Basel III is a new set of international banking regulations and the successor of Basel I & II. These regulations were put in place by the Basel Committee on Banking Supervision (BCBS), an entity led by the central bank governors of the Group of Ten (G10) and 27 other jurisdictions.
Basel III’s draft was finalized in 2010, its reforms are a reaction to the 2008 financial crisis. The intention is to set in place a banking structure that can handle future financial shocks. Some reforms were rolled out through the 2010s, but starting January 1, 2023, Basel III started implementing the entirety of its regulation system and will gradually ramp up through the next five years.
Basel III introduces 3 key changes -
Minimum capital requirements for banks will increase from 2% to 4.5%, to ensure bank holdings have enough to sustain operating losses and still honor withdrawals. On top of this 2.5% increase, banks will also be required to add an additional 2.5% buffer to their capital requirement. This is to ensure the bank will be able to endure a financial stressor, such as a crisis. This overall increases capital requirements from 2% to 7%.
A leverage ratio (measures debt) of 3%. This percentage can be higher depending on the entity. For example, insured bank holdings can have 5% and financial institutions can have 6%. This was put in place to manage highly leveraged entities to safeguard potential losses.
Regulations on Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). Both are implemented as a way to ensure banks are liquid enough to withstand financial stress. LCR is the way to measure short-term resilience and NSFR measures long-term.
A bank’s LCR is required by Basel to be 100% since 2019 - it's calculated by dividing high-quality liquid assets (HQLA) by estimated cash outflows during a 30-day period. This means banks need to have enough liquid assets (ex: short-term securities & cash equivalents) to cover all cash outflows for at least 30 days.
A bank’s NSFR is the amount of stable current funding compared to the amount of required funding over a year, which should be 100%.
Critics of Basel III note that regulations such as the capital requirement will make banks less profitable and push them to increase interest rates. Additionally, some fear that the regulations will hurt small businesses as banks may increase the capital holdings for mortgages and SME loans.
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