Basel I (1988), set minimum capital requirements for banks and focused mainly on credit risk. It is enforced by law in the G-10 countries. international banks were required to hold capital equal to 8% of the risk-weighted assets. When the Exxon Valdez oil spill occurred in Alaska, the “Credit Default Swap” (CDS) was the financial instrument created to assist banks in hedging lending risk while staying in compliance the Basel I requirements.
Basel II (2004) expanded capital requirements to include tenets to maintain consistency of banking regulations globally in respect to risk and capital management procedures. A “three pillars” concept:
(1) minimum capital requirements, (2) supervisory review, and (3) market discipline.
Basel II was heavily criticized for exacerbating the effects of the financial crisis of 2007-2008.
Basel II left the minimum capital requirements at 8% of risk-weighted assets.
Basel III was created in response to the financial crisis, the as a global regulatory standard on: bank minimum capital requirements, bank liquidity, and bank leverage.
Basel III requires banks to hold 4.5% of common equity, Basel II requires 6% of Tier I capital of risk-weighted assets. Basel III’s additional capital buffers are a mandatory capital conservation buffer of 2.5% and a discretionary counter-cyclical buffer. This allows national regulators to require up to another 2.5% of capital during periods of high credit growth.
Basel III introduced a minimum 3% leverage ratio and two required liquidity ratios:
(1) the Liquidity Coverage Ratio, which requires a bank to hold high-quality liquid assets to cover its total net cash outflows over 30 days,
(2) the Net Stable Funding Ratio, which requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.
The Organization for Economic Cooperation and Development (OECD) estimates that implementation of Basel III will decrease annual GDP growth by 0.05-0.15%.
The additional capital requirements in combination with enhanced risk management standards, is meant to reduce risk of bank failures, and to decrease the interdependence between financial institutions, thus reducing the risk of future banking crises.
However, there are potential negative side effects, including:
(a) smaller, weaker banks getting crowded out of the market by larger banks, who can raise the required capital easier than their smaller rivals;
(b) increased pressure on bank profit margins and operating capacity, with the follow on effect that there will generally be less investor appetite for bank debt and equity as they become more utility like;
(c) due to the enhanced capital and liquidity requirements, a reduction in lending capacity due to the adherence to the accords.
Critics think that these side effects will lead to reduced credit availability or increased cost of credit overall.
However implementing regualtions has not proved easy. The 2,300 page Dodd-Frank reforms, 2 were adopted in July 2010 by Congress as the devastation wrought on the US economy by the out-of-control financial sector was just being understood. Its entry into force still awaits a broad range of rulemaking and interpretation, and faces resistance from banks reticent to admit their faults. At the beginning of September, just 40 percent of the Dodd-Frank provisions had been finalized and integrated into law in the USA, according to a report by the law firm Davis Polk.
Dodd-Frank also created a new group, the Financial Stability Oversight Council headed by the USA Treasury secretary, charged with identifying risks to the US financial system and responding to those.
One key provision of Dodd-Frank remains unfinished, and toughly resisted by banks. The “Volcker Rule” to force banks to stop financial and other trading activities aimed at generating profits internally, activities that were at the heart of the crisis. Paul Volcker, the former Federal Reserve chairman for whom the rule is named, told The Wall Street Journal this week that not having completed the rule after three years is “ridiculous”.
The 10 largest US banks had $10.97 trillion in assets in June 2012, compared with $7.81 trillion at the end of 2006. (ie more not less centralisation and ‘too big too fail’ worries) Critics want to reinstate the 1933 Glass-Steagall Act – itself a product of a deep crisis – that separated commercial banking from investment banking
In late August the international Financial Stability Board, which comprises central bankers and regulators from 24 countries, pointed to the complexity and fragmentation of the US system.
So as Berlin mulls its ways to bank union without Treaty changes the prospect is of more regulation, more bank centralisation and harmonisation, more demands for monitoring and reports from Central banks who will thus demand data and reports from indvidual banks
For an update on some of the imminent legislative changesand the challenges presented and how to address those with BRSANALYTICS for regulatory compliance reporting come to our free seminar to learn more.
Call Sharmili or Maria – 0097143365589 to register.
Venue Palm room, Microsoft Gulf offices, DIC, Dubai
0900-1300
Light networking lunch
Registration 8.30
If you cannot make it, then also see us at Gitex, or register for a future seminar or ask for a one on one meeting.
