Definition of Basel III

Global banking regulators sealed a deal, in September of 2010, to effectively triple the size of the capital reserves that the world’s banks must hold against losses, in one of the most important reforms to emerge from the financial crisis.

The package, known as Basel III, sets a new key capital ratio of 4.5 per cent, more than double the current 2 per cent level, plus a new buffer of a further 2.5 per cent. Banks whose capital falls within the buffer zone will face restrictions on paying dividends and discretionary bonuses, so the rule sets an effective floor of 7 per cent.  The new rules will be phased in from January 2013 through to January 2019.

Banks will be required to triple core tier one capital ratios from 2 per cent to 7 per cent by 2019. This ratio measures the buffer of highest quality capital that banks hold against future losses.

The long-awaited agreement, developed by central bankers and officials, follows months of wrangling among the 27 member countries of the Basel Committee on Banking Supervision over how to make banks more resilient to financial shocks.

Jean-Claude Trichet, president of the European Central Bank and chairman of the negotiating group, called the deal “a fundamental strengthening of global capital standards ... Their contribution to long term financial stability and growth will be substantial.”

Tougher capital standards are considered critical for preventing another financial crisis, but bankers had warned that if the new standards were too harsh or the implementation deadlines too short, lending could be curtailed, cutting economic growth and costing jobs.

In addition to the 4.5 per cent core tier one ratio, and the 2.5 per cent buffer, the reform package also endorses the idea of an additional buffer of up to 2.5 per cent of core tier one capital to counter the economic cycle. [1]

See: FT Explainer on Basel III

FT Explainer on Basel III

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