Basel III
What is "Basel III"
A global regulatory standard
• on bank capital adequacy
• stress testing
• and market liquidity risk
With a set of reform measures to improve
• regulation
• supervision
• and risk management
Aim
•
To minimize the probability of recurrence of
crises to 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
Target
•
Bank-level, or micro prudential, regulation,
which will help raise the resilience of individual
banking institutions to periods of stress .
• Macro prudential, system wide risks that can
build up across the banking sector as well as the
procyclical amplification of these risks over time
.
Micro- prudential elements
•
•
•
•
To minimize the risk contained with individual
institutions
The elements are:
Definition of capital
Enhancing risk
Coverage of capital leverage ratio
International liquidity framework
Macro- prudential elements
•
•
•
•
To take care of the issues relating to the
systemic risk
The elements are:
Leverage ratio
Capital conservation buffer
Countercyclical capital buffer
Addressing the procyclicality of provisioning
requirements
Definition of the three pillars - Pillar 1
Pillar 1- Minimum Capital Requirements
1.
Calculate required capital
2.
Required capital based on
•
Market risk
•
Credit risk
•
Operational risk
3. Used to monitor funding concentration
Definition of the three pillars - Pillar 2
Pillar 2- Supervisory Review Process Bank
1.
Should have strong internal process
2.
Adequacy of capital based on risk evaluation
Definition of the three pillars - Pillar 3
Pillar 3 – Enhanced Disclosure
1.
Provide market discipline
2.
Intends to provide information about banks
exposure to risk
The relationship among the three
•
Second pillar - supervisory review process to ensure
the first pillar
- intended to ensure that the banks have
adequate capital
• Third pillar
- compliments first and second pillar
- a discipline followed by the bank such
as disclosing capital structure, tier- i and tier-ii capital
and approaches to assess the capital adequacy i.e.
assessment of the first pillar
• Model of commercial banks interpret first pillar as a
closure threshold rather than bank’s asset allocation
Significant Methods of Measurement
The pillar is divided in three types of risk for
which capital should be held.
• Credit Risk
• Operational risk
• Market risk
Credit Risk
Credit risk is the risk that those who owe you
money will not pay you back. Historically credit
risk is the larger risk banks run.
BIS II proposes three approaches by which a
bank may calculate its required capital for credit
risk.
• Standardized approach
• Internal rating based (IRB) advanced
• Internal rating based (IRB) foundation
Operational risk
Operational risk is defined as the risk of loss
resulting from inadequate or failed internal
processes, people and systems or from external
events.
Comparable to credit risk, BIS II proposes
three methods for measuring operational risk.
• Basic indicator approach
• Standardized approach
• Advanced measurement approach (AMA)
Market Risk
Market risk is the risk of losses due to changes
in the market price of an asset.
Market risk will only have to be calculated for
assets in the trading book.
Foreign exchange rate risk and commodities
risk are part of the market risk. Two methods
may be used:
• Standardized measurement method
• Internal models approach
Challenges in implementation of Basel
III norms
The new and stricter regulations of the basel3 like
higher capital requirements, the new liquidity standard,
the increased risk coverage, the new leverage ratio or a
combination of the different requirements will be
difficult to adopt by the banks
Banks have to take a number of actions to meet the
various new regulatory ratios, restoring of data
Banks must be able to calculate and report the new
ratios. Which requires the huge implementation effort.
Banks usually have 3 types of challenges
• Functional challenges
• Technical challenges
• Organizational challenges
Functional challenges
Developing specifications for the new regulatory
requirements, such as the mapping of positions (assets
and liabilities) to the new liquidity and funding
categories in the LCR and NSFR calculations.
The specification of the new requirements for trading
book positions and within the CCR framework (e.g. CVA)
as well as adjustments of the limit systems with regard to
the new capital and liquidity ratios .
Crucial is the integration of new regulatory
requirements into existing capital and risk management
as some measures to improve new ratios (e.g. liquidity
ratios) might have a negative effect on existing figures .
Technical challenges
The technical challenges includes the
availability of data, data completeness, and data
quality and data consistency to calculate the new
ratios .
The financial reporting system with regard to
the new ratios and the creation of effective
interfaces with the existing risk management
systems .
Operational challenges
The operational challenges includes stricter capital
definition lowers banks’ available capital. At the
same time the risk weighted assets (RWA) for
securitizations, trading book positions and certain
counterparty credit risk exposures are significantly
increased.
The stricter capital requirements, the introduction
of the LCR and NSFR will force banks to rethink
their liquidity position, and potentially require
banks to increase their stock of high-quality liquid
assets and to use more stable sources of funding .