Basel III

BASEL III (sometimes "Basel 3") refers to a new update to the Basel Accords that is under development. The Bank for International Settlements (BIS) itself began referring to this new international regulatory framework for banks as "Basel III" in September 2010. The Basel Committee of banking supervision’s idea is to strengthen global capital and liquidity regulations with goal of promoting resilient banking sector

The draft Basel III regulations include:
1. "tighter definitions of Common Equity; banks must hold 4.5% by January 2015, then a further 2.5%, totaling 7%.
2. the introduction of a leverage ratio,
3. a framework for counter-cyclical capital buffers,
4. measures to limit counterparty credit risk,
5. and short and medium-term quantitative liquidity ratios."

Summary of Changes Proposed in Basel III
1 First, the quality, consistency, and transparency of the capital base will be raised.
Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings
Tier 2 capital instruments will be harmonized
Tier 3 capital will be eliminated.
2 Second, the risk coverage of the capital framework will be strengthened. Strengthen the capital requirements for counterparty credit exposures arising from banks’ derivatives, repo and securities financing transactions. Raise the capital buffers backing these exposures, reduce procyclicality and provide additional incentives to move OTC derivative contracts to central counterparties (probably clearing houses). Provide incentives to strengthen the risk management of counterparty credit exposures
3 Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework.
The Committee therefore is introducing a leverage ratio requirement that is intended to achieve the following objectives:
a. Put a floor under the build-up of leverage in the banking sector
b. Introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simpler measure that is based on gross exposures.
4 Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers").
The Committee is introducing a series of measures to address procyclicality:
Dampen any excess cyclicality of the minimum capital requirement;
a. Promote more forward looking provisions;
b. Conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and
c. Achieve the broader macro prudential goal of protecting the banking sector from periods of excess credit growth.
d. Requirement to use long term data horizons to estimate probabilities of default,
e. downturn loss-given-default estimates, recommended in Basel II, to become mandatory
f. Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements.
g. Banks must conduct stress tests that include widening credit spreads in recessionary scenarios.
h. Promoting stronger provisioning practices (forward looking provisioning):
i. Advocating a change in the accounting standards towards an expected loss (EL) approach (usually, EL amount := LGD*PD*EAD).

5 Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio.
The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.