BASEL IIIBasel IIIis a global regulatory standard on bankcapital adequacy,stress testingandmarket liquidityriskagreed upon by the members of theBasel Committee on Banking Supervisionin 2010-11, and scheduled to be introduced from 2013 until 2018.[1][2]. The third installment of theBasel Accords(seeBasel I,Basel II) was developed in response to the deficiencies in financial regulation revealed by thelate-2000s financial crisis. Basel III strengthens bankcapital requirementsand introduces new regulatory requirements on bank liquidity and bank leverage. TheOECDestimates that the implementation of Basel III will decrease annual GDP growth by 0.05-0.15%.[3][4]Critics suggest that greater regulation is responsible for the slow recovery from thelate-2000s financial crisis,[5][6]and that the Basel III requirements will increase the incentives of banks to game the regulatory framework, which could further negatively affect the stability of the financial system.[7][8]Contents[hide] 1Overview 2Summary of proposed changes 2.1US implementation 3Macroeconomic Impact of Basel III 4Key dates 4.1Capital Requirements 4.2Leverage Ratio 4.3Liquidity Requirements 5Studies on Basel III 6See also 7References 8External links

[edit]OverviewBasel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; theNet Stable Funding Ratiorequires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.[9][edit]Summary of proposed changes First, the quality, consistency, and transparency of the capital base will be raised. Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings Tier 2 capitalinstruments will be harmonised Tier 3 capital will be eliminated.[10] Second, the risk coverage of the capital framework will be strengthened. Promote more integrated management of market and counterparty credit risk Add the CVA (credit valuation adjustment)-risk due to deterioration in counterparty's credit rating Strengthen the capital requirements for counterpartycredit exposures arising from banks derivatives, repo andsecurities financingtransactions Raise the capital buffers backing these exposures Reduceprocyclicalityand Provide additional incentives to moveOTC derivative contractsto central counterparties (probablyclearing houses) Provide incentives to strengthen therisk managementof counterparty credit exposures Raise counterparty credit risk management standards by including wrong-way risk Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework. The Committee therefore is introducing a leverage ratio requirement that is intended to achieve the following objectives: Put a floor under the build-up ofleveragein the banking sector Introduce additional safeguards againstmodel riskandmeasurement errorby supplementing the risk based measure with a simpler measure that is based on gross exposures. Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers"). The Committee is introducing a series of measures to address procyclicality: Dampen any excess cyclicality of the minimum capital requirement; Promote more forward looking provisions; Conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and Achieve the broadermacroprudentialgoal of protecting the banking sector from periods of excess credit growth. Requirement to use long term data horizons to estimate probabilities of default, downturn loss-given-defaultestimates, recommended in Basel II, to become mandatory Improvedcalibration of the risk functions, which convert loss estimates into regulatory capital requirements. Banks must conductstress teststhat include wideningcredit spreadsin recessionary scenarios. Promoting stronger provisioning practices (forward looking provisioning): Advocating a change in the accounting standards towards an expected loss (EL) approach (usually,EL amount:=LGD*PD*EAD).[11] Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio called theNet Stable Funding Ratio. (In January 2012, the oversight panel of the Basel Committee on Banking Supervision issued a statement saying that regulators will allow banks to dip below their required liquidity levels, the liquidity coverage ratio, during periods of stress.[12]) The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce theexternalitiescreated bysystemically importantinstitutions.As on Sept 2010, Proposed Basel III norms ask for ratios as: 7-9.5%(4.5% +2.5%(conservation buffer) + 0-2.5%(seasonal buffer)) for Common equity and 8.5-11% for tier 1 cap and 10.5 to 13 for total capital(Proposed Basel III Guidelines: A Credit Positive for Indian Banks)'[edit]US implementationThe USFederal Reserveannounced in December 2011 that it would implement substantially all of the Basel III rules.[13]It summarized them as follows, and made clear they would apply not only to banks but to all institutions with more than US$50 billion in assets: "Risk-based capital and leverage requirements" including firstannual capital plans, conductstress tests, andcapital adequacy"including a tier onecommon risk-based capital ratiogreater than 5 percent, under both expected and stressed conditions" -seescenario analysison this.Arisk-based capital surcharge Market liquidity, first based on the US's own "interagency liquidity risk-management guidanceissued in March 2010" that requireliquidity stress testsand set internal quantitative limits, later moving to a full Basel III regime- see below. TheFederal Reserve Boarditself would conduct tests annually "using three economic and financial market scenarios."Institutions would be encouraged to use at least five scenarios reflecting improbable events, and especially those considered impossible by management, but no standards apply yet to extreme scenarios.Only a summary of the three official Fed scenarios "including company-specific information, would be made public" but one or more internal company-run stress tests must be run each year with summaries published. Single-counterparty credit limitsto cut "credit exposureof a covered financial firm to a single counterparty as a percentage of the firm's regulatory capital. Credit exposure between the largest financial companies would be subject to a tighter limit." "Early remediation requirements" to ensure that "financial weaknesses are addressed at an early stage". One or more "triggers for remediation--such as capital levels, stress test results, and risk-management weaknesses--in some cases calibrated to be forward-looking" would be proposed by the Board in 2012. "Required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales."[14]It was unclear as of December 2011 how these rules would apply toinsurance,hedge fundsand other large financial players. The announced intent was "to limit the dangers of big financial firms being heavily intertwined."[15][edit]Macroeconomic Impact of Basel IIIAnOECDstudy[3]released on 17 February 2011, estimates that the medium-term impact of Basel III implementation on GDP growth is in the range of 0.05% to 0.15% per year. Economic output is mainly affected by an increase in bank lending spreads as banks pass a rise in bank funding costs, due to higher capital requirements, to their customers. To meet the capital requirements effective in 2015 (4.5% for the common equity ratio, 6% for the Tier 1 capital ratio), banks are estimated to increase their lending spreads on average by about 15 basis points. The capital requirements effective as of 2019 (7% for the common equity ratio, 8.5% for the Tier 1 capital ratio) could increase bank lending spreads by about 50 basis points. The estimated effects on GDP growth assume no active response from monetary policy. To the extent that monetary policy will no longer be constrained by the zero lower bound, the Basel III impact on economic output could be offset by a reduction (or delayed increase) in monetary policy rates by about 30 to 80 basis points.[16][edit]Key dates[edit]Capital RequirementsDateMilestone: Capital Requirement

2013Minimum capital requirements:Start of the gradual phasing-in of the higher minimum capital requirements.

2015Minimum capital requirements:Higher minimum capital requirements are fully implemented.

2016Conservation buffer:Start of the gradual phasing-in of the conservation buffer.

2019Conservation buffer:The conservation buffer is fully implemented.

[edit]Leverage RatioDateMilestone: Leverage Ratio

2011Supervisory monitoring:Developing templates to track the leverage ratio and the underlying components.

2013Parallel run I:The leverage ratio and its components will be tracked by supervisors but not disclosed and not mandatory.

2015Parallel run II:The leverage ratio and its components will be tracked and disclosed but not mandatory.

2017Final adjustments:Based on the results of the parallel run period, any final adjustments to the leverage ratio.

2018Mandatory requirement:The leverage ratio will become a mandatory part of Basel III requirements.

[edit]Liquidity RequirementsDateMilestone: Liquidity Requirements

2011Observation period:Developing templates and supervisory monitoring of the liquidity ratios.

2015Introduction of the LCR:Introduction of the Liquidity Coverage Ratio (LCR).

2018Introduction of the NSFR:Introduction of the Net Stable Funding Ratio (NSFR).