Summary of proposed changes in BESEL III

• First, the quality, consistency, and transparency of the capital base will be raised.
  

• Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings
• Tier 2 capital instruments will be harmonised
• Tier 3 capital will be eliminated.
  

• Second, the risk coverage of the capital framework will be strengthened.
  • Promote more integrated management of market and counterparty credit risk
  • Add the CVA (credit valuation adjustment)-risk due to deterioration in counterparty's credit rating
  • Strengthen the capital requirements for counterparty credit exposures arising from banks’ derivatives, repo and securities financing transactions
  • Raise the capital buffers backing these exposures
  • Reduce procyclicality and
  • Provide additional incentives to move OTC derivative contracts to central counterparties (probably clearing houses)
  • Provide incentives to strengthen the risk management of counterparty credit exposures
  • Raise counterparty credit risk management standards by including wrong-way risk
• Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework.
  • The Committee therefore is introducing a leverage ratio requirement that is intended to achieve the following objectives:
    • Put a floor under the build-up of leverage in the banking sector
    • Introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simpler measure that is based on gross exposures.
• Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers").
  • The Committee is introducing a series of measures to address procyclicality:
    • Dampen any excess cyclicality of the minimum capital requirement;
    • Promote more forward looking provisions;
    • Conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and
  • Achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth.
    • Requirement to use long term data horizons to estimate probabilities of default,
    • downturn loss-given-default estimates, recommended in Basel II, to become mandatory
    • Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements.
    • Banks must conduct stress tests that include widening credit spreads in recessionary scenarios.
  • Promoting stronger provisioning practices (forward looking provisioning):
    • Advocating a change in the accounting standards towards an expected loss (EL) approach (usually, EL amount := LGD*PD*EAD).
• Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio called the Net Stable Funding Ratio.
• The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.
  

As on Sept 2010, Proposed Basel III norms ask for ratios as: 7-9.5%(4.5% +2.5%(conservation buffer) + 0-2.5%(seasonal buffer)) for Common equity and 8.5-11% for tier 1 cap and 10.5 to 13 for total capital