16 February 2011

CEPS warns that Basel III is too complex

The new Basel framework, published on 15 December 2010, is an important building block in the new post-crisis regulatory paradigm. It maintains the current risk-weighted capital ratios framework (Tier 1 and 2) and adds,on top of a stricter definition of capital: 1) a minimum ratio of common equity; 2) a capital buffer; and 3) a countercyclical provision. It complements these risk-weighted ratios with 4) a simple leverage ratio, and two minimum liquidity requirements; 5) a liquidity coverage ratio; and 6) the net stable funding ratio. These new rules will be introduced from 2013 onwards over an extended transition period, and will all be fully applicable from 2019 onwards. Two important elements still need to be filled in: the re-calibration of the risk-weight of assets and a surcharge for large, systemically important financial institutions (SIFIs).

The new framework is considerably more complicated than that of the current Basel II, which required banks to hold a minimum of 8% of regulatory capital based on risk-weighted assets. The new framework is also composed of several building blocks, each of them with different implementation deadlines. Compared with Basel II, the update substantially extends the requirements and introduces significant changes for banks, supervisors, investors and users. Rather than using only one ratio, for example, banks will now be assessed on the basis of up to seven different ratios.

The big question that emerges from this complex structure is how does one determine when a bank is effectively Basel III-compliant, as some will soon start to claim. Is it when it meets all ratios at the same time? Or will it be when it complies with the leverage ratio and the minimum levels of common equity and capital buffer?

With the increased use of regulations in financial services and the objective to arrive at a single rulebook for the new supervisory authorities, a huge task lies ahead for the EU to come forward with a streamlined Basel III and to withstand pressures for national discretion.

© CEPS - Centre for European Policy Studies