BASBEL III – BROAD OVERVIEW :

Basel III has two key objectives. First, the standards in Basel III are the principal international response to the financial crisis that began in August 2007. The Basel Committee, the author of the new rules, is attempting to prevent a recurrence of the crisis, or at least to mitigate the effects of the next one. Accordingly, the new rules emphasize the importance of common stock by creating a new higher tier of capital know as common equity tier 1 capital (CET1), strengthen capital requirements, and place higher capital charges on certain risky assets. Basel III also introduces new requirements, including a leverage ratio and two measurements of adequate liquidity. Second, Basel III shares the objective of earlier versions of the Basel capital standards: ensuring international consistency of capital standards and leveling the playing field across jurisdictions. To that end, the Basel Committee has issued extensive guidance for national regulators on what constitutes adequate supervisory and capital regimes and has begun in earnest to review national compliance with Basel III.

Nearly all asset classes are affected to some degree by new Basel rules. The prices of financing and related instruments, even if they primarily serve a hedging function, may fall, since these instruments must carry greater amounts of capital. The increase in capital is the result of the new requirement that the full amount of off-balance sheet exposures be converted in full to an on-balance sheet asset for capital purposes. Other changes may affect the cost of these instruments as well. With respect to derivatives, for example, the rules impose more rigorous criteria for recognizing netting agreements. The credit risk mitigating effect of collateral is now determined through a complex calculation that requires several different haircuts. Guarantees represent an unusual approach: the universe of eligible guarantors has been expanded, rather than contracted, but there are new requirements to ensure the enforceability of a guarantee. As to securitizations, Basel 2.5 imposes generally higher capital requirements, including increased capital charges on liquidity facilities. Banks that purchase asset-backed securities must be able to demonstrate to their regulators that they have a sophisticated understanding of the risks involved.