Case study 5 ECON 623

Basel III and the amended Basel II

The three essential role-players in the process of global capital regulations are:

- the Bank for International Settlement (BIS),

- the Basel committee for Banking Supervision (BCBS) and finally

- The document named: International Convergence of Capital Measurement and

Capital Standards (Basel Accord).

The financial crises in 2009 had place a lot of attentions on the banking environment.
The banks had adopted a very expansive lending policy with the property boom in
America. The ease in which loans was granted to people normally not eligible for
loans has placed all the focus on a way to stop this from happening again.

The global market reviewed the current banking regulation and rules to determine
where the problems were and how it started and how it can be prevented in the
future. The main problem was that the banks was unable to repay all it debt
obligation because a lot of the loans they granted defaulted in the year due to
increase in interest rates and the decrease in the property market. This led to a
contagions effect in the local as well as the larger global markets and causes some
companies to close down.

Global regulators identified that banks had kept to little amount of capital reserves on
their loans and thus did not have the required amount to repay the most of the
required debt in time. The global regulators thus had to review the Basel II and need
to make some changes to prevent this crisis from happening again.

The global regulators mainly looked at the capital reserved required to be held by a
bank according to Basel II. The proposed change:

 They will be required to hold almost triple the amount they normally could hold
in capital reserves.
  The Basel 3 reforms will require banks to hold high- quality capital - known as
"core Tier 1 capital", and consisting of equity or retained earnings - equivalent
to at least 4,5% of risk-bearing assets. That is up from just 2% under existing
rules.
 Banks will have to build a new, separate "capital conservation buffer"
consisting of common equity; the buffer will be worth 2,5% of assets.
 This will bring the total top-quality capital requirement to 7%.
 The Tier 1 capital rule will take effect from January 2015, with the capital
conservation buffer phased in between January 2016 and January 2019.

These proposed changes will be under view by the G20 countries in November to
make any decisions on this matter. But there remain worries that banks in some
countries face a long road to recovery, and that the proposed changes to capital
requirements may cut the amount of money that banks can lend out to companies
and thus slowing economic growth.

Amended Basel II

A. Tier 1 Capital

A1. BASEL II:

Tier 1 capital ratio = 4%

Core Tier 1 capital ratio = 2%

The difference between the total capital requirement of 8.0% and the Tier 1
requirement can be met with Tier 2 capital.

A1. BASEL III:

Tier 1 Capital Ratio = 6%

Core Tier 1 Capital Ratio (Common Equity after deductions) = 4.5%

Core Tier 1 Capital Ratio (Common Equity after deductions) before 2013 = 2%, 1st
January 2013 = 3.5%, 1st January 2014 = 4%, 1st January 2015 = 4.5%
The difference between the total capital requirement of 8.0% and the Tier 1
requirement can be met with Tier 2 capital.

B. Capital Conservation Buffer

B1. BASEL II:

There is no capital conservation buffer.

B1. BASEL III:

Banks will be required to hold a capital conservation buffer of 2.5% to withstand

future periods of stress bringing the total common equity requirements to 7%.

Capital Conservation Buffer of 2.5 percent, on top of Tier 1 capital, will be met with
common equity, after the application of deductions.

Capital Conservation Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st
January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5%

The purpose of the conservation buffer is to ensure that banks maintain a buffer of
capital that can be used to absorb losses during periods of financial and economic
stress. While banks are allowed to draw on the buffer during such periods of stress,
the closer their regulatory capital ratios approach the minimum requirement, the
greater the constraints on earnings distributions.

C. Countercyclical Capital Buffer

C1. BASEL II:

There is no Countercyclical Capital Buffer

C1. BASEL III:

A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully

loss absorbing capital will be implemented according to national circumstances.
Banks that have a capital ratio that is less than 2.5% will face restrictions on payouts
of dividends, share buybacks and bonuses.
The buffer will be phased in from January 2016 and will be fully effective in January
2019.
Countercyclical Capital Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st
January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5%

D. Capital for Systemically Important Banks only

D1. BASEL II:

There is no Capital for Systemically Important Banks

D1. BASEL III:

Systemically important banks should have loss absorbing capacity beyond the
standards announced today and work continues on this issue in the Financial
Stability Board and relevant Basel Committee work streams.

The Basel Committee and the FSB are developing a well integrated approach to
systemically important financial institutions which could include combinations of
capital surcharges, contingent capital and bail-in debt.