Basel III rules text issued by the Basel Committee

The Basel Committee has issued the Basel III rules text, which presents the details of global regulatory standards on bank capital adequacy and liquidity agreed by the Governors and Heads of Supervision, and endorsed by the G20 Leaders at their November Seoul summit.

Mr Nout Wellink, Chairman of the Basel Committee on Banking Supervision and President of the Netherlands Bank, described the Basel III Framework as "a landmark achievement that will help protect financial stability and promote sustainable economic growth. The higher levels of capital, combined with a global liquidity framework, will significantly reduce the probability and severity of banking crises in the future." He added that "with these reforms, the Basel Committee has delivered on the banking reform agenda for internationally active banks set out by the G20 Leaders at their Pittsburgh summit in September 2009".

The rules text presents the details of the Basel III Framework, which covers both microprudential and macroprudential elements. The Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the buildup of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards.

The Committee has put in place processes to ensure the rigorous and consistent global implementation of the Basel III Framework. The standards will be phased in gradually so that the banking sector can move to the higher capital and liquidity standards while supporting lending to the economy.

With respect to the leverage ratio, the Committee will use the transition period to assess whether it’s proposed design and calibration is appropriate over a full credit cycle and for different types of business models. Based on the results of a parallel run period, any adjustments would be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

Both the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) will be subject to an observation period and will include a review clause to address any unintended consequences.

Basel III misses opportunity to break down the silo culture in banking – Algorithmics assessment

Algorithmics, the world's leading provider of risk solutions, has published a comprehensive assessment of all the elements of Basel III, and finds them lacking in their conceptual approach to capital and liquidity. In it Algorithmics questions the missing link between capital and liquidity

The raft of proposals from the Basel Committee includes the headline-grabbing tier 1 capital ratio, buffer building, and leverage and liquidity ratios, which are all significant in their own right. However, having assessed all the regulatory documents from a holistic rather than risk silo perspective, Algorithmics’ research paper, titled ‘Basel III: What’s New? – Business and Technological Challenges’, identifies what they claim is a fundamental flaw of failing to reflect the true relationship between liquidity and capital.

One of the report’s authors, Dr Mario Onorato, Head of Balance Sheet & Capital Management at Algorithmics, and Honorary Senior Lecturer, Cass Business School in London, says, “Continuing to view capital as a primary mitigant of liquidity risk fails to recognise the complete nature of liquidity risk. Should a liquidity situation arise and the bank uses reserves set aside to absorb losses and meet obligations, the value of the company and of the capital are also likely to decline, because the bank will begin to be perceived as ‘riskier’. Liquidity risk and capital are therefore inextricably linked and cannot be addressed as separate silos.”

Basel III goes only part way to addressing the weaknesses of the established silo-based approach to risk management. The compartmentalized, prescriptive nature of the liquidity coverage ratio and net stable funding ratio within Basel III is unhelpful because it does not reflect the capital-liquidity interplay. This summer’s European Bank stress tests did not touch on liquidity, the very thing that crippled the markets during the recent crisis. The avoidance of a repeat occurrence is a key Basel III objective.

Regardless of regulatory gaps, Dr Onorato suggests stakeholders’ demands for better governance will result in banks amending their risk processes and systems in order to view risk holistically for all their legal entities, from both a bottom up and top down perspective.

“A truly effective risk management system will take a holistic approach to risk measurement and reporting; viewing and managing the interconnections between all risk factors, such that their potential impact on the balance sheet and stakeholders’ interests can be properly accounted for.” says Dr Onorato

To download a copy of this Algorithmics' Basel III research paper visit: http://www.algorithmics.com/EN/media/pdfs/Algo-WP0910-LR-Basel3-Exd.pdf

Snap analysis by the experts: Implementation is key to Basel III success

The global "Basel III" deal on bank capital standards was reached at lightning speed by the usually slow moving regulators - substantive negotiations took about a year, compared to a decade for the current Basel II rules.

But implementing the new standards consistently over the lengthy phase-in period will be a headache for national regulators, and determine whether Basel III succeeds better than its predecessor in reducing bank sector risk.

• The Basel III rules are much tougher than Basel II, which failed to ensure banks held enough capital to withstand the worst financial crisis since the Great Depression.
• Although Basel III more than triples the amount of top-quality capital that banks will have to hold in reserve, there are several potential pitfalls in timing and content that could undermine the reform's effectiveness.
• The key aspects of the completed package will not all be phased in until the start of 2019, presenting a challenge for supervisors and their political masters to maintain momentum in their supervision of the sector. Lobbying by banks or an eventual return to boom times could blunt the will to enforce Basel III, as memories of the global credit crisis fade.
• The new capital conservation buffer of 2.5 percent, which is lower than some banks had feared, will not be fully in place until the start of 2019. At this time, the buffer plus the Tier 1 capital requirement will total 7 percent; in practice this is likely to become a solid floor for banks, because they will not want to face curbs on payouts such as bonuses, dividends and share buybacks. Falling below 7 percent could damage a bank's reputation among investors and in the money markets.
• The new capital rules are not the only fresh burden on banks; they should be seen in conjunction with a range of regulatory initiatives that together could have large and unpredictable effects on banks.

Banks will have to comply with the first new global liquidity standard from January 2015; this will increase pressure to build up reserves of cash-like assets.

Separately, regulators will introduce far tougher capital requirements on bank trading books from the end of 2011, and these will force some institutions to rethink whether they want to continue financial market trading.

Also, national regulators may still impose other surcharges on big, systemically important banks as they grapple with the "too big to fail" problem; this prospect could cause large banks to build up more capital than the Basel III rules, taken in isolation, appear to imply.

But there are doubts about how effective the new countercyclical buffer will be, if and when it kicks in.

"You have a bald number to protect against excess credit but bubbles tend to affect individual asset classes at different points in time so it's a blunt instrument. To manage risk you have to be more targeted," said Richard Barfield, director at PriceWaterhouseCoopers.

It will be up to each national supervisor to determine when banks on its turf should start building up a countercyclical buffer; in the past, this has been a recipe for widely different approaches by regulators.

• Implementation is likely to be more universal than it was under Basel II; this time the United States appears fully on board, after it failed to implement all of Basel II. However, the lengthy transition period means political and economic changes may have altered the intentions of U.S. regulators by the time compliance becomes mandatory.
• Some top banks already hold more high-quality capital than Basel III will require. But many banks may feel pressure to show investors they can comply with the new package sooner rather than later, in order to ensure they are not be lumped in with the stragglers in raising capital.

"I expect that what will happen is that the larger banks will move toward these figures ahead of the timetable," said Barfield at PricewaterhouseCoopers.

There are still controversial loose ends for regulators to tie up to make the Basel III package fully effective.

The announcement of full details of a planned cap on leverage and new liquidity requirements were delayed in July this year; their implementation is not due until 2018 once full details have been fleshed out, which will not be easy.

The consensus on Basel III could start to fall apart if unforeseen impacts or foot-dragging by some countries starts to give banks in certain places competitive advantages over peers elsewhere.

"There has been a tremendous focus on getting this done quickly and it has been done to the G20 timeframe, which is why we need this ongoing monitoring and ability for mid-course corrections," said Simon Hills, a director at the British Bankers' Association.

Basel III is at the core of the G20's efforts to apply lessons from the global financial crisis, and Sunday's agreement will allow G20 leaders meeting in Seoul in November to congratulate themselves by endorsing a major reform of banks.

But there is a risk that the G20 could put too much reliance on higher bank capital levels and not focus enough on strengthening other aspects of the financial system that were found wanting in the crisis.

"Apart from a consistent worldwide application, it's important that capital is just part of the process of improving financial stability. The other key factors are improved supervision, improved risk management and making those things happen as well is the difficult challenge," Barfield said.

For full details on what has been agreed by the Basle Committee please CLICK HERE to go to our “BASEL III” page.

Basle III – Almost ready to roll?

From current reports it looks like the details of the Basel III package could finalized early next week – by the 15th September in fact.

It is believed that that banks will have to hold Tier 1 capital of 9 percent (currently in Basel II this is pitched at 4%), including a 3% "conservation buffer".

At least 5 percent of Tier 1 will be pure equity or retained earnings. If Tier 1 capital is less than 9%, banks will not be allowed to pay out dividends to shareholders.

In good times, banks have to allocate another 3%, the "anti-cyclical buffer". It simply means that in good times banks need Tier 1 capital of 12% in order to be able to pay dividends.

If one adds 4% Tier 2 capital, we reach an interesting number: 16% (6 percent Tier 1, plus 4 percent Tier 2, plus 3 percent conservation buffer, plus 3 percent anti-cyclical buffer).

Hedge funds are already shorting certain banks while investors try to understand how much capital banks may need to raise in order to be able to pay dividends.

The next step? Possibly the G20 summit in November, where the group’s leadersthey will give their seal of approval.

Broad agreement reached on Basel Committee capital and liquidity reform package

The Group of Governors and Heads of Supervision (Group), the oversight body of the Basel Committee on Banking Supervision, met on 26 July 2010 to review the Basel Committee's capital and liquidity reform package. The Group is deeply committed to increase the quality, quantity, and international consistency of capital, to strengthen liquidity standards, to discourage excessive leverage and risk taking, and reduce procyclicality. The Group reached broad agreement on the overall design of the capital and liquidity reform package. In particular, this includes the definition of capital, the treatment of counterparty credit risk, the leverage ratio, and the global liquidity standard. The Committee will finalize the regulatory buffers before the end of 2010. The Group also agreed to finalize the calibration and phase-in arrangements at their meeting in September.

Mr Jean-Claude Trichet, President of the European Central Bank and Chairman of the Group, said that "the agreements reached today are a landmark achievement to strengthen banking sector resilience in a manner that reflects the key lessons of the crisis." He emphasized that "the Group of Governors and Heads of Supervision have ensured that the reforms are rigorous and promote the long term stability of the banking system. We will put in place transition arrangements that ensure the banking sector is able to support the economic recovery."



Mr Nout Wellink, Chairman of the Basel Committee and President of the Netherlands Bank added that "a strong banking sector is a necessary condition for sustainable economic growth." He added that the announcements today should provide additional transparency about the design of the Basel Committee reforms, thus reducing market uncertainty and further supporting the economic recovery. Mr Wellink underscored that "many banks have already made substantial strides in strengthening their capital and liquidity base. The phase-in arrangements will enable the banking sector to meet the new standards through reasonable earnings retention and capital raising."

In reaching their broad agreement, the Group considered the comments received during the public consultation on the Basel Committee's proposed reforms, which were published in December 2009. They also took account of the results of the Quantitative Impact Study, the assessments of the economic impact over the transition and the long run economic benefits and costs. The Basel Committee will issue publicly its economic impact assessment in August. It will issue the details of the capital and liquidity reforms later this year, together with a summary of the results of the Quantitative Impact Study.

The key broad agreements of the Governors and Heads of Supervision are summarized in the “Annex” which may be downloaded from the BIS by clicking HERE.