The Third Basel Accord (i.e. Basel III) is a voluntary global regulatory standard on banks requiring adequate capital and providing stress testing and market liquidity guidelines. Members of the Basel Committee on Banking Supervision agreed on the accord in 2010–11, and scheduled it to be phased in from 2013 through 2019. Basel III was developed in response to the deficiencies in financial regulation revealed by the late-2000s financial crisis. Basel III was supposed to strengthen bank capital requirements by increasing bank liquidity and bank leverage based on the specific types of assets and liabilities held by the bank rather than being based on general assumptions that all banks are the same.
The Basel accords derived their name from Basel, Switzerland, where the committee met to develop them. They are simply a series of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision (BSBS). The standards are not laws or enforced by the Committee; rather they are recommendations adopted by individual countries. The country is then expected to create and enforce regulations on their own respective banks.
The video below explains the changes required by the Basel III accord and how it affects liquidity and reserve requirements.
As the world grappled with the aftermath of the 2008 liquidity crisis, Basel III was developed to address the policies failures of Basel I and Basel II. Even though implementation has been slow, policy makers, have developed some guidelines regarding liquidity and have developed “stress tests” that will monitor different scenarios and bank’s abilities to handle the evolving circumstances. One of the key issues addressed was the difference between the amount of liquidity required for a banks normal retail customers and outside customers. As was demonstrated in the 2008 crisis, Basel III recognizes that capital from non-customers is only transitory and projects that it will flee in times of uncertainty and thus it can not be relied upon as a reserve.
Bank’s Reaction to Basel III
Since Basel III requires that banks hold greater reserves (thus reducing profitability in favor of safety), many in the financial sector have risen up against it in protest. But it is necessary that participants in the banking industry implement the capital regulation measures as proposed. Even though risks are taken daily in this sector, it would be wise to consider the consequences.
Liquidity is another important aspect in this regard and should not only be taken seriously but implemented as necessary. There needs to be a way of monitoring this policy to avoid the pitfalls that come with banks being too aggressive. As the policy makers state it, one should only take risks that can be taken care of when issues turn from bad to worse.
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Tim Aldiss writes for Omega Performance the credit training solutions experts.