Basel III (or the Third Basel Accord) is a global, voluntary regulatory standard on bank capital adequacy, stress

testing and market liquidity risk. It was agreed upon by the members of the Basel Committee on Banking Supervision in 2010-11, and was scheduled to be introduced from 2013 until 2015; changes from April 1, 2013 extended implementation until March 31, 2018 however. The third installment of the Basel Accords was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III was supposed to strengthen bank capital requirements by increasing bank liquidity and decreasing bank leverage. Source

Introduction The process of implementing the new rules of Basel III for the prudential regulation of banks is progressing quickly on a worldwide basis. This article takes stock of the current status of implementation in some of the major international jurisdictions. Analysis EUROPEAN UNION At the European level Basel III will be implemented through the "Regulation of the European Parliament and of the Council on prudential requirements for credit institutions and investment firms" and the "Directive of the European Parliament and of the Council on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms" (CRD IV Regulation and CRD IV Directive - together "CRD IV"). The majority of the existing CRD prudential requirements as well as the bulk of Basel III reforms will be included in the CRD IV Regulation as part of the Commission's planned single rule book. The Commission aims for agreement on CRD IV to be reached by summer 2012.

The European Parliament (EP) procedure files for the CRD IV Directive and the CRD IV Regulation, currently give June 12, 2012 as an indicative date for the Parliament to consider CRD IV in plenary session. The Commission plans for the proposed CRD IV Regulation and CRD IV Directive to come into force on January 1, 2013, with full implementation of their requirements by January 1, 2019. Member states are expected to transpose the CRD IV Directive into national law by December 31, 2012. If approved, the legislation will take effect from January 1, 2013 and will follow the Basel III transitional timetable set by the Basel Committee. During the past few months, the EP and the EU Council of Finance Ministers (ECOFIN) have put forward their respective positions on CRD IV. The rapporteur at the EP, Mr. Othmar Karas, published his first report on amendments on the CRD IV Directive on December 14, 2011 and amendments to the new CRD IV Regulation on December 16, 2011. The report stresses the importance of a maximum harmonization (single rule book). It also proposed some amendments and highlighted certain issues which include, among others: 1. Provisions to improve the corporate governance should ensure that there is no conflict of interest and that remuneration policy and top salaries are aligned with the long term interest of a financial institution. 2. The structure of the supervisory boards in banks of the different EU countries should be improved. 3. The CRD IV Directive should include less detailed rules on the Countercyclical Buffer that can be set by national authorities within a range of 0 and 2.5% of risk weighted assets. The respective rules should rather be set by the European Systemic Risk Board (ESRB). 4. The leverage ratio, while being a useful, simple and hard to manipulate backstop against the building of excessive leverage, should serve as a backstop mechanism under Pillar II (only) and not be disclosed before a final decision on its introduction has been made. 5. The requirements for management and capitalization of the counterparty credit risk when engaging in the derivatives markets need to be adapted to the outcome of decisions on the Regulation on OTC derivatives, central counterparties, and trade repositories (EMIR).

The Karas Report has in the meantime been amended and supplemented by more than 2,000 amendment proposals by members of the EU parliament. Following discussions about the CRD IV Regulation and CRD IV Directive in the second half of 2011 by the EU Parliament, the Danish Council of the EU published compromise proposals, dated January 9, 2012 and March 4, 2012, taking into account some of the changes debated and considered in the parliamentary discussion. In January 2012, the European Central Bank (ECB) published its opinion on the European Commission's legislative proposals for CRD IV. The ECB welcomed the Commission's approach to CRD IV and reaffirmed its support for the development of a single European rulebook for all financial institutions. In March 2012, the European Parliament's Committee on Economic and Monetary Affairs (ECON) published the draft reports containing proposed amendments to the CRD IV Directive and the CRD IV Regulation. The first reading of the CRD IV Directive and CRD IV Regulation in the European Parliament's Committee on Economic and Monetary Affairs (ECON) is currently scheduled for April 25, 2012. The first reading of both legislative proposals in the plenary session of the EU Parliament is currently scheduled for June 12, 2012. GERMANY On February 10, 2012 the German Federal Council (Bundesrat, i.e. the second chamber of the German federal parliament) which represents the individual German states (Lnder) and their particular regional political view published a statement on the Commission's proposal for the CRD IV Regulation and CRD IV Directive. Among others, this statement addresses the following issues: 1. The German Federal Council would prefer an implementation of Basel III rather by way of a directive (and not by way of a directly applicable regulation). Contrary to a regulation a directive must be transposed into national law. Such implementation would pass through a process of democratic control of national legislative authorities which would allow to adjust the Basel III rules to specific national situations and requirements.

2. The implementation of Basel III in Germany should consider the needs and particularities of small to medium-sized credit institutions (i.e. banks whose balance sheet totals do not exceed EUR 70 billion and which focus on regional retail banking) and their particular (lower) risk profile. For such small to medium-sized credit institutions the German Federal Council proposes the following special treatment under the Basel III implementation: a. to exclude such small to medium-sized credit institutions from the leverage ratio and net stable funding ratio; b. to consider the diversity of legal forms by establishing the relevant criteria for own funds and for deductions from common equity tier 1 items in order to ensure that small and medium-sized credit institutions do not suffer any disadvantages in comparison to larger financial institutions; and c. to exclude the small to medium-sized credit institutions from a directly binding effect of the technical standards which the European Banking Authority (EBA) would be authorized to issue under the CRD IV Regulation and CRD IV Directive. Such standards should rather become binding for small and medium-sized institutions only if adopted by the national banking authorities which should carefully consider whether such rules are in fact necessary for small and medium-sized institutions. 3. Pursuant to the German Federal Council the EBA should not be authorized to develop draft regulatory technical standards for determining which financial institutions are considered as saving banks or cooperative banks. The EBA would otherwise have the authority to interfere with the national corporate law rules of Member States governing cooperative banks and savings banks. 4. The German Federal Government is called to carefully assess the EBA's technical rule setting powers set out in the Commission proposal.

Those rules which are of mandatory importance should be set forth in the CRD Regulation or CRD Directive itself and the authority to issue such rules should not be delegated to the EBA. The statement by the German Federal Council is not a binding rule setting but merely expresses the opinion of the German Federal Council and contains recommendations for the German government in its further negotiations with the other EU member states on the appropriate approach for the implementation of Basel III within the European Union. Nonetheless, it should be taken as an indication that the "single rule book" approach taken by the proposal of the European Commission is seen skeptically within this chamber of the German parliament. FRANCE In France, both assemblies of the Parliament are working on the Commission's proposal for the CRD IV Regulation and the CRD IV Directive. The Lower Chamber, the Assemble Nationale (the "NA"), published a report in January 2012. The main conclusions of this report are the following: 1. The NA is concerned by the impact that the accelerated implementation of Basel III will have on the financing of the "real economy" and has summoned the government to carry out an assessment thereon; 2. The NA stresses the need to have a consistent approach and implementation in all relevant jurisdictions in order to avoid regulatory shopping and arbitrage. In this respect, it emphasizes the need to develop cooperation with the United States; 3. The NA welcomes the proposal to reduce to the extent possible reliance by credit institutions on external credit ratings; and 4. The NA calls for the European Union to propose regulation of shadow banking in the context of the G20. On March 6, 2012 the French Snat (the "Senate", i.e. the second chamber of the French parliament) published a report including the Senate statement on the Commission's proposal for the CRD IV Regulation and CRD IV Directive. Among others, this statement reiterates the conclusions of the NA's above report and addresses the following issues: 1. The Senate supports a maximum harmonization of prudential ratios, as proposed by the European Commission through a single rule

book. It has noted that this maximum harmonization should be accompanied by a strong European supervision. 2. With regard to capital ratios, the Senate has emphasized that the levels and quality of the composition proposed by the European Commission are likely to strengthen the banks solvency. However, the implementation of Basel III should consider national particularities in risk weighting, especially lending to small and medium enterprises, leasing or property loans. 3. As regards the retention by credit institutions of some of the risks transferred into their balance sheets, the Senate has requested an increase from 5% to 10% of the minimum rate of securitized assets retention. 4. With respect to the leverage ratio, the Senate considered that the principle of its insensitivity to risk must be maintained in order to assure its efficiency (notwithstanding the critics of penalizing credit to small and medium enterprises and to local authorities). The observation period relating to the leverage ratio should be used to assess the impact of introducing a binding leverage ratio. The assessment should also include the appropriate calibration and the appropriateness of establishing the leverage ratio as a flexible ratio. 5. With regard to structural reforms of the European banking sector, the Senate would like that the possibility and consequences of a separation of investment banking and retail banking be considered by the group of high level experts set up by the European Commissioner Michel Barnier. The Senate's and NA's reports are not binding rulings but merely express the opinions of the French Senate and NA and contain recommendations for the French government in its further negotiations with the other EU member states on the appropriate approach for the implementation of Basel III within the European Union. Nonetheless, they should be taken as an indication that the "single rule book" approach taken by the proposal of the European Commission is seen favorably within the French Parliament.

UNITED KINGDOM In the United Kingdom, the Financial Services Authority has announced that it is carrying out discussions with the banking and investment industry through a number of working groups.

Subsequently, it will conduct a formal consultation on the regulatory rules that it will make for purposes of implementing the CRD IV Directive and, to the extent necessary, the CRD IV Regulation. It has not yet published a timetable for this consultation. The development in the EU of the CRD IV Regulation and CRD IV Directive coincides with the recent publication of the Report of the Independent Commission on Banking. This Report recommended that banks carrying on retail business should not be permitted to carry on certain types of nonretail business. Such banks will be known as "ring-fenced" banks, and the Commission proposed that they should be subject to capital requirements that are higher than the capital requirements laid down by Basel III and, therefore, by the CRD IV Regulation and the CRD IV Directive. The proposal to subject ring-fenced banks to higher capital requirements than required by the CRD IV Regulation and the CRD IV Directive is causing tension within the EU. The European Commission has proposed that maximum harmonization should apply to the CRD IV Regulation and the CRD IV Directive, meaning that member states would not have discretion to impose higher requirements for banks authorized in their jurisdictions. Nevertheless, the UK government has indicated its intention to adopt the recommendations of the Report of the Independent Commission on Banking. The issue has become politicized, and was given as one of the reasons for the UK refusing to support the adoption of revisions to the EU Treaty in December 2011. UNITED STATES In the United States, Basel III implementation will require rulemaking by the federal banking agencies (the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation). As of yet, the federal banking agencies have not issued a proposed rule implementing Basel III. They have suggested that such a proposal will be issued in the first half of 2012. Under the U.S. Administrative Procedures Act, the proposed rule must be issued for public comment, the agencies must then review and consider all comments filed.

After the close of the public comment period and sufficient review, the agencies can then issue a final rule. Although no Basel III rules have been issued yet, some aspects of Basel III have been implemented in other aspects of U.S. bank regulation. For instance, the recent stress tests conducted by the Federal Reserve of the largest bank holding companies, used a measure of at least 5% tier 1 common equity under the stress scenarios as a minimum requirement before companies would be permitted to make any capital distributions.1 In addition, the Federal Reserve has stated in its proposed rule implementing enhanced supervision of large bank holding companies and systemically important non-bank financial institutions that it intends to implement the G-SIB surcharge called for by the Basel Committee consistent with the Committees 2014-2016 implementation, and noted that Basel III rules are a necessary prerequisite.

HONG KONG Hong Kong plans to follow the timetables set out by the Basel Committee on the implementation of Basel III and on transitional arrangements. This means implementation will begin on January 1, 2013 with full implementation by January 1, 2019. Basel III will be implemented in Hong Kong through amendments to the Banking Ordinance, Banking (Capital) Rules and Banking (Disclosure) Rules. The Banking (Amendment) Ordinance (the "BAO") was enacted on February 29, 2012 to introduce a number of amendments to the Banking Ordinance for the purpose of putting in place the legal framework for implementing the Basel III capital, liquidity, and disclosure requirements in Hong Kong. Key amendments include: 1. empowering the Hong Kong Monetary Authority (the "HKMA") to, i. prescribe, in rules, capital requirements applicable to authorized institutions (AIs) which are locally incorporated ii. prescribe, in rules, liquidity requirements applicable to AIs iii. prescribe information which AIs have to disclose to the public relating to their state of affairs, profit and loss or compliance with applicable capital requirements or liquidity requirements

iv. issue and approve codes of practice providing guidance on the rules on new capital and liquidity requirements; and 2. enlarging the review remit of the present Capital Adequacy Review Tribunal (CART) to cover also matters related to liquidity and disclosure for Basel III implementation, and to rename CART the "Banking Review Tribunal." The rules on capital and liquidity requirements introduced under the BAO will cover various capital ratios, buffers, and liquidity ratios introduced by Basel III as well as their calculation methodologies. As with the existing arrangements for the Banking (Capital) Rules and Banking (Disclosure) Rules, the HKMA will only be able to make rules in relation to capital, liquidity, and disclosure requirements after consultation with the Financial Secretary, the Banking Advisory Committee, the Deposit-Taking Companies Advisory Committee, and the two industry associations (i.e. the Hong Kong Association of Banks and the Association of Restricted Licence Bank and Deposit-taking Companies). The provisions of the BAO will take effect in phases. The provisions relating to capital requirements and the corresponding disclosure requirements will come into effect from January 1, 2013, while those relating to liquidity requirements will come into effect later in accordance with the Basel Committee's transitional timetable for Basel III implementation. The HKMA will inform AIs when the relevant commencement notices are gazetted. The HKMA continues to work closely with the banking industry in implementing Basel III. It has written to the Hong Kong Association of Banks and the Association of Restricted Licence Bank and Deposit-taking Companies on January 20, 2012 enclosing two consultation papers on the implementation of Basel III capital and liquidity standards, requesting comments by March 20, 2012. The HKMA has commenced preparation for the amendment of the existing Banking (Capital) Rules and Banking (Disclosure) Rules for the purpose of effecting the first phase of Basel III implementation (including minimum risk-weighted capital adequacy ratios, definitions of capital and riskweighting framework for counterparty credit risk) from January 1, 2013. The HKMA plans to issue the draft amendment rules for statutory consultation in the third quarter of 2012, and to table the same to the Legislative Council in Hong Kong for negative vetting by the fourth quarter.

ISLAMIC FINANCE CONSIDERATIONS Although most Islamic banks are positive about their ability to meet the targets set by the Basel Committee for the implementation of Basel III, the exact form of the requirements applicable to Islamic financial institutions is still a work in progress. As with the two previous Basel protocols Basel III makes no distinction between conventional banks and Islamic financial institutions. This may cause some issues for Islamic banks. Islamic banks seem to be in a good position to meet the enhanced capital requirements specified by Basel III. Islamic banks must comply with the regulations set by the Islamic Financial Services Board (IFSB) which imposes stricter capital requirements than those proposed in Basel III (Tier 1 and total capital requirements currently stand at 8% and 12%, respectively). The liquidity requirements of Basel III will prove more difficult. Islamic banks face two challenges in managing liquidity: 1. surplus liquidity cannot be transferred to conventional banks 2. constraints on their borrowing limits access to liquidity when the bank is under stress Some regulators have acknowledged this issue. The Central Bank of the United Arab Emirates has said that they will need to introduce new liquidity tools to ensure that Islamic banks will be able to implement the Basel III requirements. They have not yet indicated what these tools might be. In addition, the IFSB is still in the process of reviewing its response to Basel III. The treatment of subordinated debt, hybrid debt capital and convertible contingent capital under Basel III will need to be considered and addressed. The final draft of the IFSB's revised protocols is scheduled for issuance in 2013. As Islamic banks must comply with both Basel III and the IFSB protocol, only then will Islamic banks know what must be done to comply with this latest round of regulation. The timing of the IFSB report should not interfere with the implementation of the Basel III requirements by the 1 January 2019 deadline.

References 1 - Comprehensive Capital Analysis and Review 2012: Methodology and Results for Stress Scenario Projections (March 13, 2012)

Basell III: Fed's New Ruling On Global Banking

The Federal Reserve approved a stringent set of new global standards, known as Basel III, on capital and debt. The aim of the proposal is to prevent another financial crisis similar to the one that took place following the collapse of Lehman Brothers in 2008. FED officials also said that some of the larger banks, such as Goldman Sachs and JP Morgan, might face even stricter rules, due to the fact that they could pose a threat to the entire economy. The rules still have to be accepted by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. Basel III rests on three main fundamentals:

1. Capital conservation buffer: Banks will be required to maintain a certain Tier 1 capital ratio, which is a comparison of a banking's core equity capital and total risk-weighted assets. Banks with more than $50 billion in assets would have to maintain a Tier 1 capital ratio of 7.5% until 2019, while bigger institutions in the U.S. could be required to raise up to another 2.5%. The rationale behind this is simple: it forces banks to keep a higher amount of capital reserves that they can conjure up in the event of a crisis. 2. Leverage ratio: This ratio is calculated by dividing Tier 1 capital by the bank's average total consolidated assets. Basel III introduced a minimum leverage ratio of 3%. FED officials, however, have shown interest in raising this limit to 6% for larger banks. In the financial crisis, many firms built up excessive leverage while still showing strong risk based capital ratios. The purpose of this ratio is therefore to supplement the capital ratio with a nonrisk based measure. 3. . Liquidity requirements: Basel III introduced the liquidity coverage ratio and net stable funding ratio. The first requires banks to hold enough high-quality liquid assets that can cover its total net cash flows over 30 days. The second requires a minimum amount of stable sources of funding at a bank relative to the liquidity profiles of its assets. Both these ratios stem from a desire to implement internationally harmonized liquidity standards, which are thus far nonexistent. They aim to prevent banks relying too much on short-term, interbank funding to support longer-dated assets. Such types of funding can rapidly evaporate in the face of a crisis.

Evidently, these new rules have not gone without criticism. For one thing, because banks get to decide their own risk-weights, there is room for manipulation of some of the ratios. Moreover, bankers have argued that the limits will stifle lending as banks adjust to the stricter standards, and will thus be harmful to the economy. Nevertheless, I think the move represents a step in the right direction. While is true that less lending will likely be (slightly) detrimental in the short-run, slowing down the recovery of the American economy, in the long-run it will probably lead to better resource management, and create a safer environment for the economy. One the many things that the financial crisis has shown us is that many businesses have been dangerously relaxed about how they deal with their financial accounts. No one expected the financial crisis to hit, and few were prepared to deal with it when it did. This is precisely what Basel III is trying to fix, and it is particularly necessary for the systemic banks that can become a cause for concern for the entire economy in the face of a crisis. In the end, the new rules are a direct response to the need for a more stable and risk-averse economy. I therefore welcome them.