Whats new in Basel III

BCBS (Basel committee on banking supervision) was established in 1960 for Banks to deal with globalization and is situated in Basel, Switzerland. It focuses on exchanging information on national/international banking related issues, process and techniques. These recommendations are just made for the banks benefit but not mandated by any legal force. The countries taking part in BCBS are Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. BCBS recommends certain standards and regulations for banks. Why it is necessary? Yes, it is for lowering credit risk, banks should hold enough capital to equal at least 8% (which depends on countries to countries) of its risk-weighted assets.  BCBS members meet four times a year at Bank for international settlement (BIS) in Basel, Switzerland. The role of the community is quite clear to bring best practice in banking supervision. There happen information exchange on banking supervisory and issues related to banking. Basel II is more detailed written and documented motif for bank’s supervision, which bring recommendations that are more detailed for banks adding to previous documentation done in Basel I. Basel II includes recommendations on risks, supervisory review and market discipline. There are banks trying to implement these recommendations of Basel II, and it might take time till 2015. Basel I and Basel II which are primarily related to the required level of bank loss.

Basel III is also a set of standards and practices created to help international banks maintaining adequate capital for sustainability. This sustainability is mainly concerned at tough economic situations. Basel III attempts to add more control in banking industry those are required by Basel II which in turn the refinement of Basel I. As per Basel II, banks should declare both risky investments and risk management practices. Basel III establishes more strict regulations, tripling the amount of cash reserves must be present to deal with financial crisis. It also requires banks to maintain higher common equity than before including capital conservation buffer of 2.5% of their assets.

Basel III has been appreciated in many parts of the world for regulating banks and reducing systematic risk (beta), but also attracted plenty of criticism. There are studies suggesting it results in increased bank capital requirements on loan volumes and rates, also resulting in higher equity to debt ratios which causes higher lending costs, even there are plenty of implications to be seen due to Basel III regulations.

Source: http://chicagopolicyreview.org/2012/04/24/will-basel-iii-help-or-hurt/

“In their study of banks from 2001 to 2009, Cosimano and Hakura rely on a core principal of the academic finance literature, the Modigliani–Miller Theorem (MMT), and argue that the higher equity-to-debt ratios required by Basel III will likely increase borrowing costs for banks. This is because banks can raise money in two ways: by borrowing it (issuing debt) or by selling the rights to their future profits (issuing equity). According to the MMT, under ideal conditions an increase in the proportion of equity (which is historically more expensive than debt) should be offset by a decline in the cost of debt due to lower risks of insolvency.”

However, empirical results contradicts MMT and find that it is extraordinary expensive for a bank to raise funds by higher equity to debt ratio. Basel III regulations threatens to dramatically increase the cost of lending money. For example 1.3% increase in the required equity to debt ratio will increase loan rates by 16 basis points (.16%) across the worlds’ 100 banks.

This post in under construction………………

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