Basel III and Future Banking Systems

PreviewBasel Accord is global regulatory standard

on bank capital adequacy

A liquidity agreed upon by the members of the Basel Committee on Banking Supervision

During the lectures, we have discussed about Basel I and Basel II

Basel II vs. Basel IBasel II is an improved version of Basel I

Much more advance and complex than Basel I

BIS rate of 10% comparing to 8% from Basel I

Introduces ICAAP (Internal Capital Adequacy Assessment Process)

Two more pillars (Supervisory review and Market discipline)

However, world is not a perfect place, change of new rules and regulations are always necessary to keep banking systems in good shapes

Problems with the current banking systemsToo-big-to-fail institutions take too much risk

Large risks being driven by new innovations that took advantage of regulatory and tax arbitrage with no effective constraints on leverage.

Insolvency resulting from contagion and counterparty risk, driven mainly by the capital market (as opposed to traditional credit market) activities of banks, and giving rise to the need for massive taxpayer support and guarantees. Banks simply did not have enough capital.

Problems with the current banking systems (con’t)The lack of regulatory and supervisory

integrationAllowed promises in the financial system to be

transformed with derivatives and passed out to the less regulated and capitalized industries outside of banking – such as insurance and re-insurance.

The same promises in the financial system were not treated equally.

The lack of efficient resolution regimes to remove insolvent firms from the system.

What is Basel III Basel III was developed in a response to the

deficiencies in financial regulation revealed by the late-2000s financial crisis

A new global regulatory standard on bank capital adequacy

Improvement of three pillar system

Comparison with Basel II

Basel II Basel IIICommon Equity

requirement for Bank2% 4.5%

Tire I capital of risk-weighted assets (RWA)

4% 6%

Basel III, an enhancement of Basel IINotably the support for a leverage ratio

a capital buffer and the proposal to deal with procyclicality through dynamic provisioning based on expected losses

Adopting the buffer capital proposal to ensure the leverage ratio was not compromised in crisis situations Dividends, share buyback policies and bonuses

would be restrained as necessary to build back buffers used up in bad times

Basel III, an enhancement of Basel II (con’t)An effective implementation of Basel III will

demonstrate to regulators, customers, and shareholders that the bank is recovering well from the global banking crisis of 2008.

A speedy implementation will also contribute to a bank’s competitiveness by delivering better management insight into the business, allowing it to take advantage of future opportunities.

Major concerns with Basel III Basel III does not deal with the most

fundamental regulatory problem identified; the ‘promises’ that make up any financial system are not treated equally

Risk of setting the leverage ratio too low

Treating promises differently makes it harder to reform the structure of the supervision and regulation process

Major concerns with Basel III (con’t)Treating promises differently also require

more substantial thinking about the shadow banking system

Flaws identified in the overall RWA framework make it difficult to deal with concentration issues in Pillar 1; Suggest that other framework modifications should be considered.

Conclusion – Future is not clear!Basel III is an opportunity but also a

challenge for banks

Provide a solid foundation for the next developments in the baking sector and ensure past excesses are avoid

The new regime seeks much greater integration of the finance and risk management functions.

Conclusion (con’t)Basel III requires the introduction or

evolution of a risk management framework that is as robust as the existing finance management infrastructures.

In many ways Basel III provides a framework for true enterprise risk management, which involves covering all risks to the business.

Reference Basel Committee on Banking Supervision, (2010), “Press release”,

available at http://www.bis.org/press/p100912.pdf.

Adrian B. and Paul A. (2010). “THINKING BEYOND BASEL III: NECESSARY SOLUTIONS FOR CAPITAL AND LIQUIDITY”, OECD Journal: Financial Market Trends, issue 1, 2010.

Slovik, P. and B. Cournède. (2011), “Macroeconomic Impact of Basel III”, OECD Economics Department Working Papers, No. 844, OECD Publishing. http://dx.doi.org/10.1787/5kghwnhkkjs8-en

Pierre-Etienne Chabanel. (2011) “Implementing Basel III : Challenges, Options & Opportunities”, Moodys Analytics, White Paper, September 2011. http://www.moodysanalytics.com/Contact-Us/ERM/Contact-Form-Basel-III-Implementation/~/media/Insight/Regulatory/Basel-III/Thought-Leadership/2011/11-01-09-Implementing-Basel-III-Whitepaper.ashx