Basel III
Basel III overview
 Concepts of Basel III 1/25/2016

Lessons of Financial Crisis –
• Insufficient common equity,
• Hybrid capital (Tier 2 and Tier 3) not sufficiently loss absorbent, • Insufficient capital buffers above minimum,
• Inadequate risk capture (Securitizations, Trading and derivatives activities, Counterparty credit risk),
• No constraint on leverage,
• No recognition of greater risk posed by systemically important banks,
• Insufficient liquidity and vulnerable structural liquidity profiles,
• Weak governance resulting in poor underwriting and risk management,
• Risk management/supervision overly focused at institutional level
• Systemic risks: procyclicality and interconnectedness

After the financial crisis, the Basel Committee has revised Basel II; Basel III introduced:

Strengthening the global capital framework; Capital conservation buffer ; Countercyclical buffer. Leverage ratio;
Global liquidity standard;

Capital

● Pillar 1
Capital: Quality and level of capital (Going Concern Capital, Gone concern capital), Capital conservation buffer,
Risk coverage: Securitizations, Trading book, Counterparty credit risk Containing leverage: Leverage ratio

● Pillar 2
Risk management and supervision: Supplemental Pillar 2 requirements.

● Pillar 3
Market discipline: Revised Pillar 3 disclosures requirements

New Definition of Capital According to Basel III, bank capital will be divided into two tiers:
– Tier 1 Capital (going-concern capital)-

• Common Equity Tier 1
• Additional Tier 1 – Tier 2 Capital (gone-concern capital)
• Common Equity Tier 1 must be at least 4.5% of Risk Weighted Assets (RWA) at all times.
• Tier 1 Capital must be at least 6.0% of RWA at all times.
• Total Capital (Tier 1 Capital plus Tier 2 Capital) must be at least 12.50% of RWA at all times.
• Tier 3 Capital, defined under Basel II, has been omitted from the definition of capital. Bangladesh Bank

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8. Capital Conservation Buffer 1/25/2016 Bangladesh Bank 8 • Banks are required to maintain a capital conservation buffer of 2.5%, comprised of Common Equity Tier 1 capital, above the regulatory minimum capital requirement of 10%. • The required minimum Common Equity Tier 1 capital will be 7.00% • Banks should not distribute capital in case capital level falls within this range. • However, they will be able to conduct business as normal when their capital levels fall into the conservation range as they experience losses. • Capital conservation buffer is applicable both solo and consolidated level.
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9. Individual bank’s minimum capital conservation Ratio 1/25/2016 Bangladesh Bank 9 CET1 Ratio Minimum Capital Conservation Ratio (expressed as percentage of earnings) 4.5% - 5.125% 100% >5.125% - 5.75% 80% >5.75% - 6.375% 60% >6.375% - 7.0% 40% >7.0% 0%
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10. Countercyclical buffer •Losses incurred in the banking sector can be extremely large when a downturn is preceded by a period of excess credit growth. •These losses can destabilize the banking sector and spark a vicious circle, whereby problems in the financial system can contribute to a downturn in the real economy that then feeds back on to the banking sector. •The countercyclical buffer aims to ensure that banking sector capital requirements take account of the macro- financial environment in which banks operate. 1/25/2016 Bangladesh Bank 10
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11. LEVERAGE RATIO 1/25/2016 Bangladesh Bank 11
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12. Leverage Ratio 1/25/2016 12 ● Containing leverage: • - Leverage ratio: To constrain the build-up of leverage in the banking sector and to reinforce the risk based requirements with a simple, non- risk based “backstop” measure, • Leverage ratio will be calculated through dividing the adjusted Tier 1 Capital by adjusted Exposure (both on balance and off balance sheet) • The Committee will test a minimum Tier 1 leverage ratio of 3% during the parallel run period from 1 January 2015 to 1 January 2017. Bangladesh Bank Leverage Ratio = Tier 1 Capital (after related deductions) Total Exposure (after related deductions)
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13. LIQUIDITY RATIO 1/25/2016 Bangladesh Bank 13
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14. Liquidity 1/25/2016 14 ● Global liquidity standard and supervisory monitoring: - Liquidity coverage ratio: The liquidity coverage ratio (LCR) will require banks to have sufficient high-quality liquid assets to withstand a 30- day stressed funding scenario that is specified by supervisors. - Net stable funding ratio: The net stable funding ratio (NSFR) is a longer-term structural ratio designed to address liquidity mismatches. It covers the entire balance sheet and provides incentives for banks to use stable sources of funding. - Supervisory monitoring : The liquidity framework includes a common set of monitoring metrics to assist supervisors in identifying and analyzing liquidity risk trends at both the bank and system-wide level. Bangladesh Bank
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15. Pillar 2 1/25/2016 15 ● Risk management and supervision: - Supplemental Pillar 2 requirements: - Address firm-wide governance and risk management; - capturing the risk of off-balance sheet exposures and securitization activities; managing risk concentrations; - providing incentives for banks to better manage risk and returns over the long term; - sound compensation practices; - valuation practices; stress testing; - accounting standards for financial instruments; - corporate governance; and - supervisory colleges. Bangladesh Bank
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16. Pillar 3 1/25/2016 16 ● Market discipline: - Revised Pillar 3 disclosures requirements: The requirements introduced relate to securitization exposures and sponsorship of off balance sheet vehicles. Enhanced disclosures on the detail of the components of regulatory capital and their reconciliation to the reported accounts will be required, including a comprehensive explanation of how a bank calculates its regulatory capital ratios. Bangladesh Bank
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17. Contrast Between Basel II and Basel III- Capital Structure 1/25/2016 17 Basel II Basel III Three (3) Tiers of Capital i.e. Tier 1, Tier 2 and Tier 3. Two (2) Tiers of Capital i.e. Tier 1 and Tier 2. Minimum CAR @10% of RWA and Minimum Tier 1 @50% of CAR. Minimum CAR(including capital conservation buffer) @12.5% of RWA, Minimum Tier 1 @6% of RWA and Minimum Common Equity Tier 1 @4.5% of RWA . Regulatory Deductions: 5-7 items (Goodwill, increase in equity from securitization exposure, Investments in unconsolidated subsidiaries, Reciprocal holding, Provision shortfall, deficit on account of revaluation of investments, Significant investment in financial entities) Regulatory Deductions: 11-14 items (Deductions in Basel II as well as Deferred tax assets, Cash flow hedge reserve, Defined benefit pension fund assets and liabilities, Investments in own shares, Mortgage servicing rights, Investments in the capital of financial entities that are outside the scope of regulatory consolidation) Capital Conservation Buffer @2.5% of RWA Leverage Ratio Liquidity Ratio Bangladesh Bank
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18. Contrast Between Basel II and Basel III - Calculation of RWA 1/25/2016 18 Basel II Basel III Credit Risk: Standardized Approach Internal Ratings Based (IRB) Approach Securitization framework Credit Risk: No changes in Standardized Approach Inclusion of Counterparty Credit Risk for IRB Approach Stringency in Securitization framework Market Risk: Standardized measurement method Internal Models Approach Market Risk: Stricter method for derivatives and complex securitizations held in the trading book as well as introduction of a stressed value at-risk framework for internal model approach Operational Risk: Basic Indicator Approach Standardized Approach, Advanced Measurement Approaches (AMA) No changes in operational risk. Bangladesh Bank
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19. Work plan for Basel III Implementation in Bangladesh - Roadmap 2015 2016 2017 2018 2019 Min.CET-1 Cap. 4.50% 4.50% 4.50% 4.50% 4.50% Cap.Con.Buffer(CCB) - 0.625% 1.25% 1.875% 2.50% Min.CET-1 + CCB 4.50% 5.125% 5.75% 6.375% 7.00% Min.T-1 Cap. 5.50% 5.50% 6.00% 6.00% 6.00% Min. Total Cap. 10.00% 10.00% 10.00% 10.00% 10.00% Min. Total Cap. +CCB 10.00% 10.625% 11.25% 11.875% 12.50% Leverage Ratio 3% 3% 3% Readjustment Migration to Pillar 1 L C R ≥100% (From Sep.) ≥100% ≥100% ≥100% ≥100% N S F R >100% (From Sep.) >100% >100% >100% >100% 1/25/2016 Bangladesh Bank 19
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20. BASEL II IMPLEMENTATION STATUS 1/25/2016 Bangladesh Bank 20
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21. Implementation Status (Pillar 1) Industry Scenario 1/25/2016 Bangladesh Bank 21 8.8 9.12 9.14 11.52 11.32 10.68 10.57 11.35 0 2 4 6 8 10 12 14 Mar,13 June,13 Sep,13 Dec, 13 Mar,14 June,14 Sep, 14 Dec, 14 Industry Average CAR (%) CAR MCR Linear (CAR)
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22. Implementation Status (Pillar 1) Industry Scenario 1/25/2016 Bangladesh Bank 22 8.8 9.12 9.14 11.52 11.32 10.68 10.57 11.35 0 2 4 6 8 10 12 14 Mar,13 June,13 Sep,13 Dec, 13 Mar,14 June,14 Sep, 14 Dec, 14 Industry Average CAR (%) CAR MCR Linear (CAR) If specialized banks are excluded, The average industry CAR will be 12.32% which is higher than required CAR 10% and very close to Basel III capital requirement 12.5%!
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23. Thank you! 1/25/2016 23Bangladesh Bank

1. Basel Ⅲ Chinwe Boston Mengchun Zhang Qiuli Guo Di Xiao Nathan Tsormetsri 2. Major ChangesImplementation of the Changes Objectives Aims OVERVIEW Meaning of Basel III Why Basel III 3. market liquidity risk stress testing and bank capital adequacyWhat is "Basel III": " A global regulatory standard on: 4. 4. Risk management Supervision RegulationAlso a set of reform measures toimprove: 5. 5. Failures of Basel II being:A.Reasons for Basel III Formulation: Inability to strengthen financial stability.B. Insufficient capital reserve.C. Inadequate comprehensive risk management approach.D. Lack of uniformed definition of capital . 6. 6. Aims & To minimize the probability ofObjectives of Basel III To improve the banking sectorsrecurrence of crises to greater extent. Toability to absorb shocks arising from financial and economic stress. To strengthen banksimprove risk management and governance. transparency and disclosures . 7. 7. Targets:Bank-level or micro prudential which will help raise the resilience of individual banking institutions in periods of stress.Macro prudential system wide risks that build up across the banking sector as well as the pro-cyclical amplification of these risk over time. 8. 8. Key Elements of Reforms…Increasing the quality and quantity capital Enhancing risk coverage of capital Introducing Leverage ratio Improving liquidity rules Establishing additional buffers Managing counter party risks 9. 9. Structure of Basel II 10. 10. Pillar 1:Minimum CapitalRequirements• Pillar 1 aligns the minimum capital requirements more closely to actual risks of banks economic loss.• revised risks: √ Credit risk √ Operational risk √ Market risk 11. 11. Pillar 1:Minimum CapitalRequirements(cont.)• Credit risk √ The standardised approach √ Foundation internal ratings based (IRB) approach √ Advanced IRB approach• Operational risk √ Basic indicator approach √ Standardized approach √ Advanced measurement approach• Market risk √ standardized approach √ internal models approach 12. 12. Pillar 2:Supervisory Review Process• Pillar 2 requires banks to think about the whole spectrum of risks they might face including those not captured at all in Pillar 1 such as interest rate risk.• Coverage in Pillar 2: √ risks that are not fully covered by Pillar 1 √ Credit concentration risk √ Counterparty credit risk √ Risks that are not covered by Pillar 1 √ Interest rate risk in the banking book √ Liquidity risk √ Business risk √ Stress testing 13. 13. Pillar 3 is designed to increase thePillar 3:Market Discipline transparency of lenders risk profile by requiring them to give details of their risk management and risk distributions. 14. 14. Systemic banks.Liquidity risk.Pro-cyclicality.Weaknesses of Basel IIThe quality of capital. 15. 15. Basel III: Strengthening the global capital framework A. Capital reform. B. Liquidity standards. C. Systemic risk and interconnectedness. 16. 16. Capital conservation A new definition of capital.A. Capital Reform Minimum capital standards. Countercyclical capital buffer.buffer. 17. 17. Total regulatory capital will consist ofA new definition of capital the sum of the following elements: 1. Tier 1 Capital (going-concern capital) a. Common Equity Tier 1 b. Additional Tier 1 2. Tier 2 Capital For each of the three categories above (1a, 1b(gone-concern capital) and 2) there is a single set of criteria that instruments are required to meet before inclusion in the relevant category. 18. 18. The capital conservation buffer is designedCapital conservation buffer to ensure that banks build up capital buffers outside periods of stress A capital conservationwhich can be drawn down as losses are incurred. buffer of 2.5%, comprised of Common Equity Tier 1, is established above Outside of periods ofthe regulatory minimum capital requirement. stress, banks should hold buffers of capital above the regulatory minimum. 19. 19. The countercyclical buffer aims toCountercyclical capital buffer ensure that banking sector capital requirements take account of the It will bemacro- financial environment in which banks operate. deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. 20. 20. Minimum capital standards 21. 21. B. Liquidity Standards: 1. Short-term: Liquidity Coverage Ratio(LCR) 2. Long-term: Net Stable Funding Ratio(NSFR) 22. 22. The LCR is a response from Basel committeeto the recent1.Short-term:LCR financial crisis. The LCR proposalrequires banks to hold high quality liquidassets in order to survive in emergent stressscenario. 23. 23. high The higher the better. Must be no lower than 1.Short-term:LCR quality liquid: liquid in markets during a time of stress and, ideally, Banks are still expected to conduct their ownbe central bank eligible. stress tests to assess the level of liquidity they should hold beyond this minimum, and construct scenarios that could cause difficulties for their specific business activities. 24. 24. To promote more medium and long-term2. Long-term:NSFRObjectives: Ensure that the investmentfunding activities of banking organizations. To limit theactivities are funded by stable liabilities. over-reliance on wholesale short-term funding(money market) 25. 25. Long-term:NSFRAvailable stable funding (ASF) is defined as the total preferred stock with maturity of capital.amount of an institution’s: liabilities with effectiveequal to or greater than one year. deposits and/or term deposits withmaturities of one year or greater. maturities of less than one year that would be expected to stay with the institution for an extended period a stress event. 26. 26. The required amount of stable funding isRequired Stable Funding: calculated as the sum of the value of the assets held and funded by the institution, multiplied by a RSF factor, added to the amount of OBS activity (or potential liquidity exposure) multiplied by its associated RSF factor. 27. 27. Required Stable Funding These components of required stable funding are 85% of loans 100% of loans longer than one year.not equally weighted. 50% ofto retail clients with a remaining life shorter than one year. loans to corporate clients with a remaining life shorter than one year. off-balance sheetand 20% of government and corporate bonds. categories are also weighted. 28. 28. CapitalC. Systemic risk and interconnectedness (Counterparty risk) Higher capital for systemicincentives for using CCPs for OTC. Contingent Higher capital for inter-financial exposures.derivatives. Capital surcharge for systemic banks.capital. 29. 29. Basel III introduces a paradigm shift in capital andCONCLUSION It was constructed and agreed in relatively recordliquidity standards. The final implementationtime which leaves many elements unfinished. date a long way off. 30. 30. Market pressure and competitor pressure already drivingHOWEVER, Firms therefore should ensureconsiderable change at a range of firms. to engage with Basel III as soon as possible to be competitively advantaged in the new post- crisis financial risk and regulatory landscape. 31. 31. Basel II:References: a guide to capital adequacy standards for Lenders. [Available at: Basel III regulations: ahttp://www.cml.org.uk/cml/policy/issues/748] practical overview. [Available at: www.moodysanalytics.com] [Accessed on Basel III: Issues and implications. [Available at:30/11/12]. Federal Reserve Proposes Revisedwww.kpmg.com] [Accessed on 30/11/12]. Bank Captial Rules. [Available at: http://blogs.law.harvard.edu/corpgov/2012/06/12/federal- reserve-proposes-revised-ba...] [Accessed on 30/11/12]. Introduction to Basel II: [Available at: Introduction to Basel II.http://www.rcg.ch/papers/basel2.pdf] [Available at: http://www.horwathmak.com/Literature/Introduction_to_basel_ii. pdf] 32. 32. http://mpra.ub.uni-muenchen.de/35908/ [Accessed onReferences: (Cont.) The New Basel III Framework: Implications for Banking11/12/2012] Organisations. [Available at: www.shearman.com][Accessed on 30/11/12].