Introduction
Basel III is the regulatory norms for setting common standards for banks across different countries. The motive of Basel III norms is to enhance the regulation, supervision, and risk management in the banking industry.
Understanding Basel III
The Basel III norms seek to improve the ability of banks to handle stress. The norms specify leverage ratios and capital requirements to regulate the working of banks.
What You Should Know
Basel III norms were introduced in 2009 post the credit crisis of 2008. The first version of Basel III was published in late 2009. It gave a window period of three years to meet the Basel III requirements.
Basel III norms have introduced strong capital ratios by increasing the minimum Tier 1 capital from 4% to 6%, and minimum Common Equity Tier 1 capital from 4% to 4.5%.
Bank’s regulatory capital is divided into Tier 1 and Tier 2. Tier 1 capital is subdivided into Common Equity Tier 1 and additional Tier 1 capital. There is the highest level of subordination in security instruments of Tier 1 capital.
a. Common equity Tier 1 capital includes equity instruments that carry discretionary dividends and no maturity.
b. Additional Tier 1 capital consists of securities that are subordinated to most subordinate debt, with no maturity date, and dividends that can be cancelled at any time.
c. Tier 2 capital consists of unsecured subordinated debt with a maturity of at least five years.
The bucketing method is used to group banks according to their size and importance in the economy.
To ensure there is sufficient liquidity during a financial crisis, Basel III norms specify safeguards against excessive borrowings by banks.
Basel III norms are meant to make banks more resilient and reduce the risk of shocks from global banking issues.
Basel III specified tighter capital requirements as compared to Basel I and Basel II.
