The Standardized Approach assigns already predefined weights to the assets: The

approach assesses exposures to sovereigns, to multilateral development banks, foreign

banks, public sector entities, corporates, off-balance sheet items and many more. As
an example, family residential mortgages can be assigned different weights, depending
on their risk. To be precise, if their loan-to-value is more than 90% – that is, the loan
makes up a share of 90% of the value of the building – a risk weight of 100%
respectively 200% will be assigned – depending on the category, which is defined by
further criteria. For equities, a Federal Reserve Bank stock is assigned a weight of 0%
as it is one of the least risky assets a bank can hold in stock, whereas an equity exposure
that is not publicly traded has a risk weight of 300%.1

These criteria are set by regulators. Though, either regulators or external rating can be
used to assign weights: Mostly, rating agencies like Standard & Poor’s (S&P), Fitch
Ratings and Moody’s are considered for rating sovereign debt.

As in previous sections being outlined, Basel III particularly introduced new capital
requirements such that there is an indirect impact of Basel III on pillar 2 in the sense
that the provision of capital for ICAAP and thus also for the risk-bearing capacity
increased – referring to both Going- and Gone-Concern approaches.

Direct impacts of Basel III on the second pillar are expressed in an extended scope
instead of fundamentally new regulations. Whereas Basel II considered only credit
risk, market risk, and operational risk for the risk treatment, Basel III extended the
scope by adding the areas of liquidity risk, and legal risk.2 Further, special regulations
regarding risk concentrations, stress tests, reputational risks, capital adequacy
requirements for counterparty risks, trading books and securitisations were
introduced.3 One of the publicly adversarial modifications in banking regulation under
Basel III was the introduced wage cap. Variable remuneration is no longer allowed to

1
Federal Deposit Insurance Corporation. Notices of Proposed Rulemaking: Regulatory Capital.
https://www.fdic.gov/regulations/capital/Presentation_on_Basel_III_and_Standardized_Approach_NPRs.pdf
[accessed: 16.5.2016].
2
Zirkler, B. and J. Hofmann and S. Schmolz.2015. Basel III in der Unternehmenspraxis. Wiesbaden: Springer. p.
19.
3
Bank for International Settlements. 2009. Enhancements to the Basel II Framework.
http://www.bis.org/publ/bcbs157.pdf [accessed: 16.05.2016].
be higher than fixed salary and can – only in exception and with shareholders’ approval
– reach a maximum of twice the fixed salary. Further, the disbursement of the variable
component of remuneration shall be organized in a way that is incentive compatible
with ensuring long-term sustainability instead of taking short-term risks for boosting
short-term remuneration.4

gradually increase until 2019 where a LCR of 100% is mandatory.5

The LCR aims at mitigating the risk of illiquidity of banking institutions. In this
context, the LCR intends to ensure the financial solvency of banking institutions in a
strict stress scenario over 30 days at any point in time. Hereby the LCR realizes a cash
flow-based concept. Economically, a maximization of this liquidity ratio is not the
overarching goal but rather keeping the LCR within a certain target range that fits a
previously defined liquidity strategy of the respective institution.

Credit institutions are required to hold a liquidity buffer, i.e. a certain stock of high
quality liquid assets (HQLA) as a liquidity cushion. This liquidity cushion shall at least
cover the cumulated funding mismatch (liquidity gap) in form of stressed net liquidity
outflows over the next 30 calendar days. In this way, the financial survival of the
respective institution is guaranteed until the 30th day of the stress scenario. The period
of 30 days was chosen as it is the period that is considered sufficient to initiate
appropriate counter measures to eliminate payment difficulties by either the
supervisory authority, the institution itself or both. As a worst-case scenario, this
period is also sufficient to introduce the resolution of the banking institution. 6 Thus,
the liquidity buffer is the analogous counterpart of equity capital for other risk types.
As mentioned earlier equity capital pursues the coverage of unexpected losses in case
of severe occurrence of market or credit risks. By analogy, the liquidity buffer serves as

4
Deutsche Bundesbank. 2011. Basel III – Leitfaden zu den neuen Eigenkapital- und Liquiditätsregeln für Banken.
Frankfurt am Main: Deutsche Bundesbank.
5
European Commission. 2014. Liquidity Coverage Requirement Delegated Act. http://europa.eu/rapid/press-
release_MEMO-14-579_en.htm [accessed: 17.05.2016].
6
Basel Committee on Banking Supervision. 2013. Basel III: The liquidity coverage ratio and liquidity risk
monitoring tools. http://www.bis.org/publ/bcbs238.pdf [accessed: 17.05.2016].
a compensation of occurring liquidity gaps, respectively as a defence against
insolvency.

The liquidity buffer is part of the numerator in the LCR formula and represents the
sum of all instruments and securities, which fully meet the strict requirements of being
applicable for the buffer (HQLA). That is that they are “easily and immediately
converted to cash, with little or no loss in value”7, with low risk, a certainty of valuation,
a low correlation with risky assets and which is listed on a developed and recognised
exchange. Further they should have an “active and sizeable market” (that is, can be sold
easily), and has a low volatility.8 Those HQLA are subdivided into different liquidity
classes: Level 1, Level 2A, Level 2B. Level 1 are the most liquid assets and thus can
unlimitedly be added as HQLA without receiving a haircut, but however must at lease
account for 60% of the overall amount of HQLA. An exception in this regard are specific
covered bonds with an ECAI (external credit assessment institution) rating of 1 as those
receive a haircut of 7% and have a cap of 70%. In general, Level 1 assets comprise assets
such as cash (coins and bank notes), central bank reserves or marketable securities
(backed by sovereigns and central banks). Next, Level 2A assets are less liquid than
Level 1 assets but more liquid as Level 2B assets. Therefore, they receive a haircut of at
least

In order to improve the short-term liquidity positions of credit institutions and as such
increasing the LCR, credit institutions have two options: either increasing the
numerator or decreasing the denominator. With regard to the first possibility, banks
simply increase the amount of liquid assets, i.e. the amount of Level 1, Level 2A, and
Level 2B assets. Concerning the second option, banks ideally decrease the amount of
transactions that are largely exposed to institutions specific and systemic risk and thus
cause a high-expected liquidity outflow in the stress scenario, e.g. credit facilities.

7
Basel Committee on Banking Supervision. 2013. Basel III: The liquidity coverage ratio and liquidity risk
monitoring tools. http://www.bis.org/publ/bcbs238.pdf [accessed: 17.05.2016].
8
Ibid.
Furthermore, expected cash outflows can also be decreased by extending short-term
funding beyond the underlying 30 days.9

To achieve an improvement for the longer-term liquidity positioning of credit

institutions and as such increasing the NSFR, credit institutions need to either increase
available stable funding sources – increase the amount of more stable liabilities as
deposits from non-bank institutions – or decrease required stable funding –
restructuring of assets towards more liquid assets.10

Finally yet importantly, one must not forget that applying those previously describes
measures to meet Basel III requirements indirectly affects the earnings situation of
credit institutions. As credit institutions now have to cover their risk-weighted assets
with a larger amount of equity under Basel III, this employed capital is no longer
available for profitable transactions. Further earnings pressure arises due to the
introduction of LCR as credit institutions now have to carry high amount of HQLA,
particular in form of government bonds. This kind of asset does only pay a rather low
level of interest due to their high quality. In terms of the NSFR banks are limited in
their ability to use maturity transformation which also increases earnings pressure.
However especially the maturity transformation is still one of the most important
sources of earnings for banks which is endangered by fostering matching maturities. 11

It would be extremely valuable to quantify the previous brief description of impacts of

Basel III on the earnings situation of banks. Although there are some estimations, the
overall decrease of return metrics – such as return on equity – since the Financial Crisis
cannot only be traced back to new regulatory requirements. The entire banking market
finds itself in extremely difficult market conditions due to a low interest rate
environment, slow economic growth, increasing pressure by new market entrants and
further factors. Additionally, the return metrics were simply overvalued at pre crisis
times. Thus, it would be questionable to assign Basel III implementation to a decrease
in the earnings metrics of credit institutions.

9
Gogarn, J. 2015. Liquiditätsmeldewesen im Wandel. Norderstedt: Books on Demand. p.8f.
10
Gogarn, J. 2015. Liquiditätsmeldewesen im Wandel. Norderstedt: Books on Demand. p.44f.
11
Die Familienunternehmer – ASU e.V. 2011. Auswirkungen der Reformen der Bankenaufsicht berücksichtigen!
Kreditvergabe der Banken, Sparkassen und genossenschaftlichen Kreditinstitute. Berlin: Die
Familienunternehmer – ASU e.V.
The following sub chapter will outline the current implementation status of Basel III
requirements until the 30th June 2015. Herewith 107 German credit institutions were
analysed and categorized into two separate groups. Respectively, group 1 credit
institutions have an amount of Tier 1 capital of at least 3 bn EUR or more and are
internationally active banks whereas group 2 credit institutions are a representative
sample of remaining credit institutions. The following illustration of the current
implementation status of Basel III requirements will mostly focus on German credit
institutions, however being elaborated by setting German results in relation to
international peer results