The Basel iii Accord
Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk of the banking sector.
The Basel Committee is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability.
The Committee reports to the Group of Governors and Heads of Supervision (GHOS). The Committee seeks the endorsement of GHOS for its major decisions and its work programme.
The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, European Union, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States.
The Basel III reform measures aim to:
- Improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source
- Improve risk management and governance
- Strengthen banks' transparency and disclosures.
The reforms target:
A. Bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress.
B. Macroprudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time.
These two approaches to supervision are complementary as greater resilience at the individual bank level reduces the risk of system wide shocks.
From 1993 to 2008 the total assets of a sample of what we call global systemically important banks saw a twelve-fold increase (increasing from $2.6 trillion to just over $30 trillion). But the capital funding these assets only increased seven-fold, (from $125 billion to $890 billion). Put differently, the average risk weight declined from 70% to below 40%.
The problem was that this reduction did not represent a genuine reduction in risk in the banking system.
One of the main reasons the economic and financial crisis became so severe was that the banking sectors of many countries had built up excessive on and off-balance sheet leverage. This was accompanied by a gradual erosion of the level and quality of the capital base.
At the same time, many banks were holding insufficient liquidity buffers.
The banking system therefore was not able to absorb the resulting systemic trading and credit losses nor could it cope with the reintermediation of large off-balance sheet exposures that had built up in the shadow banking system.
The crisis was further amplified by a procyclical deleveraging process and by the interconnectedness of systemic institutions through an array of complex transactions.
During the most severe episode of the crisis, the market lost confidence in the solvency and liquidity of many banking institutions. The weaknesses in the banking sector were rapidly transmitted to the rest of the financial system and the real economy, resulting in a massive contraction of liquidity and credit availability.
Ultimately the public sector had to step in with unprecedented injections of liquidity, capital support and guarantees, exposing taxpayers to large losses.
The effect on banks, financial systems and economies at the epicentre of the crisis was immediate. However, the crisis also spread to a wider circle of countries around the globe. For these countries the transmission channels were less direct, resulting from a severe contraction in global liquidity, cross-border credit availability and demand for exports.
Given the scope and speed with which the recent and previous crises have been transmitted around the globe as well as the unpredictable nature of future crises, it is critical that all countries raise the resilience of their banking sectors to both internal and external shocks.
The G20 Leaders at the Seoul Summit endorsed the Basel III framework and the Financial Stability Board’s (FSB) policy framework for reducing the moral hazard of systemically important financial institutions (SIFIs), including the work processes and timelines set out in the report submitted to the Summit.
SIFIs are financial institutions whose disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.
We read in the final G20 Communique:
"We endorsed the landmark agreement reached by the Basel Committee on the new bank capital and liquidity framework, which increases the resilience of the global banking system by raising the quality, quantity and international consistency of bank capital and liquidity, constrains the build-up of leverage and maturity mismatches, and introduces capital buffers above the minimum requirements that can be drawn upon in bad times.
The framework includes an internationally harmonized leverage ratio to serve as a backstop to the risk-based capital measures.
With this, we have achieved far-reaching reform of the global banking system.
The new standards will markedly reduce banks' incentive to take excessive risks, lower the likelihood and severity of future crises, and enable banks to withstand - without extraordinary government support - stresses of a magnitude associated with the recent financial crisis.
This will result in a banking system that can better support stable economic growth.
We are committed to adopt and implement fully these standards within the agreed timeframe that is consistent with economic recovery and financial stability.
The new framework will be translated into our national laws and regulations, and will be implemented starting on January 1, 2013 and fully phased in by January 1, 2019."
To ensure visibility of the implementation of reforms, the Basel Committee has been regularly publishing information about members’ adoption of Basel III to keep all stakeholders and the markets informed, and to maintain peer pressure where necessary.
It is especially important that jurisdictions that are home to global systemically important banks (G-SIBs) make every effort to issue final regulations at the earliest possible opportunity.
But simply issuing domestic rules is not enough to achieve what the G20 Leaders asked for: full, timely and consistent implementation of Basel III. In response to this call, in 2012 the Committee initiated what has become known as the Regulatory Consistency Assessment Programme (RCAP).
The regular progress reports are simply one part of this programme, which assesses domestic regulations’ compliance with the Basel standards, and examines the outcomes at individual banks.
The RCAP process will be fundamental to ensuring confidence in regulatory ratios and promoting a level playing field for internationally-operating banks.
It is inevitable that, as the Committee begins to review aspects of the regulatory framework in far more detail than it (or anyone else) has ever done in the past, there will be aspects of implementation that do not meet the G20’s aspiration: full, timely and consistent.
The financial crisis identified that, like the standards themselves, implementation of global standards was not as robust as it should have been.
This could be classed as a failure by global standard setters.
To some extent, the criticism can be justified – not enough has been done in the past to ensure global agreements have been truly implemented by national authorities.
However, just as the Committee has been determined to revise the Basel framework to fix the problems that emerged from the lessons of the crisis, the RCAP should be seen as demonstrating the Committee’s determination to also find implementation problems and fix them.
Prepare for Basel iii
Connect with the global community of professionals, to gain insight into the G20 efforts to regulate the global financial system, to explore new career avenues and most of all, to acquire lifelong skills.
Join the Basel iii Compliance Professionals Association (BiiiCPA). Membership is Free.
Learn more about the Certified Basel III Professional Distance Learning and Online Certification Program