12th September 2010 saw the announcement of the new levels of capital reserves for Basel 3, the capital and liquidity package first proposed in December 2009. Basel 3 is a new regulation with the aim of preventing a repeat of the collapse in the financial system and the consequent economic slump, which began in 2007.
From a risk management perspective, the Basel committee aims to establish an international standard, to help banking regulators set capital regulations and to decide how they can best protect themselves against financial and operational risk. By promoting a more forward-looking approach to capital supervision, the committee hopes to encourage banks to both identify present and future risks and as a result, improve their ability to manage those risks.
In addition to confirming the new proposed rules from December 2009, the key feature of this new regulation is the new capital reserves requirement. The previous Basel 2 rules dictated that a bank held 2% of Core Tier 1 capital to risk-weighted assets, whereas the new stricter categorisation of “common equity” requires that banks hold 4.5% of common shares and retained income.Overall, the figure rises from 4.5% to 6% for total Tier 1 capital.
Moreover, Tier 1 capital will account for a higher proportion of total capital requirements against Tier 2 capital and Tier 3 will be rendered obsolete. Additional features of the package include two new capital buffers and significant revisions to what counts as bank capital.
While work still continues on propositions for proportionally higher capital requirements for banks deemed “systematically important”, the measures already agreed as part of the Basel 3 regulations will allow banks to strategize how they can best manage their operational risks and implement the level of change needed to insure against a future financial crisis.
Furthermore, Basel 3 comes with a generous time-frame for phasing in the new standards, which means that although changes to the banking system will start from January 2013, the regulations will not be fully implemented until as late as 2019.