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BASEL

Chinwe Boston

Mengchun Zhang

Qiuli Guo

Di Xiao

Nathan Tsormetsri


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OVERVIEW

Meaning of Basel III

Why Basel III

Aims

Objectives

Major Changes

Implementation of the Changes


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WHATIS"BASELIII":

" A global regulatory standard on:

bank capital adequacy

stress testing and

market liquidity risk


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ALSOASETOFREFORMMEASURESTO

IMPROVE:

Regulation

Supervision

Risk management


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REASONSFORBASELIII FORMULATION:

Failures of Basel II being:

A. Inability to strengthen financial stability.

B. Insufficient capital reserve.

C. Inadequate comprehensive risk management approach.

D. Lack of uniformed definition of capital .


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AIMS& OBJECTIVESOFBASELIII

To minimize the probability of recurrence of crisesto greater extent.

To improve the banking sector's ability to absorb

shocks arising from financial and economic stress.

To improve risk management and governance.

To strengthen banks' transparency and disclosures .


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TARGETS:

Bank-level or micro prudential which will help raise the

resilience of individual banking institutions in periods of

stress.

Macro prudential system wide risks that build up across

the banking sector as well as the pro-cyclical

amplification of these risk over time.


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KEYELEMENTSOFREFORMS

Increasing the quality and quantity capital

Enhancing risk coverage of capital

Introducing Leverage ratio

Improving liquidity rules

Establishing additional buffers

Managing counter party risks


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STRUCTUREOFBASELII


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PILLAR1:MINIMUMCAPITALREQUIREMENTS

Pillar 1 aligns the minimum capital requirementsmore closely to actual risks of bank's economic

loss.

revised risks:

Credit risk

Operational risk

Market risk


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PILLAR1:MINIMUMCAPITAL

REQUIREMENTS(CONT.)

Credit risk The standardised approach Foundation internal ratings based (IRB) approachAdvanced IRB approach

Operational risk Basic indicator approach Standardized approach Advanced measurement approach

Market risk standardized approach internal models approach


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PILLAR2:SUPERVISORYREVIEWPROCESS

Pillar 2 requires banks to think about the whole spectrum of risksthey might face including those not captured at all in Pillar 1 such

as interest rate risk.

Coverage in Pillar 2: risks that are not fully covered by Pillar 1

Credit concentration risk

Counterparty credit risk

Risks that are not covered by Pillar 1 Interest rate risk in the banking book

Liquidity risk

Business risk

Stress testing


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PILLAR3:MARKETDISCIPLINE

Pillar 3 is designed to increase the transparency of

lenders' risk profile by requiring them to give details

of their risk management and risk distributions.


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WEAKNESSESOFBASELII

The quality of capital.

Pro-cyclicality.

Liquidity risk.

Systemic banks.


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BASELIII: STRENGTHENINGTHEGLOBALCAPITAL

FRAMEWORK

A. Capital reform.

B. Liquidity standards.

C. Systemic risk and interconnectedness.


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A. CAPITALREFORM

A new definition of capital.

Capital conservation buffer.

Countercyclical capital buffer.

Minimum capital standards.


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A NEWDEFINITIONOFCAPITAL

Total regulatory capital will consist of the sum ofthe following elements:

1. Tier 1 Capital (going-concern capital)

a. Common Equity Tier 1b. Additional Tier 1

2. Tier 2 Capital (gone-concern capital)

For each of the three categories above (1a, 1b and2) there is a single set of criteria that instrumentsare required to meet before inclusion in therelevant category.


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CAPITALCONSERVATIONBUFFER

The capital conservation buffer is designed to ensure thatbanks build up capital buffers outside periods of stresswhich can be drawn down as losses are incurred.

A capital conservation buffer of 2.5%, comprised ofCommon Equity Tier 1, is established above theregulatory minimum capital requirement.

Outside of periods of stress, banks should hold buffers ofcapital above the regulatory minimum.


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COUNTERCYCLICALCAPITALBUFFER

The countercyclical buffer aims to ensure that banking

sector capital requirements take account of the macro-

financial environment in which banks operate.

It will be deployed by national jurisdictions when excess

aggregate credit growth is judged to be associated with a

build-up of system-wide risk to ensure the banking system

has a buffer of capital to protect it against future potential

losses.


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MINIMUMCAPITALSTANDARDS


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B. LIQUIDITYSTANDARDS:

1. Short-term: Liquidity Coverage Ratio(LCR)

2. Long-term: Net Stable Funding Ratio(NSFR)


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1.SHORT-TERM:LCR

The LCR is a response from Basel

committee to the recent financial crisis. The

LCR proposal requires banks to hold highquality liquid assets in order to survive in

emergent stress scenario.


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SHORT-TERM:LCR

Must be no lower than 1.

The higher the better.

high quality liquid: liquid in markets during a time ofstress and, ideally, be central bank eligible.

Banks are still expected to conduct their own stress teststo assess the level of liquidity they should hold beyondthis minimum, and construct scenarios that could causedifficulties for their specific business activities.


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2. LONG-TERM:NSFR

Objectives:

To promote more medium and long-term funding

activities of banking organizations.

Ensure that the investment activities are funded bystable liabilities.

To limit the over-reliance on wholesale short-term

funding(money market)


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LONG-TERM:NSFR

Available stable funding (ASF) is defined as the totalamount of an institutions:

capital.

preferred stock with maturity of equal to or greater thanone year.

liabilities with effective maturities of one year or greater.

deposits and/or term deposits with maturities of less thanone year that would be expected to stay with theinstitution for an extended period a stress event.


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REQUIREDSTABLEFUNDING:

The required amount of stable funding is calculated

as the sum of the value of the assets held andfunded by the institution, multiplied by a RSF factor,

added to the amount of OBS activity (or potential

liquidity exposure) multiplied by its associated RSF

factor.


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REQUIREDSTABLEFUNDING

These components of required stable funding are notequally weighted.

100% of loans longer than one year.

85% of loans to retail clients with a remaining life shorterthan one year.

50% of loans to corporate clients with a remaining lifeshorter than one year.

and 20% of government and corporate bonds.

off-balance sheet categoriesare also weighted.


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C. SYSTEMICRISKAND

INTERCONNECTEDNESS(COUNTERPARTYRISK)

Capital incentives for using CCPs for OTC.

Higher capital for systemic derivatives.

Higher capital for inter-financial exposures.

Contingent capital.

Capital surcharge for systemic banks.


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CONCLUSION

Basel III introduces a paradigm shift in

capital and liquidity standards.

It was constructed and agreed in relativelyrecord time which leaves many elements

unfinished.

The final implementation date a long way off.


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HOWEVER,

Market pressure and competitor pressure

already driving considerable change at a

range of firms.

Firms therefore should ensure to engage

with Basel III as soon as possible to be

competitively advantaged in the new post-

crisis financial risk and regulatory

landscape.


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REFERENCES:

Basel II: a guide to capital adequacy standards for Lenders.[Available at: http://www.cml.org.uk/cml/policy/issues/748]

Basel III regulations: a practical overview. [Available at:www.moodysanalytics.com] [Accessed on 30/11/12].

Basel III: Issues and implications. [Available at: www.kpmg.com][Accessed on 30/11/12].

Federal Reserve Proposes Revised Bank Captial Rules. [Availableat: http://blogs.law.harvard.edu/corpgov/2012/06/12/federal-reserve-proposes-revised-ba...] [Accessed on 30/11/12].

Introduction to Basel II: [Available at:http://www.rcg.ch/papers/basel2.pdf]

Introduction to Basel II. [Available at:http://www.horwathmak.com/Literature/Introduction_to_basel_ii.pdf]
http://www.cml.org.uk/cml/policy/issues/748http://www.moodysanalytics.com/http://www.kpmg.com/http://www.rcg.ch/papers/basel2.pdfhttp://www.horwathmak.com/Literature/Introduction_to_basel_ii.pdfhttp://www.horwathmak.com/Literature/Introduction_to_basel_ii.pdfhttp://www.rcg.ch/papers/basel2.pdfhttp://www.kpmg.com/http://www.moodysanalytics.com/http://www.cml.org.uk/cml/policy/issues/748


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REFERENCES: (CONT.)

http://mpra.ub.uni-muenchen.de/35908/[Accessed

on 11/12/2012]

The New Basel III Framework: Implications for

Banking Organisations. [Available at:

www.shearman.com][Accessed on 30/11/12].
http://mpra.ub.uni-muenchen.de/35908/http://www.shearman.com/http://www.shearman.com/http://mpra.ub.uni-muenchen.de/35908/http://mpra.ub.uni-muenchen.de/35908/http://mpra.ub.uni-muenchen.de/35908/

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