basel III


  • A risk-based capital surcharge • Market liquidity, first based on the United States’ 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.

  • [32] It summarized them as follows, and made clear they would apply not only to banks but also 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.

  • Currently, the BCBS has stated derivatives cleared with a QCCP will be risk-weighted at 2% (The rule is still yet to be finalized in the U.S.) o Provide incentives to strengthen
    the risk management of counterparty credit exposures o Raise counterparty credit risk management standards by including wrong-way risk • Third, a leverage ratio will be introduced as a supplementary measure to the Basel II risk-based framework.

  • Academics have criticized Basel III for continuing to allow large banks to calculate credit risk using internal models and for setting overall minimum capital requirements
    too low.

  • [23] Basel 3.1: Finalising post-crisis reforms[edit] Further information: Basel III: Finalising post-crisis reforms The Basel 3.1 standards published in 2017 cover further
    reforms in six areas: standardised approach for credit risk (SA-CR); internal ratings based approach (IRB) for credit risk; CVA risk; operational risk; an output floor; and the leverage ratio.

  • “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”.

  • Key principles See also: Capital requirement, Capital adequacy ratio, and List of bank stress tests CET1 capital requirements[edit] The original Basel III rule from 2010 required
    banks to fund themselves with 4.5% of Common Equity Tier 1 (CET1) (up from 2% in Basel II) of risk-weighted assets (RWAs).

  • [16] The proposal requires financial institutions and FSOC designated nonbank financial companies[17] to have an adequate stock of high-quality liquid assets (HQLA) that can
    be quickly liquidated to meet liquidity needs over a short period of time.

  • [9] Market risk: FRTB[edit] Further information: Fundamental Review of the Trading Book Following a Fundamental Review of the Trading Book, minimum capital requirements for
    market risk in the trading book will be based on a more sensitive standardized approach or internal model approval (IMA) for an expected shortfall measure rather than, under Basel II, value at risk.

  • [47] Criticism[edit] Think tanks such as the World Pensions Council have argued that Basel III merely builds on and further expands the existing Basel II regulatory base without
    fundamentally questioning its core tenets, notably the ever-growing reliance on standardized assessments of “credit risk” marketed by two private sector agencies- Moody’s and S&P, thus using public policy to strengthen anti-competitive duopolistic

  • Mathematically it is expressed as follows: • The Net Stable Funding Ratio requires banks to hold sufficient stable funding to exceed the required amount of stable funding
    over a one-year period of extended stress.

  • o intended to achieve the following objectives:  Put a floor under the buildup 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.

  • Notably, the Fed chose not to include GSE-issued securities in Level 1, despite industry lobbying, on the basis that they are not guaranteed by the “full faith and credit”
    of the U.S. government.

  •  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.

  • [26] • Fifth, a global minimum liquidity standard for internationally active banks is introduced that includes a 30-day liquidity coverage ratio requirement underpinned by
    a longer-term structural liquidity ratio called the Net Stable Funding Ratio.

  • [30] The LCR is a short-term liquidity measure intended to ensure that banking organizations maintain a sufficient pool of liquid assets to cover net cash outflows over a
    30-day stress period.

  • • The Federal Reserve Board itself would conduct tests annually “using three economic and financial market scenarios”.

  • In addition to increasing capital requirements, it introduces requirements on liquid asset holdings and funding stability, thereby seeking to mitigate the risk of a run on
    the bank.

  • [20] Lastly, the proposal requires both sets of firms (large bank holding companies and regional firms) subject to the LCR requirements to submit remediation plans to U.S.
    regulators to address what actions would be taken if the LCR falls below 100% for three or more consecutive days.

  • [33] • In April 2020, in response to the COVID-19 pandemic, the Federal Reserve announced a temporary reduction of the Supplementary Leverage Ratio (applicable to financial
    institutions with more than $250 billion in consolidated assets) from 3% to 2%, effective until March 31, 2021.

  • In 2013, the U.S. Federal Reserve announced that the minimum Basel III leverage ratio would be 5% for eight systemically important financial institution (SIFI) banks and 6%
    for their insured bank holding companies.

  • [44] Basel III was also criticized as negatively affecting the stability of the financial system by increasing incentives of banks to game the regulatory framework.

  • Basel III was also criticized as negatively affecting the stability of the financial system by increasing incentives of banks to game the regulatory framework.

  • While institutions have many legitimate (“hedging”, “insurance”) risk reduction reasons to deal in derivatives, the Basel III accords: • treat insurance buyers and sellers
    equally even though sellers take on more concentrated risks (literally purchasing them) which they are then expected to offset correctly without regulation • do not require organizations to investigate correlations of all internal risks they
    own • do not tax or charge institutions for the systematic or aggressive externalization or conflicted marketing of risk—other than requiring an orderly unravelling of derivatives in a crisis and stricter record keeping Since derivatives present
    major unknowns in a crisis these are seen as major failings by some critics [51] causing several to claim that the “too big to fail” status remains with respect to major derivatives dealers who aggressively took on risk of an event they did
    not believe would happen—but did.

  • To the extent that monetary policy would 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.

  • o Measures to address procyclicality:  Dampen 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 o Achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth.

  • [44][45][46] Economic output would be 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 originally effective in 2015 banks were estimated to increase their lending spreads on average by about 15 basis points.

  • The proposal would require: • Large Bank Holding Companies (BHC) – those with over $250 billion in consolidated assets, or more in on-balance sheet foreign exposure, and to
    systemically important, non-bank financial institutions;[17] to hold enough HQLA to cover 30 days of net cash outflow.

  • Furthermore, Basel III introduced two additional capital buffers: • A mandatory “capital conservation buffer”, equivalent to 2.5% of risk-weighted assets, phased in from 2017
    and fully effective from 2019.

  • • A discretionary “counter-cyclical buffer” allowing national regulators to require up to an additional 2.5% of RWA as capital during periods of high credit growth.

  • “[62] In January 2013 the global banking sector won a significant easing of Basel III rules, when the BCBS extended not only the implementation schedule to 2019, but broadened
    the definition of liquid assets.

  • Credit exposure between the largest financial companies would be subject to a tighter limit”.

  • (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.

  • [25] • Second, the risk coverage of the capital framework will be strengthened.

  • 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.

  • [13] • The “Liquidity Coverage Ratio”, which requires banks to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days under a stressed

  • It is intended to strengthen bank capital requirements by increasing minimum capital requirements, holdings of high quality liquid assets, and decreasing bank leverage.

  • Analysis of Basel III impact In the United States higher capital requirements resulted in contractions in trading operations and the number of personnel employed on trading

  • [12] In the EU, whilst banks have been required to disclose their leverage ratio since 2015, a binding requirement has not yet been implemented.

  • [52] Basel III has been criticized similarly for its paper burden and risk inhibition by banks, organized in the Institute of International Finance, an international association
    of global banks based in Washington, D.C., who argue that it would “hurt” both their business and overall economic growth.

  • • Level 2A assets generally include assets that would be subject to a 20% risk-weighting under Basel III and includes assets such as GSE-issued and -guaranteed securities.

  • The modified LCR requires the regional firms to hold enough HQLA to cover 21 days of net cash outflow.

  • [64] In March 2020, implementation of the Basel III: Finalising post-crisis reforms, the market risk framework, and the revised Pillar 3 disclosure requirements were extended
    by one year, to January 1, 2023.

  • The net cash outflow parameters are 70% of those applicable to the larger institutions and do not include the requirement to calculate the peak cumulative outflows[18] • Smaller
    BHCs, those under $50 billion, would remain subject to the prevailing qualitative supervisory framework.

  • [18] • Level 1 represents assets that are highly liquid (generally those risk-weighted at 0% under the Basel III standardized approach for capital) and receive no haircut.

  • As of September 2010, proposed Basel III norms asked 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 capital and 10.5–13% for total capital.

  • [27]) • The committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important

  • [29] On 3 September 2014, the U.S. banking agencies (Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation) issued their final
    rule implementing the Liquidity Coverage Ratio (LCR).

  • 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.

  • [53] The American Bankers Association,[54] community banks organized in the Independent Community Bankers of America, and others voiced opposition to Basel III in their comments
    to the Federal Deposit Insurance Corporation,[55] saying that the Basel III proposals, if implemented, would hurt small banks by increasing “their capital holdings dramatically on mortgage and small business loans”.

  • [15] • Regional firms (those with between $50 and $250 billion in assets) would be subject to a “modified” LCR at the (BHC) level only.

  • [9] Banking Book[edit] New rules for interest rate risk in the banking book became effective in 2018.

  • [28] On 15 April 2014, the Basel Committee on Banking Supervision (BCBS) released the final version of its “Supervisory Framework for Measuring and Controlling Large Exposures”
    (SFLE) that builds on longstanding BCBS guidance on credit exposure concentrations.

  • [citation needed] The estimated effects on GDP growth assume no active response from monetary policy.


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