What is Basel III?
• The Basel Accords are a set of rules on banking regulations in regards to capital
• Basel III is a series of additions to the existing accords designed to limit the likelihood and impact of a future financial crisis. It requires banks to hold more higher-quality capital against more conservatively calculated risk weighted assets (RWAs). It also looks to ensure sufficient liquidity during times of stress and to reduce excess leverage
What are the amendments?
Capital
• A minimum of 7 per cent of a bank’s RWAs must be core tier one to act as a buffer against losses. This compares with the 2 per cent required under Basel II
• The definition of which liabilities can be classified as core tier one will narrow
• There is a counter-cyclical buffer of 0 to 2.5 per cent, which is to be built up when the economy is strong so that it can be called upon in tougher times
• Additional requirements will also be introduced for large banks deemed vital to the global financial system – so called Global Systemically Important Financial Institutions (G-SIFIs) – to hold an extra 1 to 2.5 per cent of core tier one capital
Risk Weighted Assets
• In addition to increasing the quality and quantity of capital, Basel III also updates the risk weighted asset (RWA) calculation for counterparty credit risk
• This will see the introduction of the Credit Valuation Adjustment (CVA) capital charge, which increases the capital held against the risk that the mark-to-market value of derivatives will deteriorate due to a change in counterparty credit worthiness
• The Financial Institution Asset Value Correlation (FI AVC) will be amended to increase the RWAs for banks’ exposures to large and / or unregulated financial institutions
Liquidity
• The Liquidity Coverage Ratio (LCR) defines the amount of unencumbered, low risk assets (such as cash or gilts) that banks must hold to offset forecast cash outflows during a 30-day crisis
• Outflows are estimated, based on the nature of the customer relationship and the type of product Leverage
• A new leverage ratio of 3 per cent is due to become mandatory in 2018. This seeks to ensure banks apply adequate capital to all their exposures, including those off balance sheets, and without applying any risk weightings
Timing
Basel III requirements are being introduced from 2013 but some areas are still subject to change and total compliance is not expected until 2019. The long lead-in is designed to prevent sudden lending freezes as banks improve their balance sheets.
• In Europe, the regulations will be implemented through changes to the Capital Requirements Directive (CRD IV) and the introduction of a Capital Requirements Regulation (CRR). However, various observation and phase-in periods mean the standards will not be fully implementated until 1 January 2019
• In Asia, regulators in each country will implement the regulations individually,taking their steer from the financial centres of Hong Kong, Singapore and Australia
• In the US, consultations regarding local implementation of Basel III are ongoing
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