Basel III is a 2009 international regulatory agreement that introduced a series of risk mitigation reforms in the international banking sector by requiring banks to maintain adequate leverage ratios and maintain certain reserve capital holdings. Think tanks such as the World Pensions Council have argued that Basel III merely builds on and continues to build on the existing Basel II regulatory basis without fundamentally questioning its core principles, in particular the ever-increasing use of standardized « credit risk » assessments marketed by two private agencies – Moody`s and S&P – and thus public policies to strengthen anti-competitive duopolist practices. Uses. [35] [36] The contradictory and unreliable credit ratings of these agencies are generally considered to be the main cause of the US housing bubble. Scientists have criticized Basel III for continuing to allow large banks to calculate credit risk using internal models and set general minimum capital requirements that are too low. [37] Basel III introduced a risk-free leverage ratio as a safety net for risk-based capital requirements. Banks must maintain a leverage ratio greater than 3%, and the non-risk-based leverage ratio is calculated by dividing Tier 1 capital by a bank`s average consolidated balance sheet total. The U.S. Federal Reserve Bank has set the leverage ratio at 5% for insured bank holding companies and 6% for systematic significant financial institutions (SIFIs) to meet this requirement. Basel III (or the Third Basel Accord or Basel Standards) is a voluntary global regulatory framework for capital adequacy, stress testing and liquidity risks in banks` markets. This third episode of the Basel Accords (see Basel I, Basel II) was developed in response to the gaps in financial regulation revealed by the 2007-08 financial crisis. It aims to strengthen banks` capital requirements by increasing banks` liquidity and reducing banks` indebtedness.
Recent Updates In October 2013, the Federal Reserve Board proposed rules to implement the U.S. liquidity coverage ratio that would strengthen the liquidity positions of major financial institutions. For the first time, the proposal would create standard minimum liquidity requirements for large international banking organisations and systemically important non-bank financial corporations, developed by the Financial Stability Supervisory Board. Such institutions should hold minimum amounts of high-quality liquid assets such as central bank reserves, as well as government and corporate bonds, which can be quickly and easily converted into cash. Basel III introduced a minimum leverage ratio. This is a non-risk-based leverage ratio that is calculated by dividing Tier 1 capital by the average total of the bank`s consolidated balance sheet (sum of exposures of all assets and off-balance sheet items). [6] [7] Banks should maintain a leverage ratio above 3% under Basel III. Basel III is a comprehensive set of reform measures developed by the BCBS to strengthen the regulation, supervision and risk management of the banking sector. The measures include both liquidity and capital reforms. Basel III aims to strengthen the Basel II requirements for banks` minimum capital ratios. In addition, requirements for liquid assets and refinancing stability will be introduced, thus reducing the risk of a rush to the bank.
Finally, the proposal requires both groups of companies (large bank holding companies and regional companies) subject to the requirements of the CRL to submit recovery plans to the United States. Regulators must specify what action would be taken if the CRL fell below 100% for three or more consecutive days. Basel III has also been criticized for its paper load and risk inhibition by banks organized at the Institute of International Finance, an international association of global banks based in Washington, D.C., who say it would « harm » both their business and overall economic growth. Basel III has also been criticised for negatively affecting the stability of the financial system by increasing incentives for banks to manipulate the regulatory framework. [40] The American Bankers Association,[41] community banks organized into the Independent Community Bankers of America, and some of the most liberal Democrats in the United States. Congress, including the entire Maryland congressional delegation of Democratic Senators Ben Cardin and Barbara Mikulski, as well as Reps. Chris Van Hollen and Elijah Cummings, spoke out against Basel III in its comments to the Federal Deposit Insurance Corporation,[42] stating that the Basel III proposals, if implemented, would hurt small banks by « significantly reducing their mortgage capital holdings and small businesses. » increase ». [43] Basel III introduced new regulatory capital requirements to enable large banks to withstand cyclical changes in their balance sheets. In times of credit expansion, banks must set aside additional capital. In times of credit crunch, capital requirements can be relaxed. Requiring banks to hold a minimum capital of 7% reserve will make banks less profitable.
Most banks will try to maintain a higher capital reserve to protect themselves from financial hardship, even if they reduce the number of loans granted to borrowers. They will have to hold more capital against assets, which will reduce the size of their balance sheets. In addition, Basel III introduced two additional capital buffers: like all Basel committee standards, Basel III standards are minimum requirements that apply to internationally active banks. Members undertake to implement and enforce the standards in their jurisdiction within the time limits set by the Committee. As of September 2010, the proposed Basel III standards required ratios such as: 7–9.5% (4.5% + 2.5% (maintenance buffer) + 0–2.5% (seasonal buffer)) for share capital and 8.5–11% for Tier 1 capital and 10.5–13% for total capital. [20] The Basel III International Capital Standards proposed by the Basel Committee on Banking Supervision require all banks to hold more capital; They also levy a capital surcharge on systemically important companies. US and European banking regulators regularly assess the capital adequacy of their large systemic banking companies through a series of « stress tests ». Overall, the objective of the new focus on capital requirements as a regulatory tool is to increase the resilience of sole financial firms and thus financial markets. The introduction of new liquidity requirements, in particular the liquidity coverage ratio (LCR) and the Net Stable Funding Ratio (NSFR), will have an impact on bond market activity. In order to meet the LCR`s criteria for liquid assets, banks are reluctant to hold high-maturity assets such as special purpose vehicles (SPVs) and special purpose vehicles (SPVs). A special purpose vehicle (SPE)is a separate entity created for a specific and narrow purpose and kept off-balance sheet.
SPV is a structured investment vehicle (SIV)Structured investment vehicle (SIV)A structured investment vehicle (SIV) is a non-bank financial institution created to buy investments aimed at profiting from the interest rate difference – called the credit spread – between short-term and long-term debt. The implementation of Basel III will have an impact on derivatives markets, as more and more clearing brokers will leave the market due to higher costs. Basel III`s capital requirements focus on reducing counterparty risk, which depends on whether the bank trades through a trader or a central clearing counterparty (CCP). When a bank trades derivatives with a trader, Basel III creates responsibility and requires a high capital requirement for that trading. In contrast, Tier 2 refers to a bank`s additional capital, such as undisclosed reserves and unsecured subordinated debt, which must have an initial maturity of at least five years. Basel III also introduced debt and liquidity requirements to protect against excessive borrowing while ensuring that banks have sufficient liquidity in times of financial stress. In particular, the leverage ratio, calculated as Tier 1 capital divided by the sum of current and off-balance-sheet assets minus intangible assets, was capped at 3%. Since January 2014, the United States has been on track to implement many Basel III rules despite different requirements and ratio calculations. [26] Some critics argue that capitalization regulation is inherently unsuccessful because of these and similar problems, and agree – despite an opposing ideological view of regulation – that « too big to fail » persists. [39] An OECD study published on 17 February 2011 estimates the medium-term impact of Basel III implementation on GDP growth at between −0.05% and 0.15% per year.
[31] [32] [33] Economic performance would be mainly affected by an increase in banks` credit spreads, as banks pass on an increase in banks` refinancing costs to their customers due to higher capital requirements. To meet the capital requirements initially in place in 2015, it was estimated that banks would increase their credit spreads by about 15 basis points on average. Capital requirements from 2019 onwards (7% for the common capital ratio, 8.5% for the Tier 1 capital ratio) could increase banks` credit spreads by around 50 basis points. [Citation needed] The estimated impact on GDP growth does not require an active monetary policy response. Since monetary policy would no longer be limited by the zero floor, the impact of Basel III on economic performance could be offset by a reduction (or delayed increase) in key interest rates of around 30 to 80 basis points. [31] The new guidelines also introduced the bucketing method, which groups banks according to their size, complexity and importance to the economy as a whole.