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Overview Basel III Prudential Requirements by Rajnish Ramchurun

Overview Basel III Prudential Requirements by Rajnish Ramchurun

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Published by: rajnishramchurun on Aug 25, 2011
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08/25/2011

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Basel III: An overview of micro and macro prudential regulatoryrequirements for banks
Rajnish Ramchurun 
 
"Basel III" is a comprehensive set of reform measures, developed by theBasel Committee on Banking Supervision, to strengthen the regulation,supervision and risk management of the banking sector. These measures aimto:1. improve the banking sector's ability to absorb shocks arising fromfinancial and economic stress, whatever the source2. improve risk management and governance3. strengthen banks' transparency and disclosures.The reforms target both micro and macro prudential regulation.
Micro Prudential Regulation 
At bank-level, or microprudential, regulation, they will help raise the resilienceof individual banking institutions to periods of stress. Practically, these reformsmean:A significant increase in risk coverage, with a focus on areas that were mostproblematic during the crisis, that is trading book exposures, counterpartycredit risk, and securitisation activities;A fundamental tightening of the definition of capital, with a strong focus oncommon equity. At the same time, this represents a move away from complexhybrid instruments, which did not prove to be loss absorbing in periods ofstress. We also introduced requirements that all capital instruments mustabsorb losses at the point of non-viability, which was not the case in the crisis;
 
The introduction of a leverage ratio to serve as a backstop to the risk-basedframework;The introduction of global liquidity standards to address short-term and long-term liquidity mismatches; andEnhancements to Pillar 2’s supervisory review process and Pillar 3’s marketdiscipline, particularly for trading and securitisation activities.
Macro Prudential Regulation 
In addition, a unique feature of Basel III is the introduction of macroprudentialelements into the capital framework. At macroprudential, they wlll help to dealwith system wide risks that can build up across the banking sector as well asthe procyclical amplification of these risks over time. These include:Standards that promote the build-up of capital buffers in good times that canbe drawn down in periods of stress, as well as clear capital conservationrequirements to prevent the inappropriate distribution of capital;The leverage ratio also has system-wide benefits by preventing the excessivebuild-up of debt across the banking system during boom times.To minimise the transition costs, the Basel III requirements will be phased ingradually as of 1 January 2013.These two approaches to supervision are complementary as greaterresilience at the individual bank level reduces the risk of system wide shocks.Basel III is part of the Committee's continuous effort to enhance the bankingregulatory framework. It builds on the International Convergence of CapitalMeasurement and Capital Standards document (Basel II). The Basel III
 
framework is summarized in the following tables, which provide an overviewof the various measures taken by the Committee:

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