Basel III


Basel III is a global, voluntary regulatory framework on bank capital adequacy, stress testing, and market liquidity risk. This third installment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the financial crisis of 2007–08. It is intended to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage.
Basel III was agreed upon by the members of the Basel Committee on Banking Supervision in November 2010, and was scheduled to be introduced from 2013 until 2015; however, implementation was extended repeatedly to 31 March 2019 and then again until 1 January 2022.

Overview

The Basel III standard aims to strengthen the requirements from the Basel II standard on bank's minimum capital ratios. In addition, it introduces requirements on liquid asset holdings and funding stability, thereby seeking to mitigate the risk of a run on the bank.

Key principles

Capital requirements

The original Basel III rule from 2010 required banks to fund themselves with 4.5% of common equity of risk-weighted assets. Since 2015, a minimum Common Equity Tier 1 ratio of 4.5% must be maintained at all times by the bank. This ratio is calculated as follows:
The minimum Tier 1 capital increases from 4% in Basel II to 6%, applicable in 2015, over RWAs. This 6% is composed of 4.5% of CET1, plus an extra 1.5% of Additional Tier 1.
Furthermore, Basel III introduced two additional capital buffers:
Basel III introduced a minimum "leverage ratio". This is a non-risk-based leverage ratio and is calculated by dividing Tier 1 capital by the bank's average total consolidated assets. The banks are expected to maintain a leverage ratio in excess of 3% under Basel III.
In July 2013, the U.S. Federal Reserve announced that the minimum Basel III leverage ratio would be 6% for 8 Systemically important financial institution banks and 5% for their insured bank holding companies.

Liquidity requirements

Basel III introduced two required liquidity ratios.
On 24 October 2013, the Federal Reserve Board of Governors approved an interagency proposal for the U.S. version of the Basel Committee on Banking Supervision 's Liquidity Coverage Ratio. The ratio would apply to certain U.S. banking organizations and other systemically important financial institutions. The comment period for the proposal closed on 31 January 2014.
The United States' LCR proposal came out significantly tougher than BCBS's version, especially for larger bank holding companies. The proposal requires financial institutions and FSOC designated nonbank financial companies to have an adequate stock of high-quality liquid assets that can be quickly liquidated to meet liquidity needs over a short period of time.
The LCR consists of two parts: the numerator is the value of HQLA, and the denominator consists of the total net cash outflows over a specified stress period.
The Liquidity Coverage Ratio applies to U.S. banking operations with assets of more than $10 billion. The proposal would require:
The US proposal divides qualifying HQLAs into three specific categories. Across the categories, the combination of Level 2A and 2B assets cannot exceed 40% HQLA with 2B assets limited to a maximum of 15% of HQLA.
The proposal requires that the LCR be at least equal to or greater than 1.0 and includes a multiyear transition period that would require: 80% compliance starting 1 January 2015, 90% compliance starting 1 January 2016, and 100% compliance starting 1 January 2017.
Lastly, the proposal requires both sets of firms subject to the LCR requirements to submit remediation plans to U.S. regulators to address what actions would be taken if the LCR falls below 100% for three or more consecutive days.

Implementation

Summary of originally-proposed changes (2010) in Basel Committee language

As of September 2010, proposed Basel III norms asked for ratios as: 7–9.5% + 0–2.5% ) for common equity and 8.5–11% for Tier 1 capital and 10.5–13% for total capital.
On 15 April 2014, the Basel Committee on Banking Supervision released the final version of its "Supervisory Framework for Measuring and Controlling Large Exposures" that builds on longstanding BCBS guidance on credit exposure concentrations.
On 3 September 2014, the U.S. banking agencies issued their final rule implementing the Liquidity Coverage Ratio. The LCR is a short-term liquidity measure intended to ensure that banking organizations maintain a sufficient pool of liquid assets to cover net cash outflows over a 30-day stress period.
On 11 March 2016, the Basel Committee on Banking Supervision released the second of three proposals on public disclosure of regulatory metrics and qualitative data by banking institutions. The proposal requires disclosures on market risk to be more granular for both the standardized approach and regulatory approval of internal models.

US implementation

The US Federal Reserve announced in December 2011 that it would implement substantially all of the Basel III rules. It summarized them as follows, and made clear they would apply not only to banks but also to all institutions with more than US$50 billion in assets:
As of January 2014, the United States has been on track to implement many of the Basel III rules, despite differences in ratio requirements and calculations.

European implementation

The implementing act of the Basel III agreements in the European Union has been the new legislative package comprising Directive 2013/36/EU and Regulation No. 575/2013 on prudential requirements for credit institutions and investment firms.
The new package, approved in 2013, replaced the Capital Requirements Directives.

Key milestones

Capital requirements

Leverage ratio

Liquidity requirements

Analysis of Basel III impact

In the United States higher capital requirements resulted in contractions in trading operations and the number of personnel employed on trading floors.

Macroeconomic impact

An OECD study, released on 17 February 2011, estimated that the medium-term impact of Basel III implementation on GDP growth would be in the range of −0.05% to −0.15% per year. Economic output would be mainly affected by an increase in bank lending spreads, as banks pass a rise in bank funding costs, due to higher capital requirements, to their customers. To meet the capital requirements originally effective in 2015 banks were estimated to increase their lending spreads on average by about 15 basis points. Capital requirements effective as of 2019 could increase bank lending spreads by about 50 basis points. The estimated effects on GDP growth assume no active response from monetary policy. To the extent that monetary policy would no longer be constrained by the zero lower bound, the Basel III impact on economic output could be offset by a reduction in monetary policy rates by about 30 to 80 basis points.
Basel III was also criticized as negatively affecting the stability of the financial system by increasing incentives of banks to game the regulatory framework.

Criticism

s such as the World Pensions Council have argued that Basel III merely builds on and further expands the existing Basel II regulatory base without fundamentally questioning its core tenets, notably the ever-growing reliance on standardized assessments of "credit risk" marketed by two private sector agencies- Moody's and S&P, thus using public policy to strengthen anti-competitive duopolistic practices. The conflicted and unreliable credit ratings of these agencies is generally seen as a major contributor to the US housing bubble. Academics have criticized Basel III for continuing to allow large banks to calculate credit risk using internal models and for setting overall minimum capital requirements too low.
Opaque treatment of all derivatives contracts is also criticized. While institutions have many legitimate risk reduction reasons to deal in derivatives, the Basel III accords:
Since derivatives present major unknowns in a crisis these are seen as major failings by some critics causing several to claim that the "too big to fail" status remains with respect to major derivatives dealers who aggressively took on risk of an event they did not believe would happen—but did. As Basel III does not absolutely require extreme scenarios that management flatly rejects to be included in stress testing this remains a vulnerability. Standardized external auditing and modelling is an issue proposed to be addressed in Basel 4 however.
A few critics argue that capitalization regulation is inherently fruitless due to these and similar problems and—despite an opposite ideological view of regulation—agree that "too big to fail" persists.
Basel III has been criticized similarly for its paper burden and risk inhibition by banks, organized in the Institute of International Finance, an international association of global banks based in Washington, D.C., who argue that it would "hurt" both their business and overall economic growth. Basel III was also criticized as negatively affecting the stability of the financial system by increasing incentives of banks to game the regulatory framework.
The American Bankers Association, community banks organized in the Independent Community Bankers of America, and some of the most liberal Democrats in the U.S. Congress, including the entire Maryland congressional delegation with Democratic Senators Ben Cardin and Barbara Mikulski and Representatives Chris Van Hollen and Elijah Cummings, voiced opposition to Basel III in their comments to the Federal Deposit Insurance Corporation, saying that the Basel III proposals, if implemented, would hurt small banks by increasing "their capital holdings dramatically on mortgage and small business loans".
Professor Robert Reich has argued that Basel III did not go far enough to regulate banks as he believes inadequate regulation was a cause of the financial crisis. On 6 January 2013 the global banking sector won a significant easing of Basel III Rules, when the Basel Committee on Banking Supervision extended not only the implementation schedule to 2019, but broadened the definition of liquid assets.
Before the enactment of Basel III in 2011, the Institute of International Finance, argued against the implementation of the accords, claiming it would hurt banks and economic growth.
The American Banker's Association, community banks organized in the Independent Community Bankers of America, and some of the most liberal Democrats in the U.S. Congress, including the entire Maryland congressional delegation with Democratic Sens. Cardin and Mikulski and Reps. Van Hollen and Cummings, voiced opposition to Basel III in their comments submitted to FDIC, saying that the Basel III proposals, if implemented, would hurt small banks by increasing "their capital holdings dramatically on mortgage and small business loans."
Former US Secretary of Labor Robert Reich argued that Basel III did not go far enough to regulate banks since, he believed, inadequate regulation was a cause of the financial crisis. However, this assertion has not been proven in any academic literature and, in fact, much of the regulation called for by Reich targets areas which were not a problem in the global financial crisis.
On 6 January 2013 the global banking sector won a significant easing of Basel III Rules, when the Basel Committee on Banking Supervision extended not only the implementation schedule to 2019, but broadened the definition of liquid assets.
In 2019, American investor Michael Burry criticized Basel III for what he characterizes as "more or less remov price discovery from the credit markets, meaning risk does not have an accurate pricing mechanism in interest rates anymore."

Further studies

In addition to articles used for references, this section lists links to publicly available high-quality studies on Basel III. This section may be updated frequently as Basel III remains under development.
DateSourceArticle Title / LinkComments
Feb 2012BNP Paribas Fortis"All you need to know about Basel III in 10 minutes." Updated for 6 January 2013 decisions.
Dec 2011OECD: Economics DepartmentOECD analysis on the failure of bank regulation and markets to discipline systemically important banks.
Jun 2011BNP Paribas: Economic Research DepartmentBNP Paribas' Economic Research Department study on Basel III.
Feb 2011Georg, co-PierreAn overview article of Basel III with a focus on how to regulate systemic risk.
Feb 2011OECD: Economics DepartmentOECD analysis on the macroeconomic impact of Basel III.
May 2010OECD Journal:
Financial Market Trends		OECD study on Basel I, Basel II and III.
May 2010Bloomberg
Businessweek		Bair said regulators around the world need to work together on the next round of capital standards for banks... the next round of international standards, known as Basel III, which Bair said must meet "very aggressive" goals.
May 2010ReutersFinance ministers from the G20 group of industrial and emerging countries meet in Busan, Korea, on 4–5 June to review pledges made in 2009 to strengthen regulation and learn lessons from the financial crisis.
May 2010The Economist"The most important bit of reform is the international set of rules known as "Basel 3", which will govern the capital and liquidity buffers banks carry. It is here that the most vicious and least public skirmish between banks and their regulators is taking place."