Tuesday, September 14, 2010

Understanding Basel iii Accord

     Basel 3 Accord which was agreed by governors across the globe over this weekend to implement new set of rules to prevent another financial crisis,am not sure how its going to prevent another crisis..cause Basel 2 which was published on 2004 didnt prevent the crisis. Now its pointed by critics that basel 3 implementations got diluted for the sake of few selected countries. Will try to uncover whats this all about.
A. Tier 1 Capital

Tier 1 capital ratio = 4%
Core Tier 1 capital ratio = 2%
The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 capital
Tier 1 Capital Ratio = 6%
Core Tier 1 Capital Ratio (Common Equity after deductions) = 4.5%
Core Tier 1 Capital Ratio (Common Equity after deductions) before 2013 = 2%, 1st January 2013 = 3.5%, 1st January 2014 = 4%, 1st January 2015 = 4.5%
The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 capital.
Capital Requiement :
Tier 1 capital consists largely of shareholders' equity. This is the amount paid up to originally purchase the stock (or shares) of the Bank (not the amount those shares are currently trading for on the stock exchange), retained profits subtracting accumulated losses,

Tier 2 Capital 
A term used to describe the capital adequacy of a bank. Tier II capital is secondary bank capital that includes items such as undisclosed reserves, general loss reserves, subordinated term debt, and more

B. Capital Conservation Buffer

There is no capital conservation buffer.

Banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%.
Capital Conservation Buffer of 2.5 percent, on top of Tier 1 capital, will be met with common equity, after the application of deductions.
Capital Conservation Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5%

The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions.If Banks are in buffer zone then they are restricted of paying out bonuses ,share buy back,dividends etc..

C. Countercyclical Capital Buffer
There is no Countercyclical Capital Buffer

A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss absorbing capital will be implemented according to national circumstances.
Banks that have a capital ratio that is less than 2.5%, will face restrictions on payouts of dividends, share buybacks and bonuses.
The buffer will be phased in from January 2016 and will be fully effective in January 2019.
Countercyclical Capital Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5%
 The purpose of the counter cyclical buffer is to achieve the broader macro prudential goal of protecting the banking sector from periods of excess aggregate credit growth With them, banks increase their capital in good times, not bad. And then, in bad times, they disappear: regulators can (and indeed are encouraged to) abolish the buffers immediately, if there’s some kind of credit crisis. When write-downs eat into bank capital, they eat only into the buffer, which is no longer required, rather than the underlying minimum capital requirement.

D. Capital for Systemically Important Banks only

There is no Capital for Systemically Important Banks
Systemically important banks should have loss absorbing capacity beyond the standards announced today and work continues on this issue in the Financial Stability Board and relevant Basel Committee work streams.

The Basel Committee and the FSB are developing a well integrated approach to systemically important financial institutions which could include combinations of capital surcharges, contingent capital and bail-in debt. 
Total Regulatory Capital Ratio = [Tier 1 Capital Ratio] + [Capital Conservation Buffer] + [Countercyclical Capital Buffer] + [Capital for Systemically Important Banks]
Will try to see how these rules going to effect indian banks..I have a feeling that indian banks need to maintain a higher ratio cause here in india as we have high inflation and  it will eat into banks capital...cya in next post

links which can be referenced :
Bank of international settlements paper

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