commercial bank

Topics: Basel II, Capital requirement, Banking Pages: 8 (1961 words) Published: September 26, 2013


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Basel 3 norms were implemented by Basel committee on Banking Supervision (BCBS) with the objective to improve the banking sector’s ability to absorb shocks arising from financial and economic stress. Some of the major causes of the global financial crisis were: too much leverage, too little capital, and inadequate liquidity buffers. Other factors also responsible for this crisis were: shortcomings in risk management, corporate governance, market transparency and quality of supervision. These have pinpointed the systemic loopholes in the Basel II framework, which was considered a more risk-sensitive approach compared to its earlier version, Basel I.

Thus, Basel III was designed to address the weaknesses of the past crisis and to make the banking sector much stronger and efficient enough to face any crisis. The major thrust area of Basel III is improvement of quantity and quality of capital of banks, with stronger supervision, risk management and disclosure standards. These measures aim to 1. Improve the banking sector’s ability to absorb shocks arising from financial and economic stress. 2. Improve risk management and governance.

3. Strengthen bank’s transparency and disclosures.

Objectives of Basel 3:
Comprehensive set of reform measures to strengthen the banking sector. Strengthens bank’s transparency and disclosures.
Special emphasis on capital adequacy ratio.

Features of Basel 3 norms:
Better capital quality.
Backstop leverage ratio.
Short term and long term liquidity funding.
Counter cyclical buffer.
Capital conversion buffer.

1. Minimum regulatory capital requirement based on Risk Weighted Assets. 2. Supervisory review process.
3. Market discipline.

Challenges of Basel 3:

1. Functional:
Functional specifications of new regulatory requirements.Functional integration of new regulatory requirements into existing capital and risk management. 2. Technical:
Technical implementations of new regulatory requirements.Data availability and quality.Technical integration into existing risk management system.

3. Organizational:
Coordination of different units as well as within the group.Availability of resources.Responsibilities within implementation and beyond.

Major changes proposed in Basel 3:
1. 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. 2. 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. 3. Countercyclical Buffer:   This is also one of the key elements of Basel III.   The countercyclical buffer has been introduced 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. 4. 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...
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