Basel III

Definition

Basel III is a set of international banking regulations developed by the Basel Committee on Banking Supervision to promote stability in the international financial system. It does this by requiring banks to maintain proper leverage ratios and keep certain levels of reserve capital on hand. Introduced in 2010, it is intended to protect the economy against the type of financial crisis that happened in 2008.

Phonetic

The phonetics of the keyword “Basel III” would be: /ˈbɑːzəl θriː/

Key Takeaways

1. Improve bank’s ability to absorb shocks: Basel III regulations are designed to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thereby enhancing the banking industry’s resilience.
2. Increase transparency and disclosures: Another important goal of Basel III is to increase the banking sector’s transparency by requiring more disclosure and enhancing the role of market discipline.
3. Strengthen risk management and governance: Basel III emphasises the importance of strengthening risk management and governance, and reinforces banks’ liquidity risk management capabilities.

Importance

Basel III, a global, voluntary regulatory framework introduced by the Basel Committee on Banking Supervision, is of crucial importance due to its focus on mitigating financial risk and preventing future financial crises. Its relevance stems from its more stringent capital requirements for banks, including higher minimum requirements for common equity, more rigorous definitions of capital, and the introduction of a leverage ratio to serve as a backstop to the risk-based capital measure. Emphasizing robust risk management and greater transparency, Basel III also introduces countercyclical buffers that increase capital requirements during periods of economic boom. Thus, via these measures, Basel III attempts to increase the resilience of individual banks and the banking system as a whole to economic shocks, ensuring greater overall financial stability.

Explanation

The primary purpose of Basel III, a comprehensive set of reform measures developed by the Basel Committee on Banking Supervision, is to increase the banking sector’s ability to withstand financial and economic stress and enhance financial stability. The measures aim to mitigate the chances of a future financial crisis by implementing stringent capital and liquidity rules that banks must adhere to. Basel III enforces banks to hold higher amounts of core capital in reserve to absorb losses, minimizing the risk of bankruptcy. Additionally, it seeks to avoid the bank’s overreliance on short term funding, making them less vulnerable to sudden credit supply shocks. Basel III is also used to foster greater risk management and transparency among banks. The measures require banks to hold a capital conservation buffer in the form of a common equity tier (CET1) of 2.5%, reinforcing their resilience and enabling continuous lending cycles even during periods of stress. The introduction of a standardize leverage ratio under Basel III serves to contain the buildup of leverage in the banking sector and provide a backstop to risk-based measures. These combined measures, along with improved disclosure standards, help in protecting the end users – consumers and investors alike, by ensuring fair and efficient banking operations.

Examples

1. Bank of America: After the financial crisis in 2008, the Basel III regulations were implemented to prevent future banking crises. Bank of America is one example of a large bank that had to adjust to these new regulations. They needed to raise their capital levels to comply with the higher requirements stipulated by Basel III. As a result, they had to improve their risk management practices and also increase their buffer of easily liquidatable assets. 2. Deutsche Bank: This German bank is another example of Basel III impact. In 2014, the bank had to raise fresh capital of 8 billion Euros to meet Basel III requirements. Deutsche Bank offered new shares and adjusted its capital structure in order to raise the necessary funds. 3. Barclays: Barclays, a British multinational investment bank, has had to reduce risk-weighted assets and increase capital ratios to meet the Basel III standards. This exercise resulted in a review of their overall business strategy, which saw the bank scale back operations in certain regions and business lines to lower risk and preserve capital.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Capital Adequacy
• Liquidity Risk
• Systemic Risk
• Macroprudential Regulation
• Countercyclical Buffers

Sources for More Information

• Investopedia
• Wikipedia
• IBM
• Corporate Finance Institute