EBI Publications

Strengthening the risk coverage of the capital framework; one major problem in the crisis was the failure of the Basel approach to capture on and off balance sheet risks. In that matter, Basel III proposed to determine a capital requirement for counterparty credit risk using stressed inputs, helping to remove pro-cyclicality that might arise with using current volatility- based risk inputs. Introducing a leverage ratio as a supplementary measure to the Basel II risk-based framework; The introduction of a leverage ratio is intended to help to avoid the build-up in excess leverage that can lead to a deleveraging ‘credit crunch’ in a crisis situation. Introduction additional safeguards against model risk and measurement error by supplementing the risk-based measure with a simple, transparent, independent measure of risk. Reducing procyclicality and promoting countercyclical buffers that varies between zero and 2.5% to total risk weighted assets; The buffer that will apply to each bank will reflect the geographic composition of its portfolio of credit exposures. The Committee is introducing a series of measures to promote the buildup of capital buffers in good times that can be drawn upon in periods of stress. This can be achieved by : -Dampen any excess cyclicality of the minimum capital requirement. A quantitative impact study has shown that the average capital requirement for banks would rise by 11.5%, but the median would only rise by 3.2%. Thus, more capital of course is to be welcomed. In that matter, Basel III came to raise some propositions of reforms as follows: Raising the quality, consistency and transparency of the capital base; Tier 1 capital w ill consist of going concern capital in the form of common equity (common shares plus retained earnings), Deductions from capital and prudential filters have been harmonized internationally and generally applied at the level of common equity or its equivalent in the case of non-joint stock companies. Innovative hybrid capital instruments with an incentive to redeem through features such as step-up clauses, currently limited to 15% of the Tier 1 capital base, will be phased out. Tier 2 capital i nstruments will be harmonized and tightened and Tier 3 capital will be eliminated. Under Basel III the definition of capital will be narrowed to common shares and retained earnings and equity over risk-weighted assets will be considered as the benchmark ratio, replacing Tier 1 capital ratio.

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