Basel Iii

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  • Topic: Capital requirement, Bank, Banking
  • Pages : 7 (2164 words )
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  • Published : June 6, 2012
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Basel III is a global comprehensive collection of restructured regulatory standards on bank capital adequacy and liquidity. It was developed by the Basel Committee on Banking Supervision to strengthen the regulation, supervision and risk management of the banking sector (bis.org, 2010). It introduces new regulatory requirements on bank liquidity and bank leverage in response to the financial downturn caused by the Global Financial Crisis. Stefan Walter, Secretary General of the Basel Committee on banking supervision said in November 2010: “There are many factors that led to the build up of the crisis. At the top of the list is excess liquidity, resulting in too much credit and weak underwriting standards. The vulnerability of the banking sector to this build up of risk in the system was primarily due to excess leverage, too little capital of insufficient quality, and inadequate liquidity buffers”. (pwc.lu, May 2011). The reform’s objective is to improve both microprudential, bank-level, as well as macroprudential, system wide, regulation (actuaries.asn.au, 2011). Microprudential regulation will help increase the resilience of individual banking institutions to periods of financial and economic stress. Macroprudential regulation will help increase resilience of risks that can build up and intensify over time across the banking sector (bis.org, 2010). The greater the resilience at the individual bank level, the lower the risk of system wide shocks. Basel III aims to improve risk management and governance, strengthen banks’ transparency and disclosures, and improve the banking sector’s ability to absorb financial and economic shocks (bis.org 2010). Basel III will take effect gradually over the next eight years (theaustralian.com.au, December 2010). APRA proposed to adopt the minimum Basel III requirements for the definition and measurement of capital to ensure that its prudential capital framework is aligned with global standards. The key elements of the Basel III Accord are: 1. Raising the quality, consistency and transparency of the capital base

The Global Financial Crisis showed that credit losses and write-downs came out of retained earnings, which is part of banks’ tangible common equity base. This has showed that the quality of capital between institutions was not assessed properly because of the different definitions of capital and the lack of disclosure (bis.org, 2010). This has lead to an improvement of Tier 1 with a predominant form of common shares and retained earnings. The remainder of the Tier 1 capital base must consist of instruments that are subordinated, have fully discretionary noncumulative dividends or coupons and do not have a maturity date or an incentive to redeem (bis.org, 2010). Also, Tier 2 will be harmonised and simplified, keeping only one class of Tier 2 capital. In addition, Tier 3 will be eliminated and there will be enhanced disclosures of capital base.

2. Enhancing risk coverage

The Global Financial Crisis showed the urgent need to strengthen the risk coverage of the capital framework. On- and off-balance sheet risks as well as derivative related exposures have to be accounted for. The new framework will raise capital requirements for the trading book and complex securitisation exposures (bis.org, 2010). A stressed value-at-risk (VaR) capital requirement will be introduced. This capital requirement will be based on a continuous 12-month period of significant financial stress. The reforms also increase the standards of the Pillar 2 supervisory process and strengthen Pillar 3 disclosures. The framework also aims to strengthen the capital requirements for counterparty credit risk, which would raise the capital buffers that back these exposures, reduce procyclicality, and reduce systematic risk across the financial system (bis.org, 2010). The reform also focuses on the improvement of capital standards relating to exposure at default and collateral management in the trading book...
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