Basel III Tightens Capital Requirements – Eventually

The BIS (Bank for International Settlements) reported Sunday that it has reached an agreement to increase key capital ratios for banks.  The announcement was made by the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision. The committee is composed of representatives of the top 27 central banks in the world.

The requirements on banks are significant but perhaps not timely.  It will take more than half a generation to fully implement.  Some provisions will not be completed until 2022. 

The minimum requirement for common equity, the highest form of loss absorbing capital, will be raised from the current 2% to 4.5% after the application of stricter adjustments. This will be phased in by 1 January 2015. The total Tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% over the same period.  There will also be a “buffer requirement” of 2.5% that can be drawn down to the 4.5% minimum requirement during times of stress.  This effectively will raise common equity requirements to 7%.

If a bank draws below the 7% common equity requirement, including the buffer, distribution of earnings must be curtailed until the 7% level is recovered.  These restrictions would apply to dividends and executive compensation, including bonuses.

It appears that actual implementation won’t start until 2012 and the accords will not be fully implemented until 2018.  Here is the implementation schedule:


According to an article by Brooke Masters in The Financial Times,  the UK and the U.S had pushed for earlier implementation (2016).  Many countries (including the UK and U.S.) wanted higher Tier 1 capital ratios, up to 10%, but others, most notably Germany, argued for lower ratios, some as low as 4% including buffer.  Germany was also on the opposite side of the implementation schedule argument,  at one time wanting a 15 year schedule.

It had long been agreed that Tier 3 capital, that bastion of dark capital instruments such as CDS (credit default swaps) and SIV (special investment vehicles), would be eliminated from the capital structure of banks by the Basel 3 accords.  Tier 2 capital will remain in the equation (up to 2% of total capital) but just what can be held in tier 2 is uncertain.  As shown in the bottom line of the graphic, by 2013 definitions of prohibited instruments will be defined.

It remains to be seen if these redefinitions are actually effect.  Won’t this something like a drug addict curing himself? It remains to be seen if these redefinitions are actually effective. Won’t this something like a drug addict trying to cure himself?

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