Basel III is a set of international regulatory standards established by the Basel Committee on Banking Supervision (BCBS) to strengthen regulation, supervision, and risk management within the banking sector. It represents the third installment of the Basel Accords, succeeding Basel I and Basel II, and was introduced in response to the global financial crisis of 2007-2008.
Key components of Basel III include:
Capital Adequacy:
Basel III introduces more stringent capital requirements to enhance the resilience of banks. It establishes minimum capital ratios, including a common equity tier 1 (CET1) capital ratio, to ensure that banks maintain an adequate level of high-quality capital to cover their risk-weighted assets.
Leverage Ratio:
The leverage ratio is designed to limit the build-up of excessive leverage in the banking system. It measures the capital adequacy of a bank against its total assets, providing a simple safeguard against the risk of a bank becoming overly leveraged.
Liquidity Standards:
Basel III introduces two liquidity ratios – the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). The LCR ensures that banks have sufficient high-quality liquid assets to cover their short-term liquidity needs, while the NSFR addresses the stability of a bank's funding profile over a longer time horizon.
Counterparty Credit Risk:
Basel III enhances the risk-sensitive calculation of capital requirements for counterparty credit risk, particularly in the context of over-the-counter (OTC) derivatives. It introduces the standardized approach for counterparty credit risk (SA-CCR) to better reflect the risk of derivatives exposures.
Systemically Important Banks:
Basel III introduces additional capital buffers and requirements for systemically important banks, also known as Global Systemically Important Banks (G-SIBs). These banks are subject to higher capital requirements and more stringent regulatory measures due to their systemic importance.
Enhanced Disclosure and Transparency:
Basel III emphasizes the importance of transparency and disclosure. Banks are required to provide more comprehensive information about their risk management practices, capital structure, and risk exposures to enhance market discipline and the ability of stakeholders to assess a bank's risk profile.
Countercyclical Buffer:
The countercyclical buffer aims to address the build-up of systemic risk during periods of excessive credit growth. It allows national regulators to require banks to hold additional capital during times of economic expansion.
Basel III was developed with the objective of promoting financial stability by improving the resilience and risk management capabilities of banks. While the implementation of Basel III has been gradual, many jurisdictions around the world have incorporated these standards into their regulatory frameworks to enhance the soundness and stability of their banking systems. It represents a significant step in the ongoing efforts to create a more robust and resilient global banking sector.