Basel III

What Is Basel III?

Basel III is a 2009 international regulatory accord that introduced a set of reforms designed to mitigate risk within the international banking sector, by requiring banks to maintain proper leverage ratios and keep certain levels of reserve capital on hand.

Basel III was rolled out by the Basel Committee on Banking Supervision — then a consortium of central banks from 28 countries, shortly after the credit crisis of 2008. Although the voluntary implementation deadline for the new rules was originally 2015, the date has been repeatedly pushed back and currently stands at January 1, 2022.

Understanding Basel III

Basel III, which is alternatively referred to as the Third Basel Accord or Basel Standards, is part of the continuing effort to enhance the international banking regulatory framework. It specifically builds on the Basel I and Basel II documents in a campaign to improve the banking sector's ability to deal with financial stress, improve risk management, and promote transparency. On a more granular level, Basel III seeks to strengthen the resilience of individual banks in order to reduce the risk of system-wide shocks and prevent future economic meltdowns.

Minimum Capital Requirements by Tiers

Banks have two main silos of capital that are qualitatively different from one another. Tier 1 refers to a bank's core capital, equity, and the disclosed reserves that appear on the bank's financial statements. In the event that a bank experiences significant losses, Tier 1 capital provides a cushion that allows it to weather stress and maintain a continuity of operations.

By contrast, Tier 2 refers to a bank's supplementary capital, such as undisclosed reserves and unsecured subordinated debt instruments that must have an original maturity of at least five years.

A bank's total capital is calculated by adding both tiers together. Under Basel III, the minimum total capital ratio is 12.9%, whereby the minimum Tier 1 capital ratio is 10.5% of its total risk-weighted assets (RWA), while the minimum Tier 2 capital ratio is 2% of the RWA.

Countercyclical Measures

Basel III introduced new requirements with respect to regulatory capital with which large banks can endure cyclical changes on their balance sheets. During periods of credit expansion, banks must set aside additional capital. During times of credit contraction, capital requirements can be relaxed.

The new guidelines also introduced the bucketing method, in which banks are grouped according to their size, complexity, and importance to the overall economy. Systematically important banks are subject to higher capital requirements.

Leverage and Liquidity Measures

Basel III likewise introduced leverage and liquidity requirements aimed at safeguarding against excessive borrowing, while ensuring that banks have sufficient liquidity during periods of financial stress. In particular, the leverage ratio, computed as Tier 1 capital divided by the total of on and off-balance assets minus intangible assets, was capped at 3%.