FAQ: What is the Basel III accord, and what does it require?

Basel III is a set of standards developed to ensure that internationally active banks maintain adequate capital during periods of economic strain. How does Basel III affect you?

Basel III is a set of standards and practices developed for internationally active banks to ensure that they maintain...

adequate capital to sustain themselves during periods of economic strain. The rules, which were announced Sept. 12, strengthen previous minimum capital and liquidity requirements (Basel II) in light of the recent global financial crisis. The Basel III accord more than triples the amount of capital banks must keep on hand to absorb losses in tough times. The Group of 20, or G-20, nations is expected to endorse the standards when it meets in November.

The Basel standards are developed by the Basel Committee on Banking Supervision, a group within the Bank for International Settlements in Basel, Switzerland. The committee, which was set up by the Group of Ten countries in 1974, now comprises banking authorities from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States.

In the United States, four federal regulatory agencies are represented on the Basel Committee on Banking Supervision: the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision.

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Who is subject to Basel III, and what is required?

The Basel accords are voluntary agreements among national banking authorities. The countries signing on to the accords agree to implement the standards through national laws or regulations, and have considerable discretion in how they go about it. The standards have also been implemented by countries that are not parties to the accord.

Basel II, for instance, was applicable to all countries in the Organization for Economic Co-operation and Development, but not all countries applied the standards in the same way. In the United States, the Basel II standards were mandatory for only banks with a minimum of $250 billion in assets, or a minimum of $10 billion in foreign exposure, which are considered “core” banks. Banks with higher-risk profiles had higher capital requirements under Basel II.

The Basel III standards require that banks maintain a minimum common equity of 7% of their assets, including a capital conservation buffer of 2.5%. Additionally, banks would need a “countercyclical buffer” of 2.5%. Nations adhering to the Basel III accord must start implementing the standards by Jan. 1, 2013, and have two years to phase in the basic minimum capital requirement. They have as long as eight years to phase in additional provisions. The lengthy implementation period is meant to reduce the pressure on banks to race to raise capital.

How does Basel III differ from Basel I and Basel II?

The original Basel Capital Accord -- or Basel I -- was developed in 1988 to strengthen the stability of the international banking system and maintain sufficient consistency in the regulation of capital requirements. Critics of Basel I saw it as leaving banks too much latitude in interpreting the standards, enabling them to take excessive risks in lending. The model framework was also criticized for leading to regulatory arbitrage.

The much more complicated Basel II standards (formally titled the “International Convergence of Capital Measurement and Capital Standards: A Revised Framework”) replaced Basel I in 2004. They focused on improving risk management among internationally active banks and further improving the consistency of capital regulations. Basel II also required banks to consider the ability of corporate borrowers to repay loans when lending capital. Banks were required to look at a corporate borrower’s risk management and governance structure as well as its credit rating and history.

Basel III establishes more stringent capital requirements, tripling the amount of capital banks must keep on hand to absorb losses during financial crises. It requires banks to maintain higher common equity than before, including a capital conservation buffer of 2.5% of their assets.

Are the standards and practices under the Basel accords enforceable by law, and how are they enforced?

The Basel Committee on Banking Standards has no enforcement authority. Each nation is expected to implement the Basel standards through national laws or regulations, as best suited to its own system.

The voluntary nature of a county’s adherence to Basel standards was underscored as the committee prepared to issue the Basel III framework. Four days before Basel III was announced, France’s economic minister, Christine Lagarde, said her country would follow the standards only if the United States follows them .

In the United States, four federal bank regulatory agencies implement the standards through public rulemaking proceedings, which can entail a very lengthy process.

In Europe, the Basel II standards were implemented through the Capital Requirements Directive issued by the European Union.

What are the penalties for noncompliance with Basel III?

Each nation (or group of nations, such as the European Union) that signs the Basel accords implements its own supervisory and enforcement system. Regulatory authorities can use the threat of fines or revoked licenses to encourage compliance with Basel standards.

Under Basel III, if a bank fails to maintain the required capital conservation buffer, it could face restrictions on payments to executives and shareholders.

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