012

[19] Proposed Basel III Guidelines: A Credit Positive for Indian

Banks

[3] http://www.bis.org/bcbs/basel3/basel3_phase_in_
arrangements.pdf
[4] http://www.investopedia.com/terms/t/
tier-1-leverage-ratio.asp#axzz2FJchzgOy
[5] http://www.allbankingsolutions.com/banking-tutor/
basel-iii-accord-basel-3-norms.shtml
[6] US Federal Reserve Bank announces the minimum Basel
III leverage ratio.
[7] http://www.bis.org/publ/bcbs189.pdf
[8] Hal S. Scott (16 June 2011). Testimony of Hal S.
Scott before the Committee on Financial Services (PDF).
Committee on Financial Services, United States House of
Representatives. pp. 1213. Retrieved 17 November
2012.

[20] Stress testing: First take: Basel large exposures framehttp://www.pwc.com/us/en/financial-services/

work.
regulatory-services/publications/index.jhtml''. PwC Financial Services Regulatory Practice, April 2014.
[21] First take: Liquidity coverage ratio. http://www.
pwc.com/us/en/financial-services/regulatory-services/
publications/first-take-liquidity-coverage-ratio.jhtml''.
PwC Financial Services Regulatory Practice, September,
2014.
[22] Edward Wyatt (20 December 2011). Fed Proposes New
Capital Rules for Banks. New York Times. Retrieved 6
July 2012.
[23] Press Release. Federal Reserve Bank. 20 December
2011. Retrieved 6 July 2012.

[24] Basel leverage ratio:

No cover for US
banks
(PDF).
http://www.pwc.com/us/en/
financial-services/regulatory-services/publications/
dodd-frank-basel-leverage-ratio.jhtml''. PwC Financial
Services Regulatory Practice, January 2014.

EXTERNAL LINKS

7 External links
Basel III capital rules
Basel III liquidity rules

[25] Patrick Slovik; Boris Cournde (2011). Macroeconomic Impact of Basel III. OECD Economics
Department Working Papers.
OECD Publishing.
doi:10.1787/5kghwnhkkjs8-en.

Bank Management and Control, Springer Management for Professionals, 2014

[26] ?

- Basel III in India

[27] M. Nicolas J. Firzli, A Critique of the Basel Committee on Banking Supervision Revue Analyse Financire,
10 November 2011 & Q2 2012

How Basel III Aects SME Borrowing Capacity

U.S. Implementation of the Basel Capital Regulatory Framework Congressional Research Service

[28] Barr, David G. (23 November 2013). What We Thought

We Knew: The Financial System and Its Vulnerabilities
(PDF). Bank of England.
[29] http://scholar.harvard.edu/files/vstavrak/files/
derivregntr_article.pdf
[30] http://www.heritage.org/research/reports/2014/04/
basel-iii-capital-standards-do-not-reduce-the-too-big-to-fail-problem
[31] Jones, Huw (September 2010). Basel rules to have little
impact on economy (PDF). Reuters.
[32] John Taylor (September 2012). Regulatory Expansion
Versus Economic Expansion in Two Recoveries.
[33] Philip Suttle (3 March 2011). The Macroeconomic Implications of Basel III. Institute of International Finance.
Retrieved 17 November 2012.
[34] Patrick Slovik (2012). Systemically Important Banks
and Capital Regulations Challenges. OECD Economics Department Working Papers. OECD Publishing.
doi:10.1787/5kg0ps8cq8q6-en.
[35] Comment Letter on Proposals to Comprehensively Revise the Regulatory Capital Framework for U.S.Banking
Organizations(22 October 2012, http://www.sifma.org/
workarea/downloadasset.aspx?id=8589940758
[36] 95 entities listed at http://www.fdic.gov/regulations/laws/
federal/2012-ad-95-96-97/2012-ad95.html Retrieved
13 March 2013
[37] http://www.icba.org/files/ICBASites/PDFs/test112912.
pdf
[38] Reich, Robert. Wall Street is Still Out of Control, and
Why Obama Should Call for Glass-Steagall and a Breakup
of Big Banks. Robert Reich.org. Retrieved 2 March
2013.
[39] NY
Times
1
July
2013
http://
dealbook.nytimes.com/2013/01/07/
easing-of-rules-for-banks-acknowledges-reality/

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