What is Basel III?

The regulations imposed on the banking industry in the years following the 2008 financial crisis are extremely convoluted in the eyes of some experienced financiers, let alone the average consumer.

July 21, 2016 marked six years since the passing of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which is universally viewed as the main source of stricter regulatory measures on banking activities. However, it is not the only action taken to regulate bank operations since the 2008 recession.

What is Basel III?

 

The Basel Committee on Banking Supervision (BCBS) is a global organization consisting of several countries, which issues a set of recommendations called the Basel Accords. Basel III is an act issued by the BCBS in 2010, and which was adopted by the United States a year later. The U.S. implementation applied the act’s mandates to banks and institutions with more than $50 billion in assets under their management.

Basel III was the catalyst that lead to the regulations provided by the Dodd-Frank Act. However, the differences between the regulatory measures are often considered vague when interpreting which rules belong to which. Basel III has several different executive regulations that can be summarized as follows:

  1. Banks were required to maintain a Common Equity Tier 1 ratio (solvency ratio) of 4.5% in 2010, which is defined as the ratio of capital requirement to risk-weighted assets. This is an increase from the previously established 2% solvency ratio, which had been the norm since 2004. This minimum ratio will also progressively increase until 2019 when the established solvency ratio will be 7%.

  2. A Liquidity Coverage Ratio (LCR) was established, which states that banks must always have enough liquid assets available to cover their total net cash outflow for the following 30 days of their banking operations.

  3. Additionally, a Net Stable Funding Ratio (NSFR) was established, which entails that the amount of Available Stable Funding (ASF) divided by the Required Stable Funding (RSF) must exceed 100% for every year. The amount of ASF is defined as the total capital and liabilities that are expected to be reliable. The RSF is made up of consistent funds calculated as a function of a bank’s or company’s liquidity characteristics and residual maturity characteristics.

The primary purpose of Basel III was to increase the amount of high-quality assets that banks and bank holding companies have available so that if the 2008 recession were to repeat itself banks would be more prepared to handle the situation without U.S. government assistance. Overall, it seems to follow the trend that we also see with big-bank regulatory acts that limit the ability of banks to make expenditures that subject them to possible collapse.