Basel III is the third Basel Accord, a framework that sets international standards for

bank capital adequacy, stress testing, and liquidity requirements (Hal, 2011)
Augmenting and superseding parts of the Basel II standards, it was developed in
response to the deficiencies in financial regulation revealed by the financial crisis of
2007–2008. It is intended to strengthen bank capital requirements by increasing
minimum capital requirements, holdings of high quality liquid assets, and decreasing
bank leverage.

Basel III was published by the Basel Committee on Banking Supervision in November
2010, and was scheduled to be introduced from 2013 until 2015; however,
implementation was extended repeatedly to 1 January 2022 and then again until 1
January 2023, in the wake of the COVID-19 pandemic. Basel III aims to strengthen the
requirements in the Basel II regulatory standards for banks. In addition to increasing
capital requirements, it introduces requirements on liquid asset holdings and funding
stability, thereby seeking to mitigate the risk of a run on the bank.

Basel III was published by the Basel Committee on Banking Supervision in November
2010, and was scheduled to be introduced from 2013 until 2015; however,
implementation was extended repeatedly to 1 January 2022 and then again until 1
January 2023, in the wake of the COVID-19 pandemic. The new standards that come
into effect in January 2023, that is, the Fundamental Review of the Trading Book
(FRTB) and the Basel 3.1: Finalising post-crisis reforms, are sometimes referred to as
Basel IV. However, the secretary general of the Basel Committee said, in a 2016
speech, that he did not believe the changes are substantial enough to warrant that title
and the Basel Committee refer to only three Basel Accords.

Also referred to as the Third Basel Accord, Basel III is part of a continuing effort to
enhance the international banking regulatory framework begun in 1975 (Craig, 2012) It
builds on the Basel I and Basel II accords in an effort to improve the banking system’s
ability to deal with financial stress, improve risk management, and promote
transparency. On a more granular level, Basel III seeks to strengthen the resilience of
individual banks to reduce the risk of system-wide shocks and prevent future economic
meltdowns. Basel III is an international regulatory accord that introduced a set of
reforms designed to mitigate risk within the international banking sector by requiring
banks to maintain certain leverage ratios and keep certain levels of reserve capital on
hand. Begun in 2009, it is still being implemented as of 2022.

Banks have two main silos of capital that are qualitatively different from one another.
Tier 1 refers to a bank’s core capital, equity, and the disclosed reserves that appear on
the bank’s financial statements (Ranjit, 2012). If a bank experiences significant losses,
Tier 1 capital provides a cushion that can allow it to weather stress and maintain a
continuity of operations. By contrast, Tier 2 refers to a bank’s supplementary capital,
such as undisclosed reserves and unsecured subordinated debt instruments. Tier 1
capital is more liquid and considered more secure than Tier 2 capital. A bank’s total
capital is calculated by adding both tiers together. Under Basel III, the minimum total
capital ratio that a bank must maintain is 8% of its risk-weighted assets (RWAs), with a
minimum Tier 1 capital ratio of 6%. The rest can be Tier 2. While Basel II also imposed
a minimum total capital ratio of 8% on banks, Basel III increased the portion of that
capital that must be in the form of Tier 1 assets, from 4% to 6%. Basel III also
eliminated an even riskier tier of capital, Tier 3, from the calculation.

Basel III introduced new rules requiring that banks maintain additional reserves known
as countercyclical capital buffers—essentially a rainy day fund for banks. These buffers,
which may range from 0% to 2.5% of a bank’s RWAs, can be imposed on banks during
periods of economic expansion. That way, they should have more capital at the ready
during times of economic contraction, such as a recession, when they face greater
potential losses. So, considering both the minimum capital and buffer requirements, a
bank could be required to maintain reserves of up to 10.5%. Countercyclical capital
buffers must also consist entirely of Tier 1 assets.

Basel III likewise introduced new leverage and liquidity requirements aimed at
safeguarding against excessive and risky lending, while ensuring that banks have
sufficient liquidity during periods of financial stress (Hal, 2011). In particular, it set a
leverage ratio for so-called global systemically important banks. The ratio is computed
as Tier 1 capital divided by the bank’s total assets, with a minimum ratio requirement of
3%. In addition, Basel III established several rules related to liquidity. One, the liquidity
coverage ratio, requires that banks hold a “sufficient reserve of high-quality liquid assets
(HQLA) to allow them to survive a period of significant liquidity stress lasting 30
calendar days. HQLA refers to assets that can be converted into cash quickly, with no
significant loss of value.

Another liquidity-related provision is the net stable funding (NSF) ratio, which compares
the bank’s available stable funding essentially capital and liabilities with a time horizon
of more than one year with the amount of stable funding that it is required to hold based
on the liquidity, outstanding maturities, and risk level of its assets (Craig, 2012). A
bank’s NSF ratio must be at least 100%. The goal of this rule is to create incentives for
banks to fund their activities with more stable sources of funding on an ongoing basis”
rather than load up their balance sheets with relatively cheap and abundant short-term
wholesale funding.

Conclusively, Basel III is a set of international banking reforms and the third of the Basel
Accords. It was created by the Switzerland-based Basel Committee on Banking
Supervision, made up of central banks from around the world, including the Federal
Reserve in the United States. Basel III aims to address some of the regulatory
shortcomings of Basel I and Basel II that became clear during the financial crisis of
2007–2008. Basel III is scheduled for full implementation by 2028.
References

Craig. S (2012). "Bank Regulators to Allow Leeway on Liquidity Rule". New York Times.

Ranjit. L (2012). "From Failure to Failure: The Politics of International Banking

Regulation". Review of International Political Economy. 19 (4): 609–638.

Hal S. (2011). "Testimony of Hal S. Scott before the Committee on Financial Services"
(PDF). Committee on Financial Services, United States House of Representatives. pp.
12–13.