Introduction to Basel III

Introduction to Basel III

The Basel III reforms are an international regulatory framework that was introduced by the Basel Committee on Banking Supervision (BCBS) in December 2010 to strengthen the resilience of banks and banking systems in times of financial and economic stress. These regulations seek to raise the quality and level of capital, increase risk coverage, introduce leverage ratio as a backstop, raise supervisory review standards, and improve public disclosures. The Reserve Bank of India issued Guidelines based on these reforms in May 2012 and began its implementation from April 2013. The parallel run and prudential floor for implementation of Basel II vis-à-vis Basel I have since been discontinued. Taken together, these measures aim to ensure that banks are better able to absorb losses on both a going concern and gone concern basis while also protecting against periods of excessive credit growth.

The Basel III reforms are a comprehensive set of regulations designed to strengthen the regulatory system for banks and other financial firms globally. The primary intention is to ensure that banks have the necessary capital buffers to absorb losses during times of financial and economic stress, while also mitigating the risks associated with periods of excessive credit growth. These regulations call for higher capital standards and stricter international compensation standards, as well as improvements to the over-the-counter derivatives market and more powerful tools to hold large global firms accountable for their risk profile.

In order to further increase the resilience of individual banking institutions, Basel III reforms place a greater emphasis on micro prudential regulation as well as introducing macro prudential elements such as capital conservation buffers and countercyclical buffers. The Reserve Bank of India issued Guidelines regarding these reforms in 2012 and began implementation from April 2013, with full implementation slated for March 2018.

More specifically, high quality Tier 1 common equity must make up at least 4.5% of risk-weighted assets, with an additional 2.5% conservation buffer (for a total of 7%) in order to be considered adequately capitalized under Basel III. This is an increase from the 2% minimum Tier 1 capital requirement previously mandated by Basel I. Banks must also maintain a leverage ratio which serves as a backstop against riskier instruments such as derivatives and securitizations, limiting them from taking on debt beyond their capacity to pay it off if necessary.

The Basel Committee on Banking Supervision has made significant efforts towards improving transparency in public disclosures (Pillar 3), including requirements for disclosing information related to governance structures, credit exposure, liquidity risk management strategies and stress testing results among others. In addition, BCBS has implemented strict standards for supervisory review (Pillar 2) with respect to ensuring compliance with regulatory requirements through closer monitoring by supervisors/regulators. All these measures taken together will help ensure that banks are better able to meet their obligations even after experiencing periods of economic downturn or excessive credit growth while also promoting stability in the global financial system overall.