Basel

Chinwe Boston
Mengchun Zhang
Qiuli Guo
Di 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 capital
Introducing Leverage ratio
Improving liquidity rules
Establishing additional buffers
Managing 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 macrofinancial 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.

2.

Short-term: Liquidity Coverage

Ratio(LCR)
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 shortterm funding(money market)

Long-term:NSFR
Available stable funding (ASF) is defined as the total
amount of an institutions:

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:

BaselII: aguidetocapitaladequacystandardsforLenders.
[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/federalreserve-proposes-revised-ba...] [Accessed on 30/11/12].
IntroductiontoBaselII: [Available at:
http://www.rcg.ch/papers/basel2.pdf]
IntroductiontoBaselII. [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].