Significant Features of Basel III

Significant Features of Basel III

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Basel III is an international regulatory agreement that established a set of reforms to reduce risk in the international banking sector by requiring banks to keep certain levels of reserve capital on hand and maintain certain leverage ratios. It started in 2009 and is still in use as of 2022. Basel III is a global regulatory agreement that established a set of reforms to enhance banking sector regulation, supervision, and risk management. In the ongoing effort to improve the banking regulatory framework, Basel III is an iterative step.

In 2009, a group of 28 central banks came up with Basel III, largely in response to the 2007–2008 financial crisis and subsequent economic recession. It is still undergoing implementation as of 2022. Shortly following the financial crisis of 2007–2008, the Basel Committee on Banking Supervision, a group of 28 central banks based in Basel, Switzerland, implemented Basel III. Despite earlier reforms, many banks proved to be overleveraged and undercapitalized during that crisis. The voluntary implementation deadline for the new rules was originally set for 2015, but it has been repeatedly pushed back to January 1, 2023.

Basel III, which is also known as the Third Basel Accord, is an ongoing effort to improve the international banking regulatory framework that began in 1975. In an effort to enhance the banking system's capacity to deal with financial stress, enhance risk management, and promote transparency, it builds on the Basel I and Basel II agreements. In order to lessen the likelihood of system-wide shocks and prevent further economic meltdowns, Basel III aims to improve the resilience of individual banks on a more granular level.

Basel III's Minimum Capital Requirements - Banks have two main capital silos that are qualitatively distinct from one another. The core capital, equity, and disclosed reserves that are reflected in a bank's financial statements are referred to as "tier 1." Tier 1 capital provides a cushion that a bank can use to weather stress and continue operations in the event of significant losses. In contrast, a bank's Tier 2 capital consists of unsecured subordinated debt instruments and undisclosed reserves. Tier 1 capital is considered to be safer and more liquid than Tier 2. The sum of both tiers is used to calculate a bank's total capital. A bank must maintain a Tier 1 capital ratio of 6% and a total capital ratio of 8% of its risk-weighted assets (RWAs) under Basel III. Tier 2 could be the rest.

Banks were required to have a minimum total capital ratio of 8% under Basel II, but under Basel III, that ratio was increased to 6%, with Tier 1 assets accounting for the additional 4%. Additionally, Tier 3, an even more risky tier of capital, was excluded from the calculation under Basel III.