A summary of the updated Basel III Proposals and Rules

Basel III Overview and Update - June 2010

Firstly, some Basel II History (Basel III Overview is below)

• Basel II was implemented by many European and Worldwide banks in 2006.
• The existing guidelines were found to be unsuitable to ensure adequate bank liquidity during the Credit Crunch conditions. Basel II rules are now being reviewed in conjunction with the industry.
• There are a number of criticisms of Basel II, including that the rules are influenced by the industry, and they are very dependent on rating agencies.
  
• There were a number of weaknesses exacerbated by the credit crunch including,
  
  
  • excessive leverage in the banking and financial system and not enough high quality capital to absorb losses;
    
  • excessive credit growth based on weak underwriting standards and under pricing of liquidity and credit risk;
    
  • insufficient liquidity buffers and overly aggressive maturity transformation, both direct and indirect (for example, through the shadow banking system);
    
  • inadequate risk governance and poor incentives to manage risks towards prudent long term outcomes, including through poorly designed compensation systems;
    
  • inadequate cushions in banks to mitigate the inherent procyclicality of financial markets and its participants;
    
  • too much systemic risk, and connected financial players with common exposures to similar shocks, and inadequate oversight that should have served to mitigate the too-big-to fail problem.

Basel III Key Facts

• Basel III is an update to the existing Basel II guidelines
  
• The updated rules will affect the Capital Requirements Directive that banks use to determine the minimum capital they should hold to adequately fund them through periods of financial stress
  
• Basel III is currently in the consultation phase and here are numerous changes to the framework that are being considered.
• There are two new rations that will be used in Basel III, see below.

New Proposed Ratios to measure and monitor Liquidity Risk

Liquidity Coverage Ratio

Introduction of a Liquidity Coverage Ratio - to promote the short-term resiliency of the liquidity risk profile of institutions by ensuring that they have sufficient high quality liquid resources to survive an acute stress scenario lasting for one month.

Net Stable Funding Ratio

To promote resiliency over longer-term time horizons by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing structural basis. The Net Stable Funding Ratio has been developed to
capture structural issues related to funding choices.

Financial Message Board

External link to an overview of Basel III Proposals