SSRN Id2012596

UNIVERSITA’ CATTOLICA DEL SACRO CUORE
SEDE DI MILANO
FACULTY OF BANKING, FINANCE
AND INSURANCE SCIENCES
GRADUATE PROGRAM IN
TRADING AND RISK MANAGEMENT
HOW DO BASEL COMMITTEE

ANNOUNCEMENTS AFFECT BANK
STOCK PRICES?

SUPERVISOR
Prof. Mario Anolli
CANDIDATE
Filippo
Rizzardi

(a.y. 2010/2011)
Electronic
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Contents
Introduction
1. Financial crisis and the evolution of Basel Committee agreements

1.1 The 2007-2011 financial crisis and the issue of regulation
1.2 The Basel Committee for Banking Supervision
1.3 The 1988 Basel Capital Accord
1.3.1 Constituents of capital
1.3.2 Risk weights
1.4 The 1996 amendment to market risk
1.5 Basel II
1.5.1 New capital requirements for credit risk
1.5.1.1 Standardised approach
1.5.1.2 Internal ratings-based approach
1.5.2 Securitization and credit risk mitigation
1.5.3 Operational risk charge
1.6 Basel III
1.6.1 A global regulatory framework for more resilient banks and banking
systems
1.6.1.1 Definition of capital
1.6.1.2 Counterparty credit risk
1.6.1.3 Capital conservation buffer
1.6.1.4 Countercyclical buffer
1.6.1.5 Leverage ratio
1.6.2 International framework for liquidity risk measurement, standards and
monitoring
1.6.2.1 Liquidity Coverage Ratio
1.6.2.2 Net Stable Funding Ratio
1.6.3 Quantitative impact study
1.6.4 Global systemically important banks

2
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2. Event-study on the effects of Basel Committee announcements
2.1 Literature review
2.2 Data and methodology
2.3 Testing abnormal performance
2.3.1 The traditional Test
2.3.2 Cross-sectional Test
2.3.3 Standardized cross-sectional Test
2.3.4 Crude-dependence adjustment Test
2.3.5 Adjusted BMP Test
2.3.6 Corrado-Zivney rank Test
2.3.7 Statistical significance of cumulative average abnormal returns
(CAARs)
2.3.8 Testing for difference between sub-samples
3. Empirical analysis
3.1 20 November 2008
3.2 13 July 2009
3.3 17 December 2009
3.4 12 September 2010
3.6 26 June 2011
Conclusion
Bibliography

3
Electronic copy available at: https://ssrn.com/abstract=2012596

Introduction
Requirements that banks have sufficient capital are another way to change the banks
incentives to take on less risk. When a bank is forced to hold a large amount of equity capital,
the bank has more to lose if it fails and is thus more likely to pursue less risky activities1.
The imposition of risk-based capital requirements has been advocated by many regulatory
authorities as a means of mitigating the excessive risk-taking by financial institutions.
However, their imposition also constitutes a requirement to maintain an exogenously
influenced capital structure, which may adversely affect the values of the firms involved.
Basel III is a set of international banking regulations developed by the Bank for International
Settlements in order to promote stability in the international financial system. Basel III will
strengthen the regulatory environment currently grounded on the 1988 original Basel Capital
Accord and the 2004 reform (Basel II).
This thesis examines the wealth effects of the Basel Committee announcements regarding
Basel III.
The main hypothesis to be tested is whether the new requirements will adversely affect banks
by forcing a sub-optimal capital structure (since shareholders might prefer a higher degree of
financial leverage).
The alternative hypothesis implies that the market believes the new requirements will benefit
banks by reducing risk, hence improving the stability of the financial sector in the future.
Standard event-study methodology was utilized in order to test this hypothesis. Banks
included in the research sample (261) were chosen from countries which are going to accept
Basel Committee recommendations by turning them into national laws.
Section I of the document outlines the history of the Basel Committee and the main reforms it
undertook, with particular attention to the most recent one (Basel III). Section II describes the
data and methodology. Section III presents the empirical results and the discussion. The final
section concludes the paper.

1 F. S. Mishkin: “Prudential Supervision: What Works and What Doesn’t”, University of Chicago Press, January
2001
2 U. Ashraf, I. M. Gill, D. W. Arner: “A road to financial stability”, Global Journal Of Business Research, Vol. 5,
4

1. Financial crisis and the evolution of Basel

Committee agreements
1.1 The 2007-2011 financial crisis and the issue of

regulation
A financial crisis occurs when there is a significant fall in stock prices and a marked increase
in the uncertainty about the value of financial assets. According to leading economic figures,
the financial crisis of 2007–2011 has been the most severe financial downturn since the Great
Depression of the 1930s. While the causes are still being debated, many ramifications are
clear and include the failure of major corporations, large declines in asset values, the
sovereign debt problem in advanced industrial countries, and a significant decline in
economic activity. Many factors have been blamed for this disastrous outcome. One of them
is excessive risk taking by financial institutions and consequently the lack of regulation
imposed on them by the competent authorities.
The regulation of financial markets is a continuing task. As financial markets expand, new
and innovative products continue to develop; therefore, it is always difficult if not impossible
to apply a “one size fits all” formula in regulation and supervision of international financial
markets and institutions. The history of financial crisis depicts common patterns of behaviour
in aggravating crisis, including the lack of coordination between host and home country
supervisors, the tendency of supervisory authorities to be more reactionary to the eruption of
crisis rather than proactive in their approaches to predict issues and hence take appropriate
measures in advance, and last but not least, ineffective enforcement mechanisms to secure
implementation of financial regulations across the board between all sovereign state actors in
an efficient way2.

2 U. Ashraf, I. M. Gill, D. W. Arner: “A road to financial stability”, Global Journal Of Business Research, Vol. 5,
No. 5, 2011
5

The prevailing approach to banking regulation has put capital at front and centre: more capital
should make banks better able to absorb losses with their own resources, without becoming
insolvent or necessitating a bailout with public funds.
Over the last 20 years, regulatory capital requirements have been refined and broadened to
cover various types of risk, differentiate among asset classes of different risk, and allow for a
menu of approaches to determine the risk weights to be applied to each asset category. In the
process, the rules have become increasingly elaborate, reflecting the growing complexity of
modern banks, but also the need to address on-going efforts by regulated banks to circumvent
the requirements through financial innovation3.
The Basel Committee on Banking Supervision, hosted by the Bank for International
Settlements (BIS), was constituted to fill in these gaps by G-10 Central Bank Governors.
1.2 The Basel Committee for Banking Supervision
The Basel Committee is a committee of banking supervisory authorities established by the

central bank Governors of the Group of Ten countries at the end of 1974. It meets regularly
four times a year and it has four main working groups which also meet regularly.
The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China,
France, Germany, Hong Kong, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico,
the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland,
Turkey, the United Kingdom and the United States. Countries are represented by their central
bank and also by the authority with formal responsibility for the prudential supervision of
banking business where this is not the central bank. The present chairman of the Committee is
Mr Stefan Ingves, Governor of Sveriges Riksbank, who succeeded Mr Nout Wellink on 1 July
2011.
The Committee formulates broad supervisory standards and guidelines and recommends
statements of best practice in the expectation that individual authorities will take steps to
implement them through detailed arrangements which are best suited to their own national
systems.

3 A. Demirguc-Kunt, E. Detragiache, O. Merrouche: “Bank capital: lessons from the financial crisis”, Policy
Research Working Paper, The World Bank, November 2010
6

The Committee reports to the central bank Governors and Heads of Supervision of its member
countries. It seeks their endorsement for its major initiatives. These decisions cover a very
wide range of financial issues. One important objective of the Committee's work has been to
close gaps in international supervisory coverage in pursuit of two basic principles: that no
foreign banking establishment should escape supervision; and that supervision should be
adequate. To achieve this, the Committee has issued a long series of documents since 19754.
In 1988, the Committee decided to introduce a capital measurement system commonly
referred to as the Basel Capital Accord. It was followed by Basel II in 2004 and more recently
(2010) by Basel III.
1.3 The 1988 Basel Capital Accord
The Basel Capital Accord represents the outcome of the Committee’s work over several years
to secure international convergence of supervisory regulations governing the capital adequacy
of international banks.
The Accord was adopted, with slight changes, by the European Union and the national
banking regulators of more than 100 countries. Originally it only applied to banks that
operated on an international scale, but many national authorities (including the European
Union) decided to make it binding for all banks, including those with domestic operations
only.
There were three main reasons why regulators aimed to establish uniform capital requirements
on an international scale5:
• it would help avoid bank crises, by discouraging excessive risk taking;
• since the requirements applied to consolidated accounts, it would foster the soundness
of institutions controlled by foreign banking groups, promoting greater stability in the
international financial markets;

4 Basel Committee for Banking Supervision: “History of the Basel Committee and its Membership”, Bank for
International Settlements, http://www.bis.org/bcbs/history.htm
5 A. Resti, A. Sironi: “Risk management and shareholders’ value in banking”, John Wiley and Sons, April 2007

7

• it would help get rid of the competitive distortions produced by differences in national
regulations.
The Committee considered that a weighted risk ratio in which capital is related to different
categories of assets or off-balance-sheet exposures, weighted according to broad categories of
relative riskiness, is the preferred method for assessing the capital adequacy of banks. This
was not to say that other methods of capital measurement are not also useful, but they were
considered by the Committee to be supplementary to the risk-weight approach.
In the light of consultations and preliminary testing of the framework, the Committee agreed
that a minimum standard should be set which international banks generally were expected to
achieve. This target standard ratio of capital to weighted risk assets was set at 8% (of which
the core capital element should be at least 4%)6.
The Basel Capital Accord was divided into two main sections. The first one described the
constituents of capital and Section II the risk weighting system.
1.3.1 Constituents of capital
The Committee considered that the key element of capital on which the main attention should
be placed was equity capital (issued and fully paid ordinary shares, common stock and non-
cumulative perpetual preferred stock) and disclosed reserves.
Notwithstanding this emphasis, the member countries of the Committee also considered that
there are a number of other important and legitimate constituents of a bank’s capital base
which may be included within the system of measurement.
For this reason capital was split into two categories:
• Tier 1 Capital: paid-up share capital, disclosed reserves (share premium account, legal
reserve, retained earnings, etc.), and certain general provisions and innovative capital
instruments (lower Tier 1).
• Tier 2 Capital: undisclosed reserves, revaluation reserves, general loan-loss reserves,
hybrid debt capital instruments and subordinated term debt.

6
Basel Committee for Banking Supervision: “International convergence of capital measurement and capital
standards”, Bank for International Settlements, July 1988
8

1.3.2 Risk weights
The framework of weights was kept as simple as possible and only five weights were used: 0,
10, 20, 50 and 100%.
Off-balance sheet contingent contracts, such as letters of credit, loan commitments and
derivative instruments, which are traded over the counter, needed to be first converted to a
credit equivalent and then assigned appropriate risk weights.
Table I in Annex 1 reports the risk weights by category of on-balance sheet assets.

1.4 The 1996 amendment to market risk
In 1996, the Basel Committee amended the Capital Accord to incorporate market risks
because the 1988 document was limited only to credit risk.
This limitation had assumed growing importance because of several factors: the growth in
trading activity, particularly in derivatives, on the part of many large banks; the increased
volatility of the financial markets; and the securitization of financial assets, which had led
many banks to increase their presence in the capital markets.
Market risk is defined as the risk of losses in on and off-balance sheet positions arising from
movements in market prices. The risks subject to this requirement are:
• the risks pertaining to interest rate related instruments and equities in the trading book;
• foreign exchange risk and commodities risk throughout the bank.
The capital charges for interest rate related instruments and equities applied to the current
market value of items in banks' trading books. The trading book means the bank's proprietary
positions in financial instruments which are intentionally held for short-term resale and/or
which are taken on by the bank with the intention of benefiting in the short-term from actual
and/or expected differences between their buying and selling prices, or from other price or
interest-rate variations.
In measuring their market risks, a choice between two broad methodologies was permitted,
subject to the approval of the national authorities. The first method was to measure the risks in
9

a standardised manner; the alternative one, subject to the fulfilment of certain conditions,
involved the use of internal risk management models.
The standardised method was based on a so called “building block approach”, i.e. the total
requirement is the sum of some elements (debt securities, equities, currencies and
commodities), stacked one on the other. For the first two categories (debt and equity) two
types of risks were considered:
• specific risk: designed to protect against an adverse movement in the price of an
individual security owing to factors related to the individual issuer;
• generic risk: designed to capture the risk of loss arising from changes in the market
factors.
In contrast to the simplistic standardized approach, the internal models approach (IMA) relied
on internal risk management systems developed by banks themselves as the basis for the
market risk charge. This method (internal model approach) was conditional upon the explicit
approval of the bank's supervisory authority based on the fulfilment of some qualitative and
quantitative criteria.
If the internal model complied with these criteria, it could be used to determine the minimum
regulatory capital against market risks. In particular each bank had to meet, on a daily basis, a
capital requirement expressed as the higher of its previous day's value-at-risk and an average
of the daily value-at-risk measures on each of the preceding sixty business days, multiplied by
a multiplication factor. The multiplication factor was set by individual supervisory authorities
on the basis of their assessment of the quality of the bank's risk management system, subject
to an absolute minimum of 3.
The principal form of eligible capital to cover market risks consisted of shareholders' equity
and retained earnings (Tier 1 capital) and supplementary capital (Tier 2 capital) as defined in
the 1988 Accord. But banks could also, at the discretion of their national authority, employ a
third tier of capital (Tier 3), consisting of short-term subordinated debt for the sole purpose of
meeting a proportion of the capital requirements for market risks, subject to some conditions
(e.g. Tier 3 capital was limited to 250% of a bank's tier 1 capital that is required to support
market risks) 7.

7
Basel Committee for Banking Supervision: “Amendment to the Capital Accord to incorporate market risk”,
Bank for International Settlements, January 1996
10

1.5 Basel II
Capital markets have witnessed enormous changes since the initial Capital Accord of 1988.
Increasingly, the original credit risk charges had appeared out-dated and, even worse, could be
promoting unsound behaviours by some banks.
The 2004 reform is the result of a long and careful process. After an initial consultative
document published in June 1999, which merely outlined the general guidelines of the reform
project, the Committee started an intensive consultation process which, in combination with
quantitative simulations on the likely impact of such reform, resulted into the 2001 and 2003
drafts, and then into the final version of June 2004.
The Basel II framework is based on three pillars, viewed as mutually reinforcing:
• Pillar 1: Minimum capital requirements. These are meant to cover credit, market, and
operational risk. Relative to the 1988 Accord, banks have now a wider choice of
models for computing their risk charges.
• Pillar 2: Supervisory review process. Relative to the previous framework, supervisors
are given an expanded role.
• Pillar 3: Market discipline. The New Accord emphasizes the importance of risk
disclosures in financial statements. Such disclosures enable market participants to
evaluate banks’ risk profile and the adequacy of their capital positions.
Although all three pillars are equally meaningful in the supervisors’ eyes, the banks’ attention
has been drawn mostly by pillar one, since it contains the new quantitative rules for
computing minimum capital requirements.
As mentioned above, the new capital requirements were not limited to credit risk. Capital
charges on market risk were almost untouched by the 2004 reform and were still computed
according to the guidelines set in 1996; furthermore, a new requirement was introduced on
operational risk, which was likely to absorb a non-trivial amount of capital8.

8
standards”, Bank for International Settlements, June 2006
11

1.5.1 New capital requirements for credit risk
The Basel Committee has developed two approaches for calculating regulatory capital for
credit risk, the so-called “standardised approach” and “internal ratings based approach” (IRB).
The standardised approach uses external ratings such as those provided by “external credit
assessment institutions” (ECAIs) to determine risk-weights for capital charges, whereas the
IRB allows banks to develop their own internal ratings for risk-weighting purposes subject to
the meeting of specific criteria and supervisory approval.
1.5.1.1 Standardised approach
The standardised approach aims at providing a greater sensitivity to credit risk by linking risk-
weights to the assessments provided by ECAIs. Table 1.2 shows the risk- weighting scheme
put forward by the Basel Committee.
!"#$%&'(')&*+,-&.%+/01,&23*&4*%5+1&*+,-&+6&7",%$&88&9,1"65"*5+,%5&"::*3"40;&"65&7",%$&8
,0C-&)DD)EC$0610#1'C-1)077#"0FGH ,0C-&)D
((() (+)$") ,,,+) ,,+)$") ,+)$") ,-&".) /"$) /"6*
!"#$%"&'" $")((* (* $"),,,* ,,* ,* ,* #0$-1 2345 2345
89: ;9: <99: <99: <;9: <;9: <99: <99: <99:
4"#7"#0$-
27$'"6)< 89: ;9: <99: <99: <99: <;9: <99: =>
89: <99:
=> 89: ;9: ;9: <99: <99: <;9: ;9:
,06?)< @>
27$'"6)8
@> 89: 89: 89: ;9: ;9: <;9: 89: 89: 89:
@"A-#-'B6 9: 89: ;9: <99: <99: <;9: <99: 9: <99:

'&
/"$-I) >G-)1'C$'6F$'"6)J-$.--6)27$'"6)<)E#'C?*.-'BG$)"6-)F0$-B"#K)J-&".)$G0$)"%)$G-)C"A-#-'B6H)061)27$'"6)8)E#'C?).-'BG$)J0C-1)
"6)$G-)#0$'6B)"%)$G-)J06?H)077&'-C)"6&K)'6),0C-&)DD
Source: Basel Committee on Banking Supervision (2004)
In the Basel II framework, rated corporate claims are assigned to one of four risk buckets
(20%, 50%, 100% and 150%) depending on their external rating as opposed to only one
12

bucket (100%), while unrated corporate claims will retain the same risk-weight as in the Basel
I capital adequacy framework (100%). Regarding interbank claims, national supervisors will
have the choice between two options (Option 1 and Option 2). Under Option 1, rated
interbank claims will receive a risk-weight one category below that assigned to claims on their
sovereign of incorporation. Under Option 2, rated interbank claims will receive a risk-weight
based on their own external rating, with short-term (i.e., less than three-month maturity)
claims generally attracting lower capital charges than long-term claims. The risk-weight for
unrated interbank claims will also depend on the option chosen by national supervisors. Note
that no unrated claim on a corporate or a bank may receive a risk-weight lower than the one
applied to claims on its sovereign of incorporation. Finally, claims on sovereigns will be
classified into five risk categories (ranging from 0% to 150%) compared to only two (0% and
100%). Thus, the standardised approach in Basel II yields capital charges which are indeed
more sensitive to credit risk than the Basel I capital requirements9.
1.5.1.2 Internal ratings-based approach
Subject to certain minimum conditions and disclosure requirements, banks that have received
supervisory approval to use the IRB approach may rely on their own internal estimates of risk
components in determining the capital requirement for a given exposure. The risk components
include measures of the probability of default (PD), loss given default (LGD), the exposure at
default (EAD), and effective maturity (M).
Depending on the degree of sophistication of their models and on their historical data, banks
might be allowed to use two different approaches:
• foundation internal rating based approach: banks estimate the (PD) and supervisors
supply other inputs, which carry over from the standardized approach. Table 1.3
illustrates the link between PD and the capital requirement for various asset classes;

9
13

!"#$%&'()*&+,-&."/01"$&,%2304%5%617
!"#$%$&'&()* /#"0#"%(-* 1-2&,-3(&%'* 6(7-"*
#+*,-+%.'( 4#"(5%5- "-(%&'
898:; <9=8; 89=8; 89=8;
89<8; >9?8; <988; 89@8;
89>A; =9:8; >988; <9B8;
89A8; A9@8; :9=8; >9B8;
89?A; ?9<8; =9A8; :9C8;
<988; B988; A9A8; =9>8;
<9>A; B9?8; C9=8; =9?8;
<9A8; @9:8; ?9:8; A9<8;
>988; <89:8; B9B8; A9?8;
>9A8; <<9<8; <89>8; C9>8;
:988; <<9@8; <<9A8; C9C8;
=988; <:9=8; <:9?8; ?9<8;
A988; <=9B8; <A9?8; ?9=8;
<8988; ><988; >:9>8; B9A8;

>8988; :8988; :>9A8; <89C8;
Source: Basel Committee on Banking Supervision (2004)
• advanced internal rating based approach: banks can supply other inputs as well.
These include loss given default (LGD) and exposure at default (EAD). The
combination of PDs and LGDs for all applicable exposures are then mapped into
regulatory risk weights. The capital charge is obtained by multiplying the risk weight
by EAD by 8%. The advanced IRB approach applies only to sovereign, bank, and
corporate exposures and not to retail portfolios10.
1.5.2 Securitization and credit risk mitigation
The Basel II Accord also deals explicitly with securitization, which involves the economic or
legal transfer of assets to a third party, typically called special purpose vehicle (SPV). A bank
can remove these assets from its balance sheet only after a true sale, which is defined using
“clean break” criteria. These are satisfied if (a) the transferred assets are legally separated
from the seller, (b) the holders of the SPV have the right to pledge or exchange those interests,

10 Basel Committee for Banking Supervision: “International convergence of capital measurement and
capital standards”, Bank for International Settlements, June 2006
14

and (c) the seller does not maintain control over the assets. Otherwise, the Accord imposes
risk weights for securitization tranches that are described in Table 1.4.

!"#$%&'()*&+,-.&/%,012-&34+&-%56+,2,7"2,48&2+"851%-
((()*+) (-)*+) ...-)*+) ..-)*+) .-)#$/)0'1+2)
!"#$%&'
((, (, ..., .., +")3$"#*'/
4567)2'58&* 9:; <:; =::; ><:; =9<:;

Source: Basel Committee for Banking Supervision (2010)

For the lowest-rated tranches, the bank must hold capital equal to the notional amount, which
implies a risk weight of (1/8%) = 1250%.

1.5.3 Operational risk charge
One of the most significant, and controversial, addition to the New Accord is the operational
risk charge (ORC). The Basel Committee expects that the ORC will represent on average 12%
of the total capital charge.
The new rules give three alternative methods:
• the basic indicator approach: this is based on an aggregate measure of business

activity (fee income, operating costs, or assets). The capital charge equals a fixed
percentage of the exposure indicator;
• the standardised approach: it divides the bank’s activities into a number of
standardized business units. Each business line is then characterized by an exposure
indicator. The capital charge is obtained by multiplying each exposure indicator by a
fixed percentage and summing across business lines;
• the advanced measurement approach: this allows banks to use their own internal
models in the estimation of required capital11.

11
15

1.6 Basel III
One of the main reasons the economic and financial crisis, which began in 2007, became so
severe was that the banking sectors of many countries had built up excessive on and off-
balance sheet leverage. This was accompanied by a gradual erosion of the level and quality of
the capital base. At the same time, many banks were holding insufficient liquidity buffers.
The banking system therefore was not able to absorb the resulting systemic trading and credit
losses nor could it cope with the reintermediation of large off-balance sheet exposures that
had built up in the shadow banking system. The crisis was further amplified by a procyclical
deleveraging process and by the interconnectedness of systemic institutions through an array
of complex transactions. During the most severe episode of the crisis, the market lost
confidence in the solvency and liquidity of many banking institutions. The weaknesses in the
banking sector were rapidly transmitted to the rest of the financial system and the real
economy, resulting in a massive contraction of liquidity and credit availability. Ultimately the
public sector had to step in with unprecedented injections of liquidity, capital support and
guarantees, exposing taxpayers to large losses.
The Committee’s comprehensive reform package known as Basel III tries to address all these
issues in order to improve the banking sector’s ability to absorb shocks arising from financial
and economic stress, whatever the source, thus reducing the risk of spillover from the
financial sector to the real economy.
On December 16, 2010, the Basel Committee on Banking Supervision released the final text
of the Basel III package, which was originally proposed in December 2009, was modified and
elaborated upon in subsequent releases in July and September 2010, and was endorsed by the
G20 leaders in November 2010.
Because most of the key elements of the Basel III package had been agreed upon and
announced prior to release of the final text (including the new minimum capital requirements
and phase-in arrangements announced in September), the release is in many respects anti-
climactic. Nevertheless, the final package does flesh out in more detail than prior releases
several important elements12.

12
Basel Committee for Banking Supervision: “A global regulatory framework for more resilient banks and
banking systems”, Bank for International Settlements, December 2010
16

The final text consists of two main documents: “A global regulatory framework for more
resilient banks and banking systems” and “International framework for liquidity risk
measurement, standards and monitoring”.
1.6.1 A global regulatory framework for more resilient banks and

banking systems
The Basel Committee is raising the resilience of the banking sector by strengthening the
regulatory capital framework, building on the three pillars of the Basel II framework. The
reforms raise both the quality and quantity of the regulatory capital base and enhance the risk
coverage of the capital framework. They are underpinned by a leverage ratio that serves as a
backstop to the risk-based capital measures, is intended to constrain excess leverage in the
banking system and provide an extra layer of protection against model risk and measurement
error. Finally, the Committee is introducing a number of macroprudential elements into the
capital framework to help contain systemic risks arising from procyclicality and from the
interconnectedness of financial institutions13.
1.6.1.1 Definition of capital
The global banking system entered the crisis with an insufficient level of high quality capital.
The crisis also revealed the inconsistency in the definition of capital across jurisdictions and
the lack of disclosure that would have enabled the market to fully assess and compare the
quality of capital across jurisdictions. A key element of the new definition of capital is the
greater focus on common equity, the highest quality component of a bank’s capital.
Total regulatory capital will consist of the sum of the following elements:

13 Basel Committee for Banking Supervision: “A global regulatory framework for more resilient banks and
17

1. Tier 1 Capital (going-concern capital)
i) Common Equity Tier 1 (CET1)
ii) Additional Tier 1
2. Tier 2 Capital (gone-concern capital)
Broadly speaking, Tier 1 capital is capital that is available to absorb losses on a "going-
concern" basis, i.e. capital that can be depleted without placing the bank into insolvency,
administration or liquidation.
Tier 1 capital is comprised of both Common Equity Tier 1 capital and Additional Tier 1
capital. Common Equity Tier 1 capital is the purest form of capital and includes common
shares and retained earnings.
The remainder of the Tier 1 capital base must be comprised of instruments that are
subordinated, have fully discretionary noncumulative dividends or coupons and have neither a
maturity date nor an incentive to redeem. Innovative hybrid capital instruments with an
incentive to redeem through features such as step-up clauses, currently limited to 15% of the
Tier 1 capital base, will be phased out.
Tier 2 capital is capital that can absorb losses on a "gone-concern" basis, i.e. capital that
absorbs losses in insolvency prior to depositors losing any money.
Another substantial change made by the Committee is to ensure that deductions from capital
are applied consistently throughout all jurisdictions to avoid the scope for regulatory arbitrage.
Deductions must for the most part be made from CET1, rather than across Tier 1 and Tier 2
capital, as is currently often the case. This change will make a considerable and detrimental
difference to the cost of deductions for banks.
Items to be fully deducted from capital include most deferred tax assets (specifically those
that rely on future profitability of the bank to be realised), cash flow hedge reserves, shortfall
on the amount of provisions to expected losses, gains on sale related to securitisation
transactions, cumulative gains and losses due to changes in credit risk on fair valued liabilities,
deferred benefit pension fund assets and liabilities, investments in own shares, reciprocal
cross holdings in other financial institutions and excess holdings in the capital of banks and
finance institutions which either individually or aggregated are material holdings
The original December 2009 proposal required full deduction of minority interests, mortgage
servicing rights, deferred tax assets that arose from temporary timing differences and
significant investments in the common shares of unconsolidated financial institutions.
However, after considerable lobbying, the final rules relax these requirements. Minority
18

interests will be recognised for capital inclusion provided certain criteria are met. In addition,
mortgage servicing rights, significant investments in the common shares of unconsolidated
financial institutions, and deferred tax assets that arise from temporary differences are
recognised, with a cap of 10% of the bank’s equity component for each item.
The so-called Tier 3 capital instruments, which were only available to cover market risks, will
be eliminated. Finally, to improve market discipline, the transparency of the capital base will
be improved, with all elements of capital required to be disclosed along with a detailed
reconciliation to the reported accounts.
All elements above are net of the associated regulatory adjustments and are subject to the
following restrictions:
• Common Equity Tier 1 must be at least 4.5% of risk-weighted assets at all times;
• Tier 1 Capital must be at least 6.0% of risk-weighted assets at all times;
• Total Capital (Tier 1 Capital plus Tier 2 Capital) must be at least 8.0% of risk-
weighted assets at all times.
The transitional arrangements for implementing the new standards will help to ensure that the
banking sector can meet the higher capital standards through reasonable earnings retention
and capital raising, while still supporting lending to the economy.
National implementation by member countries will begin on 1 January 2013. Member
countries must translate the rules into national laws and regulations before this date14.

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14 Basel Committee for Banking Supervision: “A global regulatory framework for more resilient banks and
19

1.6.1.2 Counterparty credit risk
The Basel III package also includes significant reforms to the pre-existing Basel II
counterparty credit risk (CCR) framework, including substantially increased capital
requirements for CCR exposures arising from OTC derivatives, repos, and securities
financing activities. Thus, consistent with prior Basel III releases, the final text includes a new
capital charge to cover the risk of mark-to-market losses associated with deterioration (short
of default) in the creditworthiness of a derivative counterparty, referred to under the Basel III
framework as credit valuation adjustment (CVA) risk. Banks with the appropriate regulatory
approvals will be permitted to calculate the CVA capital charge using a models-based
advanced approach, while all other banks will apply a standardized approach.
The final Basel III CCR framework also continues to include a 25% asset value correlation
(AVC) adjustment, a multiplier applied when risk-weighting exposures to large financial
institutions. As announced in July 2010, however, the Committee confirmed in the final text
that this adjustment should apply to exposures to regulated financial institutions with assets
greater than $100 billion (rather than $25 billion, as under the December 2009 proposal), as
well as unregulated financial institutions regardless of size.
The final Basel III text also includes measures intended to reduce over-reliance on external
credit ratings in assessing CCR, such as limiting the extent to which an issue specific rating
can be used for unrated issues of the same issuer, and requiring banks to perform their own
credit risk assessments of exposures to individual borrowers or counterparties regardless of
whether the exposures are rated or unrated15.
1.6.1.3 Capital conservation buffer
The capital conservation buffer is designed to ensure that banks build up capital buffers
outside periods of stress, which can be drawn down as losses are incurred. It was largely
fleshed out in the original December 2009 proposal and has been adopted in final form
without any significant modification.

15
20

A capital conservation buffer of 2.5%, comprised of Common Equity Tier 1, is established
above the regulatory minimum capital requirement. This effectively increases the minimum
common equity and total capital requirements under Basel III to
7% and 10.5%, respectively. Capital distribution constraints will be imposed on a bank when
capital levels fall within this range. Banks will be able to conduct business as normal when
their capital levels fall into the conservation range as they experience losses. The constraints
imposed only relate to distributions, not the operation of the bank.
It is clear that greater efforts should be made to rebuild buffers the more they have been
depleted. Therefore, in the absence of raising capital in the private sector, the share of
earnings retained by banks for the purpose of rebuilding their capital buffers should increase
the nearer their actual capital levels are to the minimum capital requirement.
It is not acceptable for banks which have depleted their capital buffers to use future
predictions of recovery as justification for maintaining generous distributions to shareholders,
other capital providers and employees. These stakeholders, rather than depositors, must bear
the risk that recovery will not be forthcoming.
Banks with capital levels that fall within the buffer will be forced to conserve (rather than
distribute) earnings, which will limit a bank’s ability to pay dividends, engage in share
buybacks, or make discretionary bonus payments. The chart below summarizes how the
buffer will operate, with an increasing percentage of earnings subject to the conservation
requirement as a bank’s common equity approaches the Basel III minimum (i.e., 4.5%)16.

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The capital conservation buffer will be phased in between 1 January 2016 and year end 2018
becoming fully effective on 1 January 2019.

16
21

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1.6.1.4 Countercyclical buffer
Losses incurred in the banking sector can be extremely large when a downturn is preceded by
a period of excess credit growth. These losses can destabilise the banking sector and spark a
vicious circle, whereby problems in the financial system can contribute to a downturn in the
real economy that then feeds back on to the banking sector.
The countercyclical buffer aims to ensure that banking sector capital requirements take
account of the macro-financial environment in which banks operate. It will be deployed by
national jurisdictions when excess aggregate credit growth is judged to be associated with a
build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it
against future potential losses. This focus on excess aggregate credit growth means that
jurisdictions are likely to only need to deploy the buffer on an infrequent basis. The buffer for
internationally-active banks will be a weighted average of the buffers deployed across all the
jurisdictions to which it has credit exposures. This means that they will likely find themselves
subject to a small buffer on a more frequent basis, since credit cycles are not always highly
correlated across jurisdictions.
Each Basel Committee member jurisdiction will identify an authority with the responsibility
to make decisions on the size of the countercyclical capital buffer. If the relevant national
authority judges a period of excess credit growth to be leading to the build up of system-wide
risk, they will consider, together with any other macroprudential tools at their disposal,
putting in place a countercyclical buffer requirement. This will vary between 0% and 2.5% of
risk-weighted assets, depending on their judgement as to the extent of the build up of system-
wide risk.
22

To give banks time to adjust to a buffer level, a jurisdiction will pre-announce its decision to
raise the level of the countercyclical buffer by up to 12 months. Decisions by a jurisdiction to
decrease the level of the countercyclical buffer will take effect immediately.
The countercyclical buffer requirement to which a bank is subject will extend the size of the
capital conservation buffer. Banks will be subject to restrictions on distributions if they do not
meet the requirement.
The following table sets out the conservation ratios a bank must meet at various levels of
Common Equity Tier 1 capital if the bank is subject to a 2.5% countercyclical buffer
requirement.

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The countercyclical buffer regime will be phased-in in parallel with the capital conservation
buffer between 1 January 2016 and year-end 2018 becoming fully effective on 1 January
201917.
1.6.1.5 Leverage Ratio
One of the underlying features of the crisis was the build-up of excessive on- and off-balance
sheet leverage in the banking system. In many cases, banks built up excessive leverage while
still showing strong risk based capital ratios. During the most severe part of the crisis, the
banking sector was forced by the market to reduce its leverage in a manner that amplified

17
23

downward pressure on asset prices, further exacerbating the positive feedback loop between
losses, declines in bank capital, and contraction in credit availability.
In response, there was broad agreement that a straight "leverage ratio" should be given more
regulatory weight. In this context, a leverage ratio is simply the ratio of capital to total assets
with no risk weighting of the assets. This has the major disadvantage that as much capital
would have to be held to back a U.S. government bond as to back a risky loan, but it does
avoid the problems caused by inappropriately low risk weightings.
The basis of calculation is the average of the monthly leverage ratio over the quarter based on
the definitions of capital (the capital measure) and total exposure (the exposure measure).
The transition period for the leverage ratio will commence 1 January 2011. The Committee
will use the transition period to monitor banks’ leverage data on a semi annual basis in order
to assess whether the proposed design and calibration of the minimum Tier 1 leverage ratio of
3% is appropriate over a full credit cycle and for different types of business models.
The transition period will comprise of a supervisory monitoring period and a parallel run
period:
• The supervisory monitoring period commences 1 January 2011. The supervisory
monitoring process will focus on developing templates to track in a consistent manner
the underlying components of the agreed definition and resulting ratio.
• The parallel run period commences 1 January 2013 and runs until 1 January 2017.
During this period, the leverage ratio and its components will be tracked, including its
behaviour relative to the risk-based requirement.
Based on the results of the parallel run period, any final adjustments to the definition and
calibration of the leverage ratio will be carried out in the first half of 201718.
1.6.2 International framework for liquidity risk measurement,

standards and monitoring
This document presents the liquidity portion of the Basel Committee’s reforms to strengthen
global capital and liquidity regulations with the goal of promoting a more resilient banking
sector.

18
24

During the early “liquidity phase” of the financial crisis that began in 2007, many banks –
despite adequate capital levels – still experienced difficulties because they did not manage
their liquidity in a prudent manner. The crisis again drove home the importance of liquidity to
the proper functioning of financial markets and the banking sector. Prior to the crisis, asset
markets were buoyant and funding was readily available at low cost. The rapid reversal in
market conditions illustrated how quickly liquidity can evaporate and that illiquidity can last
for an extended period of time. The banking system came under severe stress, which
necessitated central bank action to support both the functioning of money markets and, in
some cases, individual institutions.
The difficulties experienced by some banks were due to lapses in basic principles of liquidity
risk management.
To complement these principles, the Committee has further strengthened its liquidity
framework by developing two minimum standards for funding liquidity. These standards have
been developed to achieve two separate but complementary objectives. The first objective is
to promote short-term resilience of a bank’s liquidity risk profile by ensuring that it has
sufficient high-quality liquid assets to survive a significant stress scenario lasting for one
month. The Committee developed the Liquidity Coverage Ratio (LCR) to achieve this
objective. The second objective is to promote resilience over a longer time horizon by
creating additional incentives for banks to fund their activities with more stable sources of
funding on an on-going basis. The Net Stable Funding Ratio (NSFR) has a time horizon of
one year and has been developed to provide a sustainable maturity structure of assets and
liabilities.
The Committee will put in place rigorous reporting processes to monitor the standards during
the observation period and will continue to review the implications of these standards for
financial markets, credit extension and economic growth, addressing unintended
consequences as necessary.
After an observation period beginning in 2011, the LCR, including any revisions, will be
introduced on 1 January 2015. The NSFR, including any revisions, will move to a minimum
standard by 1 January 201819.

19
Basel Committee for Banking Supervision: “International framework for liquidity risk measurement,
standards and monitoring”, Bank for International Settlements, December 2010
25

1.6.2.1 Liquidity Coverage Ratio
This standard aims to ensure that a bank maintains an adequate level of unencumbered, high-
quality liquid assets that can be converted into cash to meet its liquidity needs for a 30
calendar day time horizon under a significantly severe liquidity stress scenario specified by
supervisors.

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The LCR builds on traditional liquidity “coverage ratio” methodologies used internally by
banks to assess exposure to contingent liquidity events. The total net cash outflows for the
scenario are to be calculated for 30 calendar days into the future. The standard requires that
the value of the ratio be no lower than 100% (i.e. the stock of high-quality liquid assets should
at least equal total net cash outflows). Banks are expected to meet this requirement
continuously and hold a stock of unencumbered, high-quality liquid assets as a defence
against the potential onset of severe liquidity stress.
The numerator of the LCR is the “stock of high-quality liquid assets”. In order to qualify as a
“high-quality liquid asset”, assets should be liquid in markets during a time of stress and,
ideally, be central bank eligible.
Following are some factors that influence whether or not the market for an asset can be relied
upon to raise liquidity when considered in the context of possible stresses:
• low credit and market risk: assets that are less risky tend to have higher liquidity;
• ease and certainty of valuation: an asset’s liquidity increases if market participants are
more likely to agree on its valuation. The pricing formula of a high-quality liquid asset
must be easy to calculate and not depend on strong assumptions;
• low correlation with risky assets: the stock of high-quality liquid assets should not be
subject to wrong-way (highly correlated) risk;
• listed on a developed and recognized exchange market: being listed increases an
asset’s transparency;
26

• active and sizable market: the asset should have active outright sale or repurchase
agreement (repo) markets at all times (which means having a large number of market
participants and a high trading volume). There should be historical evidence of market
breadth (price impact per unit of liquidity) and market depth (units of the asset that can
be traded for a given price impact);
• presence of committed market makers: quotes will most likely be available for buying
and/or selling a high-quality liquid asset;
• low market concentration: a diverse group of buyers and sellers in an asset’s market
increases the reliability of its liquidity;
• flight to quality: historically, the market has shown tendencies to move into these
types of assets in a systemic crisis.
There are two categories of assets that can be included in the stock. Assets to be included in
each category are those that the bank is holding on the first day of the stress period. “Level 1”
assets can be included without limit, while “Level 2” assets can only comprise up to 40% of
the stock.
Level 1 assets can comprise an unlimited share of the pool, are held at market value and are
not subject to a haircut under the LCR.
As for Level 2 assets a minimum 15% haircut is applied to the current market value of each
asset held in the stock.
The denominator of the LCR is represented by the “Total net cash outflows over the next 30
calendar days”. It is defined as the total expected cash outflows minus total expected cash
inflows in the specified stress scenario for the subsequent 30 calendar days. Total expected
cash outflows are calculated by multiplying the outstanding balances of various categories or
types of liabilities and off-balance sheet commitments by the rates at which they are expected
to run off or be drawn down. Total expected cash inflows are calculated by multiplying the
outstanding balances of various categories of contractual receivables by the rates at which
they are expected to flow in under the scenario up to an aggregate cap of 75% of total
expected cash outflows20.

Total net cash outflows = outflows – Min {inflows; 75% of outflows}

20
27

1.6.2.2 Net Stable Funding Ratio
To promote more medium and long-term funding of the assets and activities of banking
organisations, the Committee has developed the Net Stable Funding Ratio (NSFR). This
metric establishes a minimum acceptable amount of stable funding based on the liquidity
characteristics of an institution’s assets and activities over a one year horizon.
In particular, the NSFR standard is structured to ensure that long-term assets are funded with
at least a minimum amount of stable liabilities in relation to their liquidity risk profiles. The
NSFR aims to limit over-reliance on short-term wholesale funding during times of buoyant
market liquidity and encourage better assessment of liquidity risk across all on- and off-
balance sheet items. In addition, the NSFR approach offsets incentives for institutions to fund
their stock of liquid assets with short-term funds that mature just outside the 30-day horizon
for that standard.

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“Stable funding” is defined as the portion of those types and amounts of equity and liability
financing expected to be reliable sources of funds over a one-year time horizon under
conditions of extended stress. The amount of such funding required of a specific institution is
a function of the liquidity characteristics of various types of assets held, off-balance sheet
contingent exposures incurred and/or the activities pursued by the institution.
Available stable funding (ASF) is defined as the total amount of a bank’s:
• capital;
• preferred stock with maturity of equal to or greater than one year;
• liabilities with effective maturities of one year or greater;
• that portion of non-maturity deposits and/or term deposits with maturities of less than
one year that would be expected to stay with the institution for an extended period in
an idiosyncratic stress event;
• the portion of wholesale funding with maturities of less than a year that is expected to
stay with the institution for an extended period in an idiosyncratic stress event.
28

The available amount of stable funding is calculated by first assigning the carrying value of an
institution’s equity and liabilities to one of five categories. The amount assigned to each
category is to be multiplied by an ASF factor and the total ASF is the sum of the weighted
amounts.
The required amount of stable funding is calculated as the sum of the value of the assets held
and funded by the institution, multiplied by a specific required stable funding (RSF) factor
assigned to each particular asset type, added to the amount of off-balance sheet activity (or
potential liquidity exposure) multiplied by its associated RSF factor. The RSF factor applied
to the reported values of each asset or OBS exposure is the amount of that item that
supervisors believe should be supported with stable funding21.
1.6.3 The quantitative impact study
Before releasing the final text of the reform, the Basel Committee on Banking Supervision
conducted a comprehensive quantitative impact study (QIS) to ascertain the impact of the new
regulatory framework.
Comprehensive QIS information was submitted by individual banks to their national
supervisors on a voluntary and confidential basis. A total of 263 banks from 23 Committee
member jurisdictions participated in the study, including 94 Group 1 banks and 169 Group 2
banks. Group 1 banks are those that have Tier 1 capital in excess of €3 billion, are well
diversified and are internationally active. All other banks are considered Group 2 banks.
The Committee directed the comprehensive QIS effort to focus on a number of specific items:
• changes to the definition of capital that result in a new capital standard, referred to as
common equity Tier 1 (CET1), a reallocation of deductions to CET1 and changes to
the eligibility criteria for Tier 1 and total capital;
• increases in risk-weighted assets resulting from changes to the definition of capital,
securitisation, trading book and counterparty credit risk requirements;
• the international leverage ratio;
• the capital conservation buffer above the CET1 minimum;

21
29

• two international liquidity standards – the liquidity coverage ratio and the net stable
funding ratio.
The report does not take into account any transitional arrangements such as phase-in of
deductions and grandfathering arrangements. Rather, the estimates presented assume full
implementation of the final Basel III package, based on data as of 31 December 2009.
The main results of the QIS were published on the same day the final Basel III text was
released.
The impact of the agreement reveals an average decrease for Group 1 banks from an 11.1%
gross CET1 ratio (gross of current deductions, based on current risk-weighted assets) to an
average net CET1 ratio of 5.7%, a decline of 5.4 percentage points. Comparing gross to net
CET1 for Group 2 banks reveals an average decline in ratios from 10.7% to 7.8%, or just 2.9
percentage points, which is considerably less than the decline seen in Group 1 banks.
Calculated on the same basis, the capital shortfall for Group 1 banks in the QIS sample is
estimated to be between €165 billion for the CET1 minimum requirement of 4.5% and €577
billion for a CET1 target level of 7.0% had the Basel III requirements been in place at the end
of 2009. As a point of reference, the sum of profits after tax prior to distributions across the
same sample of Group 1 banks in 2009 was €209 billion. The amount of additional CET1
capital required for Group 2 banks in the QIS sample is estimated at €8 billion in order to
reach the CET1 minimum of 4.5%. For a CET1 target level of 7%, Group 2 banks would need
an additional €25 billion; the sum of their profits after tax prior to distributions in 2009 was
€20 billion.
CET1 capital of Group 1 banks would fall by an average of 41.3%. Group 2 banks, on average,
would experience a decline of 24.7% in CET1 capital. The Tier 1 capital ratios of Group 1
banks would on average decline from 10.5% to 6.3%, while total capital ratios would decline
from 14.0% to 8.4%. The decline in other capital ratios is also less pronounced for Group 2
banks. Tier 1 capital ratios would decline from 9.8% to 8.1% and total capital ratios would
decline from 12.8% to 10.3%.
Overall risk-weighted assets would increase by 23.0% for Group 1 banks. The main drivers of
this increase are charges against counterparty credit risk and trading book exposures.
Accordingly, banks that have significant exposures in these areas influence the average
increase in risk-weighted assets heavily. Some banks also experience a larger than average
increase in risk-weighted assets due to securitisation exposures in their banking books. Since
30

Group 2 banks are less affected by the revised counterparty credit risk and trading book rules,
their risk-weighted assets would increase by an average of just 4.0%. As a whole, the changes
in risk-weighted assets have less impact on banks’ capital positions than changes to the
definition of capital.
The weighted average leverage ratio using the new definition of Tier 1 capital and the
measure of exposure agreed by the GHOS for testing during the parallel run period is 2.8%
for Group 1 banks and 3.8% for Group 2 banks.
The new liquidity standards result in an average liquidity coverage ratio of 83% and 98% for
Group 1 and Group 2 banks, respectively. The average net stable funding ratio is 93% and
103%, respectively22.
1.6.4 Global systemically important banks
During the financial crisis the failure or impairment of a number of large, global financial
institutions sent shocks through the financial system which, in turn, harmed the real economy.
Supervisors and other relevant authorities had limited options to prevent problems affecting
individual firms from spreading and thereby undermining financial stability. As a
consequence, public sector intervention to restore financial stability during the crisis was
necessary and conducted on a massive scale. Both the financial and economic costs of these
interventions and the associated increase in moral hazard mean that additional measures need
to be put in place to reduce the likelihood and severity of problems that emanate from the
failure of global systemically important banks (GSIB).
The document dealing with the problems involved by this class of institutions was released in
November 2011.
The capital adequacy measures we described in the previous chapters are applied to all
internationally active banks to ensure that each bank maintains an appropriate level of capital
relative to its own exposures. A number of the policy measures will have a particular impact
on global systemically important banks (G-SIBs), given their business models have generally
placed greater emphasis on trading and capital markets related activities, which are most

22
Basel Committee for Banking Supervision: “Results of the Comprehensive Quantitative Impact Study ”, Bank
for International Settlements, December 2010
31

affected by the enhanced risk coverage of the capital framework. These policy measures are
significant but are not sufficient to address the negative externalities posed by GSIB nor are
they adequate to protect the system from the wider spillover risks of GSIB. The rationale for
adopting additional policy measures for GSIB is based on the cross-border negative
externalities created by systemically important banks which current regulatory policies do not
fully address.
The measures adopted by the Basel Committee in the recently issued document address the
first objective of requiring additional going-concern loss absorbency for GSIB, thereby
reducing the probability of failure.
The Basel Committee has developed an assessment methodology for systemic importance of
GSIB. The methodology is based on an indicator-based measurement approach. The selected
indicators are chosen to reflect the different aspects of what generates negative externalities
and makes a bank critical for the stability of the financial system.
The selected indicators reflect the size of banks, their interconnectedness, the lack of readily
available substitutes or financial institution infrastructure for the services they provide, their
global (cross-jurisdictional) activity and their complexity.
The methodology gives an equal weight of 20% to each of the five categories of systemic
importance. With the exception of the size category, the Basel Committee has identified
multiple indicators in each of the categories, with each indicator equally weighted within its
category.
32

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The Basel Committee will group GSIB into different categories of systemic importance based
on the score produced by the indicator-based measurement approach. GSIB will be initially
allocated into four buckets based on their scores of systemic importance, with varying levels
of additional loss absorbency requirements applied to the different buckets.
In January 2011 the Basel Committee collected data for end-2009 which included the
indicators of the indicator-based measurement approach from 73 banks. This sample of 73
banks was chosen from the world’s largest banks on the basis of size and supervisory
judgement by Basel Committee member authorities. The Basel Committee then produced the
trial score for all banks using the methodology described above.
Based on the results of applying the methodology, the Basel Committee is of the view that the
number of GSIB will initially be 29. It should be noted that this number would evolve over
time as banks change their behaviour in response to the incentives of the GSIB framework as
well as other aspects of Basel III and country specific regulations.
Based on policy judgement informed by the various empirical analysis, the Basel Committee
is of the view that the magnitude of additional loss absorbency for the highest populated
bucket should be 2.5% of risk-weighted assets at all times, with an initially empty top bucket
33

of 3.5% of risk-weighted assets. The magnitude of additional loss absorbency for the lowest
bucket should be 1.0% of risk-weighted assets. The magnitude of additional loss absorbency
is to be met with Common Equity Tier 1 as defined by the Basel III framework.

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1 4"+"2 5-!.
5 06'+788"&79:'"+"4 5-3.

The additional loss absorbency requirement will be phased-in in parallel with the capital
conservation and countercyclical buffers, i.e. between 1 January 2016 and year-end 2018,
becoming fully effective on 1 January 201923.

23 Basel Committee for Banking Supervision: “Global Systemically Important Banks: assessment
methodology and the additional loss absorbency requirement”, Bank for International Settlements, July
2011
34

2. Event-study on the effects of Basel Committee

announcements
At its 12 September 2010 meeting, the Group of Governors and Heads of Supervision, the
oversight body of the Basel Committee on Banking Supervision, announced a substantial
strengthening of existing capital requirements.
These capital reforms, together with the introduction of a global liquidity standard,
represented the response of financial authorities to the on-going financial crisis and were
officially issued on 16 December 201024.
The aim of this thesis is to analyse the wealth effects of the Basel Committee’s
announcements regarding the imposition of a renewed regulatory environment. Especially
increased capital ratios may affect the value of the firms involved, and results of the analysis
have implications on whether the market believes the new requirements will benefit banks by
reducing risk or adversely affect them by forcing a sub-optimal capital structure (as the
shareholders may prefer that banks use a high degree of financial leverage).
Modigliani and Miller’s (1958) classic work showed that in a perfect capital market the value
of a firm is independent of its capital structure. Yet, the existence of agency costs, bankruptcy
costs and taxes could cause investors to penalize firms that deviate from a target capital
structure.
The reaction to news announcements by financial institutions can differ according to the size
of the bank or even more to the current capital levels. For those banks for which existing
capital ratios are above the newly mandated requirement, the costs of compliance may be
trivial. But for those banks that are currently operating below the new required level, capital
levels must be increased to meet the mandated minimum. These banks will either find ways to
circumvent the requirement, or they will be forced to alter their capital structure.
As for new liquidity standards, they are also likely to have an effect on the capital structure of
financial institutions, but their implementation will begin later than for capital requirements
(LCR in 2015 and NSFR in 2018) and, according to the Quantitative Impact Study, banks
already show liquidity ratios that are quite close to the mandated minimum levels.

24
Basel Committee for Banking Supervision: Press release: “Group of Governors and Heads of Supervision
announces higher global minimum capital standards”, Bank for International Settlements, 12 September 2010

35

2.1 Literature review
A discrete amount of research has been conducted in the nineties about the implications of the
first Basel Accord on the banking sector. The same quantity of investigation has not been
carried out for the Basel II reform. This discrepancy may be due to the assumed little wealth
effects of the 2004 regulatory change, since a modification of the existing minimum capital
levels was not involved.
Eyssell and Arshadi (1990) represent the first attempt to examine the wealth effects of the
announcements of the Basel Committee’s intention to impose, across international boundaries,
a pre-determined minimum level of risk-adjusted capital. The sample they use is made up of
27 American banking firms, and abnormal returns are calculated in the periods surrounding
four regulatory announcements. The main findings are that, as hypothesized, the first
announcement of the regulatory change was viewed by capital market participants as
generally unfavourable. Succeeding announcements show smaller negative values. Further,
those banks most likely to be affected, i.e., those whose capital ratios were deficient at the
time of the events, suffered the greatest value losses25.
Cooper, Kolari and Wagster (1991) seek to extend the bank stock market analysis of the
effects of risk-based capital rules by examining market reaction in different countries (USA,
Canada, UK and Japan). In this case the announcements taken into consideration are only
three and securities for each nation are combined into an equally-weighted portfolio in order
to adjust for potential cross-sectional dependence among security returns of banks in each
country. The main conclusion drawn by the authors is that investors perceived that Canadian,
American and British banks would be adversely affected by the new capital rules. In the case
of Japanese banks, there is mixed evidence concerning the perceived effect of the new capital
rules26.
Madura and Zarruk (1993) perform an event-study which is very similar to the one carried out
by Eyssell and Arshadi (1991). The announcement dates are four and the sample consists of
27 American banks, with an asset value of at least $22 billion. Two sub-samples are then
created after partitioning the data into money centre banks (with assets of more than $40

25
T. Eyssell, N. Arshadi: “The wealth effects of the Risk-Based Capital Requirement in Banking: The Evidence
from the Capital Market”, Journal of Banking and Finance, 1990
26
K. Cooper, J. Kolari, J. Wagster: “A Note on the Stock Market Effects of the Adoption of Risk-Based Capital
Requirements on International Banks in Different Countries”, Journal of Banking and Finance, 1991

36

billion) and superregionals (the remaining banks in the sample). Results of the analysis
suggest that share prices of money centre banks reacted negatively in response to the first
announcement, while superregionals were not affected. As for the other announcements, there
was no significant market reaction for the two groups27.
Lu, Shen and So (1999) draw their attention to small commercial banks, stating that they were
rich in capital before the imposition of the new rules, therefore they could be considered over-
capitalized and a positive reaction to the announcements is expected. A sample consisting of
261 banks (both large and small) is used to test this hypothesis.
Based on the empirical results, they conclude that the imposition of the risk-adjusted capital
requirements had a non-positive price effect on the stock returns of big commercial banks but
had a positive effect on the stock returns of small banks28.
2.2 Data and methodology
In order to assess the market reaction to the new regulatory framework (Basel III) standard
event study methodology is applied to a sample consisting of 261 banks. The data was
obtained from two sources: asset values and other accounting information were collected from
the Bloomberg Database, while all price data were downloaded from the Thomson
Datastream Database. Sample banks were selected from 21 Basel Committee’s member
countries in an attempt to replicate as precisely as possible the sample used by the Basel
Committee itself in the Quantitative Impact Study described in chapter 1.6.3. Some banks
(and two countries) had to be excluded either because they are missing in the database used or
because they lack a sufficient number of prices during the period considered. Financial
institutions with an asset value of at least $1 billion are included in the sample. Tables 2.1 and
2.2 report the countries used in the analysis and the number of banks for each country (and
continent). The analytical list of all banks can be found in Annex 2.
In addition to the full sample, several sub-samples were created in order to examine the
wealth effects of the announcement on financial institutions sharing similar characteristics.

27
J. Madura, E. Zarruk: “Market Reaction to Uniform Capital Adequacy Guidelines in the Banking Industry”,
Journal of Financial Research, 1993
28
L. Chiuling, S. Yangpin, R. W. So: “Wealth Effects of the Basle Accord on Small Banks”, Journal of
Economics and Finance, 1999
37

Criteria used for the differentiation were: size, Tier 1 ratio and location.
As for size, large banks are those with an asset value higher than $ 100 bln, medium banks
have it between $20 bln and $100 bln, small banks have it lower than $ 20 bln.
In terms of Tier 1 ratio, high ratio banks are those with an index higher than 10%, medium
ratio banks have it between 8% and 10%, low ratio banks have it below 8%. Clearly it was not
possible to use Tier 1 ratios calculated with the new rules, because such data are still missing
in the Database used. However, old data should represent a good approximation of the capital
position quality of the banks included in the sample.
With regards to location, banks were split into European, American and AAA (Asia, Africa,
Australia) banks.

1.-78*4)69*(")*+,*-.$/0*,"&*8.:;*:"#$%&'
!"#$%&' (")*+,*-.$/0
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1+123 456
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38

,('23$/#/4$!"#$%&$'()*+$'5$6")78)3)7
!"#$%&$'()*+
!"#$% &'(
!)*+#,$ -.
/0+12* .3
!0"4+$5#$ 6
!7+#,$ (
,%,-. /01
Source: author

For each sample firm, daily abnormal returns were calculated in the periods surrounding six
regulatory announcements concerning the imposition of the new regulatory environment. A
brief description of these announcements appears in table 2.3.

1*23#&4(56&*$$'7$-#8#$%,&29&%:#&;*,#3&<'88/%%#

!"#$%&$'( !"#$%&)*%# +#,-./0%/'$
! "#$%&'%()*+,)*++-
./%)0#&&122%%)344#546%7)89347)2#)72(%4:2/%4)
6381239)'5;;%(7)34<)91&12)9%$%(3:%)2#)3<<(%77)
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* >59?)!@,)*++A
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6#4;1(&321#4)#;)2/%)142%421#4)2#)72(%4:/2%4)

6381239)'5;;%(7
@ D%6%&'%()!E,)*++A
0#47592321$%)8(#8#7397)2#)72(%4:2/%4)2/%)
(%7191%46%)#;)2/%)'34C14:)7%62#(,)8#771'9%)

1&89%&%42321#4)'?)2/%)%4<)#;)*+!*
F G%82%&'%()!*,)*+!+
H(#58)#;)H#$%(4#(7)34<)I%3<7)#;)G58%($171#4)
344#546%7)/1:/%():9#'39)&141&5&)6381239)

7234<3(<7
J D%6%&'%()!K,)*+!+
B1439)L37%9)MMM)2%N2)1775%<)39#4:)O12/)2/%)(%75927)
#;)2/%)P534212321$%)M&8362)G25<?

K >54%)*J,)*+!! Q%375(%7);#():9#'39)7?72%&16399?)1&8#(2342)

'34C7)3:(%%<)'?)2/%)H(#58)#;)H#$%(4#(7)34<)
I%3<7)#;)G58%($171#4

Source: author
39

The first regulatory announcement occurred on 20 November 2008 and outlined for the first
time the main changes financial authorities were willing to apply to the banking regulatory
environment, even if the necessity for a shift in the financial governance was clear to
everyone as soon as the crisis blew up.
The sixth announcement (June 25, 2011) does not concern all the banks in the sample, but
only those financial institutions which were defined by the Basel Committee as “global
systemically important”. The characteristics of these banks are described in chapter 1.6.4 and
a list of the current GSIBs can be found in table 2.4.

<:=5-./>?@.8'**-().A7BC,

!"#$ %&'()*+ ",,-),./010.23.45(6 7'*89:*;-
!"#$#%&'!%( )*+,-. /0123 /456
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<(!;$<C7?($#C; 9= /0B55 /456
!%&;C%D($#C; 9= /0E// /456
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!%"=$F)$%G8&';% 9(% /0/15 /456
H#GF&?%"$;<%(8 9(% /033I /456
;':'?&F9#$'"; 9(% 30J3B /456
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;&87':$(9'((>&8? (KLMN.*O+,P 303Q5 /6
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!%";F$(%":%"78& (R+L, 301/2 3456

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;FGG8&X!%"= ?.*@+,A 30QQI 36
"F&78%$!%"=$%! (K.P., 221 36
!!Y% (R+L, 2EJ 36
Source: author

Daily residuals were calculated for each event period (defined to include the 21 days
surrounding the actual regulatory announcement), using the market model. Market model
coefficients for each sample firm were estimated using a time series of 250 daily returns
ending right before the event period.

!"#$%&#$'()*+,$'- !.+(#)*+,$'-

/01)-&2" /3)-&2"
40

The market model is:

! "#$ %&%' " %(%) " *!
+#$%(%,
"#$ (1)

where:
Ri,t single security daily return
α constant term to be estimated
β slope coefficient to be estimated
Rm,t market daily return

εi,t error term
Excess or abnormal returns (AR) are estimated on each day in the event window as:

⌃
⌃# &-&.
!" #$% &'&"#$% &(&)*" #$% +&'&"#$% &(&*, # /" 0$% +& (2)

α and ⌃β represent the parameters estimates from the 250 days estimation period
where ⌃
described earlier.
The successive step is to aggregate abnormal returns both across time and firms.
For any time interval (d1, d2), cumulative abnormal return (CAR) for stock i is estimated:

!"
#$% & '(!) *!" +',' ! $%
-,! )
&*- (3)

As for aggregation across firms average abnormal returns (AARs) are computed for each date
during the event period in the following way:

!
! !
" %& #)'
%%&'($(
#$"
(4)

Where N is the number of stocks in the sample.
41

In order to aggregate both across time and firms, the formula hereafter outlines the calculation
of cumulative average abnormal returns:

!
"
%&&' #()*"+*, -($( ! ! %&' ()* +* -(
#$"
# " , (5)

This paper will focus on AARs and CAARs estimated during the period surrounding each
event date.

2.3 Testing abnormal performance
A fundamental question is whether negative or positive AARs and CAARs are statistically
significant or not. A lot of research has been carried out in the last forty years about this
argument, and many different tests have been created in order to deal with the numerous
issues that affect abnormal returns’ analysis.
Broadly speaking, statistical significance tests are designed to answer the question whether
the calculated abnormal returns are significantly different from zero at a certain, a priori
specified, significance level.
The null hypothesis to be tested is of the form:

H0 : E(ARit) = 0 (6)

Which statistical test of this hypothesis is appropriate depends on the way in which abnormal
returns are constructed, on the statistical properties of stock returns, and on some sample
features.
The main problems one can face when looking for a suitable significance test are:
• heteroskedasticity in event period residuals: the traditional tests assume that ARit are
independently and identically distributed but the ARit that together make up the AARt
may not all have the same variance;
42

• event-induced variance: Brown, Harlow and Tinic (1988) show that many events
cause changes in both risk and return for individual securities, as indicated by a
temporary increase in the variance of abnormal returns accompanying the mean shift.
Therefore it is necessary to control for variance changes to obtain appropriate tests;
• cross-sectional correlation: it is well known that event-studies are prone to this issue
when the event day is the same for multiple firms (as in our case). Kolari and
Pynnönen (2010) show that, even when cross-correlation is relatively low, event date
clustering is serious in terms of over-rejecting the null hypothesis;
• normal distribution of abnormal returns: previous studies have shown that abnormal
returns distributions show fat tails and are right skewed. Parametric tests reject too
often when testing for positive abnormal performance and too seldom when testing for
negative abnormal performance. When the assumption of normality of abnormal
returns is violated, parametric tests are not well specified.
Several different tests were calculated in order to see how results are affected by the
factors that have been described above.
Table 2.5 shows the results of these tests for the whole sample at the first announcement
date (November 20, 2008).

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!"#$%&'() **+,-.$-/ 0=('.%.>$(2-0#,% ?=>,,-,#7%4-0#,% @AB-0#,%
!"# "$%& '$&( ))) '$** ))) '$'" )))
!+ !"$"+ !,$** ))) !'$%, ))) !,$,- )))
!( !"$-- !,$+" ))) !'$(( ))) !,$(- )))
!* #$,, -$'( ))) %$#* ))) #$+-
!' !#$"% !#$'" !#$,+ #$#+
!, !#$'( !%$-+ ))) !-$(, ))) !-$%& ))
!& !#$,* !-$*, ))) !-$'# ))) !&$-, )))
!% #$", #$*& #$(# #$+(
!- !#$'+ !%$%- ))) !%$"+ ))) !"$,* )
!" !#$&% !-$#+ )) !-$-' )) !"$'( )
#
"
#$'"
!-$--
-$+'
!"#$*&
)))
)))
-$,,
!*$"(
))
)))
-$-(
!'$'(
))
)))
- #$%, "$'+ ) #$+' !#$%#
% #$*, %$'% ))) -$*# ))) -$-" ))
& !#$'* !%$-& ))) !%$"& ))) !-$*& )))
, #$&( -$%- )) %$#" ))) %$#+ )))
' #$'& %$"- ))) %$%# ))) %$,- )))
* !"$%% !'$&' ))) !,$"' ))) !&$'# )))
( #$(% &$#" ))) %$#% ))) -$'" )))
+
"#
#$,(
#$%-
-$("
"$,,
)))
)
-$+(
"$*%
)))
)
-$('
#$*+
)))
Source: author

43

0(12#-3456-,%(%.,%.7(2-,.8$.9.7($7#-%#,%,-:3;
!"#$%&'() **+,-.$-/ <=>'#-'#?4-('@4-0#,% *'@4-ABC-0#,% <D==('D&E."$#)-0#,%
!"# "$%& "$'( "$%" "$)&
!( !"$"( !"$"* !"$#( !"$%&
!+ !"$'' !"$", !"$"* !"$%#
!, #$** #$*% #$"+ #$&&
!) !#$"% !#$"' #$#' #$#,
!* !#$)+ !#$)* !#$&) !#$'(
!& !#$*, !#$** !#$+& !#$(*
!% #$"* #$"* #$"( #$"(
!'
!"
!#$)(
!#$&%
!#$))
!#$&'
!#$%"
!#$%%
!#$*"
!#$%#
# #$)" #$*( #$&* #$,"
" !'$'' !'$"% -- !"$%' !"$&"
' #$%* #$%% !#$#) !#$"%
% #$,* #$,' #$&& #$&&
& !#$), !#$)& !#$*& !#$("
* #$&+ #$&) #$)" #$',
) #$)& #$)' #$,# #$))
, !"$%% !"$'+ !#$(" !"$#'
+ #$+% #$+# #$*' #$,+
( #$*+ #$*) #$*, #$,,
"# #$%' #$%" #$") #$%&
Source: author

2.3.1 The traditional Test
The first test which was implemented is the Brown and Warner’s “no dependence adjustment”
method. It implicitly assumes that security residuals are uncorrelated and that event-induced
variance is insignificant. The test statistic equals the sum of the event period abnormal returns
divided by the square root of the sum of all securities’ estimation period residual variances.

"
!
!#$%&
" %=!
(7)
)
" ' # ' &
! ! ! !% #$%( " ! #$%( (
" %=! ' "! (=! %$ (
(=! ' '

It is easy to notice from table 2.5 that almost all AARs are statistically significant (and most
of them at the 1% level). This does not automatically imply that the test is wrong but further
research is necessary in order to address the issues described in the previous chapter.
44

2.3.2 Cross-sectional Test
The cross-sectional method conducts a t-test by dividing the average event period residual by
its contemporaneous cross-sectional standard error. As the previous test, the cross-sectional
method requires security residuals to be uncorrelated across firms. It does not require event-
induced variance to be insignificant, but it might be misspecified if event period residuals for
different firms are drawn from different distributions.

"
!
! #$%&
" %=!

(8)
)
! #"
#$%& &
"
! %% #$%& " ! ((
"'""!( %=! $ " '
%=!

Looking again at table 2.5, the values for this test look very similar to those calculated with
the traditional method.
2.3.3 Standardized cross-sectional (BMP) Test
The standardized cross-sectional test was developed by Boehmer, Musumeci and Poulsen
(BMP) in 1991 to address the misspecification problem of the ordinary cross-sectional
technique. First, the residuals are standardized by the estimation period standard deviation
(SAR=Standardized Abnormal Returns). The ordinary cross-sectional method is then applied
to the standardized residuals.

"
!
! #$%&'
" &=!
(9)
*
! # " "
#$%&' &
#$%
! %
"(""!) &=! %$
&' " ! " ((
&=! '

45

where

"#$% "#$%
!"#$% = = (10)
!$ )
& $ '
"#$( '
'
# && "#$( " # ))

' "& (=& % (=& ' (
Table 2.5 shows that the magnitude of the t-statistics somewhat decreases with respect to the
traditional and cross-sectional tests, but still most of the AARs remain significant.
2.3.4 Crude-dependence adjustment Test
This test statistic was invented by Brown and Warner in 1985. It is the ratio of event day
average abnormal return to its estimated standard deviation; the standard deviation is
estimated from the time series of mean excess returns during the estimation period.

!!"#
(11)
# ' % &
$ $=&
(
%% " !!"$ ! !!" ) ((
'

%()

where

# $
!!" = !!!"%
$ %=# (12)

It is very clear from table 2.5 that this method substantially reduces the magnitude of the test
statistics. The difference from the previous methods is very large. Now only one event day out
of twenty-one is statistically significant.

46

2.3.5 Adjusted BMP Test
The main issue in our data seems to be cross-sectional correlation because of event date
clustering.
A very important contribution to address this problem was given by Kolari and Pynnönen
(2010). In their research paper “Event-study testing with cross-sectional correlation of
abnormal returns” the two authors show that, even when cross-correlation is relatively low,
event date clustering is serious in terms of over-rejecting the null hypothesis of zero average
abnormal returns when it is true.
Kolari and Pynnönen start from the BMP test

##$ %
!" = (13)
&

where s is the cross-sectional standard deviation of the event day scaled abnormal returns
defined as the square root of the sample variance, or

"
# #$
%&'() & $
!" = %% %&'() ! " (14)
"
$!# (=# $ $ ('
(
(=#

The authors show that

!"#$ % = "&!"%#
$ (15)
'

where ρ is the average sample cross-correlation of estimation period residuals. Thus, the
entire cross-correlation problem reduces to a single number (ρ).
"
Normally, because ρ is positive, s2 understates the true cross-sectional variance ! ! .
"
A feasible estimator of the variance ! ! is
47

#
!
!#" = (16)
$!"

This finding allows the construction of a test statistic (Adjusted BMP) that accounts for both
cross-sectional correlation and event-induced volatility in testing for the mean event effect

!""#$% &
(17)
'" (+)&!(*"

If the average sample cross-correlation is zero, the adjusted BMP and BMP statistics yield the
same results.
Table 2.6 demonstrates numerically the inflation effects of cross-correlation. Even with low
average cross-correlation, problems begin to emerge already at a small sample size (N=10
firms). Based on an average correlation of only 0.05, the true rejection probability at the 5%
level in a two-sided test with 10 firms is 0.11. In a larger sample of 100 firms, the true
rejection probability exceeds 0.40. This means that, if cross-correlation is not taken into
account, instead of a 5% rejection rate, the true type 1 error would be higher than 40%.

,-./01'#$213450140607389:1;49.-.8/8380<1-313=01!>1/0?0/1@9413A913-8/0B1CDE130<319@1
FFG<1A=0:140<8B5-/<1-401749<<H<07389:-//I179440/-30B
&'()*+(,-).//0-.))(1*23.4,567
89:;(),.<,<3):/,587
!"!! !"!# !"!$ !"#! !"#$ !"%!
! "#"! "#"$ "#"% "#&' "#&! "#&(
&" "#"! "#"$ "#&& "#&% "#') "#'(
'" "#"! "#"* "#&* "#'* "#+$ "#)'
+" "#"! "#"( "#'' "#+! "#)+ "#!"
!" "#"! "#&& "#+" "#)) "#!+ "#!(
&"" "#"! "#&* "#)+ "#!* "#$! "#*"
'"" "#"! "#'$ "#!$ "#$% "#*) "#*%
Source: Kolari and Pynnönen, “Event-study testing with cross
sectional correlation of abnormal returns”, September 2010
In our sample the number of firms is N=261. Therefore, if cross-correlation is present, it could
seriously bias rejection rates.
48

Table 2.7 reports the average cross-correlation at each announcement date for the total sample
and all sub-samples.

;")2$+,<8=+"'$*">$+7*&??@7&**$2"#A&B+C&*+("AB+?"(D2$+"BE+?1)@?"(D2$?+F4G

!"#$ %&'$()$*+,-.+,--/ 0123+45.+,--6 !$7$()$*+48.+,--6
%9,:4 %9,:4 %9,:4
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&:.;;%2.345 *+6< *+6< *+6=
>80?%!81/%6%2.345 *+6@ *+6< *+6A
'1789:%!81/%6%2.345 *+6= *+6* *+*,
$BC%!81/%6%2.345 *+66 *+*- *+*<
)9/BD1 *+6E *+6E *+6F
#:1/8G. *+E, *+EA *+E*
#58.H%#I/8G.H%#95J/.;8. *+66 *+6* *+*,
Source: author
8"(9$*.:5;*"<$)"=$*0)>??@0>))$9"#A>4*B>)*'"A4*?"'&9$*"4C*?3(@?"'&9$?*D.E
!"#$ %$&#$'($)*+,-*./+/ !$0$'($)*+1-*./+/ 234$*.5-*./++
67.1+ 67.1+ 67./
!"!#$%&#'($) *+*, *+*, *+-.
$/012%3/456 *+*7 *+*7
'289:;%3/456 *+*< *+*<
&;/==%3/456 *+>- *+>?
@91A%!920%>%3/456 *+>* *+>>
'289:;%!920%>%3/456 *+*. *+*,
$BC%!920%>%3/456 *+*7 *+*7
):0BD2 *+>? *+>?
#;209E/ *+-- *+-?
#69/F%#G09E/F%#:6H0/=9/ *+>* *+*I
Source: author

Cross-correlations are substantial, especially in the sub-samples. Therefore rejection rates
might be seriously biased for statistical tests assuming that abnormal returns are uncorrelated
(traditional test, cross-sectional test, standardized cross-sectional test).
As a proof adjusted BMP test values in Table 2.5 are markedly lower than those calculated
with the tests mentioned above.
49

2.3.6 Corrado-Zivney rank Test
Non-parametric tests refer to those methods, which do not rely on assumptions that the data
are drawn from a given probability distribution. In particular parametric tests assume that
abnormal returns are normally distributed. Brown and Warner (1985) state that single security
daily excess returns show substantial departures from normality. Nonetheless this research
focuses on average abnormal returns and the central limit theorem guarantees that, if the
excess returns in the cross-section of securities are independent and identically distributed
drawings from finite variance distributions, the distribution of the sample mean excess returns
converge to normality as the number of securities increases.
For the purpose of testing whether average abnormal returns are actually normally distributed,
a “Chi-Square Test” was carried out at each announcement date for the complete sample and
all sub-samples.
Table 2.8 reports the Chi-Square values and whether the normality assumption has been
accepted or rejected.
%"&'$()*+,(-./0123"4$(%$5#(674(8749"'/#:(;<=
!"#$ >7?$9&$4()@A()@@+ B3':(<CA()@@D !$E$9&$4(<FA()@@D
>G)H< >G)H< >G)H<
!"!#$%&#'($) *+,- ! ./,0 " .1,1 !
$2345%62789 :+,: ! .*,; " :0,- !
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&?2@@%62789 *.,/ ! .A,/ " .;,. "
B=4C%!=53%.%62789 **,/ ! .;,; " 0.,0 !
'5<=>?%!=53%.%62789 *+,0 ! 1,: " ./,: "
$DE%!=53%.%62789 0A,+ ! /,1 " :,0 "
)>3DF5 01,- ! .*,; " *.,: !
#?53=G2 ;;,A ! 00,- ! 0+,+ !
#9=2H%#I3=G2H%#>9J32@=2 A,1 " /,+ " ;,: "
!: normality assumption accepted ": normality assumption rejected
Source: author
50

."/0$()123(456789&":$(.$;#(<=:('=:>"06#?(@)A
!"#$ 8$B#$>/$:(-C+(),-, !$D$>/$:(-E+(),-, %&'$()*+(),--
FG)E- FG)E- FG),
!"!#$%&#'($) *+,- ! *+,- ! *-,. !
$/012%3/456 -,7 ! 88,8 "
'29:;<%3/456 *8,. ! =,> !
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A:1B%!:20%*%3/456 **,+ ! -,> !
'29:;<%!:20%*%3/456 *>,* ! 87,7 "
$CD%!:20%*%3/456 *-,= ! *-,= !
);0CE2 87,+ " 87,= "
#<20:F/ *-,@ ! *7,- !
#6:/G%#H0:F/G%#;6I0/?:/ -,* ! 7,+ !
!: normality assumption accepted ": normality assumption rejected
Source: author
In most cases the normality assumption is accepted, but still a non parametric statistical test
represents a useful means to check the results calculated in the previous test (adjusted BMP).
First step in the computation of the “Corrado-Zivney rank test” is the transformation of each
abnormal return, during both the estimation and event period, in a different measure called Uit.

$%&'()*+"# ,
!"# = (18)
(-" +.,

where
Mi = number of non-missing returns in the combined estimation and event period for the ith
series
and

!#
% &!"#$ ' +,-#./ 0*$#12$#3. 50-#3+ (19)
!" = "
#$
$# &!"#( ) *' +,-#./ 040.$ 50-#3+

where SARit is the scaled factor model residual during the estimation period, and SARiE/s is
the event day scaled residual rescaled with the event day cross-sectional standard deviation.

The test formula is the following
51

(! !# $ %)
"

&
(20)
'(
where

# ,+-
!" = " %&'( !# ) *+* (21)
$ (=(#

# $
!" = !!%" (22)
$ %=#

The rank test implicitly accounts for cross-sectional correlation, as the standard deviation su is
based on the averages Ut that are equally weighted portfolios of the scaled ranks. In addition,
the Corrado-Zivney rank test is robust to event-induced volatility due to the rescaling of the
event day scaled abnormal return by the cross-sectional standard deviation.
Table 2.5 shows the results for this test and they are very close to the values found with the
adjusted BMP method.
Since the last two tests (adjusted BMP and Corrado-Zivney method) explicitly account for
cross-sectional correlation and show similar values, they seem to be reliable in terms of
rejection of the null hypothesis.
Therefore, they will be used in the empirical analysis to assess statistical significance of
estimated AARs and CAARs.
52

2.3.7 Statistical significance of cumulative average abnormal

returns (CAARs)
Cumulative average abnormal returns convey further information in addition to single event
day abnormal returns. In order to test their statistical significance one of the most reliable
above-mentioned methods (Adjusted BMP) was employed. The Corrado-Zivney method was
not utilized, both because the results were going to be very similar and because there where
some methodological issues.
As for the Adjusted BMP, the t-ratio in equation (17) is readily available for testing CARs by
replacing the standardized average abnormal return (SAAR) with the standardized cumulative
average abnormal return (SCAAR) and the standard deviation sA with the cross-sectional
standard deviation of standardized cumulative abnormal returns (SCARs).
2.3.8 Testing for difference between sub-samples
The analysis of single AARs and CAARs is very useful but it could be even more valuable to
examine the difference between two opposite sub-samples and test whether this difference is
statistically significant or not.
This kind of analysis was carried out for large and small banks, high Tier 1 ratio and low Tier
1 ratio banks, European and American banks, European and AAA (Asia, Africa, Australia)
banks.
After calculating the difference between the two groups, it is necessary to understand whether
this difference is statistically significant or not.
In order to do this two methods were employed: the Welch’s T-test and the non-parametric
Wilcoxon signed rank test.
The Welch’s T-test is an adaptation of Student’s T-test intended for use with two samples
having possibly unequal variances.
The statistic is defined by the following formula:

53

!!"#! !!"$
(23)
%#$ %$$
+
&# &$

The degrees of freedom ν associated with this variance estimate is approximated using the
Welch-Satterthwaite equation:

$
! "$ "$ $
# # + $&
# %# %$ &
" %
!= (24)
"#& "$&
+
%#$ '%# '#( %$$ '%$ '#(

The Wilcoxon signed rank test is an improvement of the sign test. The first step is to rank
absolute values of all differences between each abnormal return in the “Low Tier 1 ratio
(LT1)” (or another of the groups under investigation) group and the average abnormal return
in the “High Tier 1 ratio (HT1)” group.

!"##$%$&'$ = ()*"+, !-)*, (25)

Then, it is necessary to calculate the sum of all the ranks assigned to the positive (T+) and
negative (T-) differences. Both T+ and T- are random variables taking values
0,1,2,…,n(n+1)/2. Under the null hypothesis this distribution will be symmetrical around
n(n+1)/4.
Depending on the alternative hypothesis we use T+, T- or T = min (T+,T-).

5'6"$*789:*;("2.<.&*/(=&$>*%'&?*#$/#
!"#$%&'#()$*+,-.#+$/(/ 0$1$2#*&3""*(4
!"#"! $ %"&"%'
!"("! $ %)"&"%*'
!"+"! $ %,"&"%*'
Source: author
54

The distribution of the Wilcoxon signed rank test is tabulated. For large N (>15) the
distribution of the Wilcoxon statistic can be approximated by the normal distribution using
one of the following formulae (depending on the null hypothesis)

" + !#
!= (26)
"

or

" ! !#
!= (27)
"

where

"#"+$% (28)
!=
&

and

!"!+#$"%!+#$
!= (29)
%&

55

3. Empirical analysis
The third section of this document describes the results of the empirical analysis.
As already stated in the introduction and at the beginning of the second chapter, the objective
of this thesis is to examine the wealth effects of the Basel Committee announcements about
Basel III.
The main hypothesis to be tested is whether the new requirements will adversely affect banks
by forcing a sub-optimal capital structure (since shareholders might prefer a higher degree of
financial leverage).
The alternative hypothesis implies that the market believes the new requirements will benefit
banks by reducing risk, hence improving the stability of the financial sector in the future.
This would imply a more long-term perspective by the shareholders, while the main
hypothesis would be more focused on the short-term performance of the banks, which in most
cases will be forced to raise additional capital in order to comply with the new rules.
According to the findings in past studies (see chapter 2.1), those banks most likely to be
affected, i.e. those whose capital ratios are deficient at the time of the events, are expected to
suffer the greatest value losses.
Considering the sub-samples used in this document, low Tier 1 ratio banks are expected to
experience the worst results. The same applies to large banks because their capital position is
weaker than that of small and medium financial institutions (but the gap tends to narrow from
2008 to 2010).
As for location, European and American banks should be negatively affected by the
announcements, since the capital shortfall for the banks included in these two groups is
significant (as shown by the Quantitative Impact Study). The performance of the American
group might be not so negative because a lot of US regional banks were included in the
sample (due to data availability), and their capital position is sufficiently strong.
As regards AAA (Asia, Africa, Australia) banks, Standard & Poor’s believes that most rated
Asia-Pacific banks are unlikely to face significant difficulty in complying with Basel III29.
The most significant data are presented in this chapter by means of charts, while more detailed
tables can be found in the Annex 3.

29 Standard & Poor’s: "Standard & Poor's Risk-Adjusted Capital Framework Provides Insight Into Basel III", 9
June 2011
56

At every announcement date, average abnormal returns (AARs) and cumulative average
abnormal returns (CAARs) along with statistical significance tests, are shown for the whole
sample and all sub-samples.
All tables and charts in the next pages were elaborated by the author, unless otherwise
indicated.
3.1 20 November 2008
On 20 November 2008 the Basel Committee on Banking Supervision announced a

comprehensive strategy to address the fundamental weaknesses revealed by the financial
market crisis related to the regulation, supervision and risk management of internationally-
active banks.
The key building blocks of the Committee's strategy were the following:
• strengthening the risk capture of the Basel II framework (in particular for trading book
and off-balance sheet exposures);
• enhancing the quality of Tier 1 capital;
• building additional shock absorbers into the capital framework that can be drawn upon
during periods of stress and dampen procyclicality;
• evaluating the need to supplement risk-based measures with simple gross measures of
exposure in both prudential and risk management frameworks to help contain leverage
in the banking system;
• strengthening supervisory frameworks to assess funding liquidity at cross-border
banks;
• leveraging Basel II to strengthen risk management and governance practices at banks;
• strengthening counterparty credit risk capital, risk management and disclosure at
banks;
• promoting globally coordinated supervisory follow-up exercises to ensure
implementation of supervisory and industry sound principles30.

30
Basel Committee for Banking Supervision: “Comprehensive strategy to address the lessons of the banking
crisis”, Bank for International Settlements, 20 November 2008
57

This announcement represents the first step taken by the Basel Committee to address the
issues raised by the financial crisis. No final decision was taken on this date, neither
numerical details were disclosed. Nonetheless the most substantial changes to the banking
supervision framework were anticipated and banks are expected to be affected by this piece of
news.

!"#$%&'()*&+"",-&.&/01$%&2"34$%&
"#$$%&
'#$$%&
(#$$%&
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$#$$%&
!*#$$%&
!)#$$%&
!(#$$%&
!'#$$%&
!"#$$%&
!*$& !+& !,& !-& !.& !"& !'& !(& !)& !*& $& *& )& (& '& "& .& -& ,& +& *$&

Table 3.1 shows a cumulative negative effect of the announcement on the whole sample (261
banks). It is important to notice that none of the CAARs displayed in table I.II (Annex 3) is
statistically significant, thus the hypothesis of no impact by the announcement on the full
sample cannot be rejected.

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)#$$%&

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!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&

58

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!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&
/0122&31456& 7189:&31456&

59

In terms of size, the last four tables show how large banks performed worse than medium and
small banks during the days before the event, while after that there was a substantial recovery
by large financial institutions. As highlighted in table 3.5, difference in CAARs between the
two opposite categories (large and small banks) is very relevant (-7.22%) in the period
preceding the announcement, while large banks tend to catch up small ones in the days after
the event (+4.20%).

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!,$& !-& !.& !"& !'& !(& !)& !*& !+& !,& $& ,& +& *& )& (& '& "& .& -& ,$&

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!,$& !-& !.& !"& !'& !(& !)& !*& !+& !,& $& ,& +& *& )& (& '& "& .& -& ,$&

60

!"#$%&'()*&+"",-&.&$/0&!1%,&2&,"!1/&

+#$$%&
,#$$%&
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"#$$%&
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!,#$$%&
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!"$& !'& !(& !)& !*& !+& !,& !-& !.& !"& $& "& .& -& ,& +& *& )& (& '& "$&

!"#$%&'()*&+"",-&.&$/0&!1%,&2&3&4154&!1%,&2&
)#$$%&
*#$$%&
"#$$%&

!"#$$%&
!*#$$%&
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!(#$$%&
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!""#$$%&
!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&
/0123&4156/& /789&4156/&
Tables 3.6 to 3.9 demonstrate how banks with a low Tier 1 ratio (less than 8%) have a poorer
performance than financial institutions with both a medium (between 8% and 10%) and high
Tier 1 ratio (more than 10%).
As in the case of large and small banks, the gap grows in the period before the event (-5.35%),
while after that day there is no significant difference between the abnormal returns of the two
groups.

61

!"#$%&'()*+&,""-.&/&%0-12%&
)#$$%&

*#$$%&
"#$$%&
!"#$$%&
!*#$$%&

!)#$$%&

!(#$$%&
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!""#$$%&
!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&

!"#$%&'())*&+"",-&.&"/%,0+"&

)#$$%&
*#$$%&
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!)#$$%&
!(#$$%&
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!""#$$%&
!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&

!"#$%&'()*+&,""-.&/&"01"2&"3-1,"2&"40!-"$1"&

"#$$%&
'#$$%&
(#$$%&
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*#$$%&
$#$$%&
!*#$$%&
!)#$$%&

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!'#$$%&
!"#$$%&
!*$& !+& !,& !-& !.& !"& !'& !(& !)& !*& $& *& )& (& '& "& .& -& ,& +& *$&
62

!"#$%&'()'*&+"",-&.&%/,01%&2&"3%,4+"&

)#$$%&
*#$$%&
"#$$%&
!"#$$%&

!*#$$%&
!)#$$%&
!(#$$%&

!'#$$%&
!""#$$%&
!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&
/01234& 5641789&

!"#$%&'()*+&,""-.&/&%0-12%&3&".4"5&"6-4,"5&
"0.!-"$4"&
)#$$%&

*#$$%&
"#$$%&
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!"$& !'& !+& !(& !,& !)& !-& !*& !.& !"& $& "& .& *& -& )& ,& (& +& '& "$&
/01234& 56789:&6;18<9:&607=19>895&
European banks show substantial negative CAARs and perform worse than the other two
groups. As for the difference with American banks, it is significant in the days before the
announcement, while European financial institutions seem to catch up a bit in the following
period. AAA (Asia, Africa, Australia) banks are the ones suffering less from this
announcement.
In conclusion the first Basel Committee announcement on 20 November 2008 has a negative
impact on large banks and banks with a low Tier 1 ratio. As for location, Europe displays the
worst results. The evidence is in line with the expectations described in the introduction to this
chapter.
63

As stated before, the economic explanation for the poor performance of low Tier 1 ratio banks
is quite straightforward. Since minimum capital levels (and the quality of capital as well) were
going to be raised according to this announcement, those financial institutions with an
insufficient capital position were going to have to change their financial structure in order to
comply with the new rules to come.
The interpretation of the results for large and European banks is also quite clear-cut. As
shown in tables 3.15 to 3.18, large banks and European banks have lower capital ratios (both
Tier 1 and Total Capital ratio) than the other groups. Therefore everything revolves around
the explanation given for low Tier 1 ratio banks.
The poor performance of the just mentioned categories shows up in the period before the
announcement, while all the groups tend to bounce back right after the event-date.
The anticipation of the announcement can be explained by the fact that some days before it
(14-15 November 2008) a G-20 Summit took place, where some issues regarding the
regulation of the banking system were already discussed.
As for the recovery after the event-date, this might be explained by the fact that those groups
of banks were expecting more negative news from this Basel Committee meeting (i.e. they
were already expecting numerical details and implementation deadlines).

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)'*'(*(##+% )'*'(*(##!% )'*'(*(##&% )'*'(*(#'#%
,-./0%1-234% 506789%1-234% :9-;;%1-234%

64

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,-./0%,12.3/%/45%,6-72/8./% 962:;<% ,=<2.3/%

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)'-'(-(##.% )'-'(-(##!% )'-'(-(##&% )'-'(-(#'#%
/0123%/45162%278%/90:52;12% <95=>?% /@?5162%
65

3.2 13 July 2009
At its 12 July meeting, the Basel Committee on Banking Supervision approved a final
package of measures to strengthen the 1996 rules governing trading book capital and to
enhance the three pillars of the Basel II framework.
The package is part of the Basel Committee's broader programme to strengthen the regulatory
capital framework.
Under the Basel II enhancements approved at this July meeting, the Committee is
strengthening the treatment for certain securitisations in Pillar 1 (minimum capital
requirements). It is introducing higher risk weights for resecuritisation exposures (so-called
CDOs of ABS) to better reflect the risk inherent in these products, as well as raising the credit
conversion factor for short-term liquidity facilities to off-balance sheet conduits. The
Committee is also requiring that banks conduct more rigorous credit analyses of externally
rated securitisation exposures31.

!"#$%&'()*+&,""-.&/&012$%&3"45$%&
'#$$%&

(#$$%&
)#$$%&
!)#$$%&
!(#$$%&
!'#$$%&

!"#$$%&
!)$& !*& !+& !"& !,& !'& !-& !(& !.& !)& $& )& .& (& -& '& ,& "& +& *& )$&

Table 3.19 testifies how the cumulative effect of the 13 July 2009 announcement is negative
on the full sample (-4.80% during the whole event window). However, most of the impact
takes place after the announcement (-3.11%). Like for the previous announcement, none of

31
Basel Committee for Banking Supervision: “Basel II capital framework enhancements”, Bank for
International Settlements, 13 July 2009
66

the CAARs displayed in table II.II (Annex 3) is statistically significant, thus the hypothesis of
no impact by the announcement on the full sample cannot be rejected.

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(#$$%&

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!)$& !*& !+& !"& !,& !'& !-& !(& !.& !)& $& )& .& (& -& '& ,& "& +& *& )$&

67

!"#$%&'())*&+"",-&.&/0"$$&#"12/&

)$##%&
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!"#& !+& !'& !,& !(& !-& !)& !.& !*& !"& #& "& *& .& )& -& (& ,& '& +& "#&

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/0123&40567& 890::&40567&
Unlike the previous announcement, large banks present slightly negative (and not statistically
significant) CAARs while small banks show the largest negative ones. Medium banks are in
the middle between the two groups, but, according to table II.VI (Annex 3), their negative
results are the only statistically significant ones. Small banks’ CAARs are not statistically
significant because of the high average cross-correlation shown by this category (and, as
explained in chapter 2.3.5, adjusted BMP method takes this factor into account).
As for the difference between large and small financial institutions, it is statistically relevant
in the ten days before the event.
68

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69

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As before, the evidence from these sub-samples points in the opposite direction than in the
previous announcement. High Tier 1 ratio banks show more negative CAARs than low and
medium Tier 1 ratio financial institutions.
The difference with the low Tier 1 ratio group is present and particularly visible in the ten
days after the event.

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70

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71

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As for geographical differentiation, American banks display very negative abnormal returns
after the announcement, while the remaining two groups behave in a very similar way,
showing slightly negative abnormal returns.
To sum up, the second Basel Committee announcement dated 13 July 2009 has an overall
negative impact (even if not statistically significant if looking at the whole sample). In terms
of size and capital adequacy, small banks and banks with a high Tier 1 ratio seem to be the
most affected by this piece of news (but none of the calculated CAARs is statistically
significant). However, the difference in CAARs between opposite groups (large-small, high
Tier 1 ratio-low Tier 1 ratio) is substantial and statistically relevant. As for location, America
shows the worst performance.
The evidence from this event goes against all expectations outlined in the introduction to this
chapter, but an explanation can be found if examining the content of the announcement in
question.
It involved a considerable strengthening in the trading book rules, with particular attention to
securitisation and resecuritisation exposures.
As the following table suggests, the issuance of ABS, RMBS, CMBS, CDOs is substantially
higher in the United States than in Europe. Therefore, American banks were more likely to
suffer from this regulatory announcement (and the evidence is very strong when looking at
table 3.31).
As for small and high Tier 1 ratio banks, their negative results might be explained by the
strong presence of American financial institutions in the two groups.
72

79;:2'<=<<>'?8:/@21'8!'9;1A'B@;1A'C@;1'9D5'C58)'(11/25'(D'2/B8E2'
9D5'/D(725'179721'(D'FGGH
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()* +++,-. /0,1. 233,/
45)*#6#75)* 3891/,/. :.0,:. 29,1
7;<= >/>,/. 11,0. 2>,1
7879: >89.9,-. 9/:,0. 2/,:
Source: European Securitisation Forum, “Annual market outlook”, 2008

At its 17 December meeting, the Basel Committee on Banking Supervision approved for
consultation a package of proposals to strengthen global capital and liquidity regulations with
the goal of promoting a more resilient banking sector.
The Committee's consultative documents cover the following key areas:
• raising the quality, consistency and transparency of the capital base;
• strengthening the risk coverage of the capital framework. In addition to the trading
book and securitisation reforms announced in July 2009, the Committee is proposing
to strengthen the capital requirements for counterparty credit risk exposures arising
from derivatives, repos and securities financing activities;
• introducing a leverage ratio as a supplementary measure to the Basel II risk-based
framework;
• introducing a series of measures to promote the build-up of capital buffers in good
times that can be drawn upon in periods of stress;
• introducing a global minimum liquidity standard for internationally active banks that
includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term
structural liquidity ratio.
The fully calibrated set of standards had to be developed by the end of 2010 in order to be
phased in as financial conditions improve and the economic recovery is assured, with the aim
of implementation by end-201232.

32 Basel Committee for Banking Supervision: “Consultative proposals to strengthen the resilience of the
banking sector”, Bank for International Settlements, 13 July 2009
73

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The impact of the 17 December 2009 announcement on the full sample is slightly negative
and none of the CAARs displayed in table III.II (Annex 3) is statistically significant.

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74

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75

In terms of size, large banks are the ones which mostly suffered from this event, especially in
the days after the announcement. Medium banks show negative CAARs as well (but less
pronounced than large banks), while small financial institutions experienced positive
abnormal returns.
As table III.X (Annex 3) proves, all CAARs differences between large and small banks are
considerable and statistically significant.

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76

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/01&2345& 6378&2345&

Tables 3.39 to 3.42 demonstrate how high Tier 1 ratio banks experienced positive CAARs,
while low and medium Tier 1 ratio financial institutions suffered negative abnormal returns.
However, none of the groups shows statistically significant CAARs.
From the last chart and from table III.XVIII (Annex 3) it is easy to notice that the difference
in CAARs between the two opposite groups is in some cases statistically significant.

77

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78

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The last five tables show similar negative (and statistically significant) CAARs for European
and AAA (Asia, Africa, Australia) banks, while American financial institutions’ abnormal
returns go in the opposite direction.
As highlighted in table III.XXVI (Annex 3), the difference in CAARs between European and
American banks is negative and statistically significant for all periods taken into consideration.
To conclude, the effects of the 17 December 2009 announcement are very similar to those of
the first one (20 November 2008), therefore they are in line with the expectations delineated
in the introduction.
79

Large and low Tier 1 ratio banks experienced the worst results, and the differences with the
opposite groups (small and high Tier 1 banks) are in most cases statistically significant.
As for geographical discrimination, European and AAA (Asia, Africa, Australia) banks show
negative CAARs, in contrast with American financial institutions.
The explanation of these results is similar to that given for the first announcement. Since
minimum capital levels (and the quality of capital as well) were going to be raised according
to this announcement, those financial institutions with an insufficient capital position were
going to have to change their financial structure in order to comply with the new rules to
come. As for large banks and European banks, negative abnormal returns can be explained by
the fact that these two groups show lower capital ratios than the other groups, even if the gaps
have narrowed at this date, as tables 3.15 to 3.18 show.
Only the performance of AAA (Asia, Africa, Australia) banks is difficult to explain, since
their capital position is quite strong and they would be expected to perform better than
European banks and at least as well as American ones.

3.4 12 September 2010
At its 12 September 2010 meeting, the Group of Governors and Heads of Supervision, the
oversight body of the Basel Committee on Banking Supervision, announced a substantial
strengthening of existing capital requirements. On this date new minimum capital
requirements were announced definitively.
The Committee's package of reforms increased the minimum common equity requirement
from 2% to 4.5%. In addition, banks were required to hold a capital conservation buffer of
2.5% to withstand future periods of stress bringing the total common equity requirements to
7%.
These new requirements were supplemented by a non-risk-based leverage ratio that would
serve as a backstop to the risk-based measures described above. Governors and Heads of
Supervision agreed to test a minimum Tier 1 leverage ratio of 3% during the parallel run
period.
80

All these measures will be phased in gradually thanks to the provision of transitional
arrangements33.

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As in the previous cases, cumulative average abnormal returns show negative values when
considering the whole sample. However, as table IV.II (Annex 3) proves, none of the
calculated CAARs is statistically significant.

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33
Basel Committee for Banking Supervision: “Group of Governors and Heads of Supervision announce
higher global minimum standards”, Bank for International Settlements, 12 September 2010
81

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82

Tables 3.49 to 3.52 show similar CAARs for all groups of banks differentiated according to
size.
This is in contrast with the previous events, where at least large and small financial
institutions displayed different values.

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83

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As in the previous announcements, low Tier 1 ratio banks experience statistically significant
negative CAARs. The remaining two groups do not show such negative values and, as
displayed in table IV.XVIII (Annex 3), the difference in CAARs between the two opposite
categories (low and high Tier 1 ratio banks) is relevant and statistically significant during the
whole event window and in the period after the announcement (0,+10).

84

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85

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European and AAA (Asia, Africa, Australia) banks display similar CAARs, while American
financial institutions experience lower abnormal returns in the period after the announcement.
This contrasts with the evidence from the previous announcements and is difficult to explain,
since American banks have capital ratios which are close to those of AAA banks (as shown in
tables 3.17 and 3.18).
To sum up, as regards this announcement, some results are in line with the previous events,
while others are not. Low Tier 1 ratio banks experienced negative abnormal returns, and the
difference with the opposite group (high Tier 1 banks) is statistically significant, especially in
the period after the announcement. This is consistent with earlier findings.
86

To the contrary, large financial institutions display similar values to those of small and
medium banks. In this case the explanation might revolve around the fact that large banks
have collected a lot of funds in 2009, coming very close to the capital levels of small and
medium financial institutions (see tables 3.15 and 3.16).
As for geographical discrimination, American banks experienced more negative CAARs than
the remaining groups. Previous findings suggested that American financial institutions always
reacted better than European ones (except on 13 July 2009, when the content of the
announcement was focused on trading book rules).
Possibly European banks did not perceive this piece of news as negative because they liked
the fact that they were given an extended period to comply with the rules (since in the
previous announcement the aim of implementation was by end-2012), therefore they were not
going to have to rush to raise capital.

On 16 December 2010 the Basel Committee issued the Basel III rules text, which presented
the details of global regulatory standards on bank capital adequacy and liquidity agreed by the
Governors and Heads of Supervision. There were no major modifications to the rules agreed
and announced at the 13 September meeting.
Contemporaneously the Committee released the “Results of the comprehensive quantitative
impact study”, an exercise conducted in order to assess the impact of capital adequacy
standards announced in July 2009 and the Basel III capital and liquidity proposals published
in December 2009. A total of 263 banks from 23 Committee member jurisdictions
participated in the QIS exercise. This included 94 Group 1 banks (i.e. those that have Tier 1
capital in excess of €3 billion, are well diversified and are internationally active) and 169
Group 2 banks (i.e. all other banks)34.

34
Basel Committee for Banking Supervision: “Basel III rules text and results of the quantitative impact study
issued”, Bank for International Settlements, 16 December 2010
87

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The impact of the announcement on the full sample is slightly positive, but not statistically
significant.

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88

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89

Large banks are the only ones showing slightly negative abnormal returns, even if not
statistically significant. The remaining groups (medium and small banks) experienced positive
CAARs, and the difference between large and small banks is statistically significant,
especially after the announcement.

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90

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other two other two groups and the difference with low Tier 1 banks is visible, even if not
statistically significant (see table V.XVIII in Annex 3). Medium Tier 1 banks experienced the
worst result.

91

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92

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In terms of geographical diversification, American banks perform better than the other two
groups.
In conclusion, large banks experienced the worst performance, and this might be explained by
the results of the “Quantitative Impact Study”, which put the emphasis on the capital shortfall
of Group 1 banks (those that have Tier 1 capital in excess of €3 billion, are well diversified
and are internationally active).
In contrast with the other announcements, low Tier 1 banks do not show significantly lower
CAARs than medium and high Tier 1 financial institutions.
93

As for location, American banks react positively (and better than the other two groups) to the
announcement. The bad performance by European banks is consistent with the evidence in the
previous events, while AAA (Asia, Africa, Australia) financial institutions would be expected
to experience positive (or at least less negative) abnormal returns, since they should not have
difficulty complying with the new rules.

3.6 25 June 2011
At its 25 June 2011 meeting, the Group of Governors and Heads of Supervision, the oversight
body of the Basel Committee on Banking Supervision, agreed on a consultative document
setting out measures for global systemically important banks (GSIB). These measures include
the methodology for assessing systemic importance, the additional required capital and the
arrangements by which they will be phased in. These measures will strengthen the resilience
of GSIB and create strong incentives for them to reduce their systemic importance over time.
The additional loss absorbency requirements are to be met with a progressive Common Equity
Tier 1 (CET1) capital requirement ranging from 1% to 2.5%, depending on a bank's systemic
importance35.

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35
Basel Committee for Banking Supervision: “Measures for global systemically important banks agreed by the
Group of Governors and Heads of Supervision”, Bank for International Settlements, 25 June 2011
94

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95

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Global systemically important banks (GSIB) show negative CAARs and performed worse
than the control sample (banks not subject to the surcharge), especially in the days after the
announcement.
Financial institutions subject to a 2.5%-2% surcharge perform a bit worse after the news than
those subject to a lower (1.5%-1%) surcharge.
Therefore, GSIB suffered from this announcement because they were obliged to raise
additional top quality capital (Common Equity Tier 1), thus altering further their capital
structure.

96

Conclusion
Starting from the examination of the full sample (261 banks), the first conclusion to be drawn
from the empirical findings is that investors seem to perceive Basel Committee
announcements negatively, since only in one case out of six (16 December 2010) there is a
slightly positive reaction by the whole sample. On the other dates abnormal returns are
negative, even if not statistically significant.
However, the most important findings concern the sub-samples used in the analysis.
Literature in the past (see chapter 2.1) agrees on the fact that banks, which are currently
operating below the required level of capital, are adversely affected by announcements
regarding the imposition of new minimum capital requirements.
In the introduction to chapter 3 the expectations about the results of this thesis were set out
very clearly. Low Tier 1 ratio banks are expected to experience the most negative abnormal
returns. The same applies to large banks, since they usually have lower quantities and quality
of capital than medium and small financial institutions. In terms of location, European banks
should be the ones mostly suffering from this shift in regulation.
The evidence found in chapter 3 reflects quite well these hypotheses. Two dates out of six (13
July 2009 and 25 June 2011) will be treated separately because the content of these
announcements deals with special issues.
As for the remaining four dates, the evidence suggests that, low Tier 1 ratio banks always
experience the most negative CAARs with respect to the other two groups.
The same goes for large banks, which in three cases out of four show the worst performance.
As regards geographical differentiation, European banks tend to suffer the most from the
announcements. Only in one case (12 September 2010) they overperform the other two groups,
and the reason might be that European investors did not perceive this piece of news as
negative because they liked the fact that they were given an extended period to comply with
the rules, therefore they were not going to have to rush to raise capital.
American and AAA (Asia, Africa, Australia) banks perform similarly and better than
European ones, probably for the reasons set out in the introduction to chapter 3.
As for 13 July 2009, the announcement dealt mostly with the agreement by regulators on
tougher trading book rules. Therefore it was expected to have a different impact on the banks
in the sample. In fact the evidence from this event (as highlighted in chapter 3.2) points in the
opposite direction than the remaining announcements. American banks are the ones showing
97

the most negative CAARs this time because of the large amount of securitisation and
resecuritisation exposures in their balance sheets. High Tier 1 ratio banks and small banks
show the worst results in their categories because of the large presence of American financial
institutions in these two groups.
In regards to 25 June 2011, this date does not refer to the full sample, but only to twenty
“Global Systemically Important Banks” (GSIB), which are subject to a capital surcharge
because of their size and systemic importance.
The evidence from this date follows the theory explaining the other four dates. Banks subject
to the surcharge experience more negative CAARs than the control sample (made up of banks
not subject to the surcharge), because they have to raise additional capital.
In conclusion, it is possible to state that this thesis is consistent with the main hypothesis
outlined in the introduction and with the research studies carried out in the past.
The imposition of risk-based capital requirements constitutes an obligation for banks to
maintain an exogenously influenced capital structure. Those financial institutions, whose
capital levels are below the mandated minimum, are adversely affected by the Basel
Committee announcements. For those banks, for which capital levels are close to the new
requirements, costs of compliance is trivial and the reaction to the announcements is not
significant.

98

Annex 1

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99

Annex 2
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100

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101

(",-$+./01+-23(+&4+,"!53+678
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102

Annex 3
20 November 2008

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177

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UNIVERSITA’ CATTOLICA DEL SACRO CUORE

HOW DO BASEL COMMITTEE

1. Financial crisis and the evolution of Basel Committee agreements

Electronic copy available at: https://ssrn.com/abstract=2012596

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1. Financial crisis and the evolution of Basel

1.1 The 2007-2011 financial crisis and the issue of

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1.2 The Basel Committee for Banking Supervision

The Basel Committee is a committee of banking supervisory authorities established by the

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1.3 The 1988 Basel Capital Accord

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1.3.1 Constituents of capital

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1.3.2 Risk weights

1.4 The 1996 amendment to market risk

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1.5.1 New capital requirements for credit risk

1.5.1.1 Standardised approach

@"A-#-'B6 9: 89: ;9: <99: <99: <;9: <99: 9: <99:

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1.5.1.2 Internal ratings-based approach

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1.5.2 Securitization and credit risk mitigation

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Source: Basel Committee for Banking Supervision (2010)

1.5.3 Operational risk charge

• the basic indicator approach: this is based on an aggregate measure of business

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1.6 Basel III

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1.6.1 A global regulatory framework for more resilient banks and

1.6.1.1 Definition of capital

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!"#"$%$&7"89&:&'-."+-/&0-+"( 5234 3234 ;264

Source: Basel Committee for Banking Supervision (2010)

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1.6.1.3 Capital conservation buffer

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Source: Basel Committee for Banking Supervision (2010)

1.6.1.4 Countercyclical buffer

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1.6.1.5 Leverage Ratio

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1.6.2 International framework for liquidity risk measurement,

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1.6.3 The quantitative impact study

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1.6.4 Global systemically important banks

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