Since the financial crisis, the Basel Committee on Banking Supervision (BCBS), which is an international standard setter, has developed a new regulatory framework to address problems occurred in the financial system. After a long period of consultations, quantitative impact studies, and policy discussions, the Basel III framework has been officially announced on Thursday 16 last week with an overarching goal to raise the quality, consistency, and transparency of the banks' capital base.
The Basel III can be summarised into three important areas, which are the requirements on quality and quantity of capital, leverage ratio, and liquidity ratio.
Under the new regulations, banks are required to have higher quality of capital in which the prominent form of Tier 1 must be common stocks and retained earnings (they are called - Common Equity). The minimum Tier-1 Capital Ratio and Common Equity Ratio are raised to 6 per cent and 4.5 per cent respectively, while Total Capital Ratio remains the same at 8 per cent.
On top of the minimum capital requirements, banks have to maintain capital buffers which are conservation and counter-cyclical buffers. The conservation buffer is set at 2.5 per cent above the minimum Common Equity Ratio, bringing such ratio to 7 per cent. Objective is to accumulate an adequate buffer that can be drawn down in periods of stress.
Moreover, in a period of excessive credit growth that may signal a build-up of system-wide risk, regulators may require banks to hold additional counter-cyclical capital buffer ranging from 0-2.5 per cent depending on national discretion to protect banking sector from the financial crisis.
The Leverage Ratio is introduced to constrain the build-up of leverage in the banking sector and to reinforce the risk-based requirements with a simple, non-risk based "backstop" measure. The ratio is calculated by dividing Tier-1 capital with total exposures. The BCBS will test a minimum leverage ratio of 3 per cent during the parallel run period from January 1,
2013 to January 1, 2017.
As for liquidity requirement, the BCBS has strengthened its liquidity framework by developing two minimum standards ie Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). The LCR will help to ensure that global banks have sufficient unencumbered, high quality liquid assets to offset the net cash outflows it could encounter under a 30-day stress scenario. Concurrently, the NSFR aims to limit over-reliance on short-term wholesale funding during times of buoyant market liquidity and encourage better assessment of liquidity risk across all on- and off-balance sheet items.
The internationally active banks are required to implement Basel III starting from 2013 and to fully implement in 2019. For Thai banking system, the impact from Basel III is expected to be little as the main components of capital, which can be seen in the financial statements, are already common equity. However, it is necessary for banks to carefully assess the implication of Basel III on the entire business as it is not only the capital ratio but it may also affect business strategy as well as earning management.
The opinions expressed in this article are the author’s own and do not necessarily reflect the official opinion of the Bank of Thailand.