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Basel Committee on Banking Supervision

Basel Committee on Banking Supervision B A N K F O R I N T E R N AT I O N A L S E T T L E M E N T S. Finalising Basel III. In brief 2010. 2017. reforms December 2017. Basel III. What is Basel III? What do the 2017 reforms do? The Basel III framework The Committee 's Basel III reforms complement the initial is a central element of phase of the Basel III reforms announced in 2010. The 2017. the Basel Committee 's reforms seek to restore credibility in the calculation of risk- response to the global weighted assets (RWAs) and improve the comparability financial crisis. It of banks' capital ratios. RWAs are an estimate of risk that addresses a number determines the minimum level of regulatory capital a bank of shortcomings in the must maintain to deal with unexpected losses. A prudent pre-crisis regulatory and credible calculation of RWAs is an integral element of framework and provides a the risk-based capital framework .

The Basel III framework is a central element of the Basel Committee’s response to the global financial crisis. It addresses a number of shortcomings in the pre-crisis regulatory framework and provides a foundation for a resilient ... Finalising Basel III - In brief

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Transcription of Basel Committee on Banking Supervision

1 Basel Committee on Banking Supervision B A N K F O R I N T E R N AT I O N A L S E T T L E M E N T S. Finalising Basel III. In brief 2010. 2017. reforms December 2017. Basel III. What is Basel III? What do the 2017 reforms do? The Basel III framework The Committee 's Basel III reforms complement the initial is a central element of phase of the Basel III reforms announced in 2010. The 2017. the Basel Committee 's reforms seek to restore credibility in the calculation of risk- response to the global weighted assets (RWAs) and improve the comparability financial crisis. It of banks' capital ratios. RWAs are an estimate of risk that addresses a number determines the minimum level of regulatory capital a bank of shortcomings in the must maintain to deal with unexpected losses. A prudent pre-crisis regulatory and credible calculation of RWAs is an integral element of framework and provides a the risk-based capital framework .

2 Foundation for a resilient Banking system that will help avoid the build-up Why are the 2017 reforms necessary? of systemic vulnerabilities. The framework will allow The 2017 reforms address weaknesses that were revealed the Banking system to by the global financial crisis. support the real economy through the economic Credibility of the framework : A range of studies found cycle. an unacceptably wide variation in RWAs across banks that cannot be explained solely by differences in the riskiness of banks' portfolios. The unwarranted variation makes it difficult to compare capital ratios across banks and undermines confidence in capital ratios. The reforms will address this to help restore the credibility of the risk-based capital framework . Internal models: Internal models should allow for more accurate risk measurement than the standardised approaches developed by supervisors.

3 However, incentives exist to minimise risk weights when internal models are used to set minimum capital requirements. In addition, certain types of asset, such as low-default exposures, cannot be modelled reliably or robustly. The reforms introduce constraints on the estimates banks make when they use their internal models for regulatory capital purposes, and, in some cases, remove the use of internal models. 1. Basel III: main features $. Increase the level and Enhance risk Constrain bank leverage Improve bank liquidity Limit procyclicality quality of capital capture Banks required to maintain Capital requirements for A leverage ratio constrains The Liquidity Coverage Banks retain earnings to more capital of higher quality market risk rise significantly. the build-up of debt to Ratio requires banks to hold build up capital buffers 2010.

4 To cover unexpected losses. Requirements are fund banks' investment and sufficient liquid assets to during periods of high Minimum Tier 1 capital rises calculated based on 12 activities (bank leverage), sustain them for 30 days economic growth so that from 4% to 6%, of which at months of market stress. reducing the risk of a during times of stress. The they can draw them down least three quarters must be Credit Valuation deleveraging spiral during Net Stable Funding Ratio during periods of the highest quality (common Adjustment risk is now downturns. encourages banks to better economic stress. shares and retained earnings). included in the framework . match the duration of their Global systemically important assets and liabilities. banks (G-SIBs) are subject to additional capital requirements. Revisions to the Global systemically standardised approaches important banks (G-SIBs).

5 For calculating credit risk, are subject to higher market risk, Credit leverage ratio Valuation Adjustment and requirements. 2017. operational risk mean greater risk sensitivity and comparability. Constraints on using internal models aim to reduce unwarranted variability in banks'. calculations of RWAs. An output floor limits the benefits banks can derive from using internal models to calculate minimum capital requirements. 2. Focus on risk-weighted assets What is regulatory capital? While the first phase of Banks fund their investments with capital and debt, such as Basel III focused largely customer deposits. Capital can absorb losses in a way that on the capital side of the reduces the likelihood of a bank failing and the impact if it capital ratio calculation does. Regulatory capital consists of: (the numerator), the 2017.

6 Reforms concentrate on Common Equity Tier 1 common shares, retained earnings the calculation of RWAs and other reserves. (the denominator). Additional Tier 1 capital instruments with no fixed maturity. Tier 2 subordinated debt and general loan-loss reserves. Banks with more regulatory capital are better able to fund lending growth. The capital ratio is the amount of regulatory capital divided by the Regulatory amount of risk-weighted Risk-based capital assets. The greater the capital ratio =. amount of risk-weighted Risk-weighted assets, the more capital assets is needed, and vice versa. Other Market Operational Credit risk risk risk What are risk-weighted assets? A bank's assets typically include cash, securities and loans made to individuals, businesses, other banks, and governments. Each type of asset has different risk characteristics.

7 A risk weight is assigned to each type of asset, as an indication of how risky it is for the bank to hold the asset. To work out how much capital banks should maintain to guard against unexpected losses, the value of the asset (ie the exposure) is multiplied by the relevant risk weight. Banks need less capital to cover exposures to safer assets and more capital to cover riskier exposures. 3. Improve the treatment of credit risk Credit risk, the risk of Most banks around the world use the standardised approach loss due to a borrower (SA) for credit risk. Under this approach, supervisors set the being unable to repay risk weights that banks apply to their exposures to determine a debt in full or in part, RWAs. This means that banks do not use their internal models accounts for the bulk of to calculate risk-weighted assets.

8 Most banks' risk-taking activities and regulatory The main changes to the SA for credit risk will: capital requirements. There are two broad Enhance risk sensitivity while keeping the SA for credit risk approaches to calculating sufficiently simple. RWAs for credit risk: the - Provide for a more detailed risk weighting approach standardised approach instead of a flat risk weight, particularly for residential and the internal ratings- and commercial real estate. based approach. Reduce reliance on external credit ratings. - Require banks to conduct sufficient due diligence when using external ratings. - Have a sufficiently detailed non-ratings-based approach for jurisdictions that cannot or do not wish to rely on external credit ratings. The internal ratings-based (IRB) approach for credit risk allows banks, under certain conditions, to use their internal models to estimate credit risk, and therefore RWAs.

9 The 2017 reforms introduced some constraints to banks' estimates of risk parameters. There are two main IRB approaches: Foundation IRB (F-IRB) and Advanced IRB (A-IRB). The main changes to the Exposure class Methods Change in available IRB approach for credit available under methods relative to risk will: the new credit current credit risk risk standards standard Remove the option Banks and other financial SA or F-IRB A-IRB removed to use the A-IRB institutions approach for Corporates belonging SA or F-IRB A-IRB removed exposures to financial to groups with total institutions and large consolidated revenues corporates. No IRB exceeding EUR 500m approach can be used Other corporates SA, F-IRB or A-IRB No change for equity exposures. Where the IRB Specialised lending SA, supervisory No change slotting, F-IRB or approach is retained, A-IRB.

10 Minimum levels are applied on the Retail SA or A-IRB No change probability of default Equity SA All IRB approaches and for other inputs. removed 4. Streamline the treatment of operational risk The financial crisis The 2017 reforms: highlighted weaknesses in calculating capital Simplify the framework by replacing the four current requirements for approaches with a single standardised approach. operational risk, or the risk Make the framework more risk-sensitive by combining a of loss due to inadequate refined measure of gross income with a bank's own internal or failed internal processes, loss history over 10 years. people and systems or Make it easier to compare RWAs from bank to bank by from external events. The removing the option to use multiple approaches and the capital requirements were option to use internal models.


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