Basel III
Basel III is a regulatory framework established by the Basel Committee of Banking Supervision in response to the global financial crisis of 2008 and 2009, aimed at enhancing the stability of the international banking system. It builds upon earlier agreements, Basel I and Basel II, and introduces more stringent capital requirements, increasing the minimum capital ratio to 10.5% of risk-weighted assets. One of its main objectives is to ensure that banks maintain adequate liquidity to meet their obligations and to prevent financial crises that could destabilize the economy. Basel III also addresses the need for a countercyclical capital buffer and sets regulations on leverage ratios, limiting how much banks can lend relative to their assets.
The framework has been endorsed by the G20, with a full implementation deadline originally set for 2019. However, concerns about the varied methods of implementation across different countries have persisted, reflecting the complexities of diverse banking regulations and practices globally. In 2023, the Basel III Endgame was introduced, focusing on strengthening supervision and regulation, particularly for banks engaged in trading operations. Overall, Basel III aims to create a more resilient banking environment while promoting fair competition among major financial institutions.
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Subject Terms
Basel III
Basel III is a framework developed by the Basel Committee of Banking Supervision in response to the global financial crisis of 2008 and 2009. The purposes of Basel III include improving the stability of the world banking system and creating a level playing field among major banks. Basel III is a voluntary system of regulations addressing primarily capital adequacy, i.e., the amount of liquid capital a financial institution must keep in reserve in relation to the amount of money lent out. The G20, a group of representatives from twenty of the world’s major economies, endorsed Basel III in November 2010, with a deadline of 2019 to have the reforms fully implemented.
Overview
In most modern banking systems, banks are required to hold a certain amount of capital in reserve, meaning they must have liquid assets that can be rapidly converted into cash. Because the bank does not earn interest on reserve capital, it has an incentive to keep its reserve account as low as possible. However, if the reserve account is too low, it may not be sufficient to cover the daily needs of the bank. Thus, many countries have national requirements that a bank keep a certain percentage of its holdings in a reserve account.
The tension between keeping a reserve account high enough to facilitate daily operations and as low as possible so that more money may be put into profitable lending activities creates a conflict of interest. This is especially true when bank deposits are insured by governmental authorities, such as the Federal Deposit Insurance Corporation (FDIC) in the United States. The importance of the reserve requirement was underscored in the world financial crisis of 2008 and 2009, which was fueled in part by the need for national governments to bail out banks considered “too big to fail.” These “too big to fail” banks actually were on the brink of insolvency when governments stepped in to bail them out with taxpayer money. The logic behind the action was that if the banks failed, the national and international banking systems could face extreme harm and possibly collapse, launching much of the world into another Great Depression.
Basel III is one of several international agreements created to address these issues, and was built on the framework of Basel I (1988) and Basel II (2004). Basel I required banks to have capital equal to 8 percent of the risk-weighted assets (i.e., the value of the assets is adjusted according to their riskiness), while Basel II improved the methodology for calculating risk weights and widened the scope of risks.
Basel III increased the capital requirement to 10.5 percent, strengthened regulations regarding what can be considered capital, and introduced a countercyclical capital buffer ranging from 0 to 2.5 percent to limit the creation of financial bubbles. Basel III also introduced the use of a leverage ratio, regulating the amount of money a bank can lend relative to its assets, and added liquidity ratios requiring that banks have enough liquid assets to cover expected needs for the next thirty days, and enough funding resources to cover expected needs for the next twelve months. Although all G20 countries agreed to implement Basel III, concerns existed about divergent methods of implementation as well as monitoring compliance in countries with different laws, traditions, and business practices. The final set of rules introduced in 2023, called Basel III Endgame, includes several measures to improve the supervision and regulation of banks, particularly those with trading operations.
Bibliography
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