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On December 7, 2017, the Basel Committee’s supervisory body, the Group of Central Bank Governors and Heads of Supervision (GHOS), adopted the post-crisis regulatory revisions. The GHOS approved the changes to the market risk framework on January 14, 2019. Banks will become more robust as a result of the updated regulations, and public trust in financial institutions will be restored.
It is a series of Basel Committee on Banking Supervision agreements that focuses on the risks that banks and the financial system face.
Establishment and purpose
Following the 2008 Global Financial Crisis, Basel III was implemented to increase banks’ ability to absorb financial stress shocks and boost their transparency and disclosure. Basel III expands on the earlier agreements, Basel I and Basel II, and is part of a larger effort to enhance banking regulation.
Basel Committee
The Basel Committee on Banking Supervision (BCBS) is the major worldwide standard-setter for bank prudential regulation and serves as a venue for central banks from across the world to collaborate on banking supervision issues on a regular basis.
In 1974, the Group of Ten nations’ central bank governors founded it.
In 2009 and again in 2014, the committee’s membership was extended. The BCBS today has 45 members from 28 jurisdictions, including central banks and regulatory agencies.
Basel III Norms
In 2010, the Basel III standards were released.
In reaction to the financial crisis of 2008, certain recommendations were implemented.
The system needed to be strengthened further since banks in developed nations were undercapitalized, over-leveraged, and reliant on short-term borrowing.
It was also thought that Basel II’s size and quality of capital were insufficient to contain any additional risk.
The rules focus on four key banking parameters: capital, leverage, financing, and liquidity, with the goal of promoting a more robust banking sector.
Capital: A capital adequacy ratio of 12.9 percent is to be maintained. Tier 1 and Tier 2 capital ratios must be maintained at 10.5 percent and 2% of risk-weighted assets, respectively.
In addition, banks must maintain a 2.5 percent capital conservation buffer. The countercyclical buffer should be kept at a level of 0-2.5 percent.
Leverage: A leverage rate of at least 3% is required. The leverage rate is the proportion of a bank’s tier-1 capital to total consolidated assets on average.
Liquidity and funding: Basel III established two liquidity ratios: the LCR and the NSFR.
The liquidity coverage ratio (LCR) will require banks to maintain a buffer of high-quality liquid assets adequate to cover cash withdrawals in an acute short-term stress scenario as defined by regulators.
This is to avoid scenarios such as the “Bank Run.” The purpose is to guarantee that banks have enough liquidity in the event of a 30-day stress scenario.
The Net Steady Funds Rate (NSFR) requires banks to keep their off-balance-sheet assets and operations in a stable financing profile. The NSFR mandates that banks support their operations with dependable sources of capital (reliable over the one-year horizon).
The NSFR standard is 100 percent at the very least. As a result, while LCR evaluates short-term (30-day) resilience, NSFR evaluates medium-term (1-year) resilience.
In India, the target date for adopting Basel-III was March 2019. It has been rescheduled for March 2020. The RBI chose to postpone the adoption of Basel rules for another six months due to the coronavirus epidemic.
Banks will have less capital burden in terms of provisioning obligations, including NPAs, if Basel III is extended for longer.
The Principles of Basel III
Capital Requirements at a Minimum
The Basel III agreement increased the minimum Basel III capital requirements for banks from 2% to 4.5 percent of common stock as a proportion of risk-weighted assets, up from 2% in Basel II. In order to be Basel compliant, there is additionally a 2.5 percent buffer capital requirement, bringing the total minimum need to 7%. When banks are under financial hardship, they can use the buffer.
Countercyclical Interventions
The Tier I capital requirement increased to 6% in Basel III in 2015, up from 4% in Basel II. The 6% includes 4.5 percent Common Equity Tier 1 capital and an additional 1.5 percent in Tier 1 capital.
Ratio of Leverage
As a backup to risk-based capital requirements, Basel III included a non-risk-based leverage ratio. A leverage ratio of more than 3% is needed for banks, and the non-risk-based leverage ratio is computed by dividing Tier 1 capital by a bank’s average total consolidated assets.
Requirements for Liquidity
The Liquidity Coverage Ratio and the Net Stable Funding Ratio are two liquidity ratios adopted by Basel III. The Liquidity Coverage Ratio requires banks to maintain a sufficient level of highly liquid assets to withstand a 30-day strained financing scenario as defined by regulators.
Conclusion
Basel III has significantly reinforced regulatory oversight. The agreement has spurred governments throughout the globe to increase capital requirements, implement liquidity restrictions, and establish governance and compensation standards. Banks will be less likely to fail as a result of this. Efforts to improve supervision would also be fruitful.
