Regulators around the world have been putting their heads together to fight back the mammoth of a financial crisis that hit the globe in 2008. Consequently, the new set of Basel III rules had been held in high anticipation by banks as a severe tightening was expected.
When the Basel III rules were finally announced early last week, bankers heaved a sigh of relief as the new regulations and requirements, though more stringent, had been tactfully phased out, giving banks a breather with respect to their implementation.
Capital requirements for the banks have been rendered more rigorous, having been broken down into 4 layers. Tier 1 capital has been broken down to introduce a base layer of common equity of 4.5 percent, raising the total Tier 1 capital requirement to 6 percent. It was only 4 percent in Basel II.
On top of that, a conservation buffer of 2.5 percent has also been levied, which, if breached by the banks under any circumstances, will prohibit them from paying out dividends.
To tighten the bankers belts further, a countercyclical buffer has been thrown in, essentially meaning that banks will have to maintain more capital in better times. The exact quantum of this buffer has been left at the discretion of the national regulators in countries adopting the rules.
Several other parts of the deal have been alluded to, though not quantified in exact figures. These include a stricter requirement for "bigger" banks which are systemically important, and the introduction of liquidity coverage and net stable funding ratios down the road.
Though these regulations seem rigorous at the surface, a phased implementation schedule, extending to nearly a decade till 2019, gives considerable leeway to the banks.
But for all the hype, the Basel III regulations haven essentially addressed the key issue of risk which led to the crisis in the first place; most of the capital requirements are in relation to risk weighted assets (RWAs).
This raises a pertinent concern. Triple-A rated investments and loans are assigned nearly zero risk weights, even though they might be backed by pools of risky, securitized loans and debts, such as those of the subprime mortgage. Thus, the banks will practically have no capital requirement if it lends to Triple-A rated entities as the risk weight assigned to them will be zero.
Consequently, in the face of tighter regulations for riskier investments, banks flock to the so-called "risk-free" securities and hence run the risk of bubbling up their stakes. No wonder Basel III is being criticized for overlooking unforeseeable risks. The SBP has indicated that the rules will be adopted locally after due impact assessment and discussion with all stakeholders, especially since the extended schedule allows sufficient time to ponder over its implementation in Pakistan.
The rules at home are relatively difficult with banks having to adopt stricter standards with requirements of a capital-adequacy-ratio of 10 percent. Furthermore, every banking company incorporated in Pakistan has to create a reserve fund whereby a certain percentage of profit of each year is retained.
Thus, while SBP can take its time assessing the utility of Basel III to banks in Pakistan, the risk element of the banking system needs to be carefully thought over by the international regulators.
Further, the extended timeframe also demands considerable monitoring by the regulators to ensure banks stay in line - the rod should definitely not be spared this time around.
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Phase-in arrangements (shading indicates transition periods)
(all dates are as of 1 January)
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2011 2012 2013 2014 2015 2016 2017 2018 As of
1 January
2019
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Leverage Ratio Supervisory monitoring Parallel run Migration to
1 January 2013- Pillar 1
1 Jan 2017
Disclosure starts
1 Jan 2015
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Minimum Common
Equity Capital
Ratio 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%
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Capital
Conservation
Buffer 0.625% 1.25% 1.875% 2.50%
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Minimum common
equity plus capital 3.5% 4.0% 4.5% 5.125% 5.75% 6.375% 7.0%
Conservation buffer
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Phase-in of deductions
from CET1(including
amounts exceeding the
limit for 20% 40% 60% 80% 100% 100%
DTA, MSRs and financials)
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Minimum Tier 1 Capital 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%
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Minimum Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%
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Minimum Total Capital plus conservation
buffer 8.0% 8.0% 8.0% 8.625% 9.25% 9.875% 10.5%
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Capital instruments that no longer qualify
As non-core Tier 1 capital or Tier 2 capital Phased out over 10 year horizon
beginning 2013
Source: Bank of International Settlement
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