Let’s travel to the past a little. In the 1980’s in Basel, which is a medieval town in Switzerland, the big financial regulators defined a philosophy to increase the financial stability. The Basel Committee’s aims were improving supervisory and risk management, sharing issues, exchanging information on developments and enhancing cross-border cooperation. The Basel Committee created an international framework for internationally active banks and these are called the Basel Accords.
The first pillars of Basel I were settled in 1988, Basel II, were published in 2004 and implemented gradually in the years after. But in 2008 The Global Financial Crisis happened and it has taught us that the stability of the financial market, once collapsed, can't be quickly revived. Since then every move of the banking industry has been monitored and all eyes have been fixed on it. Many people say that the big crisis could have been avoided if we had another regulatory philosophy. The latest framework, Basel III was published in 2010 and it is invented to avoid economic shocks and governs how much risk banks can take. However, this big economic breakdown raises an important question: Is the Basel III sufficient?
Below I would like to examine how the Basel III Framework increases the financial stability. To understand the current situation we have to get an insight to what is Basel III exactly about? A speech by Wayne Byres summarize these key elements well:
- Banks have to increase their core tier-one capital ratio to 4.5% by 2015. Furthermore, they will have to carry a further "counter-cyclical" capital conservation buffer of 2.5% by 2019.
- Basel III requires banks to maintain higher levels of capital, with minimum common equity holdings at banks increasing from 2% to 7% of risk weighted assets.
- Banks have to hold higher-quality forms of capital, with common equity at the core of the requirements, and standards to ensure other types of capital instruments are genuinely loss-absorbing.
- The new rules improve risk coverage, particularly for complex, illiquid trading activities and off-balance sheet exposures.
- A capital conservation buffer is introduced, designed to enforce corrective action when a bank’s capital ratio deteriorates, and a countercyclical buffer to require banks to hold more capital in good times to prepare for the inevitable rainy days ahead.
- A leverage ratio is added as a backstop for the risk-based capital approach, to ensure banks do not become unduly leveraged on a non-risk-weighted basis.
- Lastly, Basel III introduced the first ever international standards for bank liquidity and funding, designed to promote the resilience of a bank’s liquidity risk profile to both short and longer-term disruptions.
Source: Basell III: necessary but not sufficient– Speech by Wayne Byres
As you can see the Basel III sets a big amount of minimum capital requirements and these are raised year by year. Their aim is to restore and increase the financial stability. But the whole policy has drawbacks. Due to these the Basel III can’t be sufficient.
The problem can be easily seen: these are just minimum standards. It is not enough to having a set of local rules titled ‘Basel III’. The consistent implementation of Basel III around the world is the key. The supervision is as important as the implementation. The Basel Committee has published a reasonable framework but without supervisory system they will not meet their objectives.
To achieve the goals of policy reform, the big regulators have to make sure that these reforms are implemented by national authorities consistently. Basel III helps revive the financial health of the banking system, but if weaknesses remain in the prudential framework that will undermine the improvements.
Sources: Articles from www.businessweekme.com, www.investopedia.com