The Basel Committee On Banking Supervision Released Its New Set Of Prudential Standards - Coursework Example

Running Header: The Basel Committee on Banking Supervision Released its New Set of Prudential Standards Known Collectively as Basel III Name of Student: Institution: Instructor: Course Code & Name: Date of Submission: The Basel Committee on Banking Supervision Released its New Set of Prudential Standards Known Collectively as Basel III The Basel Committee on Banking Supervision issued a new consultative paper aimed at creating a anew capital adequacy framework. This was in a bid to respond to the previous accords’ shortcomings. It involves higher capital requirements associated with financial institutions. Basel 3 involves a new set of reform measures that are aimed at improving the regulation and risk management within the banking industry. The first version was published in 2009 by the Basel Committee on Banking Supervision. It has since involved continuous process of enhancing the banking regulatory framework. There was a rising divergence on the implementation of Basel 2 and the same has happened to Basel 3. Most banking organizations are looking at the increased buffers for both capital and liquidity. Others are focusing more on a comprehensive risk management program and capital management which are core factors in a banking setting. It is sometimes viewed as a solution to Basel 2.Amongst the debate of the new proposals, it is important to note that the main approach determined by Basel 2 for determining credit risk weighted assets has been the same with Basel 3 and has not changed in any way. Banks should therefore keep in mind that the implementation of Basel 3 involves the regulators will focus on risk management and governance in a robust financial sector. The Basel Committee on Banking Supervision was focusing on various objectives when putting the Basel 3 version. They aimed at strengthening a global and capital regulation with the aim of promoting a more resilient banking sector. Banks using Basel 3 were should be more absorbent to shock arising from financial and economic stress. The Basel 3 components are broken down into three main components. First, the capital reforms involve capital quality and quantity, complete risk coverage, leverage ratios and the introduction of capital conservation buffers. Liquidity reforms include both short term and long term. Also, Basel 3 focuses on the stability of the entire financial sector. In the medium term and short term, according to Basel 3, most banks will be constrained in terms of liquidity and capital and will hence need to focus on capital management and capital inefficiencies associated with Basel 2.The financial crisis that faced the financial sector and especially the banks has been contributory factor in showing and highlighting the weaknesses of Basel 2. The proposals of having Basel 3 in places are aimed at strengthening the capital requirements associated with market risks and better capturing and in the long run to spread risks. Basel 3 involves has element of liquidity coverage ratio as proposed by the committee banking supervision, this entails the idea that high quality liquidity assets could be used to offset a bank’s net outflows. Another vital element is the net stable funding ratio. It involves a formula t compare the amount of long term and stable sources of finance available to a bank and the liquidity profile of its assets. Basel 3 also involves various monitoring tools that are use to supervise various individual institutions (Sironi & resti, 2010, p. 3). After the financial crisis, it was clear that he modern landscape of increasing risk needed to be addressed. More specific rules and stringent regulations were needed to be in place. It is then that the secretariat of the Basel Committee introduced Basel 3 and made various changes. This was an improvement of the conservative approach of Basel 2. It involves five proposals or elements. The first and probably the most important proposal pertains quality, persistence and transparency of the capital base. Financial institutions will thereby have to increase their capital base and increase capital where the markets are more erratic. These funds are aimed at acting as buffers in volatile time s and at such times when the financial stress s high. The second proposal involves the strengthening of capital requirements. It calls for counterparty credit exposures arising from derivatives and other financial activities. Within this proposed change, banks are required to use stressed inputs when calculating their capital requirements. In accordance with this proposal, the committee has also proposed convergence in the measurement and supervision of operational risk. The third proposal introduces the concept of global leverage ratio. This ratio helps in the containing of build up of excessive leverage in the banking sector. Leverage ratio is the ratio between a bank’s or a company’s debt and equity. The committee suggests that it will not only rein I the leverage front but also will place safeguards against model risk and measurement errors. The fourth proposal introduces various measures that are aimed at promoting the build up of capital buffers. These buffers can be drawn upon during times of financial and economic stress. It further proposes that firms operate under what is referred to as the counter cyclical motion rule. This rule implies that banks move towards the expected loss approach. This means that there will be an assessment of expected credit losses. However, this creates conflict between accountants and regulators since accountants go by the current state of affair while regulators go by the expected loss method. The fifth and last proposal introduces a global minimum liquidity standard for international banks. This requirement involves a a30 day liquidity coverage ratio requirement. This in other words states that banks will be required to hold high quality liquidity assets to cover a minimum of a 30 day scenario of stress. Banks and institutions will be required to implement transparent process of internal management of their capital and allocation so that the management and senior leaders are well aware of the risks inherent in their routine activities. Basel 3 hopes to be fully implemented by the year 2012 and is expected to yield better results than the earlier version of basel2 (Holbrook, 2010, p. 22). In the Australian baking sector, Basel3 has had major impacts since its introduction and integration into the system. First, weaker banks have been crowded out. As more conditions deteriorate and regulatory measure get more intensive, the smaller and weaker banks find it more difficult to raise the required capital and funding required by Basel 3 proposals. This has led to reduction I business models in Australia and also the potentiality of competition. Pressure on return on equity and profitability on banks has been another significant impact. Increase d capital requirements and funding have led to much pressure on margins and operating capacities. Investors have thereby decreased considerably. Another impact on Australian banks has been change in demand from short term funding to long term funding. The introduction of the above mentioned liquidity ratios have driven most banks from sourcing for short term funds into o longer term funding. This has led to margins that are more achievable by banks and more realistic goals and objectives by the management. Legal entity reorganization has also been an impact of the introduction of Basel 3.Increased focus on supervisory rules has driven more banks in this region into group reorganizations. Basel 3 has led banks to improve the performance of existing assessment methodologies of credit risk approaches. The increase liquidity ratios amplify any inefficiency in the existing internal existing models and approaches. Also, Basel 3has led banks into active balance sheet management and hedging strategies. The pressure on bank capital has driven banks into active capital management portfolio management. It has also led to Australian banks to redesign their business models and portfolio focus. National regulators have had less flexibility allowing the inclusion of capital instruments. In periods of economic stress, banks have been able to draw on the capital conservation buffer. Banks have also been able to source for longer tem capital as opposed to short term capital (Ott & Williams, 2010). As discussed the implications of Basel 3 on credit risk management have been numerous. The diversification of risk has been amplified. The model is unlike the Basel 2 version which assumed perfect variables and completely disregarded the dependence analysis(Gregoriou, 2009, p.215)The qualification of risk is a challenging task and can The Basel 3 model aims to address this issue that has been ignored by previous models. The current proposals generally feature the weaknesses of Basel 2 on credit risk management and hence an improvement. However, concerns have been raised on the high capital requirements. The proposals encourage the banks to manage their risks and diversify them in a bid to effectively control and manage their credit base. The introduction of Basel 3 as a risk based capital structure has led to various developments in the banking sector. Increasing the capital requirements of banks would serve to increase buffers and this allow capital ratios to decline further as economic conditions deteriorate before they take any action to pull back lending. Basel 3 has managed to deal with the procyclicallity issues in increasing the actual over required capital (Pan, 2009 p. 20). Generally, the Australian Banking industry has experienced various changes and impacts since the integration of Basel 3 in their system. The implementation of this version is still underway and hopes to achieve desired results by the year 2012.Implementing the recommendations of this new version has been brought about by the financial crisis and is expected to address issues relating risk management and the Basel Committee on Banking Supervision is working towards achieving this objective. References Gregoriou, N. 2009. Operational Risk towards Basel 3. New Jersey. John Wiley & Sons Publishers. Holbrook, E. 2010. ‘Mending a Broken Banking System’. Risk Management Journal. Vol.57, no.3, p.22-25. Ott, K. & Williams, G, 2010. ‘Basel 3, Pressure is Building, viewed 22 August 2011, . Pan, N. 2009.’Look Before You Leap: A Skeptical View of Proposals to Meld Macro and Micro prudential Regulation’. Journal of Financial Services. Vol. 1 no.296 pp.15-25. Sironi, A. & Resti, A. 2010. ‘What future for Basel 2’. The Dice Report Journal. Vol. 8, no. 1, p.3-5. Read More