Basel III/Basel IV

The banking system entered the crisis with insufficient level of high quality capital, inconsistent definition of capital across jurisdictions and lack of disclosure. Banks failed to capture major balance sheet risks, derivative related exposures, which were key factors during the crisis.

To address the market failures a number of reforms to the international regulatory framework is introduced with the target to reduce the individual bank level risks, reducing the risk of system wide shocks and raising the resilience of the banking sector by strengthening the regulatory capital framework. The crisis demonstrated, that credit losses and write downs came out of retained earnings out of the bank tangible equity base.

The predominant form of Tier 1 capital has to be common shares and retained earnings. Hybrid capital will be phased out. Tier 2 capital instruments will be harmonised and Tier 3 capital instruments, that cover market risks, will be eliminated. The transparency of the capital base will be improved by disclosing along with detailed reconciliations to the reported accounts.

A key element of the new definition of capital is the greater focus on common equity.

Elements of capital

  1. Tier 1  —>Capital (going-concern capital) –>must be at least 6% of risk-weighted assets at all time
    • Common Equity  –>must be at least 4,5% of risk weighted assets at all times
      • Common shares issued by the bank
      • stock surplus resulting from issuing instruments
      • retained earnings
      • Accumulated comprehensive income and other disclosed reserves
      • common shares issued by consolidated subsidiaries
      • regulatory adjustments applied in the calculation of common equity Tier 1
    • Additional Tier 1
  1. Tier 2 Capital

Both Tier 1 and Tier 2 must be at least 8% of risk-weighted assets.

For more information see Bank for international settlements.

Update 24.01.2020:

Basel III will be introduced  by CRD IV including CRR-Capital Requirements Regulation (VO EU 2019/876 and VO EU 575/2013) and CRD IV Capital Requirements Directive (VO EU 2013/36).

Furthermore parts of Basel IV are included in CRD IV and CRRII, wheras the rest of Basel IV will be included in CRRIII.

The focus of Basel IV is the capital quote that is used for market-, credit-, counterparty- and operational  risk calculation.

Not included in Basel III are NSFR, LR, FRTB, SA-CCR and TLAC.

Banks have to look at their calculation tools for Derivatives as the regulator prefers standard calculation methods instead of individual ones.

Look at the summaries of e.g. KPMG or any other.


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