Basel III

What is "Basel III" A global regulatory standard on bank capital adequacy stress testing and market liquidity risk With a set of reform measures to improve regulation supervision and risk management

Aim To minimize the probability of recurrence of crises to 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

Target Bank-level, or micro prudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress . Macro prudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time .

Micro- prudential elements To minimize the risk contained with individual institutions The elements are: Definition of capital Enhancing risk Coverage of capital leverage ratio International liquidity framework

Macro- prudential elements To take care of the issues relating to the systemic risk The elements are: Leverage ratio Capital conservation buffer Countercyclical capital buffer Addressing the procyclicality of provisioning requirements

Definition of the three pillars - Pillar 1 Pillar 1- Minimum Capital Requirements Calculate required capital Required capital based on Market risk Credit risk Operational risk 3. Used to monitor funding concentration

Definition of the three pillars - Pillar 2 Pillar 2- Supervisory Review Process Bank Should have strong internal process Adequacy of capital based on risk evaluation

Definition of the three pillars - Pillar 3 Pillar 3 – Enhanced Disclosure Provide market discipline Intends to provide information about banks exposure to risk

The relationship among the three Second pillar - supervisory review process to ensure the first pillar - intended to ensure that the banks have adequate capital Third pillar - compliments first and second pillar - a discipline followed by the bank such as disclosing capital structure, tier- i and tier-ii capital and approaches to assess the capital adequacy i.e. assessment of the first pillar Model of commercial banks interpret first pillar as a closure threshold rather than bank’s asset allocation

Significant Methods of Measurement The pillar is divided in three types of risk for which capital should be held. Credit Risk Operational risk Market risk

Credit Risk Credit risk is the risk that those who owe you money will not pay you back. Historically credit risk is the larger risk banks run. BIS II proposes three approaches by which a bank may calculate its required capital for credit risk. Standardized approach Internal rating based (IRB) advanced Internal rating based (IRB) foundation

Operational risk Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Comparable to credit risk, BIS II proposes three methods for measuring operational risk. Basic indicator approach Standardized approach Advanced measurement approach (AMA)

Market Risk Market risk is the risk of losses due to changes in the market price of an asset. Market risk will only have to be calculated for assets in the trading book. Foreign exchange rate risk and commodities risk are part of the market risk. Two methods may be used: Standardized measurement method Internal models approach

Challenges in implementation of Basel III norms The new and stricter regulations of the basel3 like higher capital requirements, the new liquidity standard, the increased risk coverage, the new leverage ratio or a combination of the different requirements will be difficult to adopt by the banks Banks have to take a number of actions to meet the various new regulatory ratios, restoring of data Banks must be able to calculate and report the new ratios. Which requires the huge implementation effort. Banks usually have 3 types of challenges Functional challenges Technical challenges Organizational challenges

Functional challenges Developing specifications for the new regulatory requirements, such as the mapping of positions (assets and liabilities) to the new liquidity and funding categories in the LCR and NSFR calculations. The specification of the new requirements for trading book positions and within the CCR framework (e.g. CVA) as well as adjustments of the limit systems with regard to the new capital and liquidity ratios . Crucial is the integration of new regulatory requirements into existing capital and risk management as some measures to improve new ratios (e.g. liquidity ratios) might have a negative effect on existing figures .

Technical challenges The technical challenges includes the availability of data, data completeness, and data quality and data consistency to calculate the new ratios . The financial reporting system with regard to the new ratios and the creation of effective interfaces with the existing risk management systems .

Operational challenges The operational challenges includes stricter capital definition lowers banks’ available capital. At the same time the risk weighted assets (RWA) for securitizations, trading book positions and certain counterparty credit risk exposures are significantly increased. The stricter capital requirements, the introduction of the LCR and NSFR will force banks to rethink their liquidity position, and potentially require banks to increase their stock of high-quality liquid assets and to use more stable sources of funding .