Basel III

Basel III is a set of international banking regulations developed by the Basel Committee on Banking Supervision to strengthen regulation, supervision, and risk management within the banking sector. Introduced in response to the financial crisis of 2007-2008, Basel III aims to address the deficiencies in financial regulation that were exposed by the crisis, enhancing the banking sector's ability to absorb shocks arising from financial and economic stress, improving risk management, and strengthening the transparency and disclosure requirements.

History and Context

Following the Global Financial Crisis, it became evident that the existing Basel II framework was insufficient in preventing systemic banking failures. The need for a more robust framework led to the initiation of Basel III:

• Announcement: The first version of Basel III was announced in 2010.
• Implementation: The framework's rules were to be implemented gradually, with full implementation expected by 2019, though some deadlines were later extended.
• Objectives:
  • Improve the banking sector's resilience against economic and financial stress.
  • Introduce more stringent capital requirements to ensure banks maintain sufficient capital to cover risks.
  • Enhance risk coverage through better risk management practices.
  • Introduce a leverage ratio to restrict the build-up of leverage in the banking system.
  • Introduce liquidity requirements to prevent short-term funding issues.

Key Components of Basel III

• Capital Requirements: Basel III introduced higher quality capital requirements. Banks must hold:
  • Common Equity Tier 1 (CET1) capital, which must be at least 4.5% of risk-weighted assets.
  • Tier 1 capital, including CET1, at 6% of risk-weighted assets.
  • Total capital (Tier 1 + Tier 2) at 8% of risk-weighted assets.
• Conservation Buffer: A capital conservation buffer of 2.5% of risk-weighted assets, designed to absorb losses during periods of economic and financial stress.
• Countercyclical Buffer: This buffer ranges from 0% to 2.5%, allowing national regulators to require banks to hold more capital during periods of high credit growth.
• Leverage Ratio: A non-risk-based leverage ratio of 3%, to act as a safeguard against the risk of excessive leverage in the banking system.
• Liquidity Requirements:
  • The Liquidity Coverage Ratio (LCR), which requires banks to hold enough high-quality liquid assets to withstand a 30-day stress scenario.
  • The Net Stable Funding Ratio (NSFR), designed to promote more medium and long-term funding of the assets and activities of banks.
• Systemically Important Financial Institutions (SIFIs): Additional requirements for Global Systemically Important Banks (G-SIBs), which include higher loss absorbency requirements.

Impact and Implementation

Basel III has been adopted by many countries, with variations to fit local regulatory environments. Its implementation has been challenging due to:

• The complexity of the rules.
• The cost of compliance for banks, particularly smaller institutions.
• The need for international cooperation to prevent regulatory arbitrage.

External Links

• Basel III Overview by BIS
• Investopedia on Basel III
• FSB Report on Basel III

• Basel II
• Capital Adequacy Ratio
• Solvency II
• Financial Stability Board