Basel III and Its New Capital Requirements, as Distinguished from Basel II

Abstract

From July 1988 when the original Basel Accord, Basel I, was introduced until January 2013 when Basel III implementation began, over the past 25 years, capital adequacy requirements have emerged as the dominant form of regulation for maintaining the financial soundness of banks. The rationale for reserving regulatory capital is to allow a bank, when under financial stress, to draw upon a pool of reserved funds comprised of shareholders’ equity and its retained earnings, providing a buffer against a bank’s unexpected losses. The Basel Committee on Banking Supervision (“Basel Committee”) issued a consultative document in December 2009 titled “Strengthening the Resilience of the Banking Sector,” often referred to by practitioners as “Basel III.” Though a consultative document, the Basel Committee saw it as a set of proposed changes to the Basel II framework that was first issued in 2004. A comprehensive reform package, Basel III draws lessons from the global financial crisis of 2007-2009, one of them being the banking sectors in many countries had built up excessive on- and off-balance sheet leverage that was accompanied by a gradual erosion of the quantity and quality of the capital base. Basel III strengthens and redefines the global capital framework by raising banks’ capital adequacy ratios and requiring banks to build up its capital defenses in periods when credit is at excessive levels, upholding a financially sound banking system that is the backbone of a functional market economy; because a market economy needs a financially sound banking system for raising capital and extending credit. Despite its relatively long five year phase-in period, Basel III is stricter than Basel II; and, Basel III, like its predecessors, does not have enforcement mechanisms due to its soft-law nature. Focusing especially on Basel III’s capital adequacy requirement, this article aims to examine Basel III’s implementation and measures for reducing systemic risk, its improvement from Basel II as well as its impact on trade finance, project finance and small- and medium-sized enterprises (“SMEs”).