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BASEL
Chinwe Boston
Mengchun Zhang
Qiuli Guo
Di Xiao
Nathan Tsormetsri
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OVERVIEW
Meaning of Basel III
Why Basel III
Aims
Objectives
Major Changes
Implementation of the Changes
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WHATIS"BASELIII":
" A global regulatory standard on:
bank capital adequacy
stress testing and
market liquidity risk
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ALSOASETOFREFORMMEASURESTO
IMPROVE:
Regulation
Supervision
Risk management
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REASONSFORBASELIII FORMULATION:
Failures of Basel II being:
A. Inability to strengthen financial stability.
B. Insufficient capital reserve.
C. Inadequate comprehensive risk management approach.
D. Lack of uniformed definition of capital .
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AIMS& OBJECTIVESOFBASELIII
To minimize the probability of recurrence of crisesto greater extent.
To improve the banking sector's ability to absorb
shocks arising from financial and economic stress.
To improve risk management and governance.
To strengthen banks' transparency and disclosures .
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TARGETS:
Bank-level or micro prudential which will help raise the
resilience of individual banking institutions in periods of
stress.
Macro prudential system wide risks that build up across
the banking sector as well as the pro-cyclical
amplification of these risk over time.
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KEYELEMENTSOFREFORMS
Increasing the quality and quantity capital
Enhancing risk coverage of capital
Introducing Leverage ratio
Improving liquidity rules
Establishing additional buffers
Managing counter party risks
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STRUCTUREOFBASELII
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PILLAR1:MINIMUMCAPITALREQUIREMENTS
Pillar 1 aligns the minimum capital requirementsmore closely to actual risks of bank's economic
loss.
revised risks:
Credit risk
Operational risk
Market risk
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PILLAR1:MINIMUMCAPITAL
REQUIREMENTS(CONT.)
Credit risk The standardised approach Foundation internal ratings based (IRB) approachAdvanced IRB approach
Operational risk Basic indicator approach Standardized approach Advanced measurement approach
Market risk standardized approach internal models approach
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PILLAR2:SUPERVISORYREVIEWPROCESS
Pillar 2 requires banks to think about the whole spectrum of risksthey might face including those not captured at all in Pillar 1 such
as interest rate risk.
Coverage in Pillar 2: risks that are not fully covered by Pillar 1
Credit concentration risk
Counterparty credit risk
Risks that are not covered by Pillar 1 Interest rate risk in the banking book
Liquidity risk
Business risk
Stress testing
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PILLAR3:MARKETDISCIPLINE
Pillar 3 is designed to increase the transparency of
lenders' risk profile by requiring them to give details
of their risk management and risk distributions.
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WEAKNESSESOFBASELII
The quality of capital.
Pro-cyclicality.
Liquidity risk.
Systemic banks.
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BASELIII: STRENGTHENINGTHEGLOBALCAPITAL
FRAMEWORK
A. Capital reform.
B. Liquidity standards.
C. Systemic risk and interconnectedness.
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A. CAPITALREFORM
A new definition of capital.
Capital conservation buffer.
Countercyclical capital buffer.
Minimum capital standards.
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A NEWDEFINITIONOFCAPITAL
Total regulatory capital will consist of the sum ofthe following elements:
1. Tier 1 Capital (going-concern capital)
a. Common Equity Tier 1b. Additional Tier 1
2. Tier 2 Capital (gone-concern capital)
For each of the three categories above (1a, 1b and2) there is a single set of criteria that instrumentsare required to meet before inclusion in therelevant category.
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CAPITALCONSERVATIONBUFFER
The capital conservation buffer is designed to ensure thatbanks build up capital buffers outside periods of stresswhich can be drawn down as losses are incurred.
A capital conservation buffer of 2.5%, comprised ofCommon Equity Tier 1, is established above theregulatory minimum capital requirement.
Outside of periods of stress, banks should hold buffers ofcapital above the regulatory minimum.
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COUNTERCYCLICALCAPITALBUFFER
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.
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MINIMUMCAPITALSTANDARDS
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B. LIQUIDITYSTANDARDS:
1. Short-term: Liquidity Coverage Ratio(LCR)
2. Long-term: Net Stable Funding Ratio(NSFR)
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1.SHORT-TERM:LCR
The LCR is a response from Basel
committee to the recent financial crisis. The
LCR proposal requires banks to hold highquality liquid assets in order to survive in
emergent stress scenario.
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SHORT-TERM:LCR
Must be no lower than 1.
The higher the better.
high quality liquid: liquid in markets during a time ofstress and, ideally, be central bank eligible.
Banks are still expected to conduct their own stress teststo assess the level of liquidity they should hold beyondthis minimum, and construct scenarios that could causedifficulties for their specific business activities.
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2. LONG-TERM:NSFR
Objectives:
To promote more medium and long-term funding
activities of banking organizations.
Ensure that the investment activities are funded bystable liabilities.
To limit the over-reliance on wholesale short-term
funding(money market)
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LONG-TERM:NSFR
Available stable funding (ASF) is defined as the totalamount of an institutions:
capital.
preferred stock with maturity of equal to or greater thanone year.
liabilities with effective maturities of one year or greater.
deposits and/or term deposits with maturities of less thanone year that would be expected to stay with theinstitution for an extended period a stress event.
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REQUIREDSTABLEFUNDING:
The required amount of stable funding is calculated
as the sum of the value of the assets held andfunded by the institution, multiplied by a RSF factor,
added to the amount of OBS activity (or potential
liquidity exposure) multiplied by its associated RSF
factor.
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REQUIREDSTABLEFUNDING
These components of required stable funding are notequally weighted.
100% of loans longer than one year.
85% of loans to retail clients with a remaining life shorterthan one year.
50% of loans to corporate clients with a remaining lifeshorter than one year.
and 20% of government and corporate bonds.
off-balance sheet categoriesare also weighted.
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C. SYSTEMICRISKAND
INTERCONNECTEDNESS(COUNTERPARTYRISK)
Capital incentives for using CCPs for OTC.
Higher capital for systemic derivatives.
Higher capital for inter-financial exposures.
Contingent capital.
Capital surcharge for systemic banks.
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CONCLUSION
Basel III introduces a paradigm shift in
capital and liquidity standards.
It was constructed and agreed in relativelyrecord time which leaves many elements
unfinished.
The final implementation date a long way off.
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HOWEVER,
Market pressure and competitor pressure
already driving considerable change at a
range of firms.
Firms therefore should ensure to engage
with Basel III as soon as possible to be
competitively advantaged in the new post-
crisis financial risk and regulatory
landscape.
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REFERENCES:
Basel II: a guide to capital adequacy standards for Lenders.[Available at: http://www.cml.org.uk/cml/policy/issues/748]
Basel III regulations: a practical overview. [Available at:www.moodysanalytics.com] [Accessed on 30/11/12].
Basel III: Issues and implications. [Available at: www.kpmg.com][Accessed on 30/11/12].
Federal Reserve Proposes Revised Bank Captial Rules. [Availableat: http://blogs.law.harvard.edu/corpgov/2012/06/12/federal-reserve-proposes-revised-ba...] [Accessed on 30/11/12].
Introduction to Basel II: [Available at:http://www.rcg.ch/papers/basel2.pdf]
Introduction to Basel II. [Available at:http://www.horwathmak.com/Literature/Introduction_to_basel_ii.pdf]
http://www.cml.org.uk/cml/policy/issues/748http://www.moodysanalytics.com/http://www.kpmg.com/http://www.rcg.ch/papers/basel2.pdfhttp://www.horwathmak.com/Literature/Introduction_to_basel_ii.pdfhttp://www.horwathmak.com/Literature/Introduction_to_basel_ii.pdfhttp://www.rcg.ch/papers/basel2.pdfhttp://www.kpmg.com/http://www.moodysanalytics.com/http://www.cml.org.uk/cml/policy/issues/748 -
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REFERENCES: (CONT.)
http://mpra.ub.uni-muenchen.de/35908/[Accessed
on 11/12/2012]
The New Basel III Framework: Implications for
Banking Organisations. [Available at:
www.shearman.com][Accessed on 30/11/12].
http://mpra.ub.uni-muenchen.de/35908/http://www.shearman.com/http://www.shearman.com/http://mpra.ub.uni-muenchen.de/35908/http://mpra.ub.uni-muenchen.de/35908/http://mpra.ub.uni-muenchen.de/35908/