BASEL III

Basel III 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 2010-11,
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 0.05-0.15%. [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, which
could further negatively affect the stability of the financial system. [7][8]
Contents
[hide]

1 Overview
2 Summary of proposed changes

2.1 US implementation
3 Macroeconomic Impact of Basel III
4 Key dates

4.1 Capital Requirements

4.2 Leverage Ratio

4.3 Liquidity Requirements

5 Studies on Basel III
6 See also
7 References
8 External links

[edit]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 3% leverage ratio and two required liquidity ratios. 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. [9]
[edit]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.[10]

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

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).[11]

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.
[12]
)

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 Sept 2010, Proposed Basel III norms ask 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 cap and 10.5 to 13 for total
capital (Proposed Basel III Guidelines: A Credit Positive for Indian Banks)'
[edit]US

implementation

The US Federal Reserve announced in December 2011 that it would implement substantially all of the
Basel III rules.[13] 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 riskmanagement 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."[14]
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]
[edit]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.[16]
[edit]Key

dates

[edit]Capital

Requirements

Date

Milestone: Capital Requirement

201
3

Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital
requirements.

201
5

Minimum capital requirements: Higher minimum capital requirements are fully implemented.

201
6

Conservation buffer: Start of the gradual phasing-in of the conservation buffer.

201
9

Conservation buffer: The conservation buffer is fully implemented.

[edit]Leverage

Ratio

Date

Milestone: Leverage Ratio

2011

Supervisory monitoring: Developing templates to track the leverage ratio and the underlying
components.

201
3

Parallel run I: The leverage ratio and its components will be tracked by supervisors but not
disclosed and not mandatory.

201
5

Parallel run II: The leverage ratio and its components will be tracked and disclosed but not
mandatory.

201
7

Final adjustments: Based on the results of the parallel run period, any final adjustments to the
leverage ratio.

201
8

Mandatory requirement: The leverage ratio will become a mandatory part of Basel III
requirements.

[edit]Liquidity
Date

Requirements
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).