BASEL III

Introduction

BASEL 1 BASEL 2 BASEL 3 Objectives Key Outcomes Building Blocks Of BASEL 3 Impact of BASEL 3 BASEL 3 Proposals BCBS Awaiting Proposals Major Recommendations.

BASEL 1 Introduced in 1988 Amendment in 1996.

Incorporate capital charge for market risk via, (1) Standardized Measurement Method (SMM). (2) Internal Models Approach (IMA).
risk capital framework includes, (1) Capital charge for general market risk. (2) Capital charge for credit risk.

Market

The Basel 2 amendment on 2004. The main aim behind the proposal are as follows, (a) Enhanced risk coverage (1) Credit Risk (2) Market Risk (3) Operational Risk. (b) Standardized to model based with increasing complexity. (c)Three pillar approach.

The 3 Pillars of BASEL 3 are, (1) Minimum Capital Requirement (2) Supervisory review Process (3) Market Discipline

The Basel 2 of 2004 copied and pasted the capital charge for market risk of Basel 1 amendment of 1996 as a result,
(1) Not keeping pace with new market developments and practices.

(2) Capital charge for market risk much lower compared to banking book positions on the assumption that markets are liquid and positions can be hedged quickly.

Capital charge for credit risk in trading book was lower than capital charge for credit risk in banking book. Lower capital charge for trading book led to scope for capital arbitrage. Capital charge for counterparty credit risk for derivative positions covered the default risk and migration risk was not captured.

Global (1) (2) (3) (4)

financial crisis happen in the areas of Trading book Off balance sheet derivatives Market risk Inadequate liquidity risk management.

Banks suffered heavy losses in their trading book. Banks did not have adequate capital to cover the losses.

Heavy reliance on short term wholesale funding. Unsustainable maturity mismatch. Insufficient liquidity assets to raise finance during stressed period.

Global regulatory standard on bank capital adequacy, stress testing and market liquidity risk as per the Basel Committee on Banking Supervision in 2010-11. Strengthens bank capital requirements Introduces new regulatory requirements on bank liquidity and bank leverage. Banks hold 4.5% of common equity and 6% of Tier I capital of Risk-Weighted Assets (RWA).

Basel III introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5%. (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth.

Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios.

Fundamental restructuring approach to risk and regulation in the financial sector.

Enhanced level of dynamism, complexity and interdependency within the global regulatory landscape.

G20 Summit in Seoul on November 2010 endorsed the BCBS agreements on capital and liquidity.
Long transitional periods needed for the implementation of the Basel 3 proposals.

Improving banking sectors ability to absorb shocks. Reducing risk spill over to the real economy.

Fundamental reforms proposed in the areas of

(1) Micro prudential regulation at individual bank level (2) Macro prudential regulation at system wide basis

 Increase

7%.

in common equity tier1 ratio from 2% to

Less than policy makers hoped. For business the proposal is challenging. Many banks already have ratios above 7% based on Basel 2. The changes add up and well capitalised banks in Europe and the US could find it demanding. The result was reduced credit availability or increased cost of credit.

 Introduces

Additional Capital Buffers

(*) Mandatory capital conservation buffer of 2.5%. (*) Discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth.
Introduces

minimum 3% leverage ratio and 2 required liquidity ratios.

 Impact

on profitability.
bank capital requirements

Strengthens Introduces

new regulatory requirements on bank liquidity and bank leverage. has to hold 4.5% of common equity and 6% of Tier I capital of RWA.

Banks

 It

is a risk based capital regime.

Banks should keep in mind that regulators will continue to focus on risk management and governance in underpinning a robust financial sector. 3 is the solution for the outstanding issues left by Basel 1 and 2 .

Basel

Raising quality level, consistency and transparency of capital base. Improving/enhancing risk coverage on account of counterparty credit risk. Supplementing risk based capital requirement with leverage ratio. Addressing systemic risk and interconnectedness.

Reducing pro-cyclicality and introducing countercyclical capital buffers. Minimum liquidity standards

 Impact

on Individual Banks
banks crowded out.

Weaker

Significant

pressure on profitability and Return On Equity. in demand from short term to long term funding. entity reorganisation.

Change

Legal

 Impact

on the Financial System

Reduced risk of a systemic banking crisis. Reduced lending capacity. Reduced investor appetite for bank debt and equity. Inconsistent implementation of the Basel 3 proposals leading to international arbitrage.

 Impact

on Economy

IIF study loss of output of 3% in G3 on full implementation during 2011-15 Impact of 0.2% on GDP for each year for 4 years for 1% increase in TCE For 25% increase in liquid assets, half the impact of 1% increase in TCE Long term gains will be immense

Global banks have a gap of liquid assets of 1,730 billion to be met in 4 years.
Global big banks have a capital shortfall of 577 billion to meet 7% common equity norm to be met in 8 years.

Tier 1 capital ratio falls to 5.7% from 11.1% under the adjustment of capital and increase in risk coverage.

Impact

on Indian Banks

High capital ratios at 14.4% falls to 11.7%.

Tier 1 capital fall from 10% to 9%

Common equity from 8.5% to 7.4%

Most of deductions are mandated by RBI.

Most of our banks are not trading banks, so not much increase in enhanced risk coverage for counterparty credit risk

Indian banks are not as highly leveraged as their global counterparts.

The leverage ratio of Indian banks would be comfortable. Banks having a huge trading book and off balance sheet derivative exposures
Its impacted due to increased risk coverage on account of counterparty credit risk

Banks having huge off balance sheet exposures, derivatives and others have impact on account of leverage ratio.

Banks depending heavily on wholesale funds have impact on the new liquidity standards.
SIBs have implications for capital and liquidity surcharges and activity restrictions

New capital requirements Effect of proposals on hybrid capital Capital conservation ratio

Countercyclical buffer
Leverage ratio Liquidity ratios

Common equity to 4.5% of RWA phased in 2013 & 2014. Tier 1 capital raised to 6% phased in 2013 & 2014.

Minimum total capital requirement remains at 8%.

New capital conservation buffer of 2.5% phased in 2016, 2017 and 2018. New countercyclical buffer in the range of 0% to 2.5%

Tier 1 capital: (1) common equity (2) non-common equity instruments meeting specific criteria

Common Equity Tier 1

Banks common shares meeting criteria

Stock surplus/share premium on Common Equity Tier 1 instruments Retained earnings and other disclosed reserves

Common shares issued by banks consolidated subsidiaries and held by third parties for inclusion in Common Equity Tier 1 after regulatory adjustments .

Claim in liquidation of the bank Claim on the residual assets that is proportional with its share of issued capital, after repaying all claims in liquidation Principal is perpetual and never repaid outside of liquidation No circumstances under which the distributions are obligatory

Distributions paid after all legal/contractual obligations have been met. No preferential distribution. Paid in amount is recognised as equity capital for determining balance sheet insolvency and in Accounting Standards. Directly issued and paid in and the bank can not directly or indirectly have funded the purchase of the instrument

Goodwill/other intangibles, except mortgage servicing rights Deferred tax assets whose realisation depends on the banks future profitability Treasury stock Certain specified portions of investments not consolidated for regulatory purposes

Cash flow hedge reserves relating to hedging of items Any increase in equity capital resulting from securitisation transactions Unrealised gains and losses resulting from changes in banks own credit risk on fair valued liabilities

Tier 1 capital Subordinated to all depositors creditors Not secured or guaranteed No incentives to redeem & no investor put option

Fully discretionary non cumulative coupons

Callable by bank only after 5 years

Return of capital only with prior supervisory authorisation

Principal loss absorption on a going concern basis

Tier 2 capital criteria:

(1) Elimination of distinction between upper and lower tier 2

Minimum Tier 2 criteria:

(1) Original maturity at least 5 years with no incentive to redeem (2) Callable only by the issuer (3) Dividends/coupons may not have a creditsensitive dividend feature (4) subordinated to all non subordinated creditors

To comprise common equity Restraints on dividends and discretionary bonuses if buffer falls below 2.5% Capital Conservation Ratio to commence in 2016 at 0.625% and increase to 1.25% in 2017, 1.875% in 2018 and 2.5% in 2019

Protect banking sector from periods of excess credit growth Aim is to build-up phase of economic cycle Each jurisdiction to be given discretion to set countercyclical buffer: (1) Minimum buffer range under conservation buffer (2) Decisions should be preannounced by 12 months

Special rules for internationally active banks

Banks should calculate the buffer with at least the same frequency as their minimum capital requirements

Tier 1 leverage ratio at 3% during parallel run period between 2013 and 2017 Bank level disclosure of leverage ratio and components to start in January 2015

Supervisory monitoring period to commence on 1 January 2011

Leverage ratio not to become binding until early 2018

Current proposals is to base leverage ratio on banks capital compared to their Exposure on new definition of tier 1 capital. Exposure should follow accounting standards High quality liquid assets include cash and cashlike instruments in the measure of Exposure

Securitisation exposures will be counted in a manner generally consistent with accounting treatment

Two proposed liquidity ratios:

(1) Short term Liquidity Cover Ratio (LCR) (2) Long term Net Stable Funding Ratio (NSFR)

Liquidity cover ratio: High quality liquid assets to cover net cash outflows over 30 day period Builds on traditional internal methodologies used by banks to assess exposure to contingent liability events

Certain high quality liquid assets to be included on asset side on an unlimited undiscounted basis Level 2 assets must comprise no more than 40% of the overall stock and must have a minimum 15% haircut

Observation period for liquidity cover ratio commences in 2011 and ratio to be introduced at start of 2015

Going-concern proposals Systemically important banks

Trading book review

Credit ratings and securitisations Cross-border bank resolution

Increased quality of capital. Increased quantity of capital. Reduced leverage through introduction of backstop leverage ratio. Increased short term liquidity coverage.

Increased stable long term balance sheet funding.

Strengthen risk capture notably counterparty risk.