Basel III Capital requirements
The final 'Basel III' capital measures were agreed by the group of central bank Governors and Heads of Supervision (GHOS) in September 2010, endorsed by G20 leaders in Seoul in November 2010, and published on 16 December 2010. The reforms cover both micro-prudential measures, to make individual banks more resilient; and macro-prudential measures, to reduce systemic risk.
Like Basel II, Basel III requires minimum capital ratios, defined as capital divided by risk-weighted assets. Basel III tightens the definitions of both capital and risk-weighted assets, and raises the minimum capital ratios required. Capital will now focus more tightly on common equity; and risk-weights for capital market activities will be increased.
Basel III Capital requirements
Under Basel III, it was agreed that from 2015 banks will need to maintain a regulatory minimum capital requirement as follows: a 4.5% Common Equity Tier 1 (CET1) ratio (which is a ratio of capital to risk weighted assets (RWAs)); a 6% Tier 1 capital ratio; and an 8% total capital ratio. In addition, a capital conservation buffer of 2.5%, comprised of CET1, will be established above the regulatory minimum capital requirements outlined above. Capital distribution (e.g. dividends and bonuses) constraints will be imposed on a bank when capital levels fall within this range. This new capital conservation buffer requirement is intended to be phased in between 2016 and 2019.
The new ratios compare to Basel II requirements of 2% of common equity, and 4% of Tier 1 capital, based on less stringent definitions. The Basel Committee is currently looking at common definitions of risk weights.
On 25 June 2011, the GHOS agreed to require G-SIFIs to hold 1% to 2.5% (with an empty bucket of 3.5%) of extra CET1 capital ratio on top of the base of 7% CET1 capital requirement (4.5% minimum CET1 ratio and a 2.5% capital conservation buffer). This new G-SIFI requirement will be phased in between 2016 and 2019. HSBC is currently designated to the 2.5% bucket.
In addition, the Basel framework requires banks to build up a counter-cyclical buffer of additional capital in good times, to be released as and when losses occur in bad times.
The CRD IV package in Europe
On 17 July 2013, the CRD IV package which transposes - via a Regulation and a Directive - the new global standards on bank capital (the Basel III agreement) into EU law, entered into force. The rules, which have applied from 1 January 2014, tackle some of the vulnerabilities shown by the banking institutions during the crisis, namely insufficient levels of capital, both in quantity and in quality, which previously resulted in the need for unprecedented support from national authorities. They also set stronger prudential requirements for banks, requiring them to keep sufficient capital reserves.
Prudential Regulation Authority (PRA) in the UK
The PRA has published its expectations in relation to capital ratios for major UK banks and building societies, namely that, from 1 July 2014, capital resources should be held equivalent to at least 7% of RWAs using a CRD IV end point definition of CET1. This PRA capital guidance applies instead of the minimum 4% CET1 transitional ratio applicable during 2014 under CRD IV.
Despite both the CRD IV and PRA rules published to date there remains continued uncertainty around the amount of capital that UK banks will be required to hold. This relates specifically to the quantification and interaction of capital buffers and Pillar 2, on which the PRA consulted earlier in 2015.
Federal Reserve Board alignment in the US
In December 2013, the Federal Reserve Board issued a final rule that makes technical changes to its market risk capital rule to align it with the Basel III regulatory capital framework (the market risk capital rule is used by banking organisations with significant trading activities to calculate regulatory capital requirements for market risk).
The final rule also clarifies criteria for determining whether underlying assets are delinquent for certain traded securitisation positions. It also details disclosure deadlines and modifies the definition of a 'covered position'. The changes make the market risk capital rule consistent with the revised capital framework due to take effect in January 2015.
For more information about Basel III capital requirements, please visit the Bank for International Settlements (BIS) website.