Basel III summary
Basel III is an extension of the existing Basel II Framework, and introduces new capital and liquidity standards to strengthen the regulation, supervision, and risk management of the whole of the banking and finance sector.
It was agreed upon by the members of the Basel Committee on Banking Supervision in 2010–2011, and was scheduled to be introduced from 2013 until 2015. However, changes made from April 2013 extended implementation until March 31, 2018. The Basel III requirements were in response to the deficiencies in financial regulation that is revealed by the 2000’s financial crisis. Basel III was intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.
The global capital framework and new capital buffers require financial institutions to hold more capital and higher quality of capital than under current Basel II rules. The new leverage ratio introduces a nonrisk-based measure to supplement the risk-based minimum capital requirements. The new liquidity ratios ensure that adequate funding is maintained in case there are other severe banking crises.
Capital requirements
The Basel III rule introduced the following measures to strengthen the capital requirement and introduced more capital buffers:- Capital Conservation Buffer is designed to absorb losses during periods of financial and economic stress. Financial institutions will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress, bringing the total common equity requirement to 7% (4.5% common equity requirement and the 2.5% capital conservation buffer). The capital conservation buffer must be met exclusively with common equity. Financial institutions that do not maintain the capital conservation buffer faces restrictions on payouts of dividends, share buybacks, and bonuses.
- Countercyclical Capital Buffer is a countercyclical buffer within a range of 0% and 2.5% of common equity or other fully loss absorbing capital is implemented according to national circumstances. This buffer serves as an extension to the capital conservation buffer.
- Higher Common Equity Tier 1 (CET1) constitutes
an increase from 2% to 4.5%. The ratio is set at:
- 3.5% from 1 January 2013
- 4% from 1 January 2014
- 4.5% from 1 January 2015
- Minimum Total Capital Ratio remains at 8%. The addition of the capital conservation buffer increases the total amount of capital a financial institution must hold to 10.5% of risk-weighted assets, of which 8.5% must be tier 1 capital. Tier 2 capital instruments are harmonized and tier 3 capital is abolished.
Leverage ratio
Basel III introduced a minimum "leverage ratio". The leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets; the banks were expected to maintain a leverage ratio in excess of 3% under Basel III. In July 2013, the US Federal Reserve Bank announced that the minimum Basel III leverage ratio would be 6% for 8 SIFI banks and 5% for their bank holding companies.Liquidity requirements
Basel III introduced two required liquidity ratios:- Liquidity Coverage Ratio (LCR) ensures that sufficient levels of high-quality liquid assets are available for one-month survival in a severe stress scenario.
- Net Stable Funding Ratio (NSFR) promotes resilience over long-term time horizons by creating more incentives for financial institutions to fund their activities with more stable sources of funding on an ongoing structural basis.