Basel Accords which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision consists of Basel I, Basel II and Basel III. Basel I was adopted in 1988 and was enforced internationally in 1992. While Basel I is now outdated, Basel II was formed and implemented by a lot of countries.
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Soon after that Basel III came into place when the world was faced with Global Financial Crisis. Basel I primarily focused on credit risk. This Accord was enforced by law in Group of Ten (G-10) countries which included Belgium, Canada, France, Germany, Italy, Japan, United Kingdom, United States of America, Spain, Switzerland, Sweden, Netherlands and Luxembourg. Basel II is the second of Basel accords issued by the Basel committee on Banking Supervision. This framework was officially known as “International Convergence of Capital Measurement and Capital Standards”. The main purpose of Basel II, published in June of 2004, was to create an international standard that banking regulators would be able to use when creating regulations about the amount of capital that banks need to put aside to guard them against the financial and operational risks that most banks face. Australia implemented Basel II framework on January 1 2008 through its Australian Prudential Regulation Authority The 3 fundamental pillars of Basel II include: Pillar 1: It deals with the Minimum Capital Requirement calculation which has to be maintained against Credit, Operational and Market risk. Pillar 2: It deals with the Supervisory Review Process which describes the principles for effective supervision. Pillar 3: It deals with the need for Market Discipline which requires the lenders to widely provide details of their risk rating processes, risk management activities and risk distributions. Basel III was recently developed after taking in consideration the loopholes and weaknesses that contributed to the financial crisis. Basically, these rules intend to protect the world economy from the possible effects of any future financial crisis. In addition to that, they also aim to reduce the risk that would be imposed on governments to spend funds while protecting banks and their creditors. The new rules of Basel III seek to avoid the failure of Basel II -Imperfect and under-adopted rules now are no longer in use after the 2008 global financial crisis. It takes a more critical view of leverage in general, and of risk “insurance” and trading in debt between banks and other players. They ask the banks to hold a larger “buffer” of capital, and more liquid assets. The most important changes in Basel III comprise of: Ã¢â‚¬Â¢ Setting higher minimum capital requirements and changes to Tier 1 capital rules Ã¢â‚¬Â¢ Strengthening both the quantum and quality of capital for banks and insurance companies Ã¢â‚¬Â¢ Improving mechanisms for dealing with systemic risk found in the financial system Ã¢â‚¬Â¢ Enhancing the system and institutions’ abilities to cope with liquidity shocks which have occurred throughout the GFC Ã¢â‚¬Â¢ Improving forward-looking approaches to loan loss provisioning Ã¢â‚¬Â¢ Encouraging long-term thinking by counter-cyclical prudential measures, and remuneration arrangements which better align reward and risk arising over the longer term. https://www.basel-ii-risk.com/basel-iii-guide-to-the-changes/ Development of New Basel III Standard First, The quality, consistency and transparency of the capital base will be raised. Tier 1 capital will place greater emphasis on common equity component. Tier 2 capital instruments will be harmonized. Tier 3 capital will be eliminated. Second, Enhancement of risk coverage through enhanced capital requirements for counterparty credit risk. Enhanced risk coverage will address issues that arise in connection with the use of derivatives, repos and securities financing arrangements Third, Changes to non-risk adjusted leverage ratio. This ratio will supplement the Basel II risk capital framework. Fourth, Measures to improve countercyclical capital framework. While many bank investors loved Basel III, there were some problems encountered in Basel III. Basel III was considered to be implemented really quick even though Basel II took a decade to be put together but never got implemented properly. It was said that Basel III adopted some of the same problems faced in Basel II The risk weighing concept: The banks were told to hold more capital against the riskier assets than they do against safer assets. Basel III is considered to be backward-looking. A few drawbacks of Basel III were the following: Capital requirements in Basel III were too low; Credit ratings were depended upon the most; Banks could use internal models to measure risk; Banks could get around the rules by setting up off-balance-sheet entities like SIVs; It lacked any kind of liquidity requirements.
BASEL III’S EFFECTS ON UNITED ARAB EMIRATES
Over the years, United Arab Emirates have been reporting to a BASEL I framework. Since, it is progressing well, there are doubts that there will be immediate implementation of BASEL III. However, over the past year or so, the U.A.E has needed significant capital injections and liquidity support, so the ratios will report negative effects. Hence, there is no rush to adopt to Basel III, as new standards would highlight capital and liquidity drawbacks. Currently, the U.A.E’s banks are reporting elevated capital ratios ( 15% Tier I ratios, 18% CAR), but this has been boosted by public sector injections of Tier I and Tier II capital. The equity- asset ratios of – 10 % has indicated how Tier I ratios might present itself under BASEL III framework, particularly if banks attempt to setback or smooth provisioning against a likely imminent decline in asset quality. Dr. Nasser Al Saidi, Executive Director of the Hawkamah- Institute for Corporate Governance said, “Banking regulations must proceed on a global basis but since the UAE banks are almost applying the same capital adequacy ratio as Basel III requirements, the new international rules would not have a direct impact on the UAE banking sector.” However, due to the global recession, several banks buckled, while furthermore have botched various challenges, highlighting a elementary flaw amongst banks worldwide. Dr. Al Saidi also mentioned that the increase in capital requirement from 2% to 7% was a compulsory amendment as the increased capital would reduce the risk. If some banks still felt that the reserve wasn’t enough, then they would tend to increase it out of further prudence and that would reduce the finances available to businesses, thus leading to added cost of loans. UAE banks are among the paramount capitalised in the world, and traditionally inflexible principles set by the UAE Central Bank for principal needs means that local banks already outdo norms set by the Bank for International Settlements (BIS) as part of the Basel III accord, which has a 2019 deadline, analysts say. Analysts also feel that the U.A.E’s banking regulations are already stricter than those proposed by BASEL III. U.A.E’s banks are safer as compared to majority of their Western and European counterparts. At present, the Tier I and total capital requirement ratios stand at 8 percent and 12 percent respectively, which already higher than the 2019 target ratios proposed by BASEL III of 6 percent and 8 percent respectively. The BIS reported that it has developed an accord for the boosting of vital capital ratios for all banks. The least necessity for general equity, the peak form of loss absorbing capital, will be lifted from the existing 2 to 4.5 per cent after the submission of stricter adjustments, which will be ushered in by 2015. The total Tier 1 capital necessity, which includes regular equity and other qualifying financial instruments depending upon harsher grounds, will raise from 4 percent to that of 6 percent during the existing phase. A ‘buffer requirement’ of 2.5 per cent that can be strained down to the 4.5 per cent least necessity when called for. Effectively, this will elevate general equity necessities to 7 per cent. If a bank falls under the 7 per cent general equity necessities, including the cushion, allocation of income should condense atleast till the 7 per cent stage is improved. The margins above would relate to dividends and managerial reimbursement, including bonuses. These changes are supposed to reinforce the bank’s stability to absorb future potential losses. The transition period for banks to comply with these rules was set at 2012, however, it has now been extended to January, 2019. Since the U.A.E’s banks are still adjusting to Basel II’s policies since November, 2009, it will be far too early to comment upon the consequences of these new regulation changes. “Basel III rules on capital adequacy rates stipulate phased increases – from 2 per cent to 3.5 per cent in 2012, to 4.5 per cent by 2015 and to the full 7 per cent by the end of 2018.” Although the U.A.E is in recession, these regulations give banks a necessary amount of time to adjust. There is faith in the U.A.E’s financial system, as it has been able to cope flexibly and effectively to unforeseen shocks. Data Analysis https://www.systemiclogic.com.au/?p=1038 The above graph places emphasis on the quality of capital required. The new capital requirement will emerge in a period of five years, and over this period the minimum capital ratio will remain at 8%- However, its composition may change. Ordinary shares which are the highest quality capital are seen to move from 2% under Basel II to 4% under Basel III. As a result, the relevance of Tier 2/3 which is the lower quality capital will reduce to a quarter of the total required. Apart from the minimum capital requirement, institutions are expected to hold a conservation buffer also in common equity of 2.5%, which will act as a measure of relief in times of stress. https://www.allvoices.com/contributed-news/7323914-basel-3-has-arrived-finally-for-banks/content/63411911-basel-iii After the release of Basel II, the capital requirement was at 2%. With the arrival of Basel III updates the value has increased to 4.5%. (I.e. an increase of 2.5%). Basel III’s stated aims are to improve the banking sector’s ability to Absorb shocks Improve risk management Strengthen banks’ transparency To achieve this it laid down two areas of regulation, which are: micro prudential – this includes dealing with the flexibility of individual banks – and macro prudential – which includes dealing with the strength of the banking sector as a whole. According to the Basel III reforms, one of the methods to bring about the change from procyclical lending to countercyclical lending, include increasing capital requirements and adding more capital buffers to deal with times of stress, rising from 2.5% to 7%. The Tier 1 capital requirement, that covers various qualifying financial resources which are based on rigid criteria, and common equity, will increase to 6% from its current value of 4% during the same time. Basel 3 summary has given the date from which it has to be put into practice by various member nations. The date turns out to be 1st January 2013. It is said that member countries have to convert the Basel III updates into national financial regulations before this date. Basel 3 Summary also affects the Risk weighted assets or RWAs and the date of implementation is the same. The first section is 3.5% common equity for every RWA. The next one is to have 4.5% Tier 1 capital for every RWA, amounting to the total of 8% capital for every RWA. Basel III also brings forward the minimum common equity requirement that to be followed from 1st January 2013 till 1st January 2015. The change in the minimum common equity requirement from 2% to 3.5% is effective from 1st January 2013. The Tier 1 capital requirements have also risen to 5.5% from 4%, which is a slight change. The banks should aim to reach 4% minimum common equity plus 5.5% of Tier 1 capital by 1st January 2014. From the above it can be noted that Basel III summary has made 1st January 2015 into an important date, as we can see that by that time the banks will have common equity raised to 4.5% and the Tier 1 requirements raised to 6%.