Basel III Accord - Basel 3 Norms

Contributed by : Rajesh Goyal, allbankingsolutions@gmail.com

What is Basel iii or What is Basel 3 Accord or Meaning and Definition of Basel III Accord:Basel III or Basel 3 released in December, 2010 is the third in the series of Basel Accords. These accords deal with risk management aspects for the banking sector. In a nut shell we can say that Basel iii is the global regulatory standard (agreed upon by the members of the Basel Committee on Banking Supervision) on bank capital adequacy, stress testing and market liquidity risk. (Basel I and Basel II are the earlier versions of the same, and were less stringent) What does Basel III is all About ? According to Basel Committee on Banking Supervision "Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector". Thus, we can say that Basel 3 is only a continuation of effort initiated by the Basel Committee on Banking Supervision to enhance the banking regulatory framework under Basel I and Basel II. This latest Accord now seeks to improve the banking sector's ability to deal with financial and economic stress, improve risk management and strengthen the banks' transparency. What are the objectives / aims of the Basel III measures ? Basel 3 measures aim to: improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source improve risk management and governance strengthen banks' transparency and disclosures. Thus we can say that Basel III guidelines are aimed at to improve the ability of banks to withstand periods of economic and financial stress as the new guidelines are more stringent than the earlier requirements for capital and liquidity in the banking sector. How Does Basel III Requirements Will Affect Indian Banks :

The Basel III which is to be implemented by banks in India as per the guidelines issued by RBI from time to time, will be challenging task not only for the banks but also for GOI. It is estimated that Indian banks will be required to rais Rs 6,00,000 crores in external capital in next nine years or so i.e. by 2020. Expansion of capital to this extent will affect the returns on the equity of these banks specially public sector banks. However, only consolation for Indian banks is the fact that historically they have maintained their core and overall capital well in excess of the regulatory minimum. What are Three Pillars of Basel II Norms or What are the changes in Three Pillars of Basel iii Accord ? Basel III: Three Pillars Still Standing : Any one who has ever heard about Basel I and II, is most likely must have heard about Three Pillars of Basel. Three Pillar of Basel still stand under Basel 3. Basel III has essentially been designed to address the weaknesses that become too obvious during the 2008 financial crisis world faced. The intent of the Basel Committee seems to prepare the banking industry for any future economic downturns.. The framework enhances bank-specific measures and includes macro-prudential regulations to help create a more stable banking sector. The basic structure of Basel III remains unchanged with three mutually reinforcing pillars. Pillar 1 : Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs) : Maintaining capital calculated through credit, market and operational risk areas. Pillar 2 : Supervisory Review Process : Regulating tools and frameworks for dealing with peripheral risks that banks face. Pillar 3: Market Discipline : Increasing the disclosures that banks must provide to increase the transparency of banks What are the Major Changes Proposed in Basel III over earlier Accords i.e. Basel I and Basel II? What are the Major Features of Basel III ? (a) Better Capital Quality : One of the key elements of Basel 3 is the introduction of much stricter definition of capital. Better quality capital means the higher loss-absorbing capacity. This in turn will mean that banks will be stronger, allowing them to better withstand periods of stress. (b) Capital Conservation Buffer: Another key feature of Basel iii is that now banks will be required to hold a capital conservation buffer of 2.5%. The aim of asking to build conservation buffer is to ensure

that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and economic stress. (c) Countercyclical Buffer: This is also one of the key elements of Basel III. The countercyclical buffer has been introducted with the objective to increase capital requirements in good times and decrease the same in bad times. The buffer will slow banking activity when it overheats and will encourage lending when times are tough i.e. in bad times. The buffer will range from 0% to 2.5%, consisting of common equity or other fully loss-absorbing capital. (d) Minimum Common Equity and Tier 1 Capital Requirements : The minimum requirement for common equity, the highest form of lossabsorbing capital, has been raised under Basel III from 2% to 4.5% of total risk-weighted assets. The overall Tier 1 capital requirement, consisting of not only common equity but also other qualifying financial instruments, will also increase from the current minimum of 4% to 6%. Although the minimum total capital requirement will remain at the current 8% level, yet the required total capital will increase to 10.5% when combined with the conservation buffer. (e) Leverage Ratio: A review of the financial crisis of 2008 has indicted that the value of many assets fell quicker than assumed from historical experience. Thus, now Basel III rules include a leverage ratio to serve as a safety net. A leverage ratio is the relative amount of capital to total assets (not risk-weighted). This aims to put a cap on swelling of leverage in the banking sector on a global basis. 3% leverage ratio of Tier 1 will be tested before a mandatory leverage ratio is introduced in January 2018. (f) Liquidity Ratios: Under Basel III, a framework for liquidity risk management will be created. A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced in 2015 and 2018, respectively. (g) Systemically Important Financial Institutions (SIFI) : As part of the macro-prudential framework, systemically important banks will be expected to have loss-absorbing capability beyond the Basel III requirements. Options for implementation include capital surcharges, contingent capital and bail-in-debt.
Comparison of Capital Requirements under Basel II and Basel III

Requirements Minimum Ratio of Total Capital To RWAs Minimum Ratio of Common Equity to RWAs

Under Basel II 8% 2%

Under Basel III 10.50% 4.50% to

Tier I capital to RWAs Core Tier I capital to RWAs Capital Conservation Buffers to RWAs Leverage Ratio Countercyclical Buffer Minimum Liquidity Coverage Ratio Minimum Net Stable Funding Ratio Systemically important Financial Institutions Charge

4% 2% None None None None None None

7.00% 6.00% 5.00% 2.50% 3.00% 0% to 2.50% TBD (2015) TBD (2018) TBD (2011)

Click Here for: TimeLine For Implementation of Basel III ( Phase in Arrangement for Basel III ) Click Here for: Basel iii Accord for Capital Adequacy - Summary Click Here for: Draft Guidelines issued by RBI for "Implementation of Basel III Capital Regulations in India

What are Basel III guidelines?

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Basel III guidelines are norms that the Reserve Bank of India has implemented to strengthen the regulation, supervision and risk management of the banking sector.

Heres a quick guide:

1. Basel III is asset of guidelines agreed upon by the Basel Committee on Banking Supervision in 2010-11. The Basel committee was formed in 1974 by a group of central bank governors from 10 countries, and has now expanded to include members from nearly 30 countries, including India.

2. The Reserve Bank of India had released draft guidelines on its website on December 2011 for comments and feedback from various stakeholders.

3. According to the guidelines, which will be effective from January 1, 2013, banks will have to maintain their total capital ratio at 9%, higher than the minimum recommended requirement of 8% under the Basel III norms. Capital ratio is the percentage of a banks capital to its risk-weighted assets.

4. The norms also require banks to maintain Tier I capital at 7% of risk weighted assets. Tier I capital, or core capital, includes a banks equity capital and disclosed reserves.

5. Under the new norms, banks will have to maintain a capital conservation buffer of 2.5% of risk-weighted assets. A capital conservation buffer is a cushion that banks are required to build to withstand periods of stress.

6. Broadly, the Reserve Banks guidelines are tougher than global Basel III recommendations, meaning Indian banks will have to work that much harder. Banks with low return on assets will be badly hit, as they will have a harder time securing capital.

7. According to brokerage estimates, state-run banks will need up to Rs 2 trillion to meet the new norms.

8. State-run banks may also see a dilution of government stake, says brokerage Prabhudas Lilladhar.

RBI unveils draft Basel III capital norms for banks

Press Trust of India / Mumbai Dec 30, 2011, 21:05 IST
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In order to strengthen risk management mechanism, the Reserve Bank of India (RBI) today issued draft guideline envisaging that the equity capital of a bank should not be less than 5.5% of risk-weighted loans.

"Common Equity Tier 1 [CET 1] capital must be at least 5.5% of risk-weighted assets [RWAs]," the RBI said in the draft guideline for implementation of Basel III capital regulation in India.

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Besides, it also recommends, Tier 1 capital comprising of pure equity and statutory and capital reserves must be at least 7% and total capital must be at least 9% of RWAs.

Besides, it has also suggested for setting up of the capital conservation buffer in the form of Common Equity of 2.5% of RWAs.

It is proposed that the implementation period of minimum capital requirements and deductions from Common Equity will begin from January 1, 2013 and be fully implemented as on March 31, 2017, it said.

However, it said, the capital conservation buffer requirement is proposed to be implemented between March 31, 2014 and March 31, 2017.

It also said that the instruments which no longer qualify as regulatory capital instruments will be phased-out during the period beginning from January 1, 2013 to March 31, 2022.

The central bank has invited comments and feedback on the draft guidelines, including implementation schedule by February 15, 2012.

RBI Governor D Subbarao had said earlier this month that Indian banks will have to incur additional costs to build capital buffers to comply with Basel III rules.

Though the Indian banking sector was comfortably placed to implement Basel III regulations, some banks might need additional capital, he had said.

"On aggregate, banks are comfortably placed in terms of capital adequacy, but a few individual banks may fall short due to implementation of Basel III," he had said.

Banks going to gear up for Basel III norms

Suresh Nandi, May 14, 2012, DHNS

The Reserve Bank of India (RBI) this month released the final guidelines of the Basel III norms aimed at toughening up the banking system in the country to withstand all kinds of risk and financial shocks. The guidelines framed by a committee of central banks of various countries, to which RBI is also a member, based in Basel, Switzerland, seek to fortify banking systems across the world after the massive banking crisis in 2008 and in 2009. The existing norms stipulate that banks maintain Tier-I capital or core capital and Tier-II comprising instruments with debt-like features, whereas Basel III has introduced many elements of capital like a clearly defined common capital that measures core equity in relation to its total risk weighted assets. Simply put, they asses the banks financial strength and capital conservation buffers (CCB) at various levels. The new norms will be made effective in a phased manner from January 1, 2013 and fully implemented by March 31, 2018. The key point is that banks need to achieve a minimum Core Equity Tier-I (CETI) capital adequacy of 5 per cent by FY14 and then, in a staggered manner, increase it to 8 per cent by FY18. Some experts aver that Basel III is not meant for Indian banks, but insist they are relevant in addressing problems which could arise as domestic banks transform into organisations similar to their global counterparts over the next decade. From an investor perspective, there would be no impact of Basel III on the share market investors perception in the valuation of Indian banks, says Crisil Ratings Senior Director Pawan Agrawal. He also explains that transition to Basel III will not be any challenge since most banks have a common equity capital ratio which is above the prescribed requirements of 4.5 per cent, stipulated under Basel III. Yet, the transition timeline (till 2018) should suffice for banks in raising the required amount of equity and prepare the market and the system to adjust. By and large, bankers concede that the Indian banking system is already stable, far less complex and well-capitalised as compared to banks across the globe. Still, they believe that Basel III is a step in the right direction in terms of preparing the domestic banks to address or prevent some of those challenges faced by their global counterparts. Macquarie Capital Securities in a report says, Basel III would be more an issue of growth than solvency for domestic banks, more so for public sector banks (PSBs) because they are at the mercy of the government with regard to their capital needs. Frequent dilutions will be required to support growth and also simultaneously maintain capital adequacy ratio levels, it adds. Impact immediate The immediate impact of the Basel III capital regime will be benign as the CETI ratio of many domestic banks is already close to 8 per cent or higher. However, the shortfall will be likely between FY16 and FY18, mostly for government banks with loan growth outpacing internal capital generation and the minimum capital ratios stepping up. The additional equity will be needed for business growth and for creating a buffer above the regulatory minimum. Reports of many rating agencies suggest that banks in India will require Rs 3.9 to R5 trillion as capital over the next six years to comply with Basel III norms. Of this, CETI requirements will be Rs 1.3 to 2 trillion; Rs 1.9 trillion for additional tier-I; and Rs 1 trillion for tier-II, which is achievable so long as banks can find investors for the riskier additional tier I capital, says ICRA. This requirement can turn out to be higher (by another Rs 1.3 trillion) in case the investor appetite is low for non-equity tier-I capital instruments, adds Agrawal. PSBs will account for bulk (80 per cent) of the requirement and need regular infusion from the government. The largest of them is the State Bank of India and its associate banks, reflecting their significant share in the banking system. The new norms also ask banks to maintain a minimum of 5.5 per cent in common equity by March 31, 2015 as against the current 3.6 per cent, apart from creating a capital conservation buffer (CCB) consisting of common equity of 2.5 per cent by March 31, 2018. CCB is designed to ensure that banks build up capital buffers during normal times which can be drawn down as and when losses are incurred during a stressed period. However, RBI is yet to announce final guidelines on counter-cyclical capital buffer. More for capital adequacy Basel III also hiked the minimum overall capital adequacy to 11.5 per cent by March 31, 2018 as against the current 9 per cent. Over 80 per cent of common equity need relates to public sector banks (PSBs) and the government share would be Rs 0.3 to Rs 0.8 trillion in the total equity need of PSBs as per the government average stake in PSBs at around 58 per cent. Incremental equity requirement appears manageable, considering past trends in capital mobilisation, ICRA points out, adding, Banks raised over Rs 1.0 trillion in equity during 2007-08 to 2011-12, of which around 54 per cent were mobilised by PSBs and 46 per cent by private banks. ICRA also warns that if banks are unable to mop up the required additional tier-I and the gap is bridged by raising common equity, then the incremental equity requirement may go up to a high of Rs 3.2 to Rs 4.0 trillion over the next six years, of which the Centres share will be Rs 1.2 to Rs 1.7 trillion. It would also be wrong to assume that the government wont provide money for PSBs, counters Agrawal. In the last four years, the government has given a total of Rs 55,000 crore to PSBs, he says. While the equity target may appear easy at first glance, it may not be so eventually as RBI has also introduced loss-absorption features in the additional tier-I capital instruments, say experts. These features can limit investor appetite to invest in banks instruments as profitability will be under cloud though ICRA thinks higher core capital will help improve credit ratings of banks in the long run. When it comes to private players, most of them are already well-capitalised, so transition to Basel III may not impact their earnings significantly. In fact, private banks competitive position can improve when PSBs raise their lending yields. But, at the same time, the upside potential for private banks can be limited by the higher minimum core capital requirement, says ICRA. Fitch Ratings, however, points out that domestic banks raised only about $2.5 billion of common equity from the markets in FY11 and FY12 combined. Unless planned, PSBs may face risks of a sudden shortfall in capital during FY16, requiring additional support by from the government.

Enough time Most public sector bankers are neither worried about the timeline as there is enough time to raise capital, if required. If annual credit growth is around 15 per cent, then there will not be any problem, but if it is to be 20 per cent a year, then banks will be under some pressure. But, by and large, I dont see any hassle in complying with the norms, says IDBI Bank Executive Director R K Bansal. CMDs of Union Bank of India and Indian Overseas Bank maintain that Basel III will force banks to plough back a larger chunk of their profit into the balance sheet. Banks may have to lower dividend payouts and retain more profit as capital, they said. Although the total capital adequacy ratio (CAR) stipulated at 9 per cent under Basel III, unchanged from what the regulator prescribes in India currently, domestic banks will now need to raise more money than under the current Basel II norms because several capital instruments cannot be included under the new definition. Perpetual debt, for instance, now qualifies as a tier-I instrument which will be excluded under Basel III, forcing banks to raise more equity. So the challenge for banks is not in transitioning to Basel III, but in their capital-raising ability because at 20 to 25 per cent credit growth, they would need capital at a higher threshold, which could impact their return on equity, especially for PSBs.

Banks must maintain 7% core capital: RBI's Basel III norms

Published on Wed, May 02, 2012 at 20:02 | Source : Moneycontrol.com Updated at Thu, May 03, 2012 at 11:30

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Moneycontrol Bureau The Reserve Bank of India (RBI) on Wednesday directed Indian banks to maintain a minimum tier I capital or core capital which is equity and reserve under the final guidelines on Basel-III capital regulations. Moreover, the regulator, for the first time, asked lenders to keep a capital conservation buffer of 2.50%. "These guidelines would become effective from January 1, 2013 in a phased manner," RBI said in a statement. "The Basel III capital ratios will be fully implemented as on March 31, 2018. 3. The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods and higher during the later years. While undertaking the capital planning exercise, banks should keep this in view."

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Basel -III guidelines aim to make banks more resilient against any unexpected economic crisis. It prescribes more stringent capital and liquidity requirements for them. After its full implementations total capital adequacy ratio will stand at 11.50% as against the 9% currently. "The capital conservation buffer (CCB) is designed to ensure that banks build up capital buffers during normal times (i.e. outside periods of stress) which can be drawn down as losses are incurred during a stressed period. The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements," RBI said. However, the elements of Tier - 2 capital will largely remain the same under existing guidelines except that there will be no separate Tier 2 debt capital instruments in the form of Upper Tier 2 and subordinated debt. Instead, there will be a single set of criteria governing all Tier 2 debt capital instruments.

Banks may need Rs 2.5 lakh crore to meet Basel III capital norms
PTI May 4, 2012, 09.22PM IST

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State Bank Of India| ICRA

NEW DELHI: Indian banks may need to raise up to $ 50 billion (about Rs 2.5 lakh crore) of additional equity under the Basel III capital regulations announced by the RBI on top of retained earnings, a Fitch study said. "Most of the requirement is back-ended, with over 75 per cent needed to be added between 2015-16 and 2017-18. The additional equity reflects growth capital as well as a buffer above the regulatory minimum," it said.

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The guidelines released on May 2, 2012, do not yet provide for a counter-cyclical capital buffer or additional capital for systemically important banks, it said. Yesterday, another rating agency ICRA said banks will require between Rs 3.9 - 5 lakh crore as capital to comply with Basel-III norms. "Banks will need Rs 3.9-5 trillion capital over the next six years, out of which common equity requirements will be Rs 1.3-2 trillion; Rs 1.9 trillion for additional tier I; and Rs 1 trillion for tier II," ICRA had said. Fitch's calculations add half a percentage point of additional common equity to the regulatory minimum, which banks may like to maintain to avoid breaching the conservation buffer - with attendant restrictions on dividends and other payouts. The immediate impact of the Basel-III capital regime is benign, with the common equity Tier-I ratio for many Indian banks already close to 8 per cent or higher, it said. However, the shortfall mounts up between 2015-16 and 2017-18, mostly for government banks - with loan growth outpacing internal capital generation, and the minimum capital ratios stepping up, it said. The largest requirement is by State Bank of India and its associate banks, reflecting their significant share in the banking system; followed by the mid-sized and small government banks with weaker internal capital generation, it said. The large private banks fare better, due to their higher capital ratios and stronger profitability, it added. About half of the $ 40 billion needed by government banks is likely to be injected by the government based on its stated intent of maintaining majority shareholding. Unless planned, government banks may face the risk of a sudden shortfall in capital during 2005-06, requiring additional support by the sovereign and putting further pressure on government finances. The need for fresh capital comes at a time when the performance of Indian banks is clearly being affected by the economic slowdown, together with assetquality pressures from concentrated exposure to infrastructure companies and weak state-owned entities, it added.

Compliance with Basel III norms will entail additional costs for banks: Subbarao
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Business LineDr.

D. Subbarao, Governor, RBI interacts with media alongwith the West Bengal Finance Minister, Mr Amit Mitra after a brief meeting with the Cheif Minister, Mamata Banerjee on Wednesday. Photo: Arunangsu Roy Chowdhury

KOLKATA, DEC. 7: The RBI Governor, Dr D. Subbarao, on Wednesday said that Indian banks will have to incur additional costs to build capital buffers to comply with Basel III rules. Though the Indian banking sector was comfortably placed to implement Basel III regulations, some banks might need additional capital, Dr Subbarao said at a meeting with bankers here. On aggregate, banks are comfortably placed in terms of capital adequacy, but a few individual banks may fall short due to implementation of Basel III. The Basel III rules, formulated by the Basel Committee on Banking Supervision following the financial crisis of 2008-09, require banks to shore up their capital and liquidity buffers, and will be implemented in phases from 2013. The implementation of Basel III will lead to an increased cost of borrowing for Indian companies both in the domestic and overseas markets, Dr Subbarao said. Banks should look at trimming the interest rates on advances and hiking those on deposits in order to achieve a double-digit growth. For double digit growth we need more deposits, and this (more deposits will come in) happen if banks provide attractive interest rates on deposits, he pointed out. The demand for credit is set to rise, he added.
MANAGING LIQUIDITY

Dr Subir Gokarn, Deputy Governor, Reserve Bank of India, said that the apex bank would not want to compromise its monetary stance to manage liquidity in the system, thereby hinting that there could be little possibility of a cut in the cash reserve ratio of banks. The cash reserve ratio is not just a liquidity tool, but also a monetary signal and the RBI will do whatever possible to manage liquidity, but within the confines of its monetary policy, Dr Gokarn said at the bankers' meeting. Talking about the rupee volatility, Dr Gokarn said, The RBI's steps to increase inflows have helped cap the rupee movement. The central bank did not have a view on the value of rupee, he said. The RBI has not used large amount of reserves to manage currency depreciation. Our approach has been non-interventionist, he added.

Basel III
From Wikipedia, the free encyclopedia

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BASEL III is a global regulatory standard on bank capital adequacy, stress testing and market liquidity risk agreed upon by the members of the Basel Committee on Banking Supervision in 2010-11.[1] This, the third of the Basel Accords (see Basel I, Basel II) was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. For instance, the change in the calculation of loan risk in Basel II which some consider a causal factor in the credit bubble prior to the 2007-8 collapse: in Basel II one of the principal factors of financial risk management was out-sourced to companies that were not subject to supervision: credit rating agencies. Ratings of creditworthiness and of bonds, financial bundles and various other financial instruments were conducted without supervision by official agencies, leading to AAA ratings on mortgage-backed securities, credit default swaps and other instruments that proved in practice to be extremely bad credit risks. In Basel III a more formal scenario analysis is applied (three official scenarios from regulators, with ratings agencies and firms urged to apply more extreme ones). The OECD estimates that the implementation of Basel III will decrease annual GDP growth by 0.050.15%.[2][3] Outside the banking industry itself, criticism was muted. Bank directors would be required to know market liquidity conditions for major asset holdings, to strengthen accountability for any major losses.
Contents
[hide]

1 Overview 2 Summary of proposed changes

2.1 US implementation

3 Macroeconomic Impact of Basel III 4 Key dates

o o o

4.1 Capital Requirements 4.2 Leverage Ratio 4.3 Liquidity Requirements

5 Studies on Basel III 6 See also 7 References 8 External links

[edit]Overview

Basel 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; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.[4]
[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 capital instruments will be harmonised Tier 3 capital will be eliminated.[5]

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 counterparty credit exposures arising from banks derivatives, repo and securities financing transactions

Raise the capital buffers backing these exposures Reduce procyclicality and Provide additional incentives to move OTC derivative contracts to central counterparties (probably clearing houses)

Provide incentives to strengthen the risk management of 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 riskbased 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 of leverage in the banking sector Introduce additional safeguards against model risk and measurement error by 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 broader macroprudential goal 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-default estimates, recommended in Basel II, to become mandatory Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements.

Banks must conduct stress tests that include widening credit spreads in 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).[6]

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 the Net 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.[7])

The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.

As on Sept 2010, Proposed Basel III norms ask for ratios as: 7-9.5%(4.5% +2.5%(conservation buffer) + 02.5%(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

implementation

The US Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules. [1]. It summarized them as follows [2], 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 first annual capital plans, conduct stress tests, and capital adequacy "including a tier one common risk-based capital ratio greater than 5

percent, under both expected and stressed conditions" - see scenario analysis on this. A risk-based capital surcharge

Market liquidity, first based on the US's own "interagency liquidity risk-management guidance issued in March 2010" that require liquidity stress tests and set internal quantitative limits, later moving to a full Basel III regime - see below.

The Federal Reserve Board itself 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 limits to cut "credit exposure of 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 riskmanagement 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."

It was unclear as of December 2011 how these rules would apply to insurance, hedge funds and other large financial players. The announced intent was "to limit the dangers of big financial firms being heavily intertwined" [3].
[edit]Macroeconomic

Impact of Basel III

An OECD study[2] 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.[8] Basel III is an opportunity as well as a challenge for banks. It can provide a solid foundation for the next developments in the banking sector, and it can ensure that past excesses are avoided. Basel III is

changing the way that banks address the management of risk and finance. The new regime seeks much greater integration of the finance and risk management functions. This will probably drive the convergence of the responsibilities of CFOs and CROs in delivering the strategic objectives of the business. However, the adoption of a more rigorous regulatory stance might be hampered by a reliance on multiple data silos and by a separation of powers between those who are responsible for finance and those who manage risk. The new emphasis on risk management that is inherent in Basel III requires the introduction or evolution of a risk management framework that is as robust as the existing finance management infrastructures. As well as being a regulatory regime, Basel III in many ways provides a framework for true enterprise risk management, which involves covering all risks to the business.[9]
[edit]Key

dates
Requirements
Milestone: Capital Requirement

[edit]Capital

Date

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

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

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

2019 Conservation buffer: The conservation buffer is fully implemented.

[edit]Leverage

Ratio
Milestone: Leverage Ratio

Date

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

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

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

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

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

[edit]Liquidity

Requirements
Milestone: Liquidity Requirements

Date

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

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

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

[edit]Studies

on Basel III

In addition to articles used for references (see References), this section lists links to recent high-quality publicly-available studies on Basel III. This section may be updated frequently as Basel III is currently under development.
Date Source Article Title / Link Comments

Feb 2012

BNP Paribas Fortis

Basel III for dummies Video

"All you need to know about Basel III in 10 minutes."

Dec 2011

OECD: Economics Department

Systemically Important Banks

OECD analysis on the failure of bank regulation and markets to discipline systemically important banks.

Jun 2011

BNP Paribas: Economic Research Department

Basel III: no Achilles' spear

BNP Paribas' Economic Research Department study on Basel III.

Feb 2011

OECD: Economics Department

Macroeconomic Impact of Basel OECD analysis on the macroeconomic impact of Basel III. III

Jan 2011

Moody's Analytics

Basel III New Capital and Liquidity Standards FAQs

Basel III standards, key elements of new regulations, framework, and key implementation dates.

May 2010

OECD Journal: Financial Market Trends

Thinking Beyond Basel III

OECD study on Basel I, Basel II and III.

May 2010

Bloomberg BusinessWeek

FDICs Bair Says Europe Should Make Banks Hold More Capital

Bair said regulators around the world need to work together on the next round of capital standards for banks ... the next round of international standards, known as Basel III, which Bair said must meet very aggressive goals.

May 2010

Reuters

FACTBOX-G20 progress on financial regulation

Finance ministers from the G20 group of industrial and emerging countries meet in Busan, Korea, on June 45 to review pledges made in 2009 to strengthen regulation and learn lessons from the

financial crisis.

May 2010

The Economist

The banks battle back A behind-the-scenes brawl over new capital and liquidity rules

"The most important bit of reform is the international set of rules known as Basel 3, which will govern the capital and liquidity buffers banks carry. It is here that the most vicious and least public skirmish between banks and their regulators is taking place."

Basel III on the way its advantage India

Abraham Chacko | Agency: DNA | Thursday, May 24, 2012
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In spite of the preventive safeguards of Basel II, the world banking system went into a tailspin during the early 2008 ushering in a financial crisis that shook the world economy. This led to some quick rethinking on the part of the Basel Committee on Banking Supervision (BCBS) over the need to come out with a broadened framework of tighter standards under Basel III to restrict the banks from indulging in unhealthy and imprudent practices which could have great cascading effects on the economies around. The balance sheet of Lehman Brothers whose fall was the precursor of the meltdown, attracted the following comment: Whatever was on the left-hand side (liabilities) was not right and whatever was on the right-hand side (assets) was not left. It was reported that the assets of Lehman Brothers were worth only a fraction of their book value and they had little capital to tap into to pay their creditors. The comment in simple terms illustrates the rot that crept into the financial sector as a result of factors like loose lending standards, poorly underwritten subprime mortgages, shadow financing, unbridled speculation, gross asset-liability mismatches and inadequate liquidity buffers. With little owned funds left with and liquidity dried off, the banks went begging with their hats on hand to the taxpayer to bail them out. That was the scene we saw in 2008 when the financial sector in the western world went berserk. With the solemn aim never to see the repeat of the 2008 Crisis, the BCBS, through Basel III, put forward norms aimed at strengthening both sides of balance sheets of banks viz. a)enhancing the quantum of common equity b) improving the quality of capital base b) creation of capital buffers to absorb shocks c) improving liquidity of assets c) optimising the leverage through Leverage Ratio d) creating more space for banking supervision by regulators under Pillar II and e) bringing further transparency and market discipline under Pillar III. Needless to stress, banks whose balance sheets can absorb the losses with resilience, will stand in the face of a financial Tsunami. Article continues below the advertisement... Now it is timely to take a brief look into the impact that Basel III can have on Indian banking system as the norms will kick-start in a phased manner from January 1, 2013. Capital adequacy: For Indian banks, its easier to make the transition to a stricter capital requirement regime than some of their international counterparts since the regulatory norms set by RBI on capital adequacy are already more stringent.Besides, most Indian banks have historically maintained their core and overall capital well in excess of the regulatory minimum. According to a CRISIL estimate, the average equity capital ratio and overall capital adequacy ratio of rated banks in India stand well above 9% and 14%, respectively. As for Federal Bank, its tier 1 capital is 15.86% and its capital adequacy stands at 16.64% as on March 31, 2012, significantly higher than the stipulated norms. Cost of lending:Stricter capital requirements with changes in the structure of tier 1 and tier 2 capital generally result in lower return on equity (ROE). On the flip side, as capital costs increase, loans tend to be expensive. In order to offset this, banks would have to take the route of reducing deposit interest and go in for new non-interest income streams. Yet, Basel III carries the message that Indian banks will have to start finding ways to preserve capital and use it more productively as minimum capital requirements will have to be met by March 31, 2017. Leverage: RBI has set the leverage ratio at 4.5% (3% under Basel III).The ratio is introduced by Basel 3 to regulate banks having huge trading book and off balance sheet derivative positions. In India, however, in most of our banks, the derivative activities are not very large so as to arrange enhanced cover for counterparty credit risk. Hence, the pressure on banks should be moderate. Liquidity norms: Indian banks conform to two liquidity buffers already: the statutory liquidity ratio (SLR) a mandatory 24% of a banks net demand and time liabilities and cash reserve ratio (CRR) of 4.75%. The SLR is mainly government securities while the CRR is mainly cash. The Liquidity Coverage Ratio (LCR) under Basel III requires banks to hold enough unencumbered liquid assets to cover expected net outflows during a 30-day stress period. In India, the burden from LCR stipulation will depend on how much of CRR and SLR can be offset against LCR. Here too, Indian banks are better placed over their overseas counterparts. Countercyclical buffer: Economic activity moves in cycles and banking system is inherently pro-cyclic. During upswings, carried away by the boom, banks end up in excessive lending and unchecked risk build-up, which carry the seeds of a disastrous downturn. The regulation to create additional capital buffers to lend further would act as a break on unbridled bank-lending. This check will counter or smoothen wild swings in business cycles. India has witnessed moderate cycles. Yet, for countercyclical

measures to be effective, our banking system has to improve its capability to sense and predict the business cycle at sectoral and systemic levels and to use tools like Credit to GDP ratio to calibrate the level of countercyclical buffer. All said and done, viewed from a higher perspective, factors like the quality of governance of banks, the standard of regulatory control by the apex bank and the level of public confidence banks enjoy in combination with their adherence to Basel III standards will determine the standing of Indian banking system on the world scene. The writer is executive director, Federal Bank.

RBI to implement Basel III from January 1, 2013

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The Reserve Bank of India (RBI), on Wednesday, issued the final guidelines for implementation of Basel III capital regulation in India, which would be effective from January 1, 2013, in a phased manner. The Basel III capital ratios will be fully implemented on March 31, 2018. Banks have to maintain Tier I capital, or core capital, of at least 7 per cent of their risk weighted assets on an ongoing basis. Under the existing capital adequacy guidelines based on the Basel II framework, banks are required to maintain Tier I capital of at least 6 per cent of their risk weighted assets. The total capital ratio, including Tier I and Tier II, must be at least 9 per cent, unchanged from the current requirement, the RBI said in a statement, compared with the Basel III minimum requirement of 8 per cent. The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods and higher during the later years. While undertaking the capital planning exercise, banks should keep this in view, RBI said in a notification to banks. For the financial year ending March 31, 2013, banks will have to disclose the capital ratios computed under the existing guidelines (Basel II) on capital adequacy as well as those computed under the Basel III capital adequacy framework, RBI added. The Basel Committee on Banking Supervision (BCBS) issued a comprehensive reform package entitled Basel III: A global regulatory framework for more resilient banks and banking systems' in December 2010, with the objective to improve the banking sector's ability to absorb shocks arising from financial and economic stress. A revised version of this document (Basel III) was issued in June 2011 This will amend certain provisions of existing Basel II framework, in addition to introducing some new concepts and requirements.
RBI Releases Draft Guidelines on Basel III Capital Regulations The Reserve Bank today released on its website, draft guidelines outlining proposed implementation of Basel III capital regulation in India. These guidelines are in response to the comprehensive reform package entitled Basel III: A global regulatory framework for more resilient banks and banking systems of the Basel Committee on Banking Supervision (BCBS) issued in December 2010. The major highlights of the draft guidelines are: Minimum Capital Requirements

Common Equity Tier 1 (CET1) capital must be at least 5.5% of risk-weighted assets (RWAs); Tier 1 capital must be at least 7% of RWAs; and Total capital must be at least 9% of RWAs.

Capital Conservation Buffer

The capital conservation buffer in the form of Common Equity of 2.5% of RWAs.

Transitional Arrangements

It is proposed that the implementation period of minimum capital requirements and deductions from Common Equity will begin from January 1, 2013 and be fully implemented as on March 31, 2017. Capital conservation buffer requirement is proposed to be implemented between March 31, 2014 and March 31, 2017. The implementation schedule indicated above will be finalized taking into account the feedback received on these guidelines.

Instruments which no longer qualify as regulatory capital instruments will be phased-out during the period beginning from January 1, 2013 to March 31, 2022.

Enhancing Risk Coverage

For OTC derivatives, in addition to the capital charge for counterparty default risk under Current Exposure Method, banks will be required to compute an additional credit value adjustments (CVA) risk capital charge.

Leverage Ratio

The parallel run for the leverage ratio will be from January 1, 2013 to January 1, 2017, during which banks would be expected to strive to operate at a minimum Tier 1 leverage ratio of 5%. The leverage ratio requirement will be finalized taking into account the final proposal of the Basel Committee.

Comments / Feedback Comments / feedback on the draft guidelines, including implementation schedule may be sent on or before February 15, 2012 to the Chief General Manager-in-Charge, Department of Banking Operations and Development, Reserve Bank of India, Central Office Building, 12th Floor, S.B. Singh Marg, Mumbai 400001, through e-mail . The guidelines will be finalized taking into account the suggestions and comments. Background It may be recalled that in the Second Quarter Review of Monetary Policy 2011-12 (paragraph 95) on October 25, 2011, it was announced that the Reserve Bank would issue the draft guidelines for implementing the Basel III framework by end-December 2011. Ajit Prasad Assistant General Manager Press Release : 2011-2012/1046

Related Notification Dec 30, 2011 Implementation of Basel III Capital Regulations in India Draft Guidelines