Basel III: An Overview

Basel III refers to the capital and liquidity standards prescribed by the Bank for International Settlements (BIS) to promote stability of international banking system. BIS is an international financial institution, which acts as a bank of central banks

Capital and liquidity standards prescribe minimum level of capital and liquidity that banks should maintain.

 Basel I, Basel II, Basel III

Basel Committee on Banking Supervision (BCBS) is one of the six committees of BIS. The Committee introduced capital standard in 1988, which is known as Basel I. Due to some shortcomings of Basel I, it was replaced by Basel II in 2004. Again, Basel-II was felt inadequate in the recent global financial crisis. As a result, Basel III was formulated in the year 2010 with the intention of gradual implementation starting from 1 January 2015 and full implementation starting from 1 January 2019. Basel III includes both capital standard and liquidity standard. The earlier versions included capital standard only.

In line with Basel III, Bangladesh Bank (BB) circulated ‘Guidelines on Risk Based Capital Adequacy’ vide BRPD circular no. 18 dated 21 December 2014 and gradual implementation of Basel III has started from 1 January 2015 in Bangladesh. Full implementation of Basel III in Bangladesh will start from January 2019.

A.     Capital Standard

It is said earlier that Basel III has two parts: Capital Standard and Liquidity Standard. Capital Standard of Basel III is structured into three aspects, which are known as three pillars

1. Pillar 1 covers minimum capital, capital buffer and leverage 
2. Pillar 2 covers Risk management and supervision and
3. Pillar 3 covers Market Discipline, eg, disclosure of financial exposure eg, Balance sheet, Financial Statement on quarterly basis

Pillar 1 of Capital standard prescribes some ratios related to capital, which has to be maintained by banks as a minimum. Two such major ratios are Capital to Risk-weighted Asset Ratio (CRAR) and Leverage Ratio.

 Capital to Risk-weighted Asset Ratio

The Capital to Risk-weighted Asset Ratio (CRAR) is calculated by taking eligible regulatory capital as numerator and total Risk Weighted Asset (RWA) as denominator.

 CRAR=Total Eligible capital/Risk Weighted Asset

Banks in Bangladesh have to maintain minimum total capital ratio of 10% or Tk. 400 crore, whichever is higher. In addition to this minimum capital, a Capital Conservation Buffer (CCB) of 2.5% is to be built up gradually within year 2019.

The above ratio has two parts: Eligible Capital and Risk Weighted Asset,

Eligible Capital

According to loss absorbance capacity/quality, the eligible capital is divided into two tiers:

1. Tier 1 Capital: It is better quality capital. Tier 1 capital is further divided into two parts-
1. Common Equity Tier 1 Capital (CET-1 Capital): CET-1 capital generally includes the following items:
1. Paid up capital
2. General reserve
3. Statutory reserves
4. Retained earnings
5. Dividend Equalization Account
6. Share Premium
2. Additional Tier 1 Captial:  Perpetual Bond 300 crore

2. Tier 2 Capital: It is lower quality capital than Tier 1 capital. Components:

   i. subordinated (Bond 2300 crore)

   ii. general provision 

 Risk Weighted Asset:

Banks are required to calculate their 1. Risk Weighted Assets (RWA) on the basis of credit (Investment) Risk, 2. market Risk, and 3. operational risk.

( 263 page)

 Leverage Ratio:

In addition to  CRAR, a simple non-risk based Leverage Ratio has been introduced. While CRAR uses risk weighted asset/exposure as denominator, leverage ratio uses total exposure as denominator . Leverage ratio is calculated as under:

Leverage Ratio=tier I capital/Total Exposure, say IBBL 78000=100%, then 58,000 (tier I)=100*58000/78000= 7.4 %

Banks have to maintain minimum leverage ratio of 3%. In Bangladesh, the calculation of leverage ratio will be monitored in the year 2016 and readjustment, if required, will be made in the year 2017. From 2018, it will be mandatory for banks to maintain the leverage ratio.

B.     Liquidity Standard:

Basel III introduced liquidity standard as a complement (in addition to)  to the capital standard. It developed two minimum standards for liquidity. These are Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). Bangladesh Bank, in line with Basel III, has circulated 'Guidance Note on Liquidity Coverage Ratio (LCR) & Net Stable Funding Ratio (NSFR)' through DOS Circular No. 01 dated 1 January 2015.

Liquidity Coverage Ratio:

LCR aims to ensure that a bank maintains an adequate level of unencumbered, high-quality liquid assets that can be converted into cash to meet its liquidity needs for 30 calendar days in a difficult time. The equation to calculate LCR is as under:

              

The minimum standard for LCR shall be greater than or equal to 100.

Net Stable Funding Ratio:

The objective of NSFR is to promote resilience over a time horizon of one year by requiring banks to fund the activities with more stable sources of funding. NSFR aims to limit over-reliance on short-term wholesale funding during times of abundant market liquidity.

The equation to calculate NSFR is as under:

The minimum standard for NSFR shall be greater than 100.

 Summary of Capital and Liquidity Requirements/ Roadmap of implementation of Basel III in Bangladesh

	2016	2017	2018	2019	2020
Minimum Total Capital Ratio	10.00%	10.00%	10.00%	10.00%	10.00%
Capital Conservation Buffer	0.625%	1.25%	1.875%	2.50%	2.50%
Minimum Total Capital plus Capital Conservation Buffer	10.625%	11.25%	11.875%	12.50%	12.50%
Leverage Ratio	3%	3% Readjustment	Migration to Pillar 1
Liquidity Coverage Ratio	≥ 100%	≥ 100%	≥ 100%	≥ 100%	≥ 100%
Net Stable Funding Ratio	> 100%	> 100%	> 100%	> 100%	> 100%