Summary of Basel III – What You Must Know
Basel III norms are a new set of banking rules developed by the Basel Committee on Banking Supervision of BIS. The objective of the Basel III accord is to strengthen the regulation, supervision and risk management of the banking sector. The new rules prescribe how to assess risks, and how much capital to set aside for banks in keeping with their risk profile.
Basel III builds on the builds on the International Convergence of Capital Measurement and Capital Standards document (Basel II).
According to the BCBS, the Basel 3 proposals have two main objectives:
- To strengthen global capital and liquidity regulations with the goal of promoting a more resilient banking sector; and
- To improve the banking sector’s ability to absorb shocks arising from financial and economic stress.
Summary of Changes in Basel III from Basel II
The most important changes in Basel III are listed below:
Increased Capital Requirements
The rules aim at improving both the quality and quantity of capital.
According to the Basel III rules, banks will need to increase their tier-one capital ratio (ratio of equity capital to risk-weighted assets (RWA)) from 2% to 4.5%. This should be done by 2015. In addition to this, by 2019, banks will be required to add an additional conservation buffer of 2.5%. This means that they will have to hold core capital equal to 7% of their risk-weighted assets.
The minimum total capital requirements has increased from 8% to 10.5% (including the conversation buffer)
There are also significant changes in what qualifies as Tier 1 capital. For example, common equity and retained earnings should form the predominant component of Tier I capital.
The reasoning behind this move is that if banks have higher capital cushion, they will be in a better position to take the effects of a downturn.
Reduced Leverage
The leverage limit for banks has been set to 3%, i.e., a bank’s total assets (including both on and off-balance sheet assets) should not be more than 33 times bank capital.
Liquidity Reforms
To complement its “Principles for Sound Liquidity ”Risk Management and Supervision, the Basel Committee has further strengthened its liquidity framework by developing two minimum standards for funding liquidity:
