Financial Risk Management Assignment

Submitted By: Name: Tanveer Ahmad Registered No: 0920228

and invites sovereign authorities and central banks alike to be more conservative in their banking regulations. and uses a ³maximum´ level of risk to calculate its capital requirements that is only appropriate for developed economies. the Basel Committee decided not to draft general rules on these risks²it left these to be evaluated on a case-by-case basis within the G10 member states. In sum. and due to the unique risks and regulatory concerns in these economies. views domestic currency and debt as the most reliable and favorable financial instruments. With the end of the petrodollar boom and the ensuing banking crises of the early 1980s. its eleven member states (known as the G-10) began to discuss a formal standard to ensure the proper capitalization of internationally active banks. it warns its readers that capital adequacy ratios cannot be viewed in isolation and as the ultimate arbiters of a bank¶s solvency.´ where they would relocate to countries with less strict regulations. Six years of deliberations followed.1.´ Scope It should first be noted that Basel I was created to promote the harmonization of regulatory and capital adequacy standards only within the member states of the Basel Committee. the standards set forth in Basel I are tailored to banks operating within such markets. Basel I overtly states that it only proposes minimum capital requirements for internationally active banks. It does not mandate capital to guard against risks such as fluctuations in a nation¶s currency. During the 1970s and 80s. Moreover. Basel 1 After the creation of the Basel Committee. Moreover. and general macroeconomic downturns. the G-10 (plus Spain) came to a final agreement: The International Convergence of Capital Measurements and Capital Standards. should not be seen as the ³optimal´ emerging market banking reform. . Secondly. sees FDIC-style depositor insurance as risk-abating. All the states of the G-10 are considered developed markets by most (if not all) international organizations. Due to the great variability of these risks across countries. less obvious risks for its banks. known informally as ³Basel I. Thirdly. The agreement expressly states that it is not intended for emerging market economies. this desire for a common banking capitalization standard came to the forefront of the agendas of the Basel Committee¶s member states. changes in interest rates. because Basel I gives considerable regulatory leeway to state central banks. in July of 1988. it should also be noted that Basel I was written only to provide adequate capital to guard against risk in the creditworthiness of a bank¶s loan book. and therefore. its implementation could create a false sense of security within an emerging economy¶s financial sector while creating new. some international banks were able to ³skirt´ regulatory authorities by exploiting the inherent geographical limits of national banking legislation. internationally active banks also encouraged a regulatory ³race to the bottom.

cash items in collection. defines both what types of on-hand capital are counted as a bank¶s reserves and how much of each type of reserve capital a bank can hold. hybrid debt/equity instrument holdings. It sets a universal standard whereby 8% of a bank¶s risk-weighted assets must be covered by Tier 1 and Tier 2 capital reserves. which can be valued at 0.The Accord The Basel I Accord divides itself into four ³pillars. showing that instruments in this category are of low risk. all OECD debt. The first category weights assets at 0%. ³moderate risk´ category only includes one type of asset²residential mortgages²and weights these assets at 50%. its loanbook.´ The first. holdings of subordinated debt. The third. and includes a bank¶s claims on the private sector. nonOECD bank debt with a maturity of more than one year. and potential gains from the sale of assets purchased through the sale of bank stock. The fourth ³pillar. Capital in the first tier. bank debt created by banks incorporated in the OECD. Each country¶s central bank is requested to create strong surveillance and enforcement mechanisms to ensure the Basel Accords are followed. The second risk category weights assets at 20%.´ Such ³riskless´ assets are defined by Basel I as cash held by a bank. 10. stock and preferred shares. Moreover. and .e. 20. The accord divides capital reserves into two tiers. Tier 1 capital must cover 4% of a bank¶s risk-weighted assets. creates a comprehensive system to riskweight a bank¶s assets. The fifth. or 50% depending on the central bank¶s discretion. known as The Constituents of Capital. and all other assets. ³variable´ category encompasses claims on domestic public sector entities. effectively characterizing these assets as ³riskless. Securities in this category include multilateral development bank debt. and other claims on OECD central governments. and loans guaranteed by OECD public sector entities. To follow the Basel Accord. This capital can include reserves created to cover potential loan losses.´ A Target Standard Ratio. The second ³pillar´ of the Basel I Accord. ³high risk´ category is weighted at 100% of an asset¶s value. sovereign debt held and funded in domestic currency. Tier 2 Capital is a bit more ambiguously defined. claims on non-OECD dollardenominated debt or Eurobonds. The fourth. equity assets held by the bank. known as ³Tier 1 Capital. This ratio is seen as ³minimally adequate´ to protect against credit risk in deposit insurance-backed international banks in all Basel Committee member states. or in other words. Five risk categories encompass all assets on a bank¶s balance sheet.´ Transitional and Implementing Agreements. The third ³pillar. sets the stage for the implementation of the Basel Accords.´ consists of only two types of funds²disclosed cash reserves and other capital paid for by the sale of bank equity. unites the first and second pillars of the Basel I Accord. banks must hold the same quantity (in dollar terms) of Tier 1 and Tier 2 capital. non-OECD bank debt with a maturity of less than one year. Risk Weighting. i.

³transition weights´ are given so that Basel Committee banks can adapt over a four-year period to the standards of the accord. The inability of these authorities to translate Basel I¶s recommendations properly into ³layman¶s terms´ and the strong desire to enact its terms quickly caused regulators to overgeneralize and oversell the terms of Basel I to the G-10¶s public. Implementation Basel I¶s adaptation and implementation occurred rather smoothly in the Basel Committee states. nearly all countries. they did not realize that the ³oversale´ of Basel I would influence large private banks in such a way that they would begin to demand that emerging market economies follow Basel I. in turn. This. banks have found ways to ³wiggle´ around Basel I¶s standards to put more risk on their loanbooks than what was intended by the framers of the Basel Accord. In contrast to the pointed warnings written into Basel I against implementation in industrializing countries. including China. banks securitize their corporate loans and sell off the least risky securitized assets. and India. This is done through two primary vectors. Because Basel I only covers credit risk and only targets G-10 countries. other emerging market economies also adopted its recommendations. In the first strategy. While G-10 regulators saw this result as rather benign because they already had most of the known regulatory foundations for long-term growth in place. The third group critical of Basel I concentrates on the misaligned incentives the Accord gives to banks. could not immediately adopt Basel I¶s recommendations). all Basel Committee members implemented Basel I¶s recommendations²including the 8% capital adequacy target²by the end of 1992. a bank makes its assets more risky in . Japan later harmonized its policies with those if Basel I in 1996. The second group of criticisms deals with the way in which Basel I was publicized and implemented by banking authorities. One vein of criticism concentrates on perceived omissions in the Accord. created the misguided view that Basel I was the primary and last accord a country needed to implement to achieve banking sector stability. Russia. Also. By 1999. Due to the wide breath and absoluteness of Basel I¶s risk weightings. Criticisms Criticism of Basel I comes from four primary sources. With the exception of Japan (which. causing capital-hungry states such as Mexico to assuage to Basel I in order to receive cheaper bank financing. Basel I¶s omission of market discipline is seen to limit the accord¶s ability to influence countries and banks to follow its guidelines. Basel I is seen as too narrow in its scope to ensure adequate financial stability in the international financial system. the adoption of Basel I standards was seen by large investment banks as a sign of regulatory strength and financial stability in emerging markets. had²at least on paper²implemented the Basel Accord. due to the severity of its banking crisis in the late 1980s. By ³splicing´ the least risky bank loans from its loan book. Although they were not intended to be included in the Basel I framework.

the money gained through this securitization can be added to a bank¶s asset reserves. the risk associated with holding longer-term debt²namely. several unforeseen effects of Basel I also served to make the accord less desirable for industrializing economies. The second method through which banks can cosmetically maintain a low risk profile under Basel I while taking on increasing amounts of risk is through the sale and resale of short-run non-OECD bank debt. the Basel I accords actually made loanbooks riskier by encouraging the movement of both bank and sovereign debt holdings from OECD sources to higher-yielding domestic sources. view of domestic currency and debt as the most reliable and favorable of asset instruments. In countries subject to high currency fluctuation and sovereign default risks. but. are properly protecting themselves against credit risk. but not enough to bail out the whole of the sector. The second unforeseen effect of Basel I emerges from the difference between the risk weightings of sovereign and private debt. the risk weight given to the bank¶s corporate loans does not change. combined with lax regulation on what assets fall under Basel I¶s risk weightings. Because short-run bank debt created by non-OECD banks is weighted at 20% and long-run debt in this category is weighted at 100%. Basel I¶s high degree of regulatory leeway. This. and perception of FDIC-style depositor insurance as risk-abating had significant negative effects within emerging economies. while the bank¶s risk weighting is reduced. as highlighted in the Basel Accord itself. in the de jure terms of Basel I. Therefore. but in reality are taking on quantities of risk far greater than what Basel I intended. Next. Moreover. The final source of Basel I¶s criticisms relate to its application to emerging markets. the risk of default in volatile emerging markets²remains. Basel I has encouraged international investors to move from holding long-run emerging market bank debt to holding short-run developing market instruments. Because emerging market sovereign debt is seen as less risky than private debt. allowing it to give out even more risky facto terms. Although Basel I was never intended to be implemented in emerging market economies. created system-wide defaults within emerging market banking sectors when it became obvious that all banks had taken on excessive risk and when it was revealed that the country¶s central bank had the capital on hand to bail out some of the banking sector. Basel I has created a scenario where the private sector is ³squeezed out´ of many banks¶ emerging market lending portfolios. FDIC-style deposit insurance. This has amplified the risk of ³hot money´ in emerging markets and has created more volatile emerging market currency fluctuations. In addition to the foreseen drawbacks of Basel I in emerging markets. This method²called ³cherry picking´²creates banks that. This ³squeezing´ magnifies . its application to these economies under the pressure of the international business and policy communities created foreseen and unforeseen distortions within the banking sectors of industrializing economies. Firstly. The first unforeseen consequence of Basel I is a side-effect of the way it risk-weights bank debt: because short-run non OECD bank debt is risk-weighted at a lower relative riskiness than long-term debt. banks can ³swap´ their long-term debt holdings for a string of short-run debt instruments. on paper. caused emerging market regulators to underestimate the credit default risks of a bank¶s assets. in turn.

The first of these methodologies. instead of being discounted according to the participation of the sovereign in the OECD. Because the prices of stock and debt held by a bank are often incorrectly valued on illiquid emerging market exchanges. technicality. cover market. are now discounted according to the credit rating assigned to a sovereign¶s debt by an ³authorized´ rating institution²if debt is rated from AAA to AAA-. adapt to the securitization of bank assets. the first ³pillar´ provides three methodologies to rate the riskiness of a bank¶s assets. In response to Basel I¶s critics. This is done to avoid the risk that a bank will ³hide´ risk-taking by transferring its assets to other subsidiaries and also to incorporate the financial health of the entire firm in the calculation of capital requirements for its subsidiary bank. Finally. Credit Risk²the Standardized Approach Next. the risk-weightings of such instruments and the inclusion of these instruments in the calculation of a bank¶s capital adequacy ratio oftentimes causes emerging market banks to show wildly incorrect capital adequacy positions. shows the greatest amount of expansion since Basel I. operational. A. amplifies the costs of a sovereign default because domestic banks more readily accept sovereign debt. more comprehensive capital adequacy accord. each pillar is greatly expanded in Basel II to cover new approaches to credit risk. This accord. the lack of deep and liquid capital markets in emerging markets make capital adequacy ratios less reliable in emerging economies. if it is rated from A+ . extends the approach to capital weights used in Basel I to include market-based rating agencies. Basel II creates a more sensitive measurement of a bank¶s risk-weighted assets and tries to eliminate the loopholes in Basel I that allow banks to take on additional risk while cosmetically assuaging to minimum capital adequacy requirements. and depth of the original Basel Accord. and moreover. Its first mandate is to broaden the scope of regulation to include assets of the holding company of an internationally active bank.recessions in emerging markets. Basel II In response to the banking crises of the 1990s and the aforementioned criticisms of Basel I. and interest rate risk. and incorporate marketbased surveillance and regulation. the ³standardized´ approach.´ known again as ³Minimum Capital Requirements´. causing banks to ³double up´ on the higheryielding debt typically disbursed by a sovereign in the months leading up to a default. 2. Sovereign claims. known formally as A Revised Framework on International Convergence of Capital Measurement and Capital Standards and informally as ³Basel II´ greatly expands the scope. the Basel Committee decided in 1999 to propose a new. Pillar I The first ³pillar. it is assigned a 0% weight. While maintaining the ³pillar´ framework of Basel I.

Short-term bank claims with maturities of less than three months are weighted at one step lower than a sovereign bond. they encourage banks to take on customers of all types with lower probabilities of default by allowing these customers lower risk weightings. Regulators provide the ³assumptions´ in these models. and the maturity risk associated with each type of asset. Advanced IRB. namely the probability of loss of each type of asset. Unrated debt is weighted at 50%. Unrated debt is weighted at 100%. In this approach. it receives a 150% weight. in addition. authorities can choose between two risk weighting options. Risk is capped at 100% if the sovereign¶s rating is below BB+ or unrated. For bank debt. A+ to BBB. authorities can risk-weight this type of debt at one step less favorable than the debt of the bank¶s sovereign government. Firstly. Credit Risk²the Internal Ratings Based Approaches Beyond the ³standardized´ approach.debt is weighted at 20%. the Basel Committee offers banks the possibility of lower reserve holdings²and thus higher profitability²if they adopt these internal approaches. corporate debt is weighted in the same manner as bank debt. Home mortgages are. Basel II proposes²and incentivizes²two alternate approaches toward risk-weighting capital. If debt is denominated and funded in local currency. while corporate mortgages are weighted at 100%. For example. These approaches encourage banks to create their own internal systems to rate risk with the help of regulators. the risk weight of the banks under its jurisdiction would be 50%. and debt rated below B. except the 100% category is extended to include all debt that is rated between BBB+ and BB-. In the first option. except for one important difference: the banks themselves²rather than regulators² determine the assumptions of proprietary credit default models. only the largest banks with the most complex modes can use this standard. the exposure of a bank to an at-risk asset at the time of its default. The other option for the risk-weighting of bank debt follows a similar external credit assessment as sovereign bonds. risk-weighted at 35%. banks. The first internal ratings based approach is known as the Foundation IRB. regulators can also assign a lower weight to its relative riskiness. each known as an Internal Ratings Based Approach. By forcing banks to ³scale up´ their risk-weighted reserves by 6% if they use the standardized approach. In the ³standard´ approach. Both IRB approaches give regulators and bankers significant benefits.debt is weighted at 100%. if it is rated from BBB+ to BBB-. it receives a 100% weight. where AAA to AAA. if a sovereign¶s debt were rated as A+. it is assigned a 20% weight. or IRB. All debt rated below BB-is weighted at 150%. can develop probability of default models that provide inhouse risk weightings for their loan books. and if it is rated below B-. with the approval of regulators. The second internal ratings based approach.debt is weighted at 50%. BB+ to BB. is essentially the same as foundation IRB. if it is rated from BB+ to BB-. These low risk weightings translate into lower reserve . it receives a 50% weight. where BB+ debt is given a 50% weight instead of a 100% value. Therefore. unrated debt is risk-weighted at risk-weighted at A-.

requirements. ³Poor´ risks can no longer hide under a rather arbitrary risk ³category. Regulators. and other external events. is an attempt to bring market discipline and selfsurveillance into banking legislation and a move to eliminate ³wiggle room´ where banks obey regulations in rule but not in spirit. known as the Basic Indicator Approach. of course. Basel II makes a clear distinction between fixed income and other products such as equity. higher profitability for a bank.´ preventing the tendency of banks to ³wiggle´ risks around category-based weights. Basel II extends its scope into the assessment of and protection against operational risks. is much less arbitrary than its rival methodologies. commodity. The first method. the IRB approaches allow banks to engage in self-surveillance: excessive risk-taking will force them to hold more cash on had. the Advanced Measurement Approach. a proprietary risk measurement called ³value at risk´ (VAR) is first proposed alongside the lines of the IRB approaches and the Advanced Measurement Approach. This. and foreign exchange vehicles and also separates the two principal risks that contribute to overall market risk: interest rate and volatility risk. Also. the risk of loss due to movements in asset prices. the decision making of individuals. causing banks to become unprofitable. the ³tailoring´ of risk weights allows additional capital to be channeled to the private sector²because public debt is no longer ³more trusted´ by assumption. much like the IRB approaches shown in the last section. banks will be more apt to lend to private sources. regulators will be less apt to close the bank if it followed ³standard´ Basel II procedures. Regulators are allowed to adjust the 15% number according to their risk assessment of each bank. equipment. and in sum. banks can . in turn. it is much more demanding for regulators and banks alike: it allows banks to develop their own reserve calculations for operational risks. Furthermore. recommends that banks hold capital equal to fifteen percent of the average gross income earned by a bank in the past three years. Each line is weighted by its relative size within the company to create the percentage of assets the bank must hold. increases the depth of the banking sector in a country¶s economy. This approach. Moreover. self-surveillance also decreases the costs of regulation and potential legal battles with banks. if a bank does become illiquid. and ultimately. For regulators. known as the Standardized Approach. To calculate the reserves needed to adequately guard against failures in internal processes. On the other hand. The second method. must approve the final results of these models. In its evaluation of market risk. divides a bank by its business lines to determine the amount of cash it must have on hand to protect itself against operational risk. Basel II proposes three mutually exclusive methods. i.e. Market Risk The last risk evaluated in Pillar I of the Basel II accords attempts to quantify the reserves needed to be held by banks due to market risk. encourages economic growth. Secondly. The third method. For fixed income assets.

while for A+ to BBB rated fixed income instruments. currency. a 12% weight is allowed. the value of each fixed income asset is multiplied against both risk weightings and then summed alongside all other fixed income assets. . Unrated assets are given an 8% risk weighting. risk weights are not grouped according to the cosmetic features of an asset. Again. this methodology group encourages banks to develop their own internal models to calculate a stock. and hybrid instruments²is based on a second. an 8% weight is assigned. Basel II¶s risk weightings for all other market-based assets²such as stocks. the IMA is seen to be the most complex. least conservative. The first group of methodologies is called The Simplified Approach. volatility. For the final calculation of the total amount of reserves needed to protect against market risk for fixed income instruments. instead. Basel II recommends risk weightings tied to the credit risk ratings given to underlying bank assets. is much less conservative and therefore more profitable for a bank.develop their own calculations to determine the reserves needed to protect against interest rate and volatility risk for fixed income assets on a position-by-position basis. On average. but this paper will provide a short summary of the three main types of rating methodologies used to rate these assets. commodities. currencies. and uses systems similar to the ³bucket´ approaches used in non-VAR fixed income reserve calculations. separate group of methodologies. while much more complex than the Simplified Approach. For interest rate risk²the risk that interest rates may fluctuate and decrease the value of a fixed-income asset²reserve recommendations are tied to the maturity of the asset. It would be exhaustive to provide a full summary of the methods used for the calculation of reserves needed to protect against market risks. Here. or commodity¶s market risk on a case-by-case basis. risk weights are allocated according to the possible scenarios assets may face in each country¶s markets. a 0. Along the lines of the VAR and IRB approaches. from 2. and origin and assign a risk weights along a spectrum of values. and most profitable of the approaches toward market risk modeling.rating.25% for the least risky assets to 100% for the most risky assets. for instruments receiving a BB+ to B. To guard against the volatility risk of fixed income assets. The final methodological group outlined in Basel II that calculates the reserves needed to guard against market risk is known as the Internal Model Approach. For assets rated by credit-rating agencies as AAA to AA-. or IMA. a 0% weighting is assigned. The second group of methodologies for assigning the reserves needed to protect against market risk inherent in stock. Basel II recommends two separate risk protection methodologies. commodities. Furthermore. This group looks to divide assets by type. and for instruments rated below B-. This approach. regulators must approve of such an action. maturity.25% weighting is given. For banks that cannot or chose not to adopt VAR models to protect their fixed income assets against volatility or interest rate risk. currency. and other holdings is called Scenario Analysis.

the oversight body of the Basel Committee announced on September 12 2010 that it has endorsed the capital and liquidity reform package originally proposed in December 2009 and amended in July 2010. making these two regulations applicable in Basel II. the committee announced new levels for capital ratios. In addition to confirming that the proposed rules in the December 2009 consultation paper had been agreed. The Basel 3 package was proposed to ensure that the financial system cannot suffer the type of collapse and resultant economic slowdown that occurred between 2007 and 2009. in a concession to the fragile state of the economic recovery. the transitional arrangements announced are generous. a new crisis could soon strike. new and substantial capital charges for non-cleared derivative and other financial market transactions. Because of the wide range of methodologies used by banks and the diversity of bank loan books. a bank¶s needed reserves for ³capital adequacy´ is calculated as follows: Reserves = . two new capital buffers . However. which have been the subject of impact assessments and heated debates. Banks can now focus on a future strategy to meet the combined effect of these rules. Banks had argued that imposing excessively high capital ratios could lead to a double-dip recession. no change is given to both the requirement that Tier 2 capital reserves must be equal to the amount of Tier 1 capital reserves and the 8% reserve requirement for credit-default capital adequacy. known as 'Basel 3'.08 * Risk Weighted Assets + Operational Risk Reserves + Market Risk Reserves 3. regulators countered that without robust ratios. it can calculate the on-hand capital reserves it needs to achieve ³capital adequacy´ as defined by Basel II. Additionally. and significant revisions to the rules on the types of instrument that count as bank capital. the publication of the calibrated ratios and rules is one of the most significant developments for banks since the crisis began.a conservation buffer and a countercyclical buffer.Total Capital Adequacy Once a bank has calculated the reserves it needs on hand to guard against operational and market risk and has adjusted its asset base according to credit risk. with the full package not taking effect for eight years. Basel III: Introduction As widely expected. Basel II allows a great deal of variation in its calculated reserve requirements. The committee has decided to increase the capital requirements substantially. together . Although the impact of the Basel 3 rules on an individual bank will depend on its asset/capital base and on the relevant regulator's application of the rules. In sum. It encompasses: y y y y an unweighted leverage ratio.

Total capital The total minimum capital requirement remains at 8%. whereby a number of deductions are made from total capital. which had been proposed in December 2009). New capital buffers Capital conservation buffer All banks will be required to hold sufficient capital to meet the minimum capital ratios. therefore. when the buffer can be drawn down. The rules require banks to hold 4. subject to a new capital buffer. This requirement is stricter than the current rule.5% of Tier 1 capital. The purpose of this buffer is to ensure that banks can maintain capital levels throughout a significant downturn and that they have less discretion to deplete their capital buffers through dividend payments. This buffer is set at 2. Tier 3. which is used solely for market risk purposes. after deductions. the July 2010 Basel 3 amendments relaxed some of the proposed deductions. Core Tier 1 consists of ordinary shares. In effect. This update summarises the new calibrated Basel 3 rules and the transitional arrangements.5% of capital in the form of common equity or other fully lossabsorbing capital. which means that other types of Tier 1 instrument. retained earnings and profits.with other recent committee-driven changes. allowing partial inclusion of minority interests and certain deferred tax assets and mortgage-servicing rights (rather than their deduction. can account for up to 1. represents more than a threefold increase in the existing 2% Core Tier 1 requirement.5% of common equity. Total Tier 1 The total Tier 1 requirement increases from 4% to 6% under Basel 3. deductions from capital must generally be made from common equity Tier 1. This buffer is a macro-prudential tool to protect banks from periods of excessive credit growth and is at the national regulators' discretion. The Basel 3 rules replace the concept with a tougher categorisation: 'common equity'. This. will be removed completely. known as additional going concern capital. which means that Tier 2 (which will no longer be divided into upper and lower tiers) can account for no more than 2% of capital. It will therefore apply only .5% and must consist solely of common equity. New capital requirements Capital ratios and deductions Core Tier 1/common equity The Basel 2 rules require that a bank hold 2% of Core Tier 1 capital to risk-weighted assets. 6% of capital must be Tier 1. However. other than in times of stress. Countercyclical buffer In addition to the conservation buffer. common equity capital must be equal to 7% of risk-weighted assets. Deductions from capital Under Basel 3. This basically consists of common shares plus retained income. buying back shares and paying discretionary employee bonuses. as well as having a capital conservation buffer above the minimum 8% total capital. However. Banks that do not meet this buffer will be restricted from paying dividends. banks may at certain times be required to hold a countercyclical buffer of up to 2.

to be . National implementation must begin on January 1 2013. Certain conditions apply. 4. Options include capital surcharges. Their recognition will be capped at 90%. the recent statement sets out highly detailed transitional arrangements. It has made a number of changes to features of the ratio as they were set out in its July 2010 revisions. The committee has agreed to test an unweighted ratio of 3% over a transition period. which is due to announce its proposals on the treatment of derivatives imminently. it allows netting based on the Basel 2 rules. total capital and national implementation The new capital ratios will be phased in. this tool has never previously been part of the Basel regulatory framework. Increased capital requirements for derivatives and repos The December 2009 proposals contained a number of provisions that would have substantially increased the capital requirements for counterparty credit exposures arising from banks' noncleared repo and securities and derivatives financing operations. The full ratios (ie.5% Tier 1 capital. among other things. Grandfathering of existing capital instruments Capital instruments which do not meet the criteria for inclusion in the common equity element of Tier 1 cannot count as common equity from January 1 2013. Systemically important banks The committee has stated that systemically important banks should be subject to higher capital requirements than those in the Basel 3 package. These proposals. Timing and transitional arrangements Taking into account the continued fragility of global economic growth. including the provision that such instruments be treated as equity under prevailing accounting standards. are not mentioned in the September press release. Leverage ratio While banks in the United States have been subject to a leverage ratio for some time. Liquidity rules The new liquidity coverage ratio and net stable funding ratio will be introduced in accordance with the timing detailed below. and will be introduced as an extension of the capital conservation buffer.5% common equity and 6% Tier 1 capital) apply from January 2015. certain instruments issued by non-joint stock companies which are Core Tier 1 at present will be grandfathered on a declining basis over a longer period.5% common equity. Common equity. However. by which date banks should have 3.5% Tier 1 capital and 8% total capital. Work continues on the proposals.when a national regulator considers that there is excessive credit growth in the national economy. This may be because the timing for implementation needs to be coordinated with the European Commission. which were substantially revised in July 2010. contingent capital and bail-in-debt. In 2014 this increases to 4% common equity and 5. Capital instruments that no longer qualify as non-common equity Tier 1 capital or Tier 2 capital will be phased out over a 10-year period starting on January 1 2013. Tier 1. 4. The committee made a number of revisions to the components of both these ratios in the July 2010 revisions.

Liquidity ratios The liquidity coverage ratio will be introduced on January 1 2015. to be increased by 20% a year thereafter until 100% of the deductions are made from common equity by January 1 2018. Initially.625% on January 1 2016 and will reach 2. Leverage ratio The 3% ratio requirement will run parallel from January 1 2013 to 2017. The committee will track the ratio. but remain below the 7% common equity target during the transition period. 20% of the required deductions from common equity will apply by January 1 2014. final adjustments to the ratio will made in the first half of 2017 and it will be fully effective from January 1 2018. should "maintain prudent earnings" so as to meet the buffer as soon as possible. The committee also states that banks which meet their general appears to do so. Only instruments issued before September 12 2010 qualify for the transitional arrangements. Instruments with an incentive to redeem will be phased out at their effective maturity date.reduced by 10% each year. but do not meet the 7% requirement until that date . Regulatory deductions Deductions will be phased in. Based on the results of the parallel run. The net stable funding ratio will apply as a minimum standard from January 1 2018.5% by January 1 2019. Capital buffers The capital conservation buffer will be phased in at 0. Existing public-sector capital injections are grandfathered until January 1 2018. its component factors and impact over this period and will require bank-level disclosure of the ratio and its factors from January 1 2015. . It is unclear exactly what this means and whether the requirement catches banks that comply with the transitional capital buffer phase in requirements over the period until January 1 2019.

Sign up to vote on this title
UsefulNot useful