Basel III

What is the definition of a Basel III in finance? 

Definition

Basel III is the third part of a three series international banking accord known as the Basel Accords. It was first created by the Basel Committee on Bank Supervision in 1988 with the Basel I and has since evolved into a three-part series with each part designed to specifically meet certain banking demands.

The Basel III is the third part of the Basel Accord series which stands as a continuation of the ‘three pillars’ of the Basel II. It was created in response to a credit crisis, therefore, requiring banks to maintain a good level of leverage ratios and minimum capital requirements.

Understanding Basel III

Following the collapse of the Lehman Brothers in 2008 and the financial crisis that rallied around that era, the BCBS further developed the Basel Accords. The first version of the Basel III was designed in late 2009, and as of November 2010, the BCBS came to an agreement of the capital and liquidity structure of the development which resulted in the creation of Basel III. It was first scheduled to be introduced in 2013, and its implementation repeatedly extended with expected completion by January 2022.

The major target of the Basel III is financial institutions that have been considered too great to fall, “systematically important banks” as the BCBS puts it. It requires that such banks have a minimum amount of common equity and minimum liquidity ratio to avoid crashes that can affect the economy. Its goal is to supervise, regulate, and manage risk within a financial institution.

The Basel III does not effect any change on the risk-weighted assets (RWA) guidelines which require that banks maintain 8% of its RWA. A bank’s credit risk level can be assessed its risk-weighted assets. The heavier the weight the higher the credit risk. However, compared to Basel II, Basel III is able to strengthen regulatory capital ratios. Here, the minimum Common Equity Tier 1 capital is increased from 4% to 4.5% and the minimum Tier 1 is increased from 4% to 6%.

The Basel III also introduced countercyclical measures that deal with the regulatory capital for big banks to use against cyclical alterations on their balance sheets. It works in such a way that during credit expansion it will be required of banks to reserve additional capital, while in the course of credit contraction it will be required of banks to loosen capital requirements. The capital requirements are allocated according to the sizes of the banks. The bucketing method was then introduced to aid the grouping of banks according to their sizes. With its leverage and liquidity requirements, the Basel III is able to prevent banks from excessive borrowings and ensure that they have enough liquidity to last through a financial crisis.