What is Basel iii or What is Basel 3 Accord or Meaning and Definition of Basel III Accord:-

Basel III or Basel 3 released in December, 2010 is the third in the series of Basel Accords. These accords deal with risk management aspects for the banking sector. In a nut shell we can say that Basel iii is the global regulatory standard (agreed upon by the members of the Basel Committee on Banking Supervision) on bank capital adequacy, stress testing and market liquidity risk. (Basel I and Basel II are the earlier versions of the same, and were less stringent)

 

What does Basel III is all About ?

 

According to Basel Committee on Banking Supervision "Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector".

 

Thus, we can say that Basel 3 is only a continuation of effort initiated by the Basel Committee on Banking Supervision to enhance the banking regulatory framework under Basel I and Basel II. This latest Accord now seeks to improve the banking sector's ability to deal with financial and economic stress, improve risk management and strengthen the banks' transparency.

What are the objectives / aims of the Basel III measures ?

Basel 3 measures aim to:

→ improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source

→ improve risk management and governance

→ strengthen banks' transparency and disclosures.

Thus we can say that Basel III guidelines are aimed at to improve the ability of banks to withstand periods of economic and financial stress as the new guidelines are more stringent than the earlier requirements for capital and liquidity in the banking sector.

How Does Basel III Requirements Will Affect Indian Banks :

The Basel III which is to be implemented by banks in India as per the guidelines issued by RBI from time to time, will be challenging task not only for the banks but also for GOI. It is estimated that Indian banks will be required to rais Rs 6,00,000 crores in external capital in next nine years or so i.e. by 2020 (The estimates vary from organisation to organisation). Expansion of capital to this extent will affect the returns on the equity of these banks specially public sector banks. However, only consolation for Indian banks is the fact that historically they have maintained their core and overall capital well in excess of the regulatory minimum.

What are Three Pillars of Basel II Norms or What are the changes in Three Pillars of Basel iii Accord ?

 

Basel III: Three Pillars Still Standing :

 

Any one who has ever heard about Basel I and II, is most likely must have heard about Three Pillars of Basel. Three Pillar of Basel still stand under Basel 3.

Basel III has essentially been designed to address the weaknesses that become too obvious during the 2008 financial crisis world faced. The intent of the Basel Committee seems to prepare the banking industry for any future economic downturns.. The framework enhances bank-specific measures and includes macro-prudential regulations to help create a more stable banking sector.

 

 

The basic structure of Basel III remains unchanged with three mutually reinforcing pillars.

 

Pillar 1 : Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs) : Maintaining capital calculated through credit, market and operational risk areas.

Pillar 2 : Supervisory Review Process : Regulating tools and frameworks for dealing with peripheral risks that banks face.

Pillar 3: Market Discipline : Increasing the disclosures that banks must provide to increase the transparency of banks

 

 

What are the Major Changes Proposed in Basel III over earlier Accords i.e. Basel I and Basel II?

What are the Major Features of Basel III ?

 

 

(a) Better Capital Quality : One of the key elements of Basel 3 is the introduction of much stricter definition of capital. Better quality capital means the higher loss-absorbing capacity. This in turn will mean that banks will be stronger, allowing them to better withstand periods of stress.

 

(b) Capital Conservation Buffer: Another key feature of Basel iii is that now banks will be required to hold a capital conservation buffer of 2.5%. The aim of asking to build conservation 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.

 

(c) Countercyclical Buffer: This is also one of the key elements of Basel III. The countercyclical buffer has been introducted with the objective to increase capital requirements in good times and decrease the same in bad times. The buffer will slow banking activity when it overheats and will encourage lending when times are tough i.e. in bad times. The buffer will range from 0% to 2.5%, consisting of common equity or other fully loss-absorbing capital.

 

(d) Minimum Common Equity and Tier 1 Capital Requirements : The minimum requirement for common equity, the highest form of loss-absorbing capital, has been raised under Basel III from 2% to 4.5% of total risk-weighted assets. The overall Tier 1 capital requirement, consisting of not only common equity but also other qualifying financial instruments, will also increase from the current minimum of 4% to 6%. Although the minimum total capital requirement will remain at the current 8% level, yet the required total capital will increase to 10.5% when combined with the conservation buffer.

 

(e) Leverage Ratio: A review of the financial crisis of 2008 has indicted that the value of many assets fell quicker than assumed from historical experience. Thus, now Basel III rules include a leverage ratio to serve as a safety net. A leverage ratio is the relative amount of capital to total assets (not risk-weighted). This aims to put a cap on swelling of leverage in the banking sector on a global basis. 3% leverage ratio of Tier 1 will be tested before a mandatory leverage ratio is introduced in January 2018.

 

(f) Liquidity Ratios: Under Basel III, a framework for liquidity risk management will be created. A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced in 2015 and 2018, respectively.

 

(g) Systemically Important Financial Institutions (SIFI) : As part of the macro-prudential framework, systemically important banks will be expected to have loss-absorbing capability beyond the Basel III requirements. Options for implementation include capital surcharges, contingent capital and bail-in-debt.

 

 

Comparison of Capital Requirements under Basel II and Basel III :

 

RequirementsUnder Basel II

Under Basel III

Minimum Ratio of Total Capital To RWAs

8% 10.50%

Minimum Ratio of Common Equity to RWAs

2%4.50% to 7.00%

Tier I capital to RWAs 4% 6.00%

Core Tier I capital to RWAs 2% 5.00%

Capital Conservation Buffers to RWAs

None 2.50%

Leverage Ratio None 3.00%

Countercyclical Buffer None 0% to 2.50%

Minimum Liquidity Coverage Ratio

None TBD (2015)

Minimum Net Stable Funding Ratio

None TBD (2018)

Systemically important Financial Institutions Charge

None TBD (2011)

     

Basel III (or   the   Third   Basel   Accord)   is   a   global,   voluntary   regulatory   standard   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 2010–11, and was scheduled to be introduced from 2013 until 2015;   changes   from   January   7,   2013   extended   implementation   until   2019   however.[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 was supposed to strengthen bank capital requirements by increasing bank liquidity and bank leverage.

Key principles [edit]

Capital requirements [edit]

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 (up from 4% in Basel II) of "risk-weighted assets" (RWA). Basel III introduced "additional capital buffers", (i) a "mandatory capital conservation buffer" of 2.5% and (ii) a "discretionary counter-cyclical buffer", which would allow national regulators to require up to another 2.5% of capital during periods of high credit growth.

Leverage ratio [edit]

Basel III  introduced a minimum "leverage ratio". The leverage ratio was calculated by dividing Tier 1 capital  by   the bank's  average  total   consolidated assets;[3] the  banks  were expected  to  maintain   the leverage ratio in excess of 3%.

Liquidity requirements [edit]

Basel   III   introduced   two required   liquidity   ratios.[4] The  "Liquidity  Coverage  Ratio"  was  supposed   to require a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows 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.[5]

Implementation [edit]

Summary of originally (2010) proposed changes in Basel Committee language [edit]

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.[6]

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, a leverage ratio will be introduced as a supplementary measure to the Basel II risk-based framework,

intended to achieve the following objectives:

Put a floor under the build-up of leverage in the banking sector

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, a series of measures is introduced 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").

Measures to address procyclicality:

Dampen 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).[7]

Fifth,a  global  minimum  liquidity   standard   for   internationally  active banks   is   introduced   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.[8])

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 of September 2010, proposed Basel III norms asked for ratios as: 7–9.5% (4.5% + 2.5% (conservation buffer) + 0–2.5% (seasonal buffer)) for common equity and 8.5–11% for Tier 1 capital and 10.5–13% for total capital.[9]

U.S. implementation [edit]

The U.S. Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules.[10] 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."

"Early  remediation requirements"   to ensure  that  "financial  weaknesses  are addressed at  an early stage". One or more "triggers for remediation—such as capital levels, stress test results, and risk-management weaknesses—in 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."[11]

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."[10]

Macroeconomic impact [edit]

An OECD study[12] released on 17 February 2011, estimated that the medium-term impact of Basel III implementation on GDP growth would be in the range of −0.05% to −0.15% per year. Economic output would be 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 originally effective in 2015 banks were estimated to increase their lending spreads on average by about 15 basis points. 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.[13] The estimated 

effects on GDP growth assume no active response from monetary policy. To the extent that monetary policy would 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.[12]

Critics [edit]

Basel III has been criticized by banks, organized in the Institute of International Finance in Washington D.C. (large American and European banks, including Goldman Sachs, Morgan Stanley, Deutsche Bank) with the argument it would hurt them and economic growth.OECD estimated that implementation of Basel III would decrease annual GDP growth by 0.05–0.15%,[12][14] blaming regulation as responsible for slow recovery from the late-2000s financial crisis.[15][16] Basel III was also criticized as negatively affecting the stability of the financial system by increasing incentives of banks to game the regulatory framework.[17] The American Banker's Association,[18] community banks organized in the Independent Community Bankers of America, and some of the most liberal Democrats in the U.S. Congress, including the entire Maryland congressional delegation with Democratic Sens. Cardin and Mikulski and Reps. Van Hollen and Cummings, voiced opposition to Basel III in their comments submitted to FDIC,[19] saying that the Basel III proposals, if implemented, would hurt small banks by increasing "their capital holdings dramatically on mortgage  and small  business   loans."[20] Others  have  argued   that  Basel   III  did  not  go   far  enough  to regulate banks as inadequate regulation was a cause of the financial crisis.[21] On January 6, 2013 the global banking sector won a significant easing of Basel III Rules, when the Basel Committee on Banking Supervision extended not only the implementation schedule to 2019, but broadened the definition of liquid assets.[22]

Further studies [edit]

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 still under development.

Date Source Article Title / Link Comments

Feb 2012

BNP Paribas FortisBasel   III   for   dummiesVideo

"All you need to know about Basel III in 10 minutes." Updated for Jan 06 2013 decisions.

Dec 2011

OECD:   Economics Department

Systemically  Important Banks

OECD analysis on the failure of bank regulation and markets to discipline systemically important banks.

Jun 2011

BNP   Paribas: Economic Research Department

Basel   III:   no   Achilles' spear

BNP Paribas' Economic Research Department study on Basel III.

Feb 2011

Georg, Co-PierreBasel   III   and   Systemic Risk Regulation – What Way Forward?

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

Feb 2011

OECD:   Economics Department

Macroeconomic Impact of Basel III

OECD   analysis   on   the   macroeconomic   impact   of Basel III.

May 2010

OECD   Journal:Financial   Market Trends

Thinking Beyond Basel III

OECD study on Basel I, Basel II and III.

May 2010

BloombergBusinessWeek

FDIC's Bair Says Europe Should   Make   Banks Hold More Capital

Bair said regulators around the world need to work together on the next round of capital standards for banks ... the next round of international standards, known as Basel III, which Bair said must meet "very aggressive" goals.

May 2010

ReutersFACTBOX-G20 progress on financial regulation

Finance ministers from the G20 group of  industrial and  emerging   countries  meet   in  Busan,  Korea,  on June   4–5   to   review   pledges   made   in   2009   to strengthen   regulation   and   learn   lessons   from   the financial crisis.

May 2010

The Economist

The  banks  battle  backA   behind-the-scenes brawl over new capital and liquidity rules

"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."