Basel III

What is Basel III?

Basel III is a regulatory framework, an extension in the Basel Accords, I & II designed and agreed
upon by the members of the Basel Committee on Banking Supervision to strengthen the capital
requirements of banks and mitigate risk. This is done by requiring the banks to hold more capital
reserves against their assets which would in turn reduce the capacity of banks to get leverage.
Explanation
The Basel Committee on Banking Supervision was established in 1974 with the aim to ensure
financial stability by making stringent regulations on banking practices and finances. The committee
comprised of governors from central banks of ten different countries – headquartered in Basel,
Switzerland.
The Basel committee initially consisted of the G10 members. Later in 2009, it expanded the
membership to institutions from Brazil, Australia, India, Saudi Arabia, Russia, Japan, Italy, Mexico,
Argentina, Canada, Belgium, Indonesia, Switzerland, South Africa, the United Kingdom, & the US.
Objectives
Basel III introduced reforms that aimed to mitigate risk in the banking system. The objective behind
the accord is to keep more security as a reserve before raising money. It is aimed at enhancing the
banking regulatory framework that was prescribed in the earlier Basel accords. It emphasized
improving the resilience of banks by considering financial and risk management with stress testing in
extreme situations. It ensures strengthening of banks during times of liquidity crisis & fin. distress.
Implementation
Basel III came into existence upon agreement by members of BCBS in November 2010. The
implementation was scheduled from 2013 but suffered repeated extension in the rollout. The first
scheduled for March 2019 while the second schedule is due in Jan 2022.
Basel III Pillars

1. Requiring banks to maintain minimum capital reserve along with an additional layer of buffer
in common equity.
2. Stress testing the banking system by implementation of leverage requirements.
3. Additional capital and liquidity requirements for systematically important banks.

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Basel III Rules

Criticism
1. Capital reserve requirements will reduce competition in the banking sector as the barriers to
entry increase. Critics argue that stringer norms will shield the sector in adverse ways.
2. Leverage and capital adequacy requirements will also impact efficiencies of bigger banks
who have had consistent growths based on stable margins.
3. The risk-weighting methodology is the same in Basel III to calculate RWAs as it was
in Basel II. This might give importance to rating agencies that rate assets based on riskiness.
Critics argue that such reliance on rating agencies is troublesome at least after the 2008 subprime
crisis.
4. Basel III criticism is not limited to its principles and regulations but also the implementation.
5. Critics have repeatedly underscored the delay in implementation of the framework.
6. American Bankers Association criticized the regulation stating that Basel III would not only
impact but cripple the smaller banks in the United States.
Impact
Stringent Basel II norms will certainly make an impact on the ease of business that banks around the
globe enjoy. The tightened requirements of the capital buffer, leverage, and liquidity will hit the
profitability and margins of the banks. For example, a higher capital requirement introduced in Basel
III will cut banks’ profits to some extent. The size of loan disbursements will be directly affected by
the capital reserve requirement.
Conclusion
Basel III is arguable a good step in strengthening the banking environment after the global financial
crisis in 2008. The crisis showed that bigger banks are eyeing rapid expansion without giving due
weightage to riskier lending. The result was a pressing need for a stricter framework that could
regulate leverage, liquidity, and capital buffer within the sector.
It was introduced with revisions and strength to the principles of Basel II. The new framework
prescribes higher capital adequacy with respect to RWAs, capital conservation buffers, and
countercyclical buffer with respect to RWAs, thus emphasizing strengthening the international
banking system.
However, it has certain weaknesses that expose the sector to inefficiencies. It was widely accepted,
and implementation was carried out across the globe. However, harmonization of banking
regulations around the world can also lead to deteriorating results as some countries already have
better frameworks.
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Overview of Basel III Framework in Pakistan
With the implementation of Basel III, all banks/ DFIs would be required to comply with the capital
adequacy framework which comprises the following three capital standards:

1. Minimum Capital Requirement (MCR):

The MCR standard sets the nominal amount of capital banks/ DFIs are required to hold. No bank/
DFI shall commence and carry on its business in Pakistan unless it meets the nominal capital
requirements prescribed by SBP from time to time.
The existing MCR standard of Paid-up capital (net of losses) consists of sum of the following
elements:
 Fully Paid-up Common Shares/ Cash deposited with SBP1
 Balance in Share premium Account
 Reserve for issue of Bonus Shares
 Any other type of instrument approved by the SBP.
Less
 Accumulated Losses/ Discount offered on issue of shares
 Negative General Reserves
In view of the global slowdown SBP has revised the MCR downwards from Rs.23 B to Rs.10 B.
2. Capital Adequacy Ratio:
The Capital Adequacy Ratio (CAR) assesses the capital requirement based on the risks faced by the
banks/ DFIs. The banks are required to comply with the minimum requirements as specified by SBP
on standalone as well as consolidated basis.
The Capital Adequacy Ratio (CAR) is calculated by taking the Eligible Regulatory Capital as
numerator and the total Risk Weighted Assets (RWA) as denominator.

Currently, banks/ DFIs are required to maintain a minimum CAR of 10 percent on an ongoing basis
at both standalone and consolidated basis.
Operational risk is the last 3 years of profitability and assessing between those. Operational risk is
how you are running your business as a whole. Mark
Tiered 2 capital is capital which is not diretly core capital or the basis of capital. For example when
the directors of the company give a loan to the company itself it is considered equity but looked at as
the tier 2 capital and it is not purely direct.
Correspondent banking is having a Nostro account in one country and making payments for it with
an account in another country so Vostro is inside the country and nostro is outside the country.
3. Leverage Ratio:
Tier-1 Leverage Ratio of 3% is being introduced in response to the recently published Basel III
Accord as the third capital standard (parallel run to commence from March 31, 2014) which is
simple, transparent and independent measure of risk.

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Under Basel III rules, minimum Tier 1 leverage ratio of 3% is being prescribed both at solo and
consolidated basis.

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