Basel III is the third Basel Accord, an international regulatory framework for banking supervision that was introduced by the Basel Committee on Banking Supervision. It aims to strengthen the banking sector's ability to absorb shocks arising from financial and economic stress, thus promoting financial stability.
The Basel III framework was developed as a response to the global financial crisis that began in 2007-2008. The crisis revealed weaknesses in the regulatory framework, particularly with regard to capital adequacy and risk management practices of banks. Basel III was designed to address these weaknesses and enhance the resilience of the banking system.
Minimum capital requirements: Basel III introduces stricter capital requirements for banks, particularly in terms of the quality and quantity of capital they hold. Banks are required to maintain a higher Common Equity Tier 1 capital ratio, which represents high-quality capital in relation to their risk-weighted assets.
Capital conservation buffer: Banks are required to build and maintain a capital conservation buffer, which is an additional layer of capital above the minimum capital requirements. This buffer is designed to ensure that banks have sufficient capital during periods of stress and economic downturns.
Liquidity requirements: Basel III introduces new liquidity standards that require banks to maintain a minimum level of stable funding to withstand short-term liquidity stress. It also introduces a liquidity coverage ratio that ensures banks have sufficient high-quality liquid assets to meet their short-term obligations.
Leverage ratio: Basel III introduces a leverage ratio as a supplementary measure to the risk-based capital requirements. The leverage ratio sets a limit on the amount of leverage a bank can have by comparing its tier 1 capital to its total exposure.
Countercyclical capital buffer: Basel III includes a countercyclical capital buffer that can be activated during periods of excessive credit growth to build up additional capital in the banking system and mitigate systemic risks.
Enhanced risk management: The framework emphasises the importance of robust risk management practices and requires banks to have comprehensive risk management frameworks in place, including better risk measurement and reporting.
Basel III has been gradually implemented by national regulators around the world since its introduction in 2010. The framework aims to create a more resilient banking system that is better able to withstand financial shocks and contribute to overall financial stability.
