Basel III

An Evaluation of New Banking Regulation

GROUP-4
RITIKA YADAV
SALONI JIWRAJKA
SHAILENDRA
SHARMA
MANAN AGRAWAL
KULDEEP KALE
NEHA SANKHE

PGP/19/039
PGP/19/044
PGP/19/048
PGP/19/148
PGP/19/315
PGP/19/318

Introduction of Basel III and its implications

The worlds biggest banks have a combined $2,287
investments that they must fill within four years.

bn

gap in liquid

91 of the worlds biggest banks were facing a shortfall of $577 bn to meet

the 7% equity tier one capital mandated by based III rulebook
- Basel committee in 2014
Why such a big gap?
Basel III disqualified certain non-equity capital from the numerator and changed
the risk weightings of assets in the denominator
If the norm is not met, it directly leads to restriction on bonus and dividend pay-out
of banks
However, banks like Credit Suisse have come up with Coco bonds which converts
to equity if bank suffered severe losses

Key challenges in designing international banking

regulations
What prompted change in
existing regulations?
2007-08 financial crises
Need for stricter regulations
for financial markets and bank
liquidity

Challenges
Stricter regulations for banks might lead to reduction in the
lending capacity having detrimental effects on the
economy
Countries which did not get negatively affected by the
economic downturn refuse to change their existing
regulations
Most countries often disagree with the method of calculation
of various capital ratios

Advantages of internationally
consistent framework
Increased interdependence - Bank
failure in one country could negatively
affect other national economies
including their Gov. And tax payers
Uncoordinated policy may lead to
competitive advantage for some
nations

We will explore the Dodd-frank Wall Street reform and

Consumer Protection Act (USA) and principle based approach
(Canada) in further slides

Both supporters and critics agree that the

drastically
change the global banking system
recommendations in Basel III will

Past Basel Accords

Basel I

Capital

Risk
weight

Target
standard
ratio

Basel II
Agreeme
nts

Superviso
ry review
process

Inclusion of
market and
operational risk
Expansion of
capital
requirements
proposed by
Basel I
Better risk
evaluation

Ignores liquidity
and countercycle risk
Ratings based
on credit rating
agencies and
internal systems
may vary
Increase in
systemic risk
due to
procyclical
behavior

Cons

Ignores
operational risk
Emphasis on
book value and
not market
value
Inadequate
assessment of
risk

Cons

Increases capital
adequacy ratios
of banks
Simple to adopt
Benchmark for
int.
standardization
of banking
regulation

Market
discipline

Minimum capital ratio=8%; Credit, market,

operational risks

Pros

Pros

Minimum capital ratio=8%; Credit, market

risks

Capital

Basel III
Common equity requirements raised from 2% to 4.5%
Tier 1 capital requirement to be raised from 4% to 6%
Introduction of capital conservation buffer of 2.5% to withstand future periods of stress
Countercyclical buffer varying between 0%-2.5%to preserve national economies from excess credit growth
Leverage ratio>=3%
Liquidity risk coverage ratio(30-day period)>=100%
Net funding stability ratio >=100%

Pros

Maintenance of high quality capital

base
Increased ability to absorb losses
Greater common equity would
encourage investors
Introduction of liquidity risk and
countercyclical buffer

Increased cost of capital for banks

Increased interest rates on loans
Reduction in GDP, employment and increased
chances of a potential crisis

Cons

Basel III Leverage Ratio

Summary
1

Bank leverage is the use of funding borrowed from

depositors or purchased on the market to finance
2 interest-bearing assets
It is measured as a ratio of banks Tier 1 capital to
its total assets, including off-balance sheet assets.
3 Repurchase agreements, securitizations to be
included. Netting not allowed
4
The committee recommends a minimum Tier-1
leverage of 3%
5
Expected to protect banks against model risks and
measurement errors.
The goal of leverage ratio monitoring is to limit
Commercial Banking Management
banks
leverage,
and also limit rapid deleveraging
Indian Institute
of Management
Kozhikode

Basel III Leverage Ratio

Strengths and Weaknesses
Strengths
Provides a non-risk measure of
leverage, and, therefore,
overcomes model and
measurement errors associated
with risk weight measures
Increases transparency by not
distinguishing between high risk
and low risk assets
Monitors off-balance sheet
leverage
Commercial Banking Management
Indian Institute of Management Kozhikode

Weaknesses
May incentivize banks to focus on
high-risk assets because leverage
ratio does not incorporate the
riskiness of assets

Basel III Counter-Cyclical Capital Buffers

1

A capital buffer is a range defined above the

regulatory minimum capital requirement to be
maintained during the stable periods so as to
2 absorb losses during periods of stress
The goal of the counter-cyclical capital buffer is to
counter excessive leverage and unwarranted
3 lending during expansionary periods
Supervisors are empowered to suspend the buffer
to increase credit supply during economic
downturns to revitalize the economy

Commercial Banking Management

Indian Institute of Management Kozhikode

Basel III Counter-Cyclical Capital Buffers

Summary
Strengths

Allows the banks to create a capital cushion in the boom

years to absorb losses in the downturns

Checks excessive lending in expansionary phase, which

might worsen the hit of an economic crisis

Provision for keeping in check dividend payouts and bonus

issues at times of crisis

Better alternative to bank tax increases banks ability to

absorb losses and reduces moral hazard

Commercial Banking Management

Indian Institute of Management Kozhikode

Weaknesses

Requirement of high capital

surplus would require banks to
attract investors by offering
favorable terms, thereby
increasing the banks cost of
capital. Profitability will reduce.

Measures to limit Counterparty Credit Risk

Basel III imposes conservative means than Basel II
Capital Requirements calculated using historical data and estimates volatility
and correlation assumptions

High interconnectedness
of large financial
institutions
Banks to hold fewer
assets from other
institutions- reduces
dependence

OTC derivative
transactions will lead
to hedging of risk, cost
shifted to end user
Derivatives business
transfer to unregulated
institutions like hedge
funds

WEAKNESSES

STRENGHTS

Committee proposes that banks should apply a multiplier of 1.25 to historical

assumptions and banks exposure to counterparty credit risk has a zero
weightage if deals are processed using exchanges and clearinghouses

Liquidity Ratios
Two ratios to monitor short term and long term liquidityLiquidity Coverage Ratio, Net Stable Funding Ratio

Ratios
Liquidity Coverage Ratio Ratio of high quality assets
to net cash outflows over a 30-day period, should be
equal or greater than 100%, quality assets should be
highly liquid
Net Stable Funding Ratio- Ratio of available stable
funding to the amount of stable funding required to
cover all illiquid assets and securities held, stable
funding is composed of equity and liabilities financing
that are reliable sources of funding under stress
scenarios

Basel III: Exceptions

Country Exclusion:

Member countries has an option to

implement the committees
suggestions
Restrictiveness and specificity
make framework more difficult to
implement globally
Chinas criticism: It does not
consider the emerging economies
It may benefit the banking sector
of those economies which are not
implementing these norms
This may rise to transfer of
systematic risk to developing
countries

Non-Banking
Institutions:

financial

It may fail to reduce systematic

risk because may directly or
indirectly shift risk to non-bank
institutions
Banks increased operating costs
will be transferred to clients and
so may shift business to hedge
funds
Placing greater regulation on
banks and allowing non bank
institutions to operate without
supervision

National regulations

US: Dodd Frank Wall

street reform and
consumer protection
Act

Seeks to reform the

banking industry by ending
taxpayer bailouts,
monitoring compensation
practices and regulating
NBFIs
Identify banks and nonbanks for additional
supervision
Seeks to protect investors
and consumers by
increasing oversight of
lending
Consumer protection
agency to prevent
deceptive products and

Canada: Principle based

approach
Uses general framework
without need of specific
rules
Requires banks to embed
risk management
Design your own
monitoring system
Focuses on quality of
controls and on identifying
problems with institutions
through stress testing
before problems becomes
crisis

EU: A new International

Regulatory framework
Implementation of new EU
banking Union but
surrounded by many
questions
Debated the optimal
framework that can prevent
EU financial crisis
Debated the terms and
conditions for providing EU
assistance to banks in
severe difficulties
Recent proposals would
broaden this responsibility
to all banks

Conclusion
Universality: All banks, extension to NBFCs in future
Improving Capital Base: Broaden definition of highquality Capital Base
Leverage Ratio: Limiting banks holding too much leverage
Counter Cyclical Capital Buffers: Restricts Pro-cyclical
behavior
Measure to Limit Counter Part Credit Risk: Decrease
Interconnectedness
Liquidity Ratios: Efficient Stress Testing, Mitigate liquidity
Crises

Possible additions to Basel framework

Continual Stress Testing: Internationally Coordinated Tests
CEMS, OSFI
Encompass a range of financial Institutions, Living Will

Importance of Unintended Consequences

Basel 1 and Basel 2

International Framework for Liquidity Risk Measurement, Standards and Monitoring,

Strengthening the Resilience of Banking Sector

Basel 3 recommendation could increase probability of Financial Crisis

RBI extends deadline to implement Basel III norms

to 2019
Extended timeline for full implementation of the Basel III capital by a
year to March 31, 2019.
Industry-wide concerns about the potential stresses on the asset
quality and impact on the performance/profitability of banks
May necessitate some lead time for banks to raise capital within the
internationally agreed timeline for full implementation of the Basel III
capital regulations
India's banks will need about $90 billion to meet global Basel III rules
Sharp rise in NPLs and resultant losses have weakened the banks'
core capital buffers
Weak metrics & high bad loans, India's state-run banks have not
been investor favorites, forcing them to depend on government for
capital injection.
Government has plans to inject 450 billion rupees ($6.7 billion) in the
banks through March 2019.

THANKS
GROUP-4
RITIKA YADAV
SALONI JIWRAJKA
SHAILENDRA
SHARMA
MANAN AGRAWAL
KULDEEP KALE
NEHA SANKHE

PGP/19/039
PGP/19/044
PGP/19/048
PGP/19/148
PGP/19/315
PGP/19/318