Basel III is a set of reform measures for the banking sector established by the Basel Committee on Banking Supervision (BCBS) in 2010 and 2011. The BCBS is a board of advisors organized by central bankers and is comprised of the Group of Ten countries. Basel III is the third installment of the Basel implementation efforts.
Basel III was developed primarily to combat the lack of financial regulation evident in the global financial crisis that started in late 2008. The new regulations aim to improve risk management and transparency for banks and financial institutions by increasing capital requirements, liquidity and leverage. The new regulations will be phased in starting January 2013 and will continue until January 2019.
By improving the ability to absorb market volatility, the BCBS hopes to mitigate the risk of another financial crisis. The reform program is targeted at bank-level regulation, commonly referred to as the “macro prudential” industry.
The four major areas of reform include:
- strengthening the global capital framework;
- introducing a global liquidity standard;
- creating transitional arrangements to meet the new standards;
- and establishing a new scope of application, building upon the Basel II standards.
The strengthening of the global capital framework is the most extensive component of the reform and includes five major areas for change:
1) Increased quality and transparency of the capital base;
2) Stronger risk coverage of the capital framework;
3) The creation of a leverage ratio requirement of 5%, with the goal of creating a leverage floor;
4) Greater protection of the banking sector particularly from times of excessive credit growth by using countercyclical buffers;
5) And the introduction of a minimum liquidity standard for international banks
Although many small US banks avoided the regulations set forth by the previous Basel installments, the greater push for transparency has required banks of all sizes to adhere to the new requirements.
For instance, in terms of capital reserve requirements, the Basel III standards requires banks to double reserves by holding 4.5% of common equity and initially holding 6% of Tier I capital, which rises to 7% by 2019, more than tripling the Basel II Tier 1 requirements. The reform also calls for increases in capital buffers.
The Organization for Economic Cooperation and Development (OECD), which oversees reform programs such as Basel III, predicts that the reform will increase GDP growth by .05 to .15% per year. However, members of the banking sector argue that the strict regulation will shrink the economy and cause greater long term costs that might outweigh the benefits.