Basel III Endgame

Posted 21 May 2024

6 min read

Why in the news?

Consumer Bankers Association (CBA) recently released a White Paper, “The Impact of the Basel III Endgame Proposal on Consumers on the Margins of the U.S. Financial System”.

About Basel III Endgame

The final set of rules of Basel III norms has been called “Basel III Endgame.”
Basel III is a set of measures developed by the Basel Committee on Banking Supervision to strengthen the regulation, supervision, and risk management of banks.
Potential impact of the Endgame includes Globally Systemically Important Banks (G-SIBs) experiencing an increase of 21% in capital requirements.
Proposed changes are aimed at improving the “strength and resiliency” of the banking system while also improving transparency and consistency in banks’ capital frameworks.

Basel Norms (Refer box at the end of this article for key terminologies associated with Basel Norms):

Description: These rules focus on the amount of capital that banks must have against the credit, operational, and market risk of their business.
- Banks face significant risk primarily due to being one of the most heavily leveraged sectors.
- Heavily leveraged sectors rely extensively on debt for financing their operations and investments.
Basel I Norms (1987):
- In 1987, the Committee introduced capital measurement system which focused on the credit risk and risk-weighting of assets.
- These norms set minimum level of capital requirements that banks should have.
Basel II norms (2004):
- These updated norms sought to improve the risk calculation in capital measurement by introducing three important pillars: Minimum capital requirements, Supervisory Review and Market Discipline.
Basel III Norms (2010):
- Released in response to the financial crisis of 2007-08.
- It aims to build robust capital base for banks and ensure sound liquidity and leverage ratios.

Key Features of Basel I, II and III Compared
Pillars	Key Components of Pillars	Basel I	Basel II	Basel III
Pillar I (Capital Requirements)	Minimum Ratio of Capital to RWAs	At least 8% (CAR)	8%	8% + 2.5% of Capital Conservation Buffers
Pillar I (Capital Requirements)	Tier 1 capital to RWAs	At least 4%	4%	6%
Pillar II (Supervisory Review Process)		No provisions for Supervisory Review	Risk Based Supervision introduced	Enhanced Supervisory Process
Pillar III (Disclosure & Market Discipline)		No Provisions related to Market Discipline	Quantitative and Qualitative disclosures prescribed at Quarterly, Half-Yearly and Yearly intervals	Enhanced Disclosure Norms
New Banking Capital Requirement Parameters Introduced by Basel III Capital Conservation Buffers to RWAs: Banks have to maintain a capital conservation buffer of 2.5 %. Leverage Ratio: Banks have to maintain a leverage ratio of 3 %. Counter Cyclical Buffer: A buffer ranging from 0 % to 2.5%. Minimum Liquidity Coverage Ratio: It should be ≥100%. Minimum Net Stable Funding Ratio: NSFR should be ≥100%.

Significance of Basel Norms:

Development of better risk assessments system: Through capital requirement parameters, it provides an edge over other banks, by focusing on only those target segments, markets and customers who have high risk ratio.
Robust risk management process: It results in serving the customers better including small and medium sized businesses. It leads to better liquidity for small businesses and help in their growth and expansion needs.
Improved Corporate Governance: Norms also offer banks with business benefits like improving corporate governance and allocation of capital.
Stable financial System: New liquidity and leverage framework under Basel norms will not only enhance the risk absorbency of individual banks but also aid in Strengthening soundness of financial system during extreme stress.
Minimizing Economic Spillovers: These Norms ensure that the banking system as a whole does not crumble and its spill-over impact on the real economy is minimized.

Basel norms implementation in India:

Basel 1 norms were adopted in India with the announcement by RBI in its Mid-term Review of Monetary and Credit Policy for 1998-99 to raise Capital to Risk Weighted Assets Ratio (CRAR) from 8 per cent to 9 per cent.
- In 2007, RBI announced the final guidelines for implementation of Basel II.
Draft guidelines for implementation of Basel III capital regulations were issued in Dec 2011.
- The Basel III capital regulations (Pillar I of Basel III Norms) were implemented in India with effect from April 2013 and have been fully implemented as on October 2021.
- As compared to the Basel norms, the RBI’s prescribed norms are stricter and more prudential.

Conclusion

The Capital Accord of 1988, which set global standards for regulation and supervision, has emerged as one of the most significant developments. The biggest contribution of the Basel Accord has been to arrive at a common definition of capital, while capital adequacy norms have been adopted in different countries with certain country-specific adaptations.

Tier I capital (Core Capital): It include paid up share capital, stocks and disclosed reserve.
- These are more permanent in nature and as a result, have highcapacity to absorb losses.
Tier II capital (Supplementary Capital): It includes all other capital e.g. Undisclosed reserve, revaluation reserves, general provisions and loss reserves.
- It is considered less reliable than Tier 1 capital because it is more difficult to accurately calculate and more difficult to liquidate.
Risk weighed Assets (RWA): RWA is linked to minimum amount of capital that banks must have relative to bank’s risk from its lending activities. The more the risk, the more the capital needed to protect depositors.
Capital Adequacy Ratio (CAR) or Capital to Risk (Weighted) Assets Ratio: CAR is a percentage that measures a bank's financial health by comparing its capital to its risk-weighted assets.
Liquidity Coverage Ratio (LCR): LCR is a requirement that requires banks to maintain a minimum amount of liquid assets to withstand cash outflows over a 30-day period.
Leverage ratio: The leverage ratio i.e. ratio of Tier I capital to the bank's average total consolidated assets (sum of the exposures of all assets and non-balance sheet items).
- Leverage ratio shows how much of a company's capital comes from debt, or how well it can meet its financial obligations.
Net Stable Funding Ratio (NSFR): It is a liquidity standard that measures the amount of stable funding a bank has relative to amount it needs.
- It promotes resilience by creating incentives for banks to fund their activities with more stable sources of funding.
Capital Conservation Buffer: Banks are required to hold capital conservation buffer to ensure cushion of capital that can be used to absorb losses during financial stress.
Countercyclical Buffer: It is a mechanism that allows banks to build up capital during periods of excessive credit growth to help the banking system absorb losses during downturns.