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Symposium 2009

Implementation - Negotiations Basel III

The Challenge

Many observers blame excessive risk taking and inadequate regulation as the core causes of the current global financial crisis that we have been witnessing.

Many observers blame excessive risk taking and inadequate regulation as the core causes of the current global financial crisis that we have been witnessing.

Negotiations Basel IIIThe G20 Leaders at the Seoul Summit on 11–12 November 2010 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).

“Basel III” is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. These 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:

    • bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress;
    • 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.[1]

      The Basel III agreement 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.

      In the 2010 Seoul Summit, G20 Leaders committed to adopt and implement these standards starting on January 1, 2013 and fully phased in by January 1, 2019.[2]

      One important element of the Basel III agreement is the countercyclical buffer which consists in national countercyclical buffer requirements and in bank specific countercyclical buffer.

      The primary aim of the countercyclical capital buffer regime is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth that have often been associated with the build-up of system-wide risk.[3]

      Abstract from “Basel III: A global regulatory framework for more resilient banks and banking systems (revised June 2011)”[4]

      18. One of the most destabilizing elements of the crisis has been the procyclical amplification of financial shocks throughout the banking system, financial markets and the broader economy. The tendency of market participants to behave in a procyclical manner has been amplified through a variety of channels, including through accounting standards for both market-to-market assets and held-to-maturity loans, margining practices, and through the build up and release of leverage among

      financial institutions, firms, and consumers. The Basel Committee is introducing a number of measures to make banks more resilient to such procyclical dynamics. These measures will help ensure that the banking sector serves as a shock absorber, instead of a transmitter of risk to the financial system and broader economy.

      19. […] the Committee is introducing a series of measures to address procyclicality and raise the resilience of the sector in good times. These measures have the following key objectives:

          • dampen any excess cyclicality of the minimum capital requirement;
          • promote more forward looking provisions;
          • conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and
          • achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth.

        […]

        IV. Countercyclical buffer

        A. Introduction

        136. Losses incurred in the banking sector can be extremely large when a downturn is preceded by a period of excess credit growth. These losses can destabilize the banking sector and spark a vicious circle, whereby problems in the financial system can contribute to a downturn in the real economy that then feeds back on to the banking sector. These interactions highlight the particular importance of the banking sector building up additional capital defenses in periods where the risks of system-wide stress are growing markedly.

        137. The countercyclical buffer aims to ensure that banking sector capital requirements take account of the macrofinancial environment in which banks operate. It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. This focus on excess aggregate credit growth means that jurisdictions are likely to only need to deploy the buffer on an infrequent basis. The buffer for internationally-active banks will be a weighted average of the buffers deployed across all the jurisdictions to which it has credit exposures. This means that they will likely find themselves subject to a small buffer on a more frequent basis, since credit cycles are not always highly correlated across jurisdictions.

        138. The countercyclical buffer regime consists of the following elements:

        (a) National authorities will monitor credit growth and other indicators that may signal a build-up of system-wide risk and make assessments of whether credit growth is excessive and is leading to the build-up of system-wide risk. Based on this assessment they will put in place a countercyclical buffer requirement when circumstances warrant. This requirement will be released when system-wide risk crystallizes or dissipates.

        (b) Internationally active banks will look at the geographic location of their private sector credit exposures and calculate their bank specific countercyclical capital buffer requirement as a weighted average of the requirements that are being applied in jurisdictions to which they have credit exposures.

        (c) The countercyclical buffer requirement to which a bank is subject will extend the size of the capital conservation buffer. Banks will be subject to restrictions on distributions if they do not meet the requirement.

        The countercyclical buffer regime will be phased-in in parallel with the capital conservation buffer between 1 January 2016 and year end 2018 becoming fully effective on 1 January 2019. This means that the maximum countercyclical buffer requirement will begin at 0.625% of RWAs on 1 January 2016 and increase each subsequent year by an additional 0.625 percentage points, to reach its final maximum of 2.5% of RWAs on 1 January 2019. Countries that experience excessive credit growth during this transition period will consider accelerating the build-up of the capital conservation buffer and the countercyclical buffer. In addition, jurisdictions may choose to implement larger countercyclical buffer requirements. In such cases the reciprocity provisions of the regime will not apply to the additional amounts or earlier time-frames.



        [1] http://www.bis.org/bcbs/basel3.htm

        [2] G-20 Seoul Communiqué http://www.basel-iii-accord.com/

        [3] http://www.bis.org/publ/bcbs187.htm

        [4] Source: http://www.bis.org/publ/bcbs189.pdf

          Related Solutions

          Solution
          Symposium 2009

          Create an internationally harmonized and countercyclical set of capital requirements for financial institutions.

          Create an internationally harmonized and countercyclical set of capital requirements for financial institutions.

          Create an internationally harmonized and countercyclical set of capital requirements for financial institutions.

          Polity, Business
          Solution
          Symposium 2009

          Introduce capital requirements that are progressive in the size of financial institutions´ business and prevent narrow banks and investment banks from engaging in activities that present potential conflicts of interest.

          Introduce capital requirements that are progressive in the size of financial institutions´ business and prevent narrow banks and investment banks from engaging in activities that present potential co ...

          Introduce capital requirements that are progressive in the size of financial institutions´ business and prevent narrow banks and investment banks from engaging in activities that present potential conflicts of interest.

          Polity, Business