Basel III: An Evaluation of New Banking Regulations
Basel III: An Evaluation of New Banking Regulations
Basel III: An Evaluation of New Banking Regulations
Banking Regulations
Submitted by:
Amar Sneh 245
Kavya Rangineni 265
Seerat Gupta 284
Arjit Gupta 307
Divyanshu Jain 312
Rachit Mundhra - 327
The Global Financial Crisis
Less reliance on external ratings
Capital Conservation / Higher quantity & quality of capital
agencies
Leverage Ratio introduced
Counter-cyclical buffers CVA Capital Charge
100% weight for trade finance
Stressed Testing
Need for an internationally consistent regulatory framework for the worlds banking system
Challenges in designing international banking regulations
International regulation has become increasingly complex and restrictive due to negative shocks
repeatedly uncovering new problems in the banking industry
Increased regulation usually reduces the risk profile of the banks but predicting the effects of the
new regulation is difficult
A highly restrictive framework reduces the willingness banks to adopt policies for fear of lost
performance
Decrease in banks lending may be more detrimental to the economy than any bank failures
avoided in the future
Systematic risk may move to the financial systems that reject a more restrictive proposal
Basel Committee
Formed with the goal of minimising differences in bank regulation internationally
Established by the Central Bank governors of a group of 10 countries in 1974
The committees conclusions do not have a legal force and the national regulators must choose
to implement the committees recommendations independently
Focused on credit risk and appropriate weights to different kinds of loans and assets
Basel II features
Seeks to improve risk calculation in capital measurement
Introduced three pillars:
Introduced system based on external credit ratings
Pillar II Recommends supervisors evaluate a banks capital level with risk profile
Ensures early regulator intervention
Imposed standardized,
Uniformity in risk risk based capital
aversion
requirement limits
Dependence on
Encouraged pro- internal and external
cyclical behavior
risk modeling
Capital requirement: Basel III
Classification of
Capital: Basel III
Tier II 2%
Strengths-
Defined level of common equity will be maintained
Improvement in banks ability to absorb losses during crisis
Encourage investors and other banks to trust a banks reported capital ratio
Weaknesses-
Limited demand for banks common equity from investors
Issuance of common stock at favorable terms will lead to higher cost of capital
To maintain minimum high-quality capital to total RWA ratio banks will be forced to reduce total assets
Leverage Ratio
Inclusion of leverage ratio to supplement the risk-based capital requirements of Basel II
Leverage Ratio = high-quality capital / on- and off-balance sheet assets
Goals of Leverage ratio are:
To limit banks leverage
To discourage rapid deleveraging that may destabilizes the overall economy
To calculate exposure, high-quality assets, total repurchase agreements and securitizations should be
included and netting should be disallowed
A minimum 3% of Tier 1 leverage ratio is proposed
Strengths-
It increases transparency by supplementing risk-based model with a broader model
Identify banks that are operating radically different from their peers
Monitors the off-balance sheet leverage
Weaknesses-
Focus can shift to higher-risk assets as all assets will be equally weighed
Allowing ratio to be broad can lead to overstating the potential risk can make identification of outliers
difficult
Countercyclical Capital Buffer
Maintenance of a capital buffer above the Alternative Proposals
regulatory capital requirement IMF proposed flat tax on all banks, insurance
Created in the time of stable economy to companies and hedge funds
absorb losses in the time of crisis Another proposal was tax on profit
Acts as a check on excessive leverage and The funds will either be pooled into a
unwarranted lending during expansionary centralized capital buffer or become part of
phase government revenue as a pledge to support in
Regulators restricts capital eroding actions of future distress
banks when the buffer is wiped out Rejected because of Moral Hazard problem,
Only problem it further reduces the capital hence Countercyclical Buffer
base
Counterparty Credit Risk
CCR: risk that the opposite party will not honor the contract
Basel II estimate based on historical data
Basel III estimate based on worst case scenario
A multiplier of 1.25 is to be applied when calculating the correlation between asset
value and economy
Zero risk assigned to contracts settled through clearinghouse or exchanges to
incentivize banks to shift OTC derivatives to ETP
Intermediaries like exchange will increase cost of transaction and end user will suffer
Liquidity ratios
Aims to improve banks resilience to liquidity problems in the market
Two liquidity ratios intended to monitor both short-term and long-term scenarios
Strengths Weaknesses
LCR ensures maintenance of high quality Increase the cost and decrease the
assets by banks availability of credit
30-day period is enough to resolve Available funding may not be sufficient
liquidity crisis to meet required NSFR
LCR excludes both bank debt and Rush to obtain stable funding can lead to
insurance firm debt from high quality mispricing
assets to counteract interconnectedness Reduce liquidity as bank debt is not high
of financial system quality asset
Sets an international minimum standard May create liquid asset shortage and
and requires more detailed analysis of large concentration of risk
each bank to improve the quality of Could affect the interbank lending
leverage market
BASEL III - Exceptions
Country Exclusion
Recommendations are not legal binding
Countries choice whether to reject the proposal or indefinitely delay the
implementation
Faced criticism of including the norms according to banking practices of USA & Europe
and not of emerging economies
Shift of systematic risk from Western banking system to developing countries
Non-Banking Financial Institutions
May shift the risk directly or indirectly to non-bank institutions
May shift business to non-regulated institutions because of high operating costs for
banks
Greater concentration of financial services in hands of unregulated institutions may
increase systematic risk
National Regulations
USA Dodd Frank Wall Street Reform and Consumer Protection Act , Signed on July 21, 2010
Volcker Rule
Banned proprietary trading by commercial banks
Commercial bank cannot own or invest in a hedge fund and a private equity fund
National Regulations
Canada Principle based Approach EU - A New International Regulatory Framework
Source: http://dbie.rbi.org.in/DBIE/dbie.rbi?site=publications#!4
Emergence of Basel IV
Additional capital and liquidity requirements
Higher minimum leverage ratio
Less reliance on internal models
Revised standardized approaches (in particular for credit risk)
Capital floor and the trading book
Linking of asset quality review and stress testing
Pillar 2 capital add-ons
Liquidity requirements
More disclosure
It will increase banks RWAs significantly
Source: https://www.kpmg.com/IM/en/IssuesAndInsights/ArticlesPublications/Documents/basel-4-revisited-2015.pdf