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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 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 loss-absorbing 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
|
Under Basel II
|
Under Basel III
|
|
Minimum Ratio of Total Capital To
RWAs
|
8%
|
10.50%
|
|
Minimum Ratio of Common Equity to
RWAs
|
2%
|
4.50% to 7.00%
|
|
Tier I capital to RWAs
|
4%
|
6.00%
|
|
Core Tier I capital to RWAs
|
2%
|
5.00%
|
|
Capital Conservation Buffers to
RWAs
|
None
|
2.50%
|
|
Leverage Ratio
|
None
|
3.00%
|
|
Countercyclical Buffer
|
None
|
0% to 2.50%
|
|
Minimum Liquidity Coverage Ratio
|
None
|
TBD (2015)
|
|
Minimum Net Stable Funding Ratio
|
None
|
TBD (2018)
|
|
Systemically important Financial
Institutions Charge
|
None
|
TBD (2011)
|
