Finance Basel 3

Basel III is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to improve banks’ ability to absorb shocks arising from financial stress, thereby reducing the risk of spillover from the financial sector to the real economy.

One of the core pillars of Basel III is the enhancement of bank capital requirements. The reforms increase both the quantity and quality of regulatory capital that banks must hold. Tier 1 capital, which represents a bank’s core strength, is significantly emphasized. Common Equity Tier 1 (CET1), the highest quality capital, receives particular attention, with stricter definitions and higher minimum requirements. This strengthens banks’ ability to absorb losses without triggering a failure.

Beyond capital requirements, Basel III introduces a leverage ratio, which is a supplementary measure to the risk-weighted capital ratios. The leverage ratio acts as a backstop, limiting the amount of on- and off-balance sheet leverage a bank can undertake, regardless of the risk weighting of its assets. This prevents banks from becoming excessively leveraged, even if their risk-weighted assets appear well-capitalized.

Liquidity risk management is another vital component of Basel III. The reforms introduce two key liquidity ratios: the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). The LCR requires banks to hold enough high-quality liquid assets to cover their net cash outflows over a 30-day stress scenario. The NSFR promotes longer-term funding stability by requiring banks to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities.

Basel III also addresses systemic risk by introducing measures aimed at systemically important banks (SIBs). These banks, due to their size, interconnectedness, and complexity, pose a greater threat to the stability of the financial system if they were to fail. SIBs are subject to higher capital surcharges, stricter supervisory oversight, and enhanced resolution planning requirements. These measures aim to reduce the likelihood of SIB failures and to ensure that, if a failure does occur, it can be managed in an orderly manner without destabilizing the broader financial system.

The implementation of Basel III has been phased in over several years. While the initial timelines have been extended in response to economic developments, the core principles remain crucial for promoting a more resilient and stable banking sector globally. Ongoing monitoring and evaluation of the Basel III framework are essential to ensure its effectiveness in mitigating systemic risk and fostering financial stability.