Basel III is an international agreement that governs the regulation and supervision of banks globally, largely informed by the financial crisis of 2007–08. Implementation is determined at the level of individual jurisdictions. The Basel Committee published an initial version of Basel III rules in 2009, while an agreement dubbed “Basel IV” by the industry drew a line under the agreement at the end of 2017.
The main aims of Basel III rules are to ensure that banks hold sufficient capital, maintain healthy leverage and liquidity ratios and build up countercyclical buffers. Basel III increased Common Equity Tier 1 capital from 4% to 4.5% of risk-weighted assets (RWAs) and minimum Tier 1 capital from 4% to 6% compared to Basel II. Overall regulatory capital was maintained at 8% of RWAs. Basel III also added a leverage ratio, which is calculated by dividing Tier 1 capital by the bank’s average total consolidated assets. The minimum leverage ratio is 3%. Countercyclical buffers must be built up during benign periods of credit expansion, which are then released during credit contraction. Global systemically important banks (G-Sibs) were also assigned extra buffers, based on a formula dividing them into a series of systemic risk buckets.
Basel III also introduced the Fundamental Review of the Trading Book, and the concept of a standardised floor on internal model outputs. In December 2017, the Basel Committee agreed to set an internal model output floor at 72.5% of RWAs, while the implementation of the FRTB rules was postponed until 2022. The advanced measurement approach to operational risk has also been removed, so banks can only calculate op risk RWAs using the standardised approach. In theory, Basel III was also supposed to include changes to the credit risk capital framework for exposures to sovereigns, but the Basel Committee was unable to agree on these measures.
See also Capital floor.
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