Introduction: Definition and Importance of Basel III
Basel III is considered as an international regulatory approach which is introduced to provide a set of reforms to improve the current regulations, rules, supervisions and risk management factor in the banking sector across the globe. In the year 2009, the Basel Committee on the Banking revision released the first version of Basel III. It was introduced to provide banks all the requirements to face credit crisis, for maintenance of leverage ratio and to meet the minimum capital requirements.
According to the analysis and statement of Bank for International Settlements Basel III can be defined as set of comprehensive reforms and measures which is introduced and developed by the Basel Committee for the banking revisions to improve the banking regulation, management of risk factor and supervision of the banking sector. These regulation are made to measure;
- For the improvement of the banking sector and to ensure stability in case of financial and economic stress raised
- For the improvement and development of corporate governance and management of risk factor
- To maintain transparency and disclosure in the banking statements and guidelines.
In December 2010, the Basel Committee issued the rules and regulation which contains the details regarding the global regulatory standards on the capital adequacy and liquidity ration. This set of regulatory framework was approved and agreed by the Governor and heads of the Supervision and was also endorsed by leaders of G20 present at the Seoul Summit which was held in November. The aforesaid committee also released the results of the analysis on the QIS i.e. quantitative impact study.
The chairman of Basel Committee and President of Netherland Banks Mr. Nout Wellink explained the Basel III concept as
The Basel III concept is a developed and improved concept and also considered it as an achievement. It helps to maintain the financial stability and plays an a major role in the economic growth of a country. With the higher requirement of capital including the global liquidity framework will reduce the crisis happening in the banking sector presently and in future. He was also of the opinion that the changes in the banking regulation provided by the Basel Committee have helped the banking sector an agenda for the internationally active banks.
The rules and regulations lay down for the Basel III concept includes both micro and macro prudential factors. The framework of Basel III has set higher and quality capital, coverage of risk, introduced the leverage ratio etc. for the measurement and promotion of the capital that can be considered at the time of stress period and the global liquidity standards.
The Basel Committee has ensured the consistent global application and implementation of the Basel III Framework. The standards of the Basel III Framework are applied gradually so that the banking sector can be improved through the higher capital and liquidity standards at the time of supporting the economy of the country.
Key Elements of Basel III Framework
The leverage ratio can be used for the transition period to assess the design and caliber of the business models and credit cycles of the business. Basing on the aforesaid result, the adjustments of the same will be carried forward in the year 2017 with respect to migrating the pillar 1 treatment on 1 January 2018 which is based on that review and caliber.
According to the Basel III Framework, the liquidity coverage ratio and Net Stable Funding Ratio both are considered subject to the observation period. It will include a clause of review and consequences of the same which are unintentional.
Until the year 2015 and 2018, the banks have to meet the Liquidity Coverage Ration and Net Stable Funding Ratio respectively for the revision of the standards of the Basel II during the observation period. At that time, the banks who have 100% minimum thresholds can meet the standard laid down by Basel III Framework. For example, at the time of restructuring and funding of the business model the liquidity risk is considered as the period of risk. It is to be noted that the decrease in Liquidity Coverage Ratio and Net Stable Funding Ratio cannot be added and that the decrease in the standard may lead to decrease in the other standard.
According to Mr Wellink, Basel III framework will rapidly arise the level of high quality capital in the banking system in the near future. As a result, the increase in liquidity will reduce the funding structure. The banks will be given ample of time set out new standards for growth and sound economy of the country during this transition period. He also added that the in case of the liquidity standards. He also added that they will use the observation period required for the liquidity ratio that have been designed for the rights of the banks without any unintentional consequences. It may be banking sector or any other system level.
An updated report issued by the Basel Committee and the Financial Stability Board (FSB) containing the details of the Macroeconomic Assessment Group which helps to analyze the economic affect of the Basel III framework during the transition period.
The committee also has published the Guidance for the national authorities working for the countercyclical capital buffer as a supplement to the Basel III Framework. The essential element of the countercyclical capital buffer system is for the achievement of the large scale macro prudential goal for the protection of the banking sectors. The credit growth in excess will provide the national authorities to build system wise risk. The aforesaid document also helps the banks to understand the buffer decision in a particular jurisdiction.
Tier 1 Capital Requirement and Non-risk Based Leverage Ratio
The committee is also concentrating on the further work on the systematic banking system and contingent capital in relation to financial Stability Board. The Committee also has plans to issue the consultation paper on the capitalization of the banking exposures.
The following are some of the important points regarding the Basel III Framework;
1. Minimum Capital Requirements
According to the Basel III Framework, the minimum capital requirement for bank was 2% in Basel II. There is also an additional 2.5% buffer capital requirement for the same which brought the total equity to 7%. During the financial stress banks can use the buffer as a result the financial constraints will increase while paying dividends.
According to the reports, from the year 2015 the Tier 1 capital requirement raised from 4% in Basel II to 6% in Basel III. The increase in the 6% includes the common equity of 4.5%. the requirements of the same will be implemented in the year 2013 by but the same has been cancelled a number of times.
- Leverage Ratio
The Non -risk based leverage ratio was introduced by Basel III introduced to meet the risk based capital requirements. According to the Basel II regulatory Framework banks must hold a leverage ratio in excess of 3%. It is calculated by division of the Tier 1 capital with the total assets of the bank. To find out the exact requirement, the Federal Reserve Bank of the United States of America set a leverage ratio at the rate of 5% for companies engaged in insurance business and 6% for Systematically Important Financial Institutions (SIFI).
- Liquidity Requirements
The Basel III framework has introduced two liquidity ratios such as the Liquidity Coverage Ratio and the Net Stable Funding Ratio. The Liquidity Coverage Ratio is required for the banks to maintain sufficient high liquid assets that can be used during the financial stress period. The Liquidity Coverage Ratio was introduced in the year 2015 with a requirement of 60% which is expected to rise by 1% each year till the year 2019.
The Net Stable Funding Ratio is required for the banks to meet the stable funding purposes for the period of extended stress. It was designed to avoid liquidity mismatch and it will be operational from 2018.
In December 2010, the Basel Committee issued the rules and regulation which contains the details regarding the global regulatory standards on the capital adequacy and liquidity ration. This set of regulatory framework was approved and agreed by the Governor and heads of the Supervision and was also endorsed by leaders of G20 present at the Seoul Summit which was held in November. The aforesaid committee also released the results of the analysis on the QIS i.e. quantitative impact study.
Liquidity Ratios: Liquidity Coverage Ratio and Net Stable Funding Ratio
The banks have to meet the Liquidity Coverage Ration and Net Stable Funding Ratio respectively for the revision of the standards of the Basel II during the observation period. At that time, the banks who have 100% minimum thresholds can meet the standard laid down by Basel III Framework. For example, at the time of restructuring and funding of the business model the liquidity risk is considered as the period of risk. It is to be noted that the decrease in Liquidity Coverage Ratio and Net Stable Funding Ratio cannot be added and that the decrease in the standard may lead to decrease in the other standard.
The leverage ratio can be used for the transition period to assess the design and caliber of the business models and credit cycles of the business. Basing on the aforesaid result, the adjustments of the same will be carried forward in the year 2017 with respect to migrating the pillar 1 treatment on 1 January 2018 which is based on that review and caliber.
The term Bank Failure refers to the closing of the insolvent bank by the federal and state regulator. The power to close the insolvent bank has been given the comptroller of the currency. The banking commissioner has the power to close the state-charted banks, The bank failures happens when a bank is unable to pay its debts or fails to meet the obligations of the depositors. The Federal Deposit Insurance Corporation is provided the authority to cover the depositors balance in case of a bank failure.
The Basel III regulations were applied in case of bank failures since June 2011 according the report published by EU regulator. The report states that about 56% of the Europe’s 48 biggest banks fall short by 7% as result of the requirement of capital due to bank failure.
The EBA data published in the year 2011 suggest that the EU banks have a good future to achieve Basel III requirements. Currently the banks have 70% of the liquid assets which will be required to be maintained by 2015. A shortfall in the same will give rise to the bank failure. The capital figures shown in the year 2009 has a little change as it will be fall short by €263bn.
A shadow banking refers to a system where a association of financial intermediaries facilitate the credit across the global financial system but the members of the association are not subject to the oversight of the regulator. In simple words, it can be referred to the unregulated activities of the banks by the regulated institutions. The examples of some of the intermediaries are hedge funds, derivatives, unlisted instruments etc. The example of unregulated activities is credit default swap.
Applications and Implementations of Basel III Regulation
The Net Stable Funding Ratio is a liquidity standard which was first introduced by Basel III for the promotion of the liquidity position of the banks so that the bank funds can be treated as the assets. The Net Stable Funding Ratio is required to maintain the minimum funding requirement according to the provisions of the Basel III framework. The sectors like project finance and infrastructure development were affected the most as result of this development. Since the global demand for the development of the infrastructure the shadow banking system have seen a important source of project finance. The capital requirement of the banks affects the business models for the availability of the credit even if the risk is involved as a result of the rapidly growing shadow banking in project finance.
The term Small business financing refers to the means by which an present business owner gets the money to start a small business enterprise. The owner of the business may also buy a small business and collect money for the investment purposes of the current and future businesses.
The impact of the Basel III Framework on the small business can differ according to its capital requirements. The regulations of the Basel III Framework can lead to high risk factor to small business as compared to large scale businesses. As a result of which the higher level of the capital can supported by providing small business loan.
The banks can continue provide small business loans within its limits. However, there is not flexibility in the banks to customize the small business requirements. If there are banks which can provide small business loans they will make the business loans more costly and will charge high rate of interest.
Now a days, it is very difficult to make loans for the small businesses. There are also a few banks operating in the market to provide such type of business loans which can negatively impact their growth potential. According to the statement if S3 Partners,
“And the ripple effect will be slower overall economic growth in the United States.”
Most of the bankers have the opinion that the approach of the Basel III model can vary basing on the complexity and risk factor involved. They are of the opinion that the regulations provided by the Basel III framework can be taken in to consideration for the improvement of the economic condition and needs of the small business and banks as a whole.
Hence, it can be rightly said that the regulations that are effective now a days cannot be considered as the part of the growing economy. The implementation of the Basel III framework can cause small business growth and creation of employment in the near future.
The term financial innovation refers to the payments systems used in the lending and borrowing of funds by a financial institution. The changes in the technology, risk transfer and credit generation has given rise to the term financial innovation. The Basel III framework is applicable for the businesses to meet the banking crisis and market competition. The financial Innovation scheme is also related to the Basel III framework.
References
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Investopedia. (n.d.). Basel III. Retrieved from https://www.investopedia.com/: https://www.investopedia.com/terms/b/basell-iii.asp
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J.M. Petersen, L. N. P. Hlatshwayo, M.A. Petersen, F. Gideon. (2013, January). Download citationShare Request full-text .
Lamia Bouattour Boulifa, Dalenda Khouaja. (2017, February 24). Could Basel III Capital and Liquidity Requirements Avoid Bank Failure?
Sadler, J. (n.d.). How Might Basel III Hurt Small Businesses?
Times, F. (2011, April 5). Big banks failed to meet Basel III in 2011. Retrieved from https://www.ft.com/content/: https://www.ft.com/content/1629c818-7e74-11e1-b20a-00144feab49a
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