Basel Ⅲ

Chinwe BostonMengchun Zhang

Qiuli GuoDi Xiao

Nathan Tsormetsri

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 capitalIntroducing Leverage ratioImproving liquidity rules

Establishing additional buffersManaging 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 institution’s:

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_ii.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].