Basel

OVERVIEW

Meaning of Basel III

Why Basel III

Aims

Objectives

Major Changes

Implementation of the Changes

 What is "Basel III":

" A global regulatory standard on:

bank capital adequacy

stress testing and
market liquidity risk
Also a set of reform measures to
improve:

Regulation
Supervision
Risk management
Reasons for Basel III Formulation:

Failures of Basel II being:

A. Inability to strengthen financial stability.

B. Insufficient capital reserve.

C. Inadequate comprehensive risk management approach.

D. Lack of uniformed definition of capital .

Aims & Objectives of Basel III

To minimize the probability of recurrence of crises to

greater extent.

To improve the banking sector's ability to absorb

shocks arising from financial and economic stress.

To improve risk management and governance.

To strengthen banks' transparency and disclosures .

 Targets:
Bank-level or micro prudential which will
help raise the resilience of individual
banking institutions in periods of stress.

Macro prudential system wide risks that

build up across the banking sector as
well as the pro-cyclical amplification of
these risk over time.
 Key Elements of Reforms

Increasing the quality and quantity capital

Enhancing risk coverage of capital
Introducing Leverage ratio
Improving liquidity rules
Establishing additional buffers
Managing counter party risks
Structure of Basel II
Pillar 1:Minimum Capital
Requirements
Pillar 1 aligns the minimum capital requirements
more closely to actual risks of bank's economic
loss.

revised risks:
Credit risk
Operational risk
Market risk
Pillar 1:Minimum Capital
Requirements(cont.)
Credit risk
The standardised approach
Foundation internal ratings based (IRB)
approach
Advanced IRB approach
Operational risk
Basic indicator approach
Standardized approach
Advanced measurement approach
Market risk
standardized approach
internal models approach
 Pillar 2:Supervisory Review
Process
Pillar 2 requires banks to think about the whole spectrum
of risks they might face including those not captured at all
in Pillar 1 such as interest rate risk.
Coverage in Pillar 2:
risks that are not fully covered by Pillar 1
Credit concentration risk
Counterparty credit risk
Risks that are not covered by Pillar 1
Interest rate risk in the banking book
Liquidity risk
Business risk
Stress testing
Pillar 3:Market Discipline

Pillar 3 is designed to increase the

transparency of lenders' risk profile by
requiring them to give details of their
risk management and risk distributions.
 Weaknesses of Basel II

The quality of capital.

Pro-cyclicality.

Liquidity risk.

Systemic banks.
Basel III: Strengthening the global capital
framework

A. Capital reform.

B. Liquidity standards.

C. Systemic risk and interconnectedness.

 A. Capital Reform
A new definition of capital.

Capital conservation buffer.

Countercyclical capital buffer.

Minimum capital standards.

 A new definition of capital
Total regulatory capital will consist of the sum of
the following elements:

1. Tier 1 Capital (going-concern capital)

a. Common Equity Tier 1
b. Additional Tier 1

2. Tier 2 Capital (gone-concern capital)

For each of the three categories above (1a, 1b and

2) there is a single set of criteria that instruments
are required to meet before inclusion in the
relevant category.
Capital conservation buffer
The capital conservation buffer is designed to ensure that
banks build up capital buffers outside periods of stress
which can be drawn down as losses are incurred.

A capital conservation buffer of 2.5%, comprised of

Common Equity Tier 1, is established above the
regulatory minimum capital requirement.

Outside of periods of stress, banks should hold buffers

of capital above the regulatory minimum.
Countercyclical capital buffer

The countercyclical buffer aims to ensure that banking

sector capital requirements take account of the macro-
financial environment in which banks operate.

It will be deployed by national jurisdictions when excess

aggregate credit growth is judged to be associated with a
build-up of system-wide risk to ensure the banking system
has a buffer of capital to protect it against future potential
losses.
Minimum capital standards
B. Liquidity Standards:
1. Short-term: Liquidity Coverage
Ratio(LCR)

2. Long-term: Net Stable Funding

Ratio(NSFR)
1.Short-term:LCR

The LCR is a response from Basel committee

to the recent financial crisis. The LCR
proposal requires banks to hold high quality
liquid assets in order to survive in emergent
stress scenario.
Short-term:LCR
Must be no lower than 1.

The higher the better.

high quality liquid: liquid in markets during a time of

stress and, ideally, be central bank eligible.

Banks are still expected to conduct their own stress tests

to assess the level of liquidity they should hold beyond
this minimum, and construct scenarios that could cause
difficulties for their specific business activities.
 2. Long-term:NSFR
Objectives:
To promote more medium and long-term funding
activities of banking organizations.
Ensure that the investment activities are funded by
stable liabilities.
To limit the over-reliance on wholesale short-term
funding(money market)
 Long-term:NSFR

Available stable funding (ASF) is defined as the total

amount of an institutions:

capital.

preferred stock with maturity of equal to or greater than

one year.

liabilities with effective maturities of one year or greater.

deposits and/or term deposits with maturities of less

than one year that would be expected to stay with the
institution for an extended period a stress event.
 Required Stable Funding:

The required amount of stable funding is

calculated as the sum of the value of the assets
held and funded by the institution, multiplied by a
RSF factor, added to the amount of OBS activity
(or potential liquidity exposure) multiplied by its
associated RSF factor.
 Required Stable Funding
These components of required stable funding are not
equally weighted.

100% of loans longer than one year.

85% of loans to retail clients with a remaining life

shorter than one year.

50% of loans to corporate clients with a remaining life

shorter than one year.

and 20% of government and corporate bonds.

off-balance sheet categories are also weighted.
 C. Systemic risk and
interconnectedness (Counterparty
risk)
Capital incentives for using CCPs for OTC.

Higher capital for systemic derivatives.

Higher capital for inter-financial exposures.

Contingent capital.

Capital surcharge for systemic banks.

CONCLUSION
Basel III introduces a paradigm shift in
capital and liquidity standards.

It was constructed and agreed in relatively

record time which leaves many elements
unfinished.

The final implementation date a long way off.

HOWEVER,
Market pressure and competitor pressure
already driving considerable change at a
range of firms.

Firms therefore should ensure to engage with

Basel III as soon as possible to be
competitively advantaged in the new post-
crisis financial risk and regulatory landscape.
References:
Basel II: a guide to capital adequacy standards for Lenders.
[Available at: http://www.cml.org.uk/cml/policy/issues/748]
Basel III regulations: a practical overview. [Available at:
www.moodysanalytics.com] [Accessed on 30/11/12].
Basel III: Issues and implications. [Available at:
www.kpmg.com] [Accessed on 30/11/12].
Federal Reserve Proposes Revised Bank Captial Rules. [Available
at: http://blogs.law.harvard.edu/corpgov/2012/06/12/federal-
reserve-proposes-revised-ba...] [Accessed on 30/11/12].
Introduction to Basel II: [Available at:
http://www.rcg.ch/papers/basel2.pdf]
Introduction to Basel II. [Available at:
http://www.horwathmak.com/Literature/Introduction_to_basel_i
i.pdf]
References: (Cont.)
http://mpra.ub.uni-muenchen.de/35908/ [Accessed
on 11/12/2012]
The New Basel III Framework: Implications for
Banking Organisations. [Available at:
www.shearman.com][Accessed on 30/11/12].