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EVOLUTION OF BANKING
SECTOR OF ASEAN MEMBER
COUNTRIES FROM BASEL I
REGIME TO BASEL III REGIME
DESSERTATION SUBMITTED IN THE
PARTIAL FULFILLMENT OF BANKING
AND FINANCE
SEMESTER JAN 2015- MAY 2015
LINK :

SUBMITTED BY KRITIKA GUPTA (602)

LLM , BANKING AND FINANCE
4/15/2015

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EVOLUTION OF BANKING SECTOR OF ASEAN

MEMBER COUNTRIES FROM BASEL I REGIME TO
BASEL III REGIME

A Dissertation Submitted to National Law University, Jodhpur, in Partial

Fulfillment of the Requirement for the Degree of

LL.M( BANKING AND FINANCE)

Under the
Supervision of:

MR. RITUPARNA
DAS

Submitted by:

Kritika Gupta (602)

LL.M
(BANKING
FINANCE)

AND

Deptt. of Law,

NATIONAL LAW UNIVERSITY ,

JODHPUR
SESSION 2014-2015

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MR. RITUPARNA DAS

of Law

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Department

PUBLICATION:

PUBLISHED LINK:

NUMBER OF WORDS:

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SUPERVISOR'S CERTIFICATE

It gives me pleasure to certify that Ms. Kritika Gupta, 602, LL.M (2 ND

SEMESTER), Session 2014-2015 has partially completed her dissertation
entitled Evolution of Banking Sector in ASEAN Member Countries from
Basel I Regime to Basel III Regime , as partial fulfilment of the requirement
of LL.M degree of National Law University , Jodhpur under my supervision.
The dissertation is fit for submission and evaluation for the above purpose.

SUPERVISOR AND GUIDE

MR. RITUPARNA DAS

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ABSTRACT
Todays financial and regulatory environment has increased the importance of regulation in
banking industry. Basel framework for capital adequacy is the cornerstone of international
banking architecture which has strong emphasis on risk management and ongoing
improvement in risk assessment capabilities of banks. In order to achieve harmonization at
international level, bank regulators in Asia Pacific region consented to implement Basel
norms according to sophistication of their respective banking markets. In the present study,
an attempt has been made to examine the importance of Basel norm and their background
and importance respectively with respect to ASEAN Countries. The study revealed that
among developing countries of Asia Pacific region, Philippines was first to move towards
new Accord and among advanced countries, Japanese financial institutions along with
Taiwanese and Hong-Kong banks were among the first movers to Basel II. The study has also
tried to throw light on specific challenges encountered by sampled countries in adoption of
Basel regime. Proposed Basel III reforms for more stringent capital requirements and their
implications for the developing world in particular. BIS proposals for better regulation of
financial derivatives, including commodities futures , moving away from OTC transactions
towards organized exchanges. The Basel reforms and the BIS proposals for regulating the
derivatives markets have many positive features. The consequences of Basel I and II and
proposed Basel III are analyzed from the perspective of the developing countries.
.

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ACKNOWLEDGEMENT
It gives me immense pleasure and sense of gratitude to acknowledge my indebtedness
to my Hon'ble teacher and Research supervisor Mr. Rituparna Das (Supervisor) and also to
Mr. Anindhya Tiwari for suggesting me the idea of this topic , National Law University ,
Jodhpur. It is due to unreserved guidance and sparing of time for me by respected teacher
that I am able to complete this work. His sympathetic attitude, scholarly guidance and keen
interest in the work have inspired me at every stage of my efforts. With equal sincere feeling.
I place on record my indebtedness to other teachers of Department whose sincere
encouragement was tremendous moral support for me.
I am thankful to friends who shared with me their precious time and encouraged me to
complete this work.

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TABLE OF CONTENTS
PUBLICATION................................................................................................3
SUPERVISORS CERTIFICATE......................................................................4
ABSTRACT.......................................................................................................5
ACKNOWLEDGEMENT..................................................................................6
TABLE OF CONTENTS................................................................................7-12
ABBREVIATIONS ..........................................................................................13
CHAPTER1: INTRODUCTION:............................................................14-17
1.1 Background .........................................................................14
1.2 Scope of the study................................................................15
1.3 Importance of ASEAN.............................................................15
1.4 HOW THE UK IS Helping..........................15
1.5 CAPITAL MARKETS .......................................................... 15
1.6INSURANCE AND PRIVATE PENSIONS 16
1.7 OBJECTIVES..........................................................................16
1.8 METHODOLOGY..................................................................16.
1.9 LIMITATIONS.......................................................................17.
1.10 UTILITY..............................................................................17.
1.11 CONCLUSION....................................................................17
CHAPTER2: HISTORICAL ANALYSIS OF EARLIER BASEL NORM
AND INDIAN PERSPECTIVE..................................18-23
2.1 BACKGROUND OF BASEL NORMS................................18
2.2 BASEL I...........................................................................18
2.3 BASEL II................................................................................19

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2.4 INDIAN PERSPECTIVE....................................................21

2.5 CONCLUSION......................................................................21
CHAPTER3: IMPACT OF BASEL NORMS ON THE BANKS....22-52
3.1 HISTORY OF BANKING REGIME WITH RESPECT TO
ASEAN COUNTRIES24.
3.2 BASEL II REGULATORY COMPLIANCE AMONG ASIAPACIFIC COUNTRIES 25
3.3 DEVELOPING ECONOMIES OF

ASIA

PACIFIC

REGION25
3.4 BASEL II IMPLEMENTATION: CHALLENGES28
3.5 BASEL III , BIS AND GLOBAL FINANCIAL
GOVERNANCE.30
3.6 PROPOSED BASEL III

REFORMS

FOR

MORE

STRINGENT CAPITAL REQUIREMENTS AND THEIR

IMPLICATIONS

FOR

THE

DEVELOPING

WORLD..32
3.7 FURTHER EVOLUTION: GOING FROM BASEL II TO
BASEL III35
3.8 CREDIT ACCESS UNDER BASEL III37
3.9 DEVELOPING WORLD BANKS AND COMPETITION
UNDER BASEL III38
3.10 STATES AS COLLECTIVE CORPORATE ACTORS AND
BASEL III39
3.11 BIS PROPOSALS FOR BETTER REGULATION OF
FINANCIAL

DERIVATIVES,

INCLUDING

COMMODITIES FUTURES, BY MOVING AWAY FROM

OTC

TRANSACTIONS

EXCHANGES.

TOWARDS

PRE-CRISIS

ORGANIZED

BUILDUP

OF

PROBLEMS..43
3.12 EMERGING MARKETS44
3.13 FINANCIAL DERIVATIVES45

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3.14 COMMODITY FUTURES46

3.15 ORGANIZED
EXCHANGES
FOR

OTC

TRANSACTIONS47.
3.16 CONCLUSION52
CHAPTER4: AN

ANALYSIS

BANKING

OF

THE

SECTOR

IN

PERFORMANCE
ASEAN

OF

MEMBER

COUNTRIES.....................................53-57
4.1

BANKING

INTEGRATION

IN

ASEAN

GATHERS

4.2

PACE53
ASEAN BANKS ON LONG ROAD TO FINANCIAL

4.3

INTEGRATION54
SURGING ASEAN TRADE PROMPTS BANKING

4.4

REALIGNMENT55
CONCLUSION57

CHAPTER5: IMPACT OF CAPTAL ADEQUACY RATIO ON THE

PERFORMANCE OF BANKING SECTOR IN ASEAN
MEMBERCOUNTRIES.......................................58-59
5.1
5.2

CAPITAL

ADEQUACY

RATIOS

(CAR)

AND

DEVELOPING MARKETS58
CONCLUSION59

CHAPTER 6 ADOPTION OF CAPITAL ADEQUACY NORMS OF

BASEL III.........................................60-66
6.1

MAJOR CHANGES IN BASEL III............................60-66

6.2

CONCLUSION

............................................66

`
CHAPTER-7: BASEL III AND FINANCIAL CRISIS.................67-80
7.1

CONCLUSION80

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CHAPTER-8: CHALLENGES AND IMPLICATIONS................81-86

8.1
8.2
8.3

CHALLENGES.81-84
IMPLICATIONS84-85
BASEL III IMPLICATIONS FOR BANKING INDUSTRY
STRENGTH85-86

CHAPTER-9: SUMMARISE OF BASEL III....................................87-90

9.1
9.2
9.3
9.4

SUMMARISE87
WHAT IS BASEL III87-88
WHAT ARE THE MAIN PRINCIPLES88
HOW IT WILL WORK.89

CHAPTER-10: CONCLUSION...............................91-103
10.1

LITERATURE REVIEW..93-99

10.2

BIBLIOGRAPHY..99-102

10.3

REFERENCE..102-103

LIST OF ABBREVIATIONS
AESAN
AFC
ASA
BCBS
BIS
BITs
BOP
BRIC
CAR
CCP
CDS
CET

Association of Southeast Asian Nations

Asian Financial Crisis
ASEAN Swap Agreement
Basel Committee on Banking Supervision
Bank for International Settlements
Bilateral Investment Treaties
Balance of Payments
Brazil, Russia, India and China
Capital Adequacy Ratio
Central Counterparty
Credit Default Swap
Constructive Evolutionary Theory

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CFTC
CPSS
CRPRID
CSO
FYDP
GDP
HDR
ICT
IPS
MDGs
MPND
MPO
MPND
MPO
MTEF
NAPEP
NEEDS
NGO
NPC
PRS

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Commodity Futures Trading Commission

Committee on Payment and Settlement Systems
Center for Poverty Reduction & Income Distribution
Civil Society Organizations
Five Year Development Plan
Gross Domestic Product
Human Development Reports
Information, Communication and Technology
Integrated Package Services
Millennium Development Goals
Ministry of Planning and National Development
Management and Planning Office
Ministry of Planning and National Development
Management and Planning Office
Medium Term Expenditure Framework
National Poverty Eradication Programme
National Economic Empowerment and Development Strategy
Non Governmental Organizations
National Planning Commission
Poverty Reduction Strategy

CHAPTER -1
INTRODUCTION
BACKGROUNDThe banking system plays an important role in the economic development of any country.
Commercial banks, which are the main component of the banking system and that have to be
efficient otherwise they will create mal-adjustments and impediments in the process of
development in any economy. Technological advancements and globalisation have added to
the pressure on the part of the banks to maintain market shares so as to survive and remain
competitive. Competition from foreign banks as well from domestic banks themselves creates

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greater pressure. Commercial banks in ASEAN are of no exception. Therefore not only do
commercial banks need to be profitable, but also efficient, since banks are exposed to intense
competition both locally and globally. The basic benefit to enhance efficiency is a reduction
in spreads between lending and deposit rates and this will likely stimulate both greater loan
demand for industrial investment and greater mobilization of financial savings through the
banking system.
The governing body of the Basel Committee on Banking Supervision (BCBS) had made its
announcement on the Basel III framework proposal on September 12, 2010. The key changes
to the proposed framework consist of the followings: Minimum core Tier-1 ratio , Capital
conservation buffer 2.5% , Countercyclical buffer 0-2.5% etc The initial focus of Basel II was
to enhance the risk sensitivity of banks to determine the minimum capital requirement under
Pillar One, but the credit crisis and related economic crisis shifted the focus towards Pillar
Two, thus increasing the uncertainty about the actual regulatory capital requirements at
individual bank level and thus a potential uneven playing field across countries. Though the
recent Basel III announcement had draw most of the market attentions in response to the
2008-2009 global financial tsunami.
SCOPE OF THE STUDY- The study will focus on analyzing different parameters for
maintaining capital adequacy which are taken into account by banks with respect to the
ongoing Basel norms implemented all over the country.
THE IMPORTANCE OF ASEAN1
ASEAN is one of the most dynamics regions in the world and is becoming an increasingly
important driver of global growth. The ten members of ASEAN are also working towards the
launch of the ASEAN Economic Community (AEC, single market) at the end of 2015.
Diversity is one major characteristic of the member states of ASEAN. They differ
significantly in size, stage of development, and industrial structure. For example, Indonesia,
the largest economy in the region (with a nominal gross domestic product (GDP) of $546.5
billion in 2009). Most ASEAN member states have chosen to pursue an export oriented
1

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development strategy over the past several decades. The ASEAN member states do not trade
among themselves as much as they do with other parts of the world.2
HOW THE UK IS HELPING
The UK is keen to support SE Asian countries, and ASEAN as a bloc, take forward these
ambitious reform plans at the national and regional level. As home to the world largest
international financial centre and many of the leading players in global financial markets, the
UK has a wealth of experience and expertise- from policymakers, market participants and
industry associations- which we are keen to share with our SE Asian partners. The Prosperity
Fund is our main vehicle for doing this in SE Asia. Some of the areas we have worked on
before and are interested in co-operating more on are:
CAPITAL MARKETS:
A Prosperity Fund project with the Ministry of Finance (MoF) in Vietnam has already
supported the development of new policies on credit rating agencies and bond markets.
Basically different Prosperity Fund project is running to develop a roadmap for the
Indonesian authorities on government bonds, aimed at enhancing the liquidity and efficiency
of the market.
INSURANCE AND PRIVATE PENSIONS:
Prosperity Fund project with MoF in Vietnam has supported reforms to the private pensions
market. They are eager to work more on issues related to the development of the insurance
sector and private pensions, which are of increasing importance in SE Asia given rising
development levels and changing demographic.
OBJECTIVES To examine the Basel norms regulatory compliance among advanced and developing
countries of ASEAN member countries.

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To bring into light major challenges faced by the countries in adopting Basel
frameworks.

METHODOLOGY- Dissertation work is primarily based on doctrinal and analytical

research. Keeping this in view the researcher utilized the resources like print and electronic
media, articles and reports of various authorities, books in the library, internet, websites,
search engines, like Google. Efforts have also been made to discuss and take note of the
inputs of faculties, classmates and friends, along with the guidance of the supervisor. As the
study is legal in nature, historical and doctrinal methods are adopted because it is not possible
to study purely by experimental method. From the collected material and information,
researcher proposes to critically analyze and comparative analysis of the topic of the study
and try to reach the core aspect of study. The researcher has analyzed primary sources for the
legal prospect like different related statutes, policies and notifications issued time to time in
India. Policies made by the concerned authorities and agencies, circulars etc. The help from
the secondary sources like books, newspapers, journals, articles, magazines, internet etc for
critically analyzing the concept of economic offences. The secondary sources would help in
understanding the view point of various authors reading the offences and would help in
understanding the nature of such acts.
LIMITATIONS- The propose study is not covering any specific time period this is the
overall coverage of the Basel I , Basel II and Basel III norms. The research only based on the
analysis made by the different ASEAN (Association of South East Asian Nations) member
countries. The statistical data is also taken into consideration so there is no direct approach
for getting the information in this regard.
UTILITY - The outcome of the research would comprise of the impact of Basel norms on
each and every aspect of banking operations in ASEAN Countries and the world thereby
achieving all the research objectives. The recommendations based on the findings of the
study will help modern day banks in acquiring the knowledge on how their counterparts are
mitigating risks and maintaining adequate capital as per norms. The research hypothesis will
lead the study to a conclusion Whether Basel guidelines are the ultimate solution for
protecting the booming banking industry? Or Whether the regulatory bodies world

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over need to look beyond Basel standards for forming norms more stringent and
effective to build stabilized economies resilient to global financial shocks?
CONCLUSION:
This chapter is basically talking about the initial beginning of my research work as to what is
the research methodology of my research and the respective topic. This chapter is talking
about the comprehensible study of research objectives and the scope and what can be the
limitation and whatever literature which has been reviewed is incorporated in my respective
chapters but also at the end respective articles are shown as to what literature has been
reviewed and from where. Further chapters are elaborated with different explanations
subsequently.

CHAPTER 2
HISTORICAL ANALYSIS OF EARLIER BASEL NORM AND INDIAN
PERSPECTIVE
BACKGROUND OF BASEL NORMS3
On 26 June 1974, a number of banks had released payment of Deutshce Marks to Herstatt in
Frankfurt in exchange for US Dollars (USD) that was to be delivered in New York but
because of time-zone differences, Herstatt ceased operations between the times of the
respective payments. German regulators forced the troubled Bank Herstatt into liquidation.
The counter party banks did not receive their USD payments , the G-10 countries , Spain for
3

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International Settlements (BIS) , called the Basel Committees on Banking Supervision , Since
BIS is headquarter in Basel , this committee got its name from there. The committee
comprises representatives from central banks and regulatory authorities.
BASEL I
In 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland,
published a set of minimum capital requirements for banks. These were known as Basel I. It
focused almost entirely on credit risk (default risk) the risk of counter party failure. It
defined capital requirement and structure of risk weights for banks.
Under these norms, Assets of banks were classified and grouped in five categories according
to credit risk, carrying risk weights of 0% (Cash, Bullion, Home Country Debt like
treasuries), 10, 20, 50and 100% and no rating. Banks with an international presence are
required to hold capital equal to 8% of their risk- weighted assets at least 4% in Tier I
Capital ( Equity capital + retained earnings) and more than 8% in Tier I and Tier II Capital .
One of the major role of Basel norms is to standardize the banking practice across all
countries. However there are major problems with the definition of Capital and Differential
Risk Weights to assets across Countries, like Basel standards are computed on the basis of
book-value accounting measures of capital like Basel standards are computed on the basis of
book-value accounting measures of capital not market values. Accounting practices vary
significantly across the G-10 countries and often produce results that differ markedly from
market assessments. Other problem was that the risk weights do not attempt to take account
of risks other than credit risk viz., market risks , liquidity risk and operational risks that may
be important sources of insolvency exposure for banks.
BASEL II
The past few decades have witnessed substantial economic and financial turbulence in the
global financial system. Moreover, with increased globalization, liberalization and emergence
of financial conglomerates financial sector stability has emerged a key concern for regulators
worldwide. Therefore, need was felt for strengthening the global capital adequacy regime
which led Bank of International Settlements (BIS) to introduce improvement to the 1988

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accord with the launching of new capital adequacy framework known as Basel II (Bank
Indonesia, 2008).4 The accord is a cornerstone of current international financial architecture
and its recommendations have been acknowledged as a new paradigm in risk management
and supervision. Its aim is to establish risk sensitive capital allocation and improving the
quality of risk management at banks thereby to strengthen the security and soundness of
financial system.
Advocators of Basel II believe that creation of such an international standard can help to
protect the international financial system from type of problems that might arise should a
major bank or series of banks collapse. Although, Basel accord regulations are primarily
intended for banks in G-10 countries yet the guiding principles embodied in three pillars are
generally suitable for any bank in the jurisdiction. The Basel Committee believes that the
safety of banks around the globe is achieved at its best by national supervisors by fully
implementing the three pillars of the accord and by adoption of Core Principles of Effective
Banking Supervision in their respective jurisdictions. This in turn will enhance countries
prospective for successfully integrating with world economy and gaining the benefits of
international capital flows (RBI, 2000). With a view to improve soundness, to improve
stability of banking system and to achieve harmonization, bank regulators in Asia Pacific
region also supported the broad objectives of Basel II and consented for its implementation
according to degree of development of their financial markets which would help them to
maintain and improve their global competitiveness
Basel II was introduced in 2004, laid down guidelines for capital adequacy, risk
management ( Market risk and operational risk) and disclosure requirements.
Use of external ratings agencies to set the risk weights for corporate, bank and
sovereign claims.
Operational risk has been defined as the risk of loss resulting from inadequate or
failed internal processes, people and systems or from external events. This definition
includes legal risk , but excludes strategic and reputation risk , whereby legal risk
4

The Basel Committees official objectives regarding the overall level of minimum capital requirements are to
broadly maintain the aggregate level of such requirements, while also providing incentives, by reduction in the
capital requirement, to adopt the more advanced risk-sensitive approaches of the revised capital adequacy
framework. (BCBS, 2006:4)

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includes exposures to fines , penalties pr punitive damages resulting from supervisory

actions as well as private settlements . There are complex methods to calculate this
risk.
Disclosure requirements allow market participants assess the capital adequacy of the
institution based on information on the scope of application, capital, risk exposures,
risk assessment processes.
In Asia Pacific region also, bank regulators have begun their march towards this ambitious
project. Basel II implementation in Asia- Pacific countries is occurring at the time of
heightened risk and highly complex and competitive environment. In this environment, the
implementation of Basel II presents a powerful lever for banks to significantly augment both
their long term resilience and competitive advantage. It promises greater financial stability
through closer alignment of risk with capital . Asia- Pacific countries have wide diversity in
banking and financial markets and Basel II implementation requires consideration of their
own specific issues and circumstances to develop an appropriate strategy to incorporate
capital adequacy and risk management framework. Although, much regulatory framework for
the structure has gradually been developed in Asia Pacific countries with an objective to
ensure its envisaged implementation yet level of regulatory compliance achieved is still an
unveiled issue. The present study aims to shed light on Basel II regulatory compliance in Asia
Pacific countries along with specific challenges encountered by them in its adoption.

INDIAN PERSPECTIVE: 5
INTRODUCTION
Banks being the financial backbone of an economy affect the countrys monetary and fiscal
policies. With the advent of globalization , more and more foreign banks coming down to
India and vice versa , banks are now exposed to a number of risks. Therefore , the entire
banking system and its operations require close scrutiny and control. Moreover , the global
financial crisis right from the Herstatt Bank Failure , US sub prime crisis, Dubai crisis as
5

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well as the recent Euro Debt crisis drawn attention towards having stringent norms for the
banking system world over. In order to avert such crisis in future and protect banks from
various threats and risks, several guidelines have been introduced by Regulatory Authorities
all over the world and one such standard is prescribed by the Basel Committee for Banking
Supervision (BCBS) for maintaining capital adequacy which gaining ground in recent times
all over the world.
In India, RBI being the Regulatory Authority for the banking sector has implemented Basel
norms which are followed by banks all over the world. Initially in April 1992, RBI introduced
a Risk asset ratio system as a capital adequacy measure in line with the capital adequacy
norms prescribed by the Basel Committee (Basel I) where risk weights are assigned for
balance sheet assets, non funded items and other off balance sheet exposures and the
minimum capital to be maintained as ratio to the aggregate of risk weighted assets, and other
exposures as well as capital requirements in the trading book on an ongoing basis. Down the
years Basel I was replaced by Basel II guidelines, where banks are required to maintain a
Capital to Risk Weighted assets ratio (CRAR) at 9% (which remain unchanged from Base I) ,
the predominant reason for adopting Basel II norms was that , it recognizes both credit and
operational risks apart from market risks as the primary sources of risks and directs banks to
allocate adequate amounts of capital for these types of risks unlike Basel I. The Revised
Framework provides a range of options for determining the capital requirements for credit
risk and operational risk to allow banks and supervisors to select approaches that are most
approaches that are most appropriate for their operations and financial markets.
The main structure of Basel II rests on 3 Pillars concept:
1. Minimum capital requirements.
2. Supervisory review of capital adequacy.
3. Market discipline.
THE FIRST PILLAR: It deals with the maintenance of regulatory capital for three
major risk components- Credit risk , Operational risk and Market risk

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THE SECOND PILLAR: It provides framework for dealing with all the other risks a
bank may face such as systemic risk , pension risk , concentration risk , strategic risk ,
reputational risk , liquidity and legal risk which the accord combines under residual
risk. It gives banks a power to review their Risk Management System by encouraging
banks to develop and use better risk management techniques in monitoring and
managing their risks. Supervisors are expected to evaluate how well banks are
assessing their capital needs relative to their risks and to intervene, where appropriate.
THE THIRD PILLAR: It aims to promote greater stability in the financial system .
Market Discipline supplements regulation as sharing of information facilitates
assessment of banks by market participants such as investors , analyst , customers ,
other banks and rating agencies.
Basel I dealt with only parts of the above pillars whereas Basel II represents a fundamental
change in how bank capital is determined for regulatory purposes. However , on the
contrary , according to RBI Governor D Subbarao the Indian banks are not likely to be
impacted by the new capital rules under Basel III . At the end of June 30, 2010, the aggregate
capital to risk weighted assets ratio of the Indian banking system stood at 13.4% of which
Tier-I capital constituted 9.3% . As such , RBI does not expect our banking system to be
significantly stretched in meeting the proposed new capital rules , both in terms of the overall
capital requirement and the quality of capital. There may be some negative impact arising
from shifting some deductions from Tier-I and Tier-II capital to common equity.
The outcome of the research will be primarily useful to the Indian banks as well as their
foreign counter parts , Non banking Financial Companies and other market participants such
as analysts , credit rating agency officials, officials , officials in RBI and other regulatory
bodies in analyzing the implication of ongoing Basel II norms on the above mentioned
components of the banking system , particularly system , particularly with respect to the
different risks they are and safeguarding themselves from those risks in turn maintain
adequate capital ensuring long term growth , profitability and survival in the markets both
local and global.
CONCLUSION:

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My research is basically towards the Basel III norm and for this earlier Basel norm has to b
studied then only it can be possible to move forward. Hence, this chapter is basically giving
brief overview of Basel I and Basel II norm with respect to ASEAN countries and also
comparative analysis has to be done with Indian perspective. Explanation of three pillar is
very important in Indian scenario.
However, how the minimum capital requirements for banks are publishedand the assets of
banks are categorised accordingly. The points which are mentioned for improvement in their
global competitiveness.

CHAPTER 3
IMPACT OF BASEL NORMS ON THE BANKS
HISTORY OF BANKING REGIME WITH RESPECT TO ASEAN COUNTRIES: 6
1. Financial Markets and Institutions
Reflecting the diversity of their economies , some standard metrics of financial development
such as deposit money banks assets , stock market capitalization and the value of bonds
outstanding as a proportion of GDP show considerable differences across ASEAN. These
differences are largely associated with differences in the size of stock and bond markets .
Financial institutions in ASEAN are generally classified into:
Banks including commercial banks and special purpose banks ( or specialized
financial institutions).
6

http://www.bnm.gov.my/index.php?rp=road-to-asean-financial-integrat

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Non banking institutions.

Capital market related financial institutions.
a. Banking Institutions:
Commercial banks are by far the most important type of financial institutions in ASEAN.
Overall , they accounted for more than 82% of total financial assets in ASEAN in 2009. For
the BCLMV the share was even higher at 98%. Commercial banks are supervised and
regulated mainly by the central bank, whereas special purpose banks and non-bank financial
institutions are regulated by different regulatory agencies. The average capital adequacy ratio
of all ASEAN commercial banks was higher than 15% in 2009. The average non performing
loan ratio of commercial banks was higher than 15 % in 2009. The average non performing
loan ratio of commercial banks in most of the member states was less than 5%. These ratios
suggest that on average most ASEAN banks meet the international standards for soundness
and safety . measured in terms of assets , ASEAN banks are on average rather small on an
international scale. The average size of assets of these banks amounted to $ 4.8 billion in
2009 far below the $14 billion in total assets of the worlds 500 largest commercial banks.
Moreover, there are large differences in the size of banks across ASEAN: the average size is
higher than $14 billion in Malaysia and Singapore , and almost $10 billion in Thailand but it
is less than $ 3 billion in other member states. The list of the top 500 commercial bank brands
as selected by Brand Finance of the United Kingdom includes 24 ASEAN commercial banks.
Of these 24 banks , only one is among the top global 100 commercial banks. In terms of
market capitalization , only three Singaporean banks and one Malaysian bank rank among the
worlds top 100 banks .
Moreover, the market capitalization of all of the 24 ASEAN commercial banks combined is
smaller than that of Industrial and Commercial Bank of China (ICBC) , China Construction
Bank or Hong-kong and Shanghai Banking Corporation (HSBC).
ASEAN needs to nurture globally competitive banks. The integration of ASEAN banking
institutions will create an environment conducive to the emergence of such banks. It will
build up a customer base large enough to support the growth of large competitive banks with
a foothold in global banking through mergers and the acquisition of small banks.

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b. Non bank Financial Institutions

Non-bank and capital market related financial institutions, except for insurance companies,
are at an early stage of development, with limited intermediation capacity. Insurance
companies are the only type of non bank financial institution that is common across ASEAN,
and even these differ in their main business activities from one member country to the other.
Life insurance has a relatively large market in ASEAN 5, whereas non life or general
insurance dominates the insurance market in the BCLMV members. Lending and borrowing
by non bank financial institutions, except for insurance companies, is often limited to a
particular geographic area or a particular type of activity, such as financing for medium-sized
companies.
Their asset and liability management is subject to government regulations, and there are
constraints on foreign competition. An exception is the insurance industry, which is
substantially open to foreign investors. The average market share of foreign-owned and
foreign controlled insurance companies is as high as 40% in some ASEAN member states.
Yet, because of their small size and the complexity involved in designing and marketing
insurance products, local companies have been unable to compete against large Western
companies that have long penetrated the regional market. For this reason, it is difficult to find
a local insurance company that operates in other ASEAN member states.
2. Regional Financial Integration
a. Commercial Banks
ASEANs banking market has so far seen little integration . Although the ASEAN 5 states
have taken steps to open up their banking industry , cross-border banking and the cross
border penetration of ASEAN based banks within ASEAN have been slow to develop. In
2010 not a single ASEAN based commercial bank had either a branch or a subsidiary in all
ASEAN member states. The three ASEAN banks with the widest regional presence ( Bank of
Malaysia , Bangkok , Bank of Thailand and United Overseas Bank of Singapore) have

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operations in seven ASEAN member states . In contrast , global commercial banks have a
large presence in the region. Standard Chartered Bank has subsidiaries in seven member
states and representative offices in three.
Besides, Citibank and HSBC also have subsidiaries in seven member states. To compete
effectively , ASEAN banks must develop financial resources managerial capacity , meet
international standards and achieve similar levels of regional penetration . Liberalization
alone will not achieve the intended result of banking integration since some ASEAN banks
will still fall short of national regulatory standards compared with foreign banks.
b. Portfolio Investment Flows among ASEAN
Member States Reflecting the gradual pace of financial integration, intra-ASEAN portfolio
investments as a proportion of the regions total investments have been relatively small.
Among ASEAN 5, Singapore and Malaysia are the two largest portfolio investors, with
84.2% and 12.1% of the total intra- ASEAN portfolio investments in 2009. Outward portfolio
investments of ASEAN 5 within ASEAN more than tripledfrom $103.6 million to $352.1
millionbetween 2001 and 2009. Inward investments of these countries more than
quadrupled over the same period, to $407.2 million.
BASEL II7 REGULATORY COMPLIANCE AMONG ASIA-PACIFIC COUNTRIES
Asia Pacific Countries vastly differ in terms of sophistication of banks and presents a
relatively unique situation from a banking regulation perspective. 8 Banks in Asia Pacific
region range from full-service and global banks in developed economies to small, local and
limited service banks in emerging countries. With the release of Basel II by BIS in 2004,
regulatory bodies in Asia Pacific countries have announced their support for broad objectives
of Basel II and believed that the framework will provide further incentives for improvements
in risk management and supervision. Although, Banks in Asia- Pacific region are spending

ZENITH International Journal of Business Economics & Management Research Vol.2 Issue 3, March 2012,
ISSN 2249 8826 Online available at http://zenithresearch.org.in/
8
Deloitte,2005,Understanding the Framework :,http ://www .deloitte .com/ assets /Dcom Malaysia /Local %20
Assets /Documents/02720 _Basel_II_Adopting_SCRN.PDF on May 23, 2011 Deloitte (2005),

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millions of dollars in achieving envisaged implementation of Basel II Accord yet the general
level of Basel II implementation in the Asia Pacific region is widely diverse.
In general, banks in Asian region do not mandate banks to adopt specific approaches. Asian
banks are free to choose appropriate approach that commensurate with their risk profile
depending upon size, complexity and other considerations. At the same time regulatory
authorities have encouraged their supervised banks to continuously improve and upgrade
their risk management capabilities to be able to adopt sophisticated and advanced approaches.
The Basel II regulatory compliance among developing and advanced countries is discussed as
follows:
DEVELOPING ECONOMIES OF ASIA PACIFIC REGION
The major developing countries of Asia Pacific include India, China, Thailand, Malaysia,
Pakistan, Philippines and Indonesia. There is also a wider variation between the general
approaches across these countries and consequently in the level of progress achieved till date.
PHILIPPINES
The revised capital adequacy framework was adopted by Bangko Sentralng Pilipinas (BSP)
in 2007. Consistent with Basel II recommendations, the Monetary Board of Philippines
approved major methodological revisions to the calculation of minimum capital that universal
banks, commercial banks and their subsidiary banks and quasi-banks should hold against
actual credit risk exposures. The Monetary Boards early approval of the implementing
guidelines for Basel II signified BSP commitment to deep and far reaching banking reforms
to strengthen the banking industry. It also reflected BSP confidence in the fundamental
soundness and ability of the industry to make the necessary adjustments to be fully compliant
with international standards9. Regulators in Philippines directed universal and regular
commercial banks as well as their subsidiary banks and quasi-banks, to adopt the
standardized approaches of Basel II by 2007 and subsequently migrate to advanced
approaches of Basel II by 2010. In 2009, BSP issued circular containing guidelines on
compliance with Basel II requirements which became effective in January, 2011. Upon

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effectiveness of this circular in 2011, BSP completed implementation of Basel II for all
banks.10
THAILAND
Basel II was adopted by the Bank of Thailand in 2008. The Bank of Thailand intended to
gradually raise the overall standard of the Thai banking industry by implementing the Basel II
in Thai commercial banks. The Bank of Thailand was of view that banks should adopt the
Basel II according to the degree of their operational complexity. In January 2008, most banks
in Thailand began to provide parallel reports to the Bank of Thailand (BOT) using both the
existing calculations for required capital and those which are required under Basel II. After a
year of parallel reporting, the Thai banking sector moved to full implementation at the end of
2008. By the end of 2009 many of the banks in Thailand started migrating towards advanced
approaches .

MALAYSIA
Bank Negara Malaysia (BNM) implemented the Basel II framework in 2008. Malaysia
adopted the standardized approach from January 2008 and detailed the parameters for the
implementation of the more advanced approaches to be adopted by 2010. According to a
mandate set by the central bank, all banks in Malaysia were required to compute their capital
adequacy ratios under Basel II from January 2008. In addition, banking institutions adopting
the new capital adequacy framework from 2008 were also subject to a capital requirement for
operational risk based on either the basic indicator, standardized or alternative standardized
approaches .
INDONESIA
Bank Indonesia conducted parallel run in 2008 and implemented the framework by initially
adopting the simplest approaches by 2008. Subsequently, any bank capable of making the
necessary system changes and meeting all requirements adequately were allowed to move
towards the more sophisticated approaches upon Bank Indonesias (BI) approval. According
10

www.bsp.gov.ph

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to BIs roadmap of implementing Basel II in Indonesia, it is expected to migrate to advanced

approaches by 201111.
SINGAPORE
Monetary Authority Singapore (MAS) supports the broad objectives of Basel II and believes
that it will incentivize improvements in risk management, as well as complement MAS
supervisory objectives. MAS has implemented Basel II in Singapore for all Singaporeincorporated banks on 1 January 200812. Basel II rules apply to all locally-incorporated banks
in Singapore. MAS has prescribed a minimum Capital Adequacy Ratio (CAR) that is above
the current minimum Basel requirement.
Further, where appropriate, additional supervisory capital add on may be prescribed above
the minimum CAR, based on supervisory assessment of the net risk profile of a given bank.
Singapore banks, for their own commercial reasons, hold substantial buffers above the
regulatory minimum. Moreover, MAS has also circulated the latest BCBS liquidity risk
management guidance to the banks to help them in concerned practices

13

. Regulatory

authorities in Singapore have made all approaches available and banks were encouraged to
adopt the approach as per their risk profile in each risk category .
In nutshell, among advanced and developed banking market economies of Asia Pacific,
Japanese financial institutions along with Taiwanese and Hong-Kong banks were among the
first movers to Basel II requirements as these economies closely followed timelines suggested
by Basel II standard i.e. January 2007. While Australian banks implemented all of the Basel
II approaches at the earliest date i.e. 2008 that the BCBS prescribed for implementation of
advanced approaches. Basel II was implemented in South Korea and Singapore in January
2008 where banking regulators in Singapore also made all the approaches available and
banks were encouraged to adopt the approach according to their risk profile. So, almost all
regulators in these sampled countries have migrated to Basel II framework by the year end

11

http://www.bi.go.id
www.mas.sg
13
www.financialstabilityboard.org/publications
12

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2008 by starting its implementation firstly with simplified approaches in initial years and then
subsequently moving towards advanced and sophisticated approaches.
BASEL II IMPLEMENTATION: CHALLENGES
Global and regional banks in Asia Pacific are facing a phenomenon familiar to bankers in
many other jurisdictions a formidable and increasing array of regulatory requirements .
Effective implementation of Basel II in Asia Pacific region requires a deeper understanding of
challenges encountered by banks for smooth implementation of framework in the region. The
multi-dimensional challenges for banks operating in Asian countries vary according to market
specific to that region and state of risk management architecture and capabilities of respective
banks. Some of the major challenges are discussed as under:
RESOURCE CONSTRAINTS:
The major peculiar challenge for Asia Pacific institutions is shortage of skilled and
experienced human resources. So, banks in the region have to deal with resource and
technical expertise implications in trying to implement the more complex and advanced
approaches for credit risk and operational risk. While institutions in the region have made
major strides in recent years to gear up the risk management, the cadre of risk management
professions is still relatively small. In addition to attract and retain human resources with
expertise and high skill set, institutions can also use external expertise to support risk
management process. But the focus should be on building in house expert capabilities to
achieve envisaged implementation.
DATA LIMITATIONS:
Many of the Asia Pacific banks are encountering issues such as data collection and data
accuracy and availability. The use of advanced approaches under revised framework requires
banks to collect and store multiple years historical data on borrower default, rating histories,
and loss data. Furthermore, data collected is often not sufficient to cover a full economic
cycle, thereby exacerbating implementation issues. Some analysts have suggested that this
problem is more acute in Asia, as cycles in Asian economies historically have been longer

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than those in more mature economies . Beyond data availability, data quality is also a major
issue that banks have to deal with. Historically, the risk data that was used in the risk
management process was for internal use only, and may not have been of auditable quality
after all, data that is 90% or 95% accurate may be fine for risk measurement and management
information purposes. Pillar 3 raises the bar considerably in respect of the quality of this
data .
RISK MANAGEMENT ARCHITECTURE:
Robust risk management architecture is prerequisite for successful implementation of
advanced approaches. But many of the well- established banks in Asian region are still less
aware of risk management issues i.e. their risk management infrastructure is not well aligned
with international standards. If banks in the region are to derive real benefits of advanced
approaches they need a sound risk identification and management framework backed by
sufficient systems and controls. Furthermore, risk management system should be flexible
enough to adapt changing business environment

COST OF COMPLIANCE:
Another challenge that came into scene is the high compliance cost of Basel II. There is
substantial increase in operational cost due to greater operational challenges in management
and production of data. According to survey conducted by KPMG in Asia Pacific region in
2008, cost of compliance was rated as major impediment in implementation of Basel II.
Further, the expenditure on Information Technology was considered as single largest cost of
implementing Basel II by FSI survey on non BCBS countries.

CROSS BORDER SUPERVISORY CHALLENGES:

To achieve harmonized and universal application of Basel II framework, there is a dire need
for enhanced cooperation and coordination between home and host country supervisors. It is
mainly true for internationally active banks, including those with operations in Asia that are
implementing the advanced approaches in cross-border locations. Some major cross-border
issues include the implementation of different approaches in different jurisdictions,

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differences in implementation timelines, information sharing between supervisors, and

validation and approval of various models . In a survey conducted on low income countries,
results showed lack of communication and cooperation between cross border supervisors on
Basel II issues.Therefore adequate information sharing and coordination between homehost
supervisors is identified as major challenge.
BASEL III , BIS AND GLOBAL FINANCIAL GOVERNANCE
1. INTRODUCTION AND BACKGROUND
As the Report of the Commission of Experts of the President of the United Nations General
Assembly on Reforms of the International Monetary and Financial System put it:
the standard policy nostrumsthat countries should have sound macroeconomic policies
strong governance, transparency, and good institutions may be less than helpful. Countries
that held themselves out as models of best practices have been shown to have had deeply
flawed macroeconomic policies and institutions and to have suffered from major shortfalls in
transparency.
Against this backdrop, there have been many calls for changes in the global financial and
economic governance architecture that would lead to a more stable and less risky
international financial system. For example, internationally, there is momentum around
BASEL III, a package of proposals to strengthen global capital and liquidity regulations. The
United States government and various EU countries had introduced legislation aimed at
reforming financial institutions under their jurisdiction. Changes in the world financial and
economic order have consequences for developing countries directly, through banking
regulations and global/regional policies, and also indirectly through the impact on developed
countries themselves, which can affect lending, foreign investments as well as international
aid. In this context, it is possible to find the motivations for undertaking a study that will
examine the principal changes that have taken place (or are likely to do so) as a result of the
financial and economic crisis. These changes can also include alterations in financial and
economic governance mechanisms and policies given the general economic context in which

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countries, in particular developing countries, are operating. The developments covered

include:
Proposed BASEL III reforms for more stringent capital requirements and their
implications for the developing world in particular.
BIS proposals for better regulation of financial derivatives, including commodities
futures, by moving away from OTC transactions towards organized exchanges.
The social and political construction of global and regional financial arrangements also
depends critically on a supporting structure of complementary institutional network (CIN),
norms, ideas and practices. Global financial architecture (GFA) and Regional financial
architecture (RFA) both depend on their respective CIN within a global system of nation
states and international organizations. Given the real interdependence within the system, all
actors have some stake in sustained growth and stability with equity. At the same time part of
the complexity of the global financial system arises from various contradictions and
asymmetries in the system itself. Thus the sustainable policies at the national level require a
supporting network of GFA and RFAs that go some distance towards resolving the key issues
arising from such contradictions and asymmetries. Appropriate national policies in their turn
can contribute to the sustainability of the GFA and RFA.
The ongoing politics of re/construction of IMF along a more functional and equitable line is
and will remain complex and require a separate treatment that is beyond the scope of this
paper and therefore is not attempted here. However, the tentative steps taken towards regional
cooperation in Asia since Asian Financial Crisis (AFC) are discussed to illustrate the
opportunities and challenges posed by the need to evolve towards a hybrid GFA. The
opportunities and challenges arising from the current global crisis are analyzed in this
context. In light of the above observations, in this paper I will discuss the problems of
creating and expanding national macroeconomic policy space and economic governance for
the developing countries in particular within a framework of overall global and regional
financial architectures.

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PROPOSED

BASEL III

REFORMS

FOR

MORE

STRINGENT

CAPITAL

REQUIREMENTS AND THEIR IMPLICATIONS FOR THE DEVELOPING WORLD

The banking and finance world is now witnessing a transition from Basel I and II to Basel III.
Drafted in 1988, the Basel I Accord was the first to set minimum capital requirements for
international banks. The goal was to stop international banks from evading national
regulators. Equity capital and published reserves from post-tax retained earnings (Tier I
capital) were required to be equivalent to 8% of risk-weighted assets. Tier 2 capital
requirements (reserves to cover losses, subordinated debt holdings, gains from the potential
sale of assets, etc. were set at the same levels for Tier I capital. Much of the accord focused
on delineating the appropriate risk-weights for assets. Risk weights were drawn to privilege
sovereign debt, public sector entities and long term claims on other banks. Mortgage and
private sector debt were weighted much higher (50% and 100% respectively). The 1998
accord allowed national supervisors to implement stronger/supplementary measures of capital
adequacy for nationally chartered institutions. Drafted in 2004, Basel II represented a
significant revision of the 1988 accord. It expanded the scope of the 1998 accord to cover
alternative approaches to a variety of topics.
The goal of the accord was to promote the adoption of stronger risk management practices by
the banking industry. The three pillars rationale (minimum capital requirements, supervisory
review and market discipline) was developed as a conceptual framework on the revision of
the initial accord. While many of the key elements of the Basel I were kept in place (general
requirement for banks to hold capital equivalent to at least 8% of risk-weighted assets, 1996
Market Risk Amendment, and the definition of eligible capital), a major change in the way
risk was assessed was put into place. It allowed risk to be assessed under Banks own internal
models, thus relying upon banks to largely self-monitor their own risk-taking strategies.
National supervisors were to buttress internal risk assessments by assuring minimum
compliance to national standards. And banks were required to provide more public
disclosures related to its capital positions. The Basel II framework was more risk sensitive
than the 1998 Accord. Operational risk and market risk was separated from credit risk.

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TABLE: KEY FEATURES OF BASEL I AND BASEL II14

Key Features

Basel I

Basel II

Capital Adequacy

Tier I Capital

Tier I & II requirements were

Requirements (CAR)

Requirements:

not

Equity capital and

changed.

Disclosed reserves

2.

Had to be held at 4% of

companies were

risk weighted assets

included into requirements of

Tier II Capital

banks.

Requirements:

3. Capital Reserves = 8% *

Miscellaneous debt

Risk

Held at 8% - Tier I

Weighted

Holdings

Operational Risk

Assets

Reserves

of

holding

Assets
+

Market

Risk

debt

was

Reserves
Risk Weighting

Categories of risk

1.

Sovereign

weights:

weighted

1. 0%--included cash,

according to its credit rating.

sovereign debt held in

2.

domestic currency,

indexed to

OECD debt

sovereign debt ratings or to

2. 20%--development

their

bank debt, OECD bank

specific ratings.

debt, short term non-

3. Private corporate debt

OECD debt

rated junk

3. 50%--mortgage debt

was weighted at 150%.

4. 100%--private sector

4. Home mortgages were

Debt

riskweighted

Bank

debt

could

be

at 35%; corporate
14

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mortgages 100%.
Other Features

Promoted the

Banks could choose between

harmonizing of

three

national regulations

approaches to risk weighting:

Allowed national

Standardized Approach

regulatory specificities

Internal Ratings (IRB)

into capital

Approach

requirements

Advanced IRB Approach

Operational risk and market
risk was
separated from credit risk.
Bank disclosures were made
public.
Regulators

were

given

additional
powers:
Creating capital buffers
requirements
Intervene into internal risk
modelling

FURTHER EVOLUTION: GOING FROM BASEL II TO BASEL III15

Under Basel III, banks will be required to hold more capital against their assets than under
Basel I and II. Among other things, this will have the effect of decreasing the size of their
balance sheets and their ability to leverage themselves. The minimum amount of equity, as a
percentage of risk-weighted assets, will increase from 2% to 4.5%. There is also an additional
2.5% buffer requirement, the so-called capital conservation buffer, bringing the total equity
15

APRA Insight (2008), http://www.apra.gov.au/Insight/upload/Insight_Issue_2_2008_implementation _baselII

_aust.pdf on March 27, 2011

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requirement to 7% . Total risk-adjusted capital requirements will remain unchanged at 8% [.

Deferred tax assets, mortgage servicing rights and other obscure forms of capital are now not
allowed to be used to boost capital levels. Deployment of capital and payment of dividends
will be constrained more. In effect, banks will be required to triple core Tier I capital ratios
from 2% to 7% to hold against potential losses. They have until 2019 to implement these
requirements .
There is also agreement on tough new liquidity rules. With the so-called liquidity coverage
ratio, for the first time that Basel rules have specified a notional global target for liquidity
needs . The rule would require banks to hold enough cash and sovereign debt to survive at
least a month-long market crisis. Banks will have to hold reserves equal to 100% of undrawn
corporate borrowing lines. This could be potentially problematic for developing market banks
in countries without liquid government bond markets. A second liquidity rule, the net stable
funding ratio, would seek to reduce banks dependence on shortterm funding. Like much of
the agreement, there is considerable delay over when banks have to begin formally observing
the rules. For the new liquidity rules, banks have until 2015 to put them into place .
Basel III imposes tougher requirements on the bonds that banks can count towards their
regulatory capital. So-called hybrid securities which sit between equity and debt and were
intended to act as a buffer to soak up unexpected losses must now include a mechanism (so
called bail-in mechanism) for taking losses. This would allow them to be converted into
equity or written off . This rule will have to be implemented domestically (through national
regulatory laws) or individually (through each bond issue) by 2013. Hybrid forms of debt like
this and preferred shares are used to bolster regulatory capital and are cheaper to issue than
equity. However, Basel III will force the phasing out of these types of protected forms of
debt.
The Basel Committee has also proposed a counter cyclical buffer that could be imposed when
aggregate credit growth is rapid enough to build up system-wide risk .The buffer would be as
large as 2.5% of risk-weighted assets and would be released on the judgment of domestic
authorities to help absorb losses. Systemically important banks may also be asked to operate
under more stringent rules. Capital surcharges, contingent capital, bail-in debt arrangements

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and peer reviews are policies that could be employed under rules delineated for these kinds of
institutions . Basel III also embeds a reciprocity agreement into the operation of the
agreements countercyclical capital buffer: Consider the case of a country in the region
receiving strong capital inflows and experiencing rapid credit growth and buoyant asset
prices. Before Basel III, any tightening in capital required of locally incorporated banks
would lead to the objection that foreign banks could lend to firms from offshore without
being subject to the more rigorous capital requirements. With Basel III, however,
internationally active banks would be required by their home regulators to calculate the
countercyclical capital buffer add-on for exposures to the country whether booked in the local
subsidiaries or offshore .
In 2008, the Basel Committee opened its membership to large emerging markets in the hope
that a more globally relevant set of standards could be conceived . In some ways, developing
countries were able to help shape a couple of the rules. New capital rules would have
penalized countries which require international banks to take on local partners by requiring
these banks to strip equity held by local partners from their Tier I capital totals. However, in
July of 2010, a compromise was agreed upon to the benefit of these emerging economies .
For key milestones of Basel III upto 2018.
The federal banking agencies have just adopted comprehensive regulatory capital rules that
will implement Basel III in the U.S. In turn, it is time for banking organizations to
understand the new rules and bring themselves into compliance with them by the beginning
of 2015 (2014, for the largest banking organizations). The new rules make important changes
to the definitions and components of, and minimum requirements for, regulatory capital;
revise the required regulatory deductions from, and adjustments to, regulatory capital; and
create a new standardized approach framework for the risk-weighting of assets on the
banking and trading books of U.S. banks. In addition, the federal banking agencies have
made some important changes to the advanced approaches regulatory capital framework
that applies to the largest U.S. banking organizations.
CREDIT ACCESS UNDER BASEL III

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New leverage requirements on Tier I and Tier II capital may mean that banks will be induced
to reduce both their exposure to riskier assets to a significant degree. For developing
economies, the implications are serious for much of the formal economy. Evidence of credit
rationing from earlier Basel implementation is pertinent here. The introduction of Basel I in
Brazil and India in the 1990s helped lead to a continual decline in total credit (as a percentage
of GDP). Credit expansion in India slowed over the same period . Under Basel II simulations,
access to household credit in large developing nations did fall significantly. However, higher
interest charges vis--vis higher capital ratios would most likely lead to a decrease in
household wealth and consumption. Basel II accords meant that domestic and foreign banks
in emerging markets would have to ration credit away from SMEs and towards larger
institutions (for standard risk and information-gap reasons).
Under Basel III, pressure from regulatory authorities may lead to further rationing in
developing markets by commercial banks. Less credit to SMEs in the formal sector and to
others in the informal sector will obviously play a role in reducing the overall economic
activity of the country in question. Informal sector-formal sector linkages may further
exacerbate the problem, as the SAM-CGE modeling .16
DEVELOPING WORLD BANKS AND COMPETITION UNDER BASEL III
Basel II had already presented tremendous implementation challenges for banks in
developing countries The challenges included the need to build large databases to run
sophisticated risk models and to import the human capital necessary to assess, monitor and
act on such models These costs were detrimental to competition against large foreign banks
which had the resources to use these models to their advantage. Complying with Basel II
meant that developing country banks had to divert resources away from activities that directly
benefit economic growth and poverty alleviation in developing countries. Some of the PRSP

16

See Anushree Sinha and Haider A. Khan, 2010. The Gains from Growth for Women in India: A SAM- and
CGEbased
analysis, in Amelia Santos-Paulino and Guanghua Wan ed. The Rise of China and India: Development
Strategies and Lessons, Palgrave/Macmillan,

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documents allude to this problem. Clearly, this has implications for MDG goals and MDGRs
that will need further exploration for which the LDCs in particular are poorly equipped.17
Technically, Basel III is going to be very difficult to implement for banks in the developing
world. Proposals involve sophisticated stress testing that goes beyond the capacities of banks
in developing markets . While banks have until 2019 to meet Basel III requirements,
domestic financial markets will face global concerns that will constrain their ability to meet
requirements. Loose monetary policy in the developed world will continue to funnel cheap
money to developing markets. Reigning in this money by meeting Basel III standards would
be beneficial and relatively painless. Emerging markets, though, face pressure to continue to
allow cheap credit to flow in and not risk alienating foreign investors .
The unevenness and asymmetry of the current global economy and finance is particularly
striking in this context. Because developing country banks are going to be held to the same
risk and regulatory standards as banks in the developed countries, it will be critical to see to
what extent developing country banks can realistically handle all of these new requirements..
The Basel Committee has raised the bar for the supervisory review of risk management
practices.
Areas that are more fully addressed in the new management rules include: firm-wide
governance18, capturing off-balance sheet exposure risk and securitization activities, valuation
processes for financial instruments, stress testing programs, risk concentrations and aligning
risk and return incentives. Transparency is also being stressed. New rules from the
Committee require that banks disclose all elements of the regulatory capital case, the
deductions applied and a full reconciliation to the financial accounts .
As regards capital requirements, leverage ratios for Tier I capital will not probably be of
much relevance to developing market banks which rely mostly on equity, reserves and
deposits. Their Tier I ratios are already high. Most big banks in China and India hold core
17

See Haider A. Khan, 2006b. An In-Depth Review of the Country Millennium Development Goals
Reports,( submitted to UNDP) which anticipates some of these problems.
18
This was already an issue in the aftermath of the AFC for the Asian economies. See Khan (2004) chapter 6,
pp.98-144 on corporate governance for a detailed discussion.

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Tier I ratios above 9% . A slowdown in the proliferation of financial products means less to
these kinds of banks.
One of the major critiques against Basel I and II was its bias towards bank concentration and
towards less diversity in financial sectors in terms of ownership, role and size. Financial
innovation was also hampered . Unless developing market banks can, over this decade, bring
up to speed the risk-management and supervisory capacity that exists Elsewhere, they face
serious competitive issues. Further liberalization of financial markets in accordance with the
Washington consensus will only compound this issue. This has serious implications for
borrowers who may get shut out if international finance comes to predominate in domestic
banking systems. The most serious problems may arise in the SME financing for employment
and development.
STATES AS COLLECTIVE CORPORATE ACTORS AND BASEL III
National regulatory authorities will have to begin incremental implementation of Basel III on
January 1, 2013. Implementation will end on January 1, 2019 . To implement the new rules,
authorities must be able to engage in an ongoing dialogue with senior bankers on business
and risk models, have a more intensive and effective presence in the banking sector and be
capable of developing the capacity to have broad power for early intervention and corrective
action . Regulators will need clear mandates, independence, accountabilities, tools and
resources adequate enough to do their job in using Basel III to strengthen domestic financial
and banking systems. Risk management systems to be imposed domestically by Basel III face
serious impediments in developing markets. Implementing and monitoring such systems
require high levels of human capital and other things not readily available in emerging
markets: independence, legal protections and integrity to challenge corruption at the State
level .
Domestic banking systems which implemented Basel I and II saw a distinct trend towards
higher banking concentration, more distinct division of labor between larger and smaller
banks (and between foreign and domestic banks) and changes in banks portfolios away from
credit to the private sector and towards government securities. These systems also saw a trend
away from corporate credit and towards consumer credit . Basel II had an implicit bias

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against SME borrowers towards larger corporations. As capital requirements and definitions
are more stringent this time around, the major focus for States will be how to make up for the
impending problem of credit rationing by domestic banks away from small but productive
businesses in the economy.
To address this problem, some options do exist under Basel III. States in the developing
world will see their ability to issue sovereign debt buoyed by Basel III. Because sovereign
debt carries a very low risk weight, it will continue to be a preferred method of asset creation
through loan expenditure by international banks. Developing countries must thus be wary of
the attractiveness of its sovereign debt to banks that are looking to manipulate their capital
and risk structures. Simulations done on the effects of Basel II on sovereign access to credit
and spending showed that countries would be more likely to increase their spending and
deficit levels .
As we already know, Basel capital requirements have forced banks to disburse an increasing
portion of priority credit towards more profitable, but not necessary productive, endeavors .
These sources include many forms of consumer credit. Social priorities of credit have been
negatively affected by the Basel regimes [Gottschalk 2010, 12]. Fiscal policy, whether direct
or through policy banks may not be able to make up for the credit gap that forms as Basel
regimes hit smaller banks in developing countries.
The attractiveness of sovereign debt then could provide means for the State to channel more
financing towards State development banks or to firms directly. As such, they must traverse a
thin line between excessive and perhaps anti-developmentalist fiscal conservatism and one
that promotes expenditures/lending for pro-poor and development activities without much
fiscal prudence. Critical to this cause, the IMF and the World Bank must allow for countries
to use their policy space to further promote growth and development priorities, especially
under the new Basel regime.
Thus for developing market banks, States will have to find creative and reliable means for
their banks to meet capital requirements more easily. For this purpose, the nurturing of
nascent equity and bond markets will be critical. Developing new instruments and financial

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markets are tedious and time- and resource-consuming. If developing market banks are not
able to increase their buffers through equity or bond markets, then they face serious
competitive issues from international rivals. This will especially be the case in countries that
have liberalized their financial markets. The Basel Committee has sought to allay these
worries by lengthening the time over which the developing country banks need to come into
compliance. With that said, any push to strengthen financial market depth and maturity could
lead to fewer resources going to generate sustainable growth and pursue poverty- reduction.
It must also be emphasized that inadequate regulatory capacity will make it difficult for
developing markets to cope with financial innovation, and ultimately to keep the financial
system stable. Multilateral institutions will have to be ready to provide technical support and
resources to help countries deal adequately with the implications of Basel III on regulatory
authorities. States will also have to find ways to hang onto to critical regulatory staff.
Regulatory staff proficiency has been a recurrent problem in developing countries, because
many competent staff are hired away into the private sector .
Finally, the Basel Committee Macroeconomic Assessment Group (MAG) has produced an
estimate of the implications of Basel III on the global economy. Its results show a maximum
decline in the worlds GDP of 0.22% over the next decade from its baseline forecast . These
estimates include the potentiality of spillovers across countries. Countries that rush to put
Basel III in place may face relatively larger reductions in GDP and growth . Firms that are
already well stocked with capital and/or are able to shift their risk profile towards safer assets
will fare much better over the next decade. They will be able to offer debt more cheaply and
avoid cutting back on lending volumes.
Lending volumes are projected to fall by 1.4% relative to baseline estimates over the next
decade . Lending spreads are projected to widen by 15.5 basis points during the same period.
To ensure positive effects of spreads and lending volumes on future growth is critical. Based
on the MAG models, tighter lending requirements in the face of Basel III could have a larger
negative effect on world GDP than in models that weight the effect of credit spreads on
volumes more heavily. Models also forecast that growth will be lower for countries that do
not (or cannot) employ monetary policy to address the effects of higher capital requirements .

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In light of these econometric estimates, further emphasis here is placed on the ability of
States to use fiscal and monetary policy to support the growth of their economies. Because
poor States are already fiscally constrained (whether through tax capacity, IMF/WB
conditionality, economic shocks/hardships), Basel III further complicates the growth and
poverty-alleviation picture. Unfortunately, it means that these States will need to become
more reliant on each other to implement the reforms and support regional development
initiatives. Failure to do so will then mean that States will have to become more reliant on
international technical expertise and resources. In this light that fact that the States have a full
decade to delineate and implement a proper course is not as long a time horizon as it first
appears to be. Even if the banking sector is adequately reformed, the proper use of financial
markets will also require an enabling global financial architecture and an overall reduction of
systemic risk. In the next three sections I take up these topics. The next section discusses
risks arising from the OTC derivatives markets. The two sections following discuss the role
of a reformed IMF and regional financial architectures in promoting financial stability for
pursuing development policies leading towards equitable and sustainable growth and poverty
reduction.
BIS PROPOSALS FOR BETTER REGULATION OF FINANCIAL DERIVATIVES,
INCLUDING COMMODITIES FUTURES, BY MOVING AWAY FROM OTC
TRANSACTIONS TOWARDS ORGANIZED EXCHANGES. PRE-CRISIS BUILDUP
OF PROBLEMS19
Recently BIS annual report summarized its current position as follows:
Since 2007, actions by central banks have prevented financial collapse. Further
accommodation is borrowing time for others to act. But the time must be used wisely. The
focus of action must be on balance sheet repair, fiscal sustainability and, most of all, the
economic and financial reforms needed to return economies to the real growth paths
authorities and the public both want and expect . After reviewing the past year's economic
developments , the remaining economic chapters of the 83rd Annual Report cover the critical
19

http://mpra.ub.uni-muenchen.de/49513/

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policy challenges in detail: reforming labour and product markets to restore productivity
growth , ensuring the sustainability of public finances , adapting financial regulation to
ensure resilience of the increasingly complex global system , and re-emphasising the
stabilisation objectives of central banks. 20
The hallmarks of the global financial crisis were the contagion and counterparty risks taken
on by financial institutions. Both of these arose at least in part from banks involving
themselves in capital market activities for which they did not carry enough capital.
Securitization and its warehousing on and off-balance sheets proved to be an intractable
problem even for the firms involved. In the U.S., Variable Interest Entities (VIEs) to which
banks are linked had to be consolidated onto balance sheets if banks became insolvent or if
liquidity of funding became problematic. Capital regulations simply could not cope.
Similarly, counterparty risk became a major issue with the failures of Lehman Brothers and
AIG.
During the pre-crisis period, financial firms were able to increase the asymmetry of
information and costs for consumers in the OTC and exchange-traded derivatives
marketplaces through the internalization of information. This led to higher bid-ask spreads
that benefitted financial firms fee schedule. Customers were left in the dark on the intricacies
of contracts, the risk of holding such contracts and were forced to pay more for the contracts
than they would otherwise. Had these contracts been transparent and competitive, the price
would have been much lower. This lack of transparency and a non competitive, imperfect
market structure is coupled with sheer size of the derivatives industry. At its peak in June
2008, the outstanding notional amount of contacts stood at $760 trillion, equivalent to the
value of everything produced on Earth in the previous 20 years .
EMERGING MARKETS
Daily turnover in derivatives in emerging markets has expanded fourfold over the past
decade, to over 6% of emerging market GDP . Daily turnover derivatives was about $1.2
trillion daily last year . While this daily turnover is still less than a tenth of the turnover in
20

See http://www.bis.org/publ/arpdf/ar2013e.htmLast consulted on August 1,2013.

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advanced economies, the figures are notable. Since 2001, turnover has increased by over
300%, a faster rate than the increase in the daily turnover in advanced financial markets
(~250%). Both OTC and exchange-traded transactions are substantial. Most of these
derivatives are foreign exchange derivatives (around 50% of the total daily turnover) .
A growing majority share of these transactions are being completed cross-border and
offshore. Counterparties to FX derivatives trades are increasingly doing cross-border
business; cross-border shares have risen to 67% in 2010 from 59% in 2004 . This ratio now
mimics that found in advanced economies. Offshore trading of currency has increased
substantially as well. For example, more than 90% of trading in the Brazilian real, the
Mexican peso, the Hungarian forint, the Polish zloty and the Turkish lira takes place offshore.
OTC markets are more important for derivatives trading in emerging markets. Half of
turnover occurs on OTC markets in these countries. In advanced countries, the ratio is more
like 60/40]. Of the OTC derivatives transactions in emerging markets, nearly 90% are foreign
exchange derivatives This makes any proposals coming out of the BIS on OTC reform
especially important for derivatives markets that are maturing in emerging economies.
The financial crisis did not work to reverse the proliferation of OTC and exchange-traded
derivatives in emerging markets, unlike in advanced economies. The total daily turnover of
derivatives (both markets) increased by a quarter from 2007 to 2010. Notable and expected,
lightly-regulated traders (pension, insurance, hedge funds) have increased their share of total
turnover by nearly a third during this time period as commercial and investment banks have
had to slow operations. Reporting dealers constituted only 43% of daily turnover in OTC FX
trading in 2010 . This could be particularly problematic as reform on these transactions goes
further. As countries continue to develop their financial markets and their economies grow,
the proliferation of OTC and exchange-traded derivatives markets will occur making the
institution of a proper regulatory structure a clear imperative.
FINANCIAL DERIVATIVES
World OTC derivatives markets have seen shrinkage in volume during the last couple of
years. Despite the proliferation in OTC markets in emerging markets, the value of

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outstanding contracts fell 4% in the BIS latest figures . Most of the shrinkage has been in the
market for credit default swaps, as companies and countries have largely (save Europe) been
able to recover from the financial crisis. Leading regulatory figures have stressed that
derivatives markets must become more transparent, not only amongst themselves, but with
the public as well. In the wake of the crisis, firms which have large derivatives trading desks
have had to vastly increase the information they provide to regulators about their positions .
More is going to be asked of these traders in the future. It is hoped that greater transparency
will allow customers to both have more knowledge of these products and be able to demand
smaller bid-ask spreads.
As part of new Basel III proposals, banks will be required to apply tougher and longer
margining periods as a basis for determining regulatory capital when they have large and
illiquid derivative exposures to a counterparty .
COMMODITY FUTURES
Financial market dynamics have played a part in fuelling the most recent commodityboom.
Regression analysis has shown that commodities are uncorrelated or negatively correlated
with traditional asset classes of equities and bonds. Such analysis has allowed investment
portfolios to hold commodities to reduce risk and enhance returns. More non-traditional
players have entered the market as the financial crisis deepened and spread. Global turnover
in commodity derivatives has grown significantly over the past several years .
According to BIS statistics, the notional value of OTC commodity derivatives contracts
outstanding reached $6.4 trillion in mid-2006, about 14 times the value in the late 1990. By
the middle of last decade, the share of commodities in overall OTC derivatives trading
reached nearly 2% . Outstanding commodity derivatives contracts peaked in 2008 ($13.3
trillion notional amount outstanding) and have declined rapidly in the wake of the crisis. In
June 2010, the notional amount outstanding was around $3 trillion 21 . Compared with
physical production, the volume of exchange-traded derivatives was around 30 times larger
for major minerals in 2005 . At that time, 90% of swaps and options trading in oil was done
21

BIS Quarterly Review 2010, A121

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in the OTC market. Speculation on U.S. commodity exchanges now probably constitutes the
majority of all interest/positions on these markets.
Fund managers and other investors have also piled money into commodities markets. During
asset bubbles or even during a partial downturn, the return on going long in these markets is
compared with many other asset classes . High commodity prices will continue to shape
manufacturing decisions and future trade flows. Elevated shipping costs and scarcity in some
commodities markets raise the stakes on ensuring that exchanges and markets in the future
are conducted in a fair and licit manner. Needless to say, prolonged political turmoil can
inevitably complicate the picture.
Thus commodities markets now are very similar to mature financial markets and exchanges.
The BIS admitted as much in a paper on financial investors and commodity markets back in
2007 . The increasing diversity and complexity of financial instruments in commodities
markets demand an increasing need for infrastructure and regulation to protect actual supply
and demand interests . The 2007 BIS paper acknowledged that evidence pointed to price
levels and volatility in commodities markets that could not be justified by economic
fundamentals . Prices were supporting speculative investor/ interests, as opposed to sound
commercial interests.
ORGANIZED EXCHANGES FOR OTC TRANSACTIONS
Counterparty risk arising from the use of OTC derivatives was one of the key hallmarks of
the crisis. Regulatory arbitrage and shifting promises was an important contributor to the
explosion in credit default swap(CDS) use. Tax arbitrage too has allowed promises to be
transformed with strong implications for bank on- and off-balance sheet activity. In 2009, key
regulatory officials from the BIS and around the world sought to discuss and then formulate
ways to regulate OTC markets. As it stands, the interest rate swap market is the only OTC
derivatives market in which actors and financial institutions rely on central clearing
mechanisms in any way. Forty five per cent of this market is based in London. The uses of
clearing houses for other OTC transactions are virtually non-existent Currently, only about
11% of positions have been shifted to CCPs, exchanges or clearing houses

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The BIS has specifically called for the requirement that all standardized OTC derivatives be
cleared through central clearing houses In their Review of the Differentiated Nature and
Scope of Financial Regulation, the BIS stressed that these CCPs impose robust margin
requirements, necessary risk controls and minimize the use of customized OTC derivatives. It
also stressed that unregulated traders in these markets (hedge funds, SPVs etc.) ought to be
placed under a regulatory architectures, especially given their proliferation in CDS and
insurance markets in the past several years Collateral requirements on derivatives exposure
(even for firms with high credit ratings) is another option being debated within the BIS.
The chief economist at the BIS and the US Fed Chairman Bernanke both have spoken about
the need to require corporate derivatives users to rely on central clearing houses.
Encouragement would come through requiring additional capital for contracts not cleared
through a CCP22. CCPs would have to be very well designed (strong operational controls,
appropriate collateral requirements, sufficient capital, etc.) to guard against the issue of
concentrating risk onto the clearing houses. Officials also spoke of the need to encourage
market participants to create standardized exchange traded derivatives for all risk types
currently handed in OTC transactions. Non-standardized contracts would then be place higher
capital requirements on financial institutions. In the future, more serious consideration could
be given towards the introduction of product registration and consumer protection for
financial innovations, products and contracts. This kind of consumer protection, product
registration scheme would be akin to a pharmaceutical style warning system.
Another goal of early discussion would be to increase transparency in the CDS market so as
to improve the ability of market participants to identify potential problems Increasing
transparency would have to involve targeting the index and single-name CDS contracts that
are relatively liquid and standardized[and] introducing trade-reporting similar to that in the
TRACE system, which provides post-trade price transparency for US corporate bonds

22

Cecchetti 2010; French et. al. 2010

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U.S. And EU legislation will require financial institutions to trade through CCPs, but many
market participants would be exempt from any legislation. Regulators are pushing for a
narrow exemption rule to be into place that only allows non-financial end-users to be exempt
from having to clear through exchanges or clearing houses Dodd-Frank Act implementation
will mean that many of the worlds largest derivatives traders will be subject to have
transactions cleared through CCPs and other types of exchanges Specific rules for firms
doing business within the U.S. should be set this summer. Dodd-Frank will place two
agencies, the Commodity Futures Trading Commission (CFTC) and the Securities and
Exchange Commission (SEC), in charge over directly overseeing these OTC market.
Delineation of rules by these agencies will certainly play an important role in how the BIS
and other regulators will oversee these markets in the years ahead.
Critical to the BIS proposal to move OTC transactions onto organized exchanges, banks
under the new Basel III regime will qualify for a 2% risk weight for counterparty risk
exposure if they deal with centralized exchanges (that meet regulatory criteria). Qualifying
CCPs will receive a low risk weight (2%) . Default fund exposures to a CCP will be
capitalized according to the estimated risk from such a default fund. This proposal creates
incentives to use these centralized exchanges since higher risk weight charges will apply for
bilateral OTC derivatives:
As part of the Basel III reforms, the Committee has materially changed the CCR regime.
These changes significantly increase the capital charges associated with bank OTC
derivatives and SFTs and thereby create important incentives for banks to use CCPs wherever
practicable. Rules arising from the consultation on the BIS proposal will be finalized in
September this year (following an impact study) and plans to be implemented beginning in
2013. CCPs will ultimately under the regulatory reach of the CPSS-IOSCO. Any CCP that
does not qualify under CPSS-IOSCO rules will force any financial institution to hold
significantly more capital to protect against default of that CCP [BIS CCP Proposal 2010, 6].
The use of trade repositories (TRs) will also be boosted. TRs for CDS and interest rate
derivatives already exist. They feature electronic databases of open OTC positions and
publish statistics on volumes and market activity. Very little of this information is available,

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however In addition, the CPSS-IOSCO has issued recommendations on improving the

accessibility and capacity of trade repositories. Augmenting trade repositories would provide
much greater transparency to OTC derivatives markets by making available data on open
trades available to the public [CPSS 2010]. Repositories standardize and make information
widely accessible to all market actors.
It should be emphasized that the pervasive discussions and many proposals on OTC markets,
commodity rules and CCPs are in their relative infancy. Most of the specifics are still in the
consultative phase. It is hoped that by September of this year 23 a more thorough regulatory
regime will be developed. There are many controversial areas as Blundell-Wignall and
Atkinson (2010) and others have pointed out. According to the former:
Prior domestic and international regulatory regimes were unable to properly gauge to what
extent securitization dampened (hid) balance sheet credit growth in the past, leading to false
signals that there were no leverage problems. The same could very well occur in Basel III,
where future developments in the shadow banking system could lead to similar distortions
that would be impossible for supervisors and other policy makers to identify. They also claim:
Measures/proposals from Basel and the BIS to get more OTC derivatives onto exchanges
should create more reliable traded price data and improve the modeling of some of these
exotic instruments. Firm-specific requirements of non-financial and financial firms for tailormade derivatives suitable to individual needs, however, will likely contribute to the already
large size of the OTC market. Individual derivatives (continually innovating) are neither
conducive nor really able to be traded on exchanges. This presents a significant regulatory
problem in the future [Blundell-Wignall and Atkinson 2010, 11].
The argument that there may be over-regulation of securities and derivatives markets has also
been advanced. The OECD points to the activity of hedge funds, who act like capital market
oriented banks [Blundell-Wignall and Atkinson 2010, 13]. They are lightly regulated, issue
securities in their own name and invest with leverage on behalf of investors. Market
discipline in the absence of public guarantees help keep leverage ratios significantly lower for
these institutions. If regulations on banks are ramped up (especially on diverse, exotic
23

That is, 2011.

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transactions), there will be a corresponding shift in the quantity and nature of business
conducted within the shadow banking system [Blundell-Wignall 2010, 14].
Despite the proposal to move OTC transactions onto exchanges, Basel III does not deal with
the most fundamental regulator problem identified: that the promises that make up any
financial system are not treated equally in particular banks can shift them around by
transforming risk buckets with derivatives (particularly credit default swaps) to minimize
their capital costs including shifting them beyond the jurisdiction of bank regulators e.g.
to the insurance sector in a least regulated jurisdiction. The extent of activities in the shadow
banking system also a part of the problem related to how similar promises are treated by
regulators. This has many implications for the reform process
It has also been claimed that increasing capital requirements on counterparty risks provides a
strong incentive to push OTC transactions onto CCPs and other exchanges. It is likely that a
significant amount of activity will be pushed here, concentrating risk onto members of the
clearing houses and onto the clearing houses themselves. The total risk might be lower
overall, but its concentration introduces new systemic concerns over the integrity of
exchanges
Furthermore, questions can be asked about the ability of CCPs and other exchanges to
effectively manage the centralization of risk onto their books [Financial Times 2010]. Lack of
availability of prices, limitations of market liquidity and product differentiation is going to
make it hard for any exchange to model and contain risk. Lack of liquidity within these
markets may arise if capital requirements on counterparty risk are increased. This could
adversely affect the integrity of the clearing system [Financial Times 2010]. Tighter
derivatives markets may be good for the future of the entire financial system, but it will
certainly have a short- to medium-term impact on real economic activity. As Das
thoughtfully remarks:
The credit quality of the CCP is crucial. Currently, private clearing houses are contemplated.
The CCPs capitalisation and financial resources as well as the risk management systems will
be important in ensuring its credit standing. Commercial motivation (for market share and

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profit) may conflict with risk management requirements. It is not immediately apparent how
these competing pressures will be accommodated. The US believes that privately-owned
clearing houses are the solution.
The CCP is designed to reduce systemic risk but in reality, the CCP may become a node of
concentration. The heavy investment required to establish the infrastructure to clear contracts
through the CCP will mean that a few large derivative dealers (probably US and European)
will quickly dominate the business. Other dealers will inevitably be forced to clear and settle
trades through these dealers creating different counterparty credit risk and perversely
increasing systemic risk. Maximisation of benefits of central clearing requires a single
clearing house. Currently, multiple CCP appear likely, as different commercial clearing
houses compete for the latest frontier land grab in financial markets. National prejudices,
inherent mutual distrust, promotion of national champions as well as feared loss of
sovereignty and control of financial markets will mean multiple CCPs located in different
jurisdictions. This will require, if feasible, inter-operability, cross margining and clearing
arrangements between exchanges and jurisdictions. Instead of decreasing risk, this may create
new and complex exposures. For example, international regulators are yet to agree on the
definition of a standardised contract or the market participants required to transact through
the CCP. It is also not clear who will regulate and oversee the system, especially where it
transcends national boundaries.
CONCLUSION:
This chapter is talking about history of banking regime. As my research work is with respect
to Banking law hence it is very important to understand the history of Banking regime with
respect to ASEAN countries. There the inclusion of Financial Markets and Institutions where
the diversity of their economies are circumscribed and the classification is made necessarily
and those categorisation are defined elaborately.
Moreover, different ASEAN countries are defined independently and the evolution of
banking regime in it. Under this Basel II and its impact and challenges are also elaborated as
it is the part of it. And what are the possible challenges are also incorporated and explained.

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As to the introduction of Basel III regime with respect to my research topic was initialize.
With respect to my respective research made the categorised features of Basel II and Basel III
regime.

CHAPTER 4
AN ANALYSIS OF THE PERFORMANCE OF BANKING SECTOR IN
ASEAN MEMBER COUNTRIES
BANKING INTEGRATION IN ASEAN GATHERS PACE :

The ASEAN Economic Community, planned to come into effect in 2015, is expected to
liberalise goods, capital and skilled labour flows in the ASEAN region. While there has been
considerable progress in the area of trade integration, financial integration still lags behind.
The ASEAN Banking Integration Framework, which aims to liberalise the banking market by
2020, could help pave the way for further integration and the entry of ASEAN banks into
regional banking markets. Greater banking integration in ASEAN will benefit the region.
Currently, the level of integration in ASEANs banking sector is relatively limited. The share
of ASEANs banking assets held by regional banks is generally smaller than global banks.
Indonesia has the highest share of banking assets held by other ASEAN banks at almost 15
per cent, followed by Malaysia at around 9 per cent. Malaysian and Singaporean banks have
been actively expanding their operations in recent years into other ASEAN markets. For
example, CIMB Bank from Malaysia has large subsidiaries in Thailand and Indonesia while
United Overseas Bank of Singapore has a strong presence in Malaysia and Thailand. Greater

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intra-ASEAN trade and investment could also help encourage more banks to expand their
operations regionally to better serve their clients.
While the share of ASEAN banks in the regions banking market is still relatively small, it is
not that different from that of European banks in the five largest European Union countries
which benefit from operating in an integrated common market. This suggests that dropping
regulatory barriers alone may not be sufficient to bring about close cross-border integration.
Singaporean banks which are dominant in their highly developed banking market will be hard
to challenge. The three largest Singaporean banks control 80 per cent of assets in the banking
system in the country. However, banks in Indonesia and the Philippines which have large
populations and relatively underdeveloped banking sectors are likely to come under greater
competitive pressure from other regional banks. The banking systems in Indonesia and the
Philippines are also more fragmented. The three largest banks in Indonesia and the
Philippines only have 35 per cent and 41 per cent of total national banking assets
respectively.
As barriers to entry fall, the prospects of stronger competition from other ASEAN banks
could push banks to merge as they look to strengthen their domestic position and better
compete against regional rivals. Three Malaysian financial institutions, CIMB Bank, RHB
Bank and Malaysian Building Society Berhad (MBSB) announced plans in July 2014 to
merge. The merged entity is expected to overtake May bank to become the largest Malaysian
bank. The merger will help consolidate the banking market in Malaysia and create a regional
banking power that can hold its own in its home market and have the resources to expand to
other countries.
ASEAN BANKS ON LONG ROAD TO FINANCIAL INTEGRATION :
Full integration could spur the emergence of major banks that can compete with large banks
outside the region, in our view. Better economies of scale would also make financial systems
within the region more efficient. Along with the improvement of financial infrastructure in
each country, Standard & Poors believes the integration will make the banking sectors more
resilient to external shocks. "Integration will also increase the risk of contagion and spill

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over effects within the region; when one system gets in trouble, it will affect other systems
too.
Moreover, In addition, the varying pace of liberalisation and divergent regulatory frameworks
among ASEAN countries complicate the industrys consolidation. Greater intra-ASEAN
trade could encourage banks to expand regionally to better serve their clients. Central bank
governors have endorsed the ASEAN Banking Integration Framework (ABIF) to achieve
multilateral liberalization in the banking sector by 2020. This will pave the way for future
integration of the ASEAN banks, and banks are already preparing to leverage the
opportunities from increased trade flows in the region. The major banks in Malaysia and
Singapore have been the most active in expanding regionally. Thai banks are also expanding,
although they are focusing more on the Greater Mekong sub region. Indonesian and
Philippines banks, on the other hand, are playing defence and strengthening their domestic
networks. According to Standard & Poor's, banks in ASEAN are mostly small by global
standards and dont have the scale and footprint to compete effectively with global
behemoths.
In particular, the fragmented banking systems in some countries, such as Philippines,
Indonesia, and Vietnam, have a large number of small financial institutions with weaker
financial profiles than their global peers. These systems would find it difficult to compete if
the larger banks join the fray. " ASEANs financial system still has a way to go to meet its
goal of integration by 2020. The uneven pace of financial liberalisation in different countries,
along with significant divergence in regulatory frameworks, could complicate cross-border
mergers,".
The rating agency viewed that ASEAN banks would continue growing their loan books
prudently in the next few quarters, considering the higher capital requirement under Basel III
and generally improving discipline in loan underwriting."We believe asset quality will remain
a major risk factor in ASEAN banks credit profiles. Tighter monetary policy in the U.S. and
a subsequent increase of interest rates could trigger similar hikes in ASEAN markets.
Households and companies with heavier debt-servicing burdens will be more vulnerable to
such shocks," Lee said, The solution needs to be flexible, to fit the needs of the bank, and
sufficiently open to accommodate changes to the business and the regulations.

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The complexity and demands of Basel III and the commercial demands of the banking world
will require a flexible Basel III management solution that delivers speed, accuracy, and
performance to deliver competitive advantage. And those banks that implement the optimal
solution will not only have an ideal platform for delivering Basel III, they will also have a
solid platform for their future commercial development.
SURGING ASEAN TRADE PROMPTS BANKING REALIGNMENT24
Regional banks are getting busy ahead of the launch of the ASEAN Economic Community.
Major banks are realigning their businesses in Southeast Asia, where a winding back of crossborder tariffs and regulations has led to sharp rise in regional trade ahead of the launch of the
ASEAN Economic Community (AEC).
The latest, Standard Chartered, has announced that it will realign its operations, particularly
in the Greater Mekong Sub-region (GMS), which takes in Thailand, Myanmar, Vietnam,
Cambodia and Laos, to take advantage of a trading boom. We are the only international bank
with a network covering all five countries therefore we are well placed to support the flows of
businesses in ASEAN and leverage our experience to help strengthen economies in Thailand
and the GMS, Group Chief Executive Peter Sands said this week in Thailand.
Last year cross-border trade with the 10-nation Association of Southeast Asian Nations
(ASEAN) surged 26 percent to $323 billion. However, this figure is expected to grow still
further once the AEC is instituted by the end of 2015 with an anticipated combined gross
domestic product of $2.1 trillion. Following that, international banks will face stiff
competition from the regionals through the ASEAN Banking Integration Framework (ABIF),
expected to be implemented by 2020.
Under ABIF an ASEAN-based bank will be re-classified as a local bank across the 10
ASEAN countries, as opposed to being categorized as foreign banks in a neighboring
country. This will enable them to compete with an influx of major banks from China and
Japan.

24

Hunt,luke, Surging ASEAN Trade Prompts Banking Realignment , 22, march ,2014

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Indonesia, by far the biggest economy in the region, has more than 100 banks but so far its
the Philippine banks that have been particularly active in raising capital for an aggressive
expansion plan amid the integration plans.
The objective of the ABIF is to come up with strong, well-managed banks in the ASEAN
region and one of the things that would help do this is to allow greater competition and
greater access to markets within the ASEAN region and even to markets outside member
jurisdictions, Philippine central bank governor Amando Tetangco said recently.
In terms of asset value Philippines banks remain small when compared with their peers in
Thailand and Malaysia, and lag substantially behind banks in Singapore. Many are thrift
banks that are expected to benefit from changes in foreign equity laws.
Similar policies are being adopted across the region and this is expected to lead to
increased mergers and acquisitions over the short to medium term. Sands said the five GSM
countries were well positioned to benefit from a significant boost in foreign direct investment
despite a slowdown in the global economy.
All countries have problems, and even the global economy has upward and downward
cycles, he noted during an address to mark his banks 120th anniversary in Thailand.
CONCLUSION:
This chapter is explaining in broad way as to Banking Sector in ASEAN member countries.
As this chapter is different from previous chapter , this chapter is specifically focusing upon
the banking integration and earlier chapter talked about the evolution and history of banking
where the role of Basel II and Basel III came into picture. Moreover, this chapter is
explaining the ASEAEN banks on long road to financial integration as how it is connected
with the financial perspective. Also explaining the Banking realignment respectively.

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CHAPTER 5
IMPACT OF CAPTAL ADEQUACY RATIO ON THE PERFORMANCE
OF BANKING SECTOR IN ASEAN MEMBER COUNTRIES
CAPITAL ADEQUACY RATIOS (CAR) AND DEVELOPING MARKETS
Stricter definitions on what constitutes core Tier I capital is of interest to developing market
banks. Banks are going to have to hold much higher levels of common equity to satisfy their
Tier I requirements. Resilience and capability will be judged, then, by the soundness and
depth of equity markets in developing countries. No doubt, domestic debt and equity markets
must be strengthened to provide space for banks to raise fresh capital. Improving the quality
and depth of debt and equity markets in developing countries will be quite a task, especially
for countries who currently have very limited markets.
Boosting capital adequacy requirements may indeed lead to institutions being perceived as
safer, lowering their cost of capital. Larger banks would benefit most by being able to issue
debt more cheaply. Banks and corporate firms that are guaranteed through large banks will

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probably see their costs of issuing debt decrease. This will occur, because bonds issued by
these institutions will be an attractive investment for firms wishing to purchase assets that are
lower risk-weighted.
The effects of higher CARs on banks are difficult to tease out. Simulations done on the
effects of Basel II and increased capital adequacy ratios on the Brazilian and Mexican
economies showed that GDP in each country would be adversely affected. The analysis
showed that a credit crunch would occur in each of these cases, and accompanied by an
increase in lending rates. Although the Basel II reforms were never implemented fully,
marginal changes in the nature of capital requirements will most likely not affect the results
of the econometric analysis. If anything, tougher capital restrictions and more stringent ratios
might affect GDP even more adversely.
In the wake of Basel III then, it might be more difficult to tease out how even the developed
country banks could respond to more stringent capital requirements. That the success of
raising capital in equity markets was buoyed in 2010 can be noted here. As regards
developing countries, banks in search of returns may therefore not shy away from ramping up
lending and investment operations. Indeed, it is feasible that the total amount of credit to
developing countries may continue to increase. More important, where and to whom will that
credit go? This result should be compared against the finding by Montgomery (2005) which
indicated that since Basel I was implemented, international banks based out of Japan reduced
their risk profile. This was, in part, caused by regulatory pressures from the MOF and BOJ.
Econometric analysis on developing country banks showed that poorly capitalized banks
reduced risk when under regulatory pressure (from Basel I and II regimes), as opposed to
raising new capital . More stringent CARs under Basel III will force poorly capitalized banks
in developing countries to make difficult choices over how they will provision capital and
furthermore, how they will dole out credit.
Banks in large developing markets have had to hold CARs higher than the 8% minimum
under Basel for some time now . This is a result of domestic regulatory regimes which were
more stringent than Basel I and II regimes. This is directly related to the risk-weighting
formula imposed by earlier Basel regimes. The same effects have also been seen in India .

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Increases in bank credit have notably lagged behind increases in deposits and holdings of
sovereign debt by large Indian banks.
CONCLUSION:
Study of Capital adequacy ratio (CAR) is very important with respect to Basel regime. Many
changes with respect to change in Basel norm is came in occurrence. There was effect on
CARs on banks which are difficult to describe and increased CAR depends upon the GDP of
the economy. The analysis showed that a credit crunch would occur in each of these cases,
and accompanied by an increase in lending rates. In the wake of Basel III then, it might be
more difficult to tease out how even the developed country banks could respond to more
stringent capital requirements.

CHAPTER 6
ADOPTION OF CAPITAL ADEQUACY NORMS OF BASEL III
MAJOR CHANGES IN BASEL III25
1. Adjustment in capital composition Basel III adjusts the definition of capital composition,
making it more transparent and stringent. The biggest impact of Basel III is that it
significantly elevates banks primary capital adequacy ratio requirements, stipulating that Tier
1 capital must be composed of common shares or retained earnings. The ratio of Tier 1 capital
has been raised to 6 percent. The composition of Tier 2 capital has been simplified and
increased to 8 percent. There is no longer a requirement for Tier 3 capital. Due to significant
changes in the capital composition standard, the Basel Committee has outlined a timetable for
the banks to meet the supervision requirements, with full compliance required by 2018,
allowing banks small incremental increases on an annual basis.
2. Enhanced risk coverage In terms of credit risk, Basel III amends the current framework to
simplify large exposure limit requirements and introduces the concept of risk exposure limits.
On securitization risks, Basel III strengthens supervision over securitized credit. Compared to
other forms of securitization, Basel III imposes higher capital requirements on re-securitized
25

http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture-Beyond-Basel-III.pdf%23zoom=50

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positions to reflect the higher risk of unexpected losses. Moreover, Basel III toughens
disclosure requirements for securitized positions. In future, disclosure should not only include
risks of securitized positions in bank accounts but also related position risks in trading
accounts. With regard to market risk, Basel III raises capital requirements for counter-party
credit risks involved in trading account positions, derivatives, repos (sales and re-purchases
of highly liquid collateral), and bonds.
3. Introduction of Leverage Ratio Basel III introduces the concept of a Leverage Ratio
the ratio between Tier 1 Capital and Total Capital Exposure and sets the upper limit for this
ratio at 3 percent. Tier 1 capital refers to the Tier 1 capital defined by the new accord. Total
Capital Exposure refers to total capital without consideration of any kind of credit mitigation.
By introducing this relatively simple indicator, one solely based on total exposure, Basel III
establishes a measure for additional risk calculation. This measure is designed to reduce risk
from modeling and calculation errors to establish a bottom line for leveraged operation by
different bank departments.
4. Reduced Pro-cyclicality The Basel Committee is introducing a series of measures to
increase banks capital buffers when times are good to make them more resilient during
periods of economic downturn. These measures include:
Introduction of the Through-the-Cycle Provision concept
Adjustment of factors for internal rating, including adoption of a longer timeframe to
calculate the probability of default (PD), or adoption of PD estimates for economic
downturns. While Basel II suggested the use of estimates of the loss a bank experiences at
default (LGD), Basel III requires the use of these estimates
Introduction of Capital Conservation Buffer, with a standard set at 2.5 percent
Introduction of Counter-Cyclical Buffer, with the ratio increased from nil to 2.5 percent. 5.
Determination of the liquidity standard The Basel Committee is introducing minimum
liquidity standards for all banks, including the 30-day Liquidity Coverage Ratio (LRC) and
the long-term structural Net Stable Funding Ratio (NSFR), which requires:

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The LRC to be higher than 100 percent. In other words, financial institutions must ensure
they have adequate, high-quality current assets to support operation for one month during
severe conditions.
The NSFR must be higher than 100 percent, so that, under structural economic pressure, a
financial institution can provide stable financing sources to provide funding for its operation
over one year.
Basel III Background The Basel III framework, which was introduced in 2010, is the latest
bank capital framework produced by the Basel Committee on Banking Supervision, and
provides the basis for significant bank capital reforms which are now being implemented
globally.26 The reforms aim to improve the banking sectors ability to absorb shocks arising
from financial and economic stress, reducing the risk of spillover from the financial sector to
the real economy.
Basel III complements the Basel II and 2.5 capital frameworks which focused on asset
weightings in risk-based capital ratios and attempts to address key areas of weakness
identified after the financial sector crisis through the following new features:
Higher quantity and quality of capital;
Short-term liquidity and stable funding requirements; and
A leverage ratio to complement risk-based measures.
The Basel II framework updated the 1988 Basel I capital framework that had standardized
risk weights for credit and market risk exposures . Basel II continued the focus on the asset
side of the balance sheet and attempted to capture more nuanced risk-based capital
requirements for credit, market, operational and counterparty credit risk, with the latter two
being included for the first time. For the most advanced banks, internal models could be used,
subject to regulatory approval, to assign asset risk weights. The Basel II framework
introduced the concepts of Pillar I (minimum capital requirements), Pillar II (additional
capital for risks not captured or not fully covered in Pillar I and capital requirements under a
26

BCBS, which includes members of G20 countries, produces best practices documents on the measurement
and management of risk, corporate governance, and risk modeling. Its guidance is translated into legislation
within relevant jurisdictions.

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forward looking stress test), and Pillar III (enhanced risk disclosure to enhance market
discipline). Basel 2.5 was introduced in response to the recent financial crisis to improve the
capture of tail risks in the trading book.
Basel III largely focuses on the liability side of the balance sheet, modifying requirements for
both quantity and quality of loss-absorbing capital, and introduces requirements for a
leverage ratio, as well as liquidity and stable funding requirements (a short-term 30-day
liquidity coverage ratio and a 1-year net stable funding ratio). Basel III requires more highquality common equity Tier 1 (CET1) capital relative to total Tier 1 and Tier 2 capital, and
adds a number of capital buffers which can only be met with CET1 capital . Finally, the Basel
III framework also includes revisions to risk weighted assets (RWAs) relating to counterparty
credit risk, including the treatment of wrong-way risk. 27
The Basel III framework introduces the concept of buffers above regulatory minimums that
range from an additional 2.5% of risk-weighted assets up to 8.5%, and even higher in some
regions. The buffers must be met with loss-absorbing CET1 capital.
The capital conservation buffer (CCB), which is set at 2.5%, is meant to ensure that banks
build up capital buffers above regulatory minimums outside periods of stress. Such buffers
can be drawn down as losses are incurred and rebuilt through restrictions on capital
distributions.
The countercyclical capital buffer, which can range up to 2.5%, would be introduced in a
period of high credit growth, as a precaution against losses in a subsequent downturn.28
Basel III recommends an additional loss-absorbing buffer for global and domestic
systemically important banks (G-SIB and D-SIB, respectively). The size of the buffer
which can range up to 3.5% would depend on a banks cross-jurisdictional activity (only for
G-SIBs), size, interconnectedness, substitutability, and complexity.29
27

Wrong-way risk is the risk of positive correlation between potential future exposure to a trading counterparty
and the creditworthiness of the counterparty
28
Each regulator determines when a buffer is required, depending on the countrys position in the credit cycle.
Banks are subject to the countercyclical buffer requirements for all the jurisdictions in which they operate.
29
Currently, BCBS has created five buckets of additional loss-absorbency buffer requirements under Basel III,
ranging from 1.0% to 3.5%, and has allocated a group of global banks (G-SIBs) among the categories. No banks
currently fall in the highest bucket, requiring 3.5% additional CET1 capital. The group of G-SIBs will be
updated annually and published by the Financial Stability Board

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In the European Union (EU), the Capital Requirements Directive (CRD IV) implementing
Basel III creates an additional buffer known as a systemic risk buffer, which is applied to the
whole financial sector, or subsets of it, to prevent or mitigate long-term non-cyclical systemic
or macroprudential risks. EU member states can apply systemic risk buffers of 1% 3% for
all exposures, and up to 5% for domestic exposures, without having to seek prior approval
from the European Commission. 30 For banks subject to both a systemically important bank
buffer and the systemic risk buffer, the higher of the two will apply, but if the systemic risk
buffer applies to domestic exposures only, they will be combined.
When buffers are breached, they progressively restrict the amount of capital distributions
(dividends and discretionary Tier 1 payments) and discretionary bonus payments that can be
made out of earnings. Basel recommends that minimum capital conservation standards are
based on a combined buffer, which is divided into quartiles to determine payout restrictions..
The purpose and design of Pillar 2 requirements are important to understand in the context of
Basel III buffer standards. Pillar 2, which requires an internal capital adequacy assessment
process (ICAAP) and a supervisory review and evaluation process (SREP), entails an
incremental assessment of capital for risks not sufficiently or not covered in Pillar I. Pillar 2
is divided into capital held against risks not captured or not fully captured by the regulation
and risks to which a firm may become exposed, as assessed under forward-looking stress
tests, over a 3-5 year horizon (referred to as Pillar 2B). In some jurisdictions, regulatory
authorities may retain the discretion under Basel III to assess additional Pillar 2 buffer
requirements for specific banks in cases where they deem the standardized Basel III buffers
are insufficient, given a firms risk profile and potential exposure to losses under stressed
conditions.31
Pillar 2 How Firms Will Be Required to Meet Additional Capital Requirements While most
jurisdictions are allowing the use of total capital to meet Pillar 2 add-on requirements, though
30

EU member states can impose buffers higher than 5% with prior approval from the European Commission.
Some European regulators have developed special SREP practices to foster increased capitalization of banks
for example, the UK Prudential Regulation Authority (PRA) conducts thorough reviews of a banks risk
assessments and risk and capital management processes, including ICAAP. Such assessments can result in
Individual Capital Guidance (where ICG = Pillar 1 + Pillar 2A) and Pillar 2B stressed capital buffer
requirements that materially increase overall capital requirements. In the US, the Federal Reserve has mandated
stress tests for the largest domestic and foreign-owned banks, and in Europe, the European Banking Authority
and now the European Central Bank have undertaken forward-looking stress tests to assess capital adequacy
under a range of adverse scenarios and shocks.
31

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some regulators are modifying the required quality of capital to be more restrictive, requiring
at least 56% CET1, in line with the proportions of CET1, Tier 1 and T2 in the 8% total capital
requirement. However, jurisdictions have inconsistent application of Pillar 2 additional
capital assessments as well as inconsistent disclosures, which are problems that remain from
Basel II. Many jurisdictions do not formally assess additional capital for risks not captured or
not fully captured under Pillar 1, or when they do, these are often not disclosed by regulators
or the banks themselves. The UK has ruled that from 2015 onwards, instead of total capital,
capital to meet Pillar 2A requirements must be at least 56% CET1, no more than 44% AT1
and at most 25% T2. Hong Kong and Sweden have also proposed this requirement. Australia
has indicated that it expects Pillar 2 capital to be primarily CET1. While few authorities
actively disclose Pillar 2 requirements (with Sweden and Denmark as exceptions), which are
generally firm specific, the imposition of requirements to meet a portion of Pillar 2 in CET1
has resulted in some banks disclosing this portion of their overall Pillar 2 add-on requirement
in their target capital stack disclosures. This information regarding total CET1 requirements
is important for investors who hold contingent capital instruments of issuers whose securities
have CET1-based triggers. In Europe, the move to the ECB as the single supervisor for the
regions largest banks (with the exception of the UK, Switzerland and others outside of the
framework) may lead to greater harmonization in the use of Pillar 2 and potentially in greater
disclosure of Pillar 2 requirements or Pillar 1 adjustments, such as risk-weight floors, all of
which would be credit positive.
Leverage Ratio The leverage ratio requirement is in early stages of rulemaking in most
countries, as many countries are waiting for BCBS to finalize definitions and calibrations
before implementing rules. The BCBS leverage ratio definition includes both on- and offbalance-sheet exposures in the denominator and Tier 1 transitional capital in the numerator.
Despite its early stages, the rule is already a binding constraint, impacting the strategies of
many banks due to market pressure. To help meet the leverage ratio requirement, banks could
increase their risk profiles to boost weak profitability or reduce holdings of high quality
liquid assets, which could be credit negative. On the other hand, how banks seek to address
the Basel III leverage constraints could be credit positive if they reduce complexity and risk
or dispose of underperforming assets. Banks that are leverage constrained are highly likely to
issue AT1 securities to meet this requirement.

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Liquidity Coverage Ratio Basel III introduces the Liquidity Coverage Ratio (LCR), a shortterm liquidity standard to ensure that banks have sufficiently high levels of liquid assets to
overcome an urgent stress scenario lasting for 30 days.23 The LCR minimum standard will
be put in place in January 2015, with 100% compliance required by January 2019. Excess
liquidity is allowing some jurisdictions to phase-in requirements early, such as in Asia and
North America, trapping excess liquidity in the systems, a credit positive

CONCLUSION:
In this chapter as per the research major changes in Basel III has been focused as to the
adjustment in capital composition Basel III and adjusts the definition of capital composition ,
making it more transparent and stringent. Also the enhanced risk coverage Interms of credit
risk. Moreover, introduction of Leverage Ratio introduced and reduced the pro- cyclicality
and more concept was introduced necessarily.

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CHAPTER 7
BASEL III AND FINANCIAL CRISIS
The Basel Committee continues to produce new guidance to address deficiencies of previous
frameworks. Such deficiencies became more apparent as a result of the global financial crisis
in 2008- 09. Below, we summarize the key issues that Basel III has been designed to address
in light of lessons learned from the financial crisis.
The crisis demonstrated that firms did not hold, nor were they required to hold, sufficient
quantity or quality of loss-absorbing capital. For example, the CET1 requirement was only
2% of RWAs and the Tier 1 requirement was 4% of 8% total minimum capital. Coupled with
the lack of leverage constraints in most jurisdictions, banks were able to build up significant
amounts and concentrations of risk when the pre-crisis market was at its peak. Consequently,
they found themselves with insufficient loss-absorption capacity when markets collapsed.
Basel III requires banks to gradually move towards requirements for more and betterquality regulatory capital (more loss-absorbent) with stricter deductions from capital and the
introduction of standardized and firm-specific loss-absorbing capital buffers. Basel III makes
a distinction between going concern high-quality common equity Tier 1 capital and other
capital instruments that qualify for Additional Tier 1 versus gone concern Tier 2 capital.
Eligibility criteria for qualifying capital instruments have been enhanced, including the
requirement for coupons to be discretionary and subject to non-payment on a non-cumulative
basis. Instruments that no longer qualify as non-core Tier 1 capital or Tier 2
Hybrid instruments proved weak in absorbing losses during the financial crisis and no
longer count as regulatory capital except for certain contingent capital instruments, which

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include a mandatory full or partial write-down or conversion into equity feature. Qualifying
new capital securities under Basel III, other than common equity, must have explicit terms
that impose losses on investors when a bank is deemed by the regulator to have reached the
point of non-viability or when a CET1 trigger is breached, whichever comes first, and must
have no incentive to be redeemed prior to maturity (e.g. step-up).32
Basel III changes the overall proportion of the most loss-absorbing capital within the 8%
total capital requirement versus the minimal requirements under Basel II. Going forward,
4.5% or 56% of the 8% requirement must be met with CET1 capital, excluding CET1 buffers
and CET1 portions of Pillar 2A requirements (previously, only 25% of the total capital
requirement had to be met with common equity).33
Basel III simplifies capital levels and requirements compared to Basel II, Deductions from
capital were allowed to be taken from higher tiers of capital rather than core capital.
Basel III requires that more deductions be taken fully from CET1, making this highest
quality capital even more scarce. BCBS Basel II guidelines required 50% of deductions from
Tier 1 and 50% from total capital, but under Basel III, most deductions will be taken fully
from CET1. The shift from deducting these items from CET1 will be phased in gradually by
20% a year, between 2014 and 2018. Key items fully deducted from CET1 include goodwill
and intangible assets, deferred tax assets that rely on future profitability, pension deficits, and
the excess of expected loss relative to provisions for banks on the internal ratings based
approaches for credit risk. Some items are considered threshold deductions, and can only
be included up to a certain proportion of common equity. These items include DTAs arising
from temporary differences, mortgageservicing rights, and investments in unconsolidated

32

Tier 1 instruments must be perpetual with non-cumulative discretionary coupons, and include features
enabling them to be fully or partially written down or converted into equity at the earlier of either: (1) when a
pre-determined capital trigger is breached (the BCBS proposes a numerical trigger of a CET1 ratio below
5.125%); or (2) when the bank is deemed to be no longer viable without the PONV securities absorbing losses
or without public money being injected. Tier 2 instruments must also be loss absorbing through features
enabling them to be fully or partially written down or converted into equity at PONV. In the last five years prior
to maturity, Tier 2 instruments will amortize at 20% per year.
33
In addition to the Basel III going and gone concern capital requirements, steps to enable the orderly resolution
of banks and maintenance of key operations, if they fail, will add an additional layer of loss-absorbing bail-in
capital at the level of holding and potentially operating companies, most likely reducing loss in the event of
failure.

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financial institutions.34 Some capital components such as deferred tax assets (DTAs) were not
realizable in resolution.
Basel III requires all DTAs that rely on future profitability to be deducted from capital.
Deferred tax assets that arise from temporary differences such as loan loss provisions can be
included in capital, but are limited to 10% of CET1 capital. Certain risks were not captured in
RWA calculations particularly certain market risks and wrong-way risk in counterparty
credit risk.
Basel 2.5, introduced in 2011, addressed market risks that were not captured by the
previous market risk amendments, such as stressed VAR and credit migration risk on bond
holdings. Basel III modified the counterparty credit risk capital requirement of Basel II,
enhancing the default risk capital requirements for counterparty credit exposures arising from
over-the-counter (OTC) derivatives, repo and securities financing transactions, and
introduced a new credit valuation adjustment (CVA) capital charge, requiring banks to
measure and capitalize the potential mark-to- market losses associated with OTC derivatives
counterparty quality deterioration.
Both the Basel 2.5 and Basel III amendments in these areas have made a material difference
to the overall cost of many capital markets activities, resulting in full reviews of business
models, the exiting of many business lines, and efforts to reduce capital charges for the
remaining activities through measures such as trade compression, netting agreements and
shortening of the maturities of transactions. Firms were over levered, particularly where there
were no leverage constraints, as they had been focusing on optimizing return on RWAs. This
build-up of leverage had negative systemic consequences and resulted in greater
deleveraging, as capital was eroded by losses, exacerbating the effects of the downturn on the
real economy.
Basel III formally introduces a leverage requirement, including both on- and off-balancesheet exposures, as a backstop to the risk-weighted capital requirements, a requirement that
only a few jurisdictions had before the crisis. As measurement of risk-weighted assets is
based on a prediction of the likely future course of events, involving a high degree of
34

These items can each receive limited recognition in CET1 of up to 10% of the banks common equity and
collectively cannot exceed 15% of CET1.

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judgment and potential model error, the leverage ratio is meant to provide a backstop, in
cases where the risk and liquidity inherent in assets and contingent off-balance-sheet
liabilities are underestimated in risk-adjusted capital calculations.
Underestimation of asset risk may also be addressed in the future by the imposition of riskweight floors on low-risk assets, which attract minimal RWAs when internal models are used.
Although not part of the Basel III framework, further enhancements of the capital framework
along these lines are being discussed and have already been imposed by some jurisdictions.
Liquidity buffers were inadequate both in terms of quantity and quality and there was an
over-reliance on short term wholesale liabilities funding long-term assets.
Basel III introduces a short-term liquidity coverage ratio, requiring buffers against shortterm liquidity disruptions, and a longer-term net stable funding requirement, to encourage
greater use of more stable funding sources and to increase the duration of funding profiles to
limit risks from loss of market access. As a result, banks have significantly increased their
liquidity buffers, reduced their reliance on short-term wholesale funding, and reduced
funding gaps by increasingly funding loan books with deposits. They have also increased the
duration of their medium- and long-term funding profiles. Basel I and II were pro-cyclical in
that capital requirements for firms were the highest at the same time as when losses were
peaking and the ability to accrete capital was at its weakest.
Basel III addresses pro-cyclicality by adding a countercyclical buffer capacity for regulators
to enact when they believe that a banking system or particular asset sector is overheating.
Such a move was designed to dampen the build up of credit and preserve capital in cyclical
upturns, helping to reduce the need to deleverage when downturns occur.
Additional proposals being considered by some authorities, including the UK, for a
complementary time varying leverage buffer will have a similar effect Firms continued to pay
capital distributions to shareholders and employees at the same time as capital levels were
receding, potentially reaching undercapitalized levels.
Basel III introduces capital conservation and additional systemically important institution
buffer requirements, composed of common equity Tier 1 capital, which entail predefined
progressive restrictions on distributable items (dividends, coupons and discretionary bonuses)

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when capital buffers are breached, as well as requirements for firms to agree with their
regulator on the actions they will take to restore the buffers. Pre-crisis, many firms held
minimal or no capital buffers above minimum own funds requirements. Basel III attempts to
address the issues of bank interconnectedness, systemic risk, and banks that are too big to
fail.
Basel III adds progressive capital surcharges for the largest, most interconnected domestic
and global financial firms whose failure pose the greatest risk to financial stability. Basel III
also recognizes contingent capital, which can serve to absorb losses on a going concern basis,
as regulatory capital.
Further efforts to reduce interconnectedness between financial institutions have been
introduced through Basel III and other legislation, which together require mandatory clearing
through central clearing counterparties of certain types of OTC derivative transactions, and
impose higher risk weights for OTC derivatives not cleared through a central counterparty.
Causes of global financial crisis From the macroeconomic perspective, the crisis has been
attributed to the persistence of global imbalances. It is often said that the solution to a
previous crisis becomes the cause for the next crisis.
They developed structured financial products like securitization and re-securitization based
on sub-prime mortgage backed securities (MBS), collateralized debt obligations (CDOs) and
CDO squared etc. Credit default swaps (CDS) were also used to create synthetic structures
which increased their illiquidity and complexity. Oblivious of the inherent risks created by
these features, securitizations continued to grow by leaps and bounds leading to sub-prime
lending with impending disastrous consequences. Another cause of the crisis was attributed to
the socio-economic and political factors in the USA.
The politicians could not improve the income of the people but devised policies to encourage
2 BIS central bankers speeches them to the dream of owning a house by taking loans from
banks and financial institutions at the prevailing low interest rates. Thus, the birth of the toxic
product sub-prime mortgage took place. It was said if the poor people cannot have income
for consumption, let them eat credit. At the micro level, the business models of banks and

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financial institutions also contributed to the fermentation of the crisis. The originate-todistribute model of sub-prime mortgages did not create any incentive for banks for better
appraisal and supervision of such mortgages. Their reliance on wholesale funding markets
created gaps in liquidity risk management. Short term funds were used for creating long term
assets. The availability of plenty and cheap funds encouraged banks to be highly leveraged,
that too by borrowing short term funds. The crisis has also been attributed to the inadequate
corporate governance and inappropriate and perverse incentive system in the financial sector.
There were several weaknesses in corporate governance in the run up to the crisis. Corporate
governance arrangements failed to curb excessive risk taking in banks and financial
institutions. The Board and even senior management, in some cases, failed to establish an
informative and responsive risk measurement and management reporting framework. The
institutional arrangements in many instances conferred importance and status on the risk
takers at the expense of independent risk managers and control personnel. Where strategy
was in place, Boards did not establish suitable metrics to monitor implementation There has
been wide spread criticism that incentives and pay packages were set inappropriately,
encouraged irresponsible risk taking, were inconsistent with the firms capital bases and
focused on short-term profit maximization.
The Basel requirement of common equity was as low as 2% of risk-weighted assets (RWAs).
Banks did not calculate the risk-based capital properly. The Basel capital rules favoured
lower capital for the trading book and higher capital for the banking book. Banks exploited
this loophole and parked banking book assets in the trading book, indulging in capital
arbitrage. Similarly, capital requirement for mortgage loans was higher than capital
requirement for mortgaged backed securities (MBS). This encouraged banks to securitize
their mortgage loans through a Special Investment Vehicle (SIV) set up by them. Banks
offered liquidity supports to their own SIVs which securitized the mortgage loans and
enhanced the credit rating of such instruments. Enhanced ratings require less capital. Banks
invested in such products requiring less capital. Thus, there was an incestuous relation in
keeping banking book assets in trading book, for which liquidity support was given by the
bank to enhance its rating and reduce capital requirement.

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The credit rating agencies also did not perform their role as envisaged and junked
themselves. Every banking crisis has some common elements. But every time, experts say,
this time is different. Then what was different this time? Probably, the phenomenal growth
of shadow banking system, most of which was outside the regulatory purview, and the
excessive dependence of banks and financial institutions on the wholesale funding markets,
are the different factors behind this crisis. Trust, which takes time to build up is an
important element in the functioning of financial markets as the very nature of financial
contracts requires a high level of trust.
The inter-connection between banks in the financial system propagated it into a systemic
crisis. Banks, starved of liquidity, started to deleverage and stopped lending to the real sector.
The financial crisis, thus, became a full-scale economic crisis. Since banks are essential to an
economy and their failure affects the real sector, particularly when they are too big, the public
authorities had no alternative but to rescue the banks by injecting capital, guaranteeing their
liabilities and purchasing their toxic assets. This created the moral hazard issue of
privatization of profits but socialization of losses. However, one unintended but interesting
aspect of the rescue programme was that non-equity capital providers to the banks escaped
scot free as they were required to absorb losses only in the event of liquidation of banks and
not other-wise. There are several estimates of the cost of the crisis to the public exchequer.
Enhancement to Basel II or Introduction of Basel II.5 Post-crisis, the global initiatives to
strengthen the financial regulatory system are driven by the political leadership of the G20
under the auspices of the Financial Stability Board (FSB) and the Basel Committee on
Banking Supervision (BCBS). Immediately after the crisis, the Basel Committee, in July
2009, came out with certain measures, also called enhancement to Basel II or Basel II.5, to
plug the loopholes in its capital rules which were exploited to 4 BIS central bankers speeches
arbitrage capital by parking certain banking book positions in the trading book which
required less capital. These measures, under Pillar 1, include introduction of an incremental
risk charge (IRC) for specific risk or credit risk in trading book under the Internal Models
Approach (IMA).

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Moreover, Capital charge for securitization of commercial real estate was increased and that
for re-securitization introduced. The Value-at-Risk (VaR)-based measure for capital charge
for market risk under IMA has been substantially enhanced by including a stressed-VaR
element. The overall capital requirement for the trading book is expected to rise by about 3
times. Pillar 2 has been strengthened by issuing guidance on firm-wide risk management;
managing reputation risk and liquidity risk; improving valuation practices; and implementing
sound

stress

testing

practices. Appropriate

additional

disclosures

complementing

enhancements in Pillar 1 and 2 have also been introduced.

The Basel III The Basel Committee published its Basel III rules in December 2010. The
objectives of Basel III are to minimise the probability of recurrence of a crisis of such
magnitude. Towards this end, the Basel III has set its objectives to improve the shock
absorbing capacity of each and every individual bank as the first order of defence and in the
worst case scenario, if it is inevitable that one or a few banks have to fail, Basel III has
measures to ensure that the banking system as a whole does not crumble and its spill-over
impact on the real economy is minimized. Therefore, Basel III will have some microprudential elements so that risk is contained in each individual institution; and a macroprudential overlay that will lean against the wind to take care of issues relating to the
systemic risk. Micro-prudential elements of Basel III The micro-prudential elements of Basel
III are:
(i)

definition of capital;

(ii)

enhancing risk coverage of capital;

(iii)

leverage ratio; and

(iv)

international liquidity framework.

Therefore, under Basel III, the terms and conditions of all non-common Tier 1 and Tier 2
instruments issued by banks will have a provision that requires such instruments, at the
option of the relevant authority, to be either written off or converted into common equity
upon the bank being adjudged by the supervisory authority as having approached or
approaching the point of non-viability. Additionally, innovative features in non-equity capital
instruments are no longer acceptable. Tier 3 capital has also been completely abolished. The
regulatory adjustments or deductions from capital presently applied at 50% to Tier 1 capital

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and 50% to Tier 2 capital will now be 100% from the common equity Tier 1 capital. To
improve market discipline, all elements of capital are required to be disclosed along with a
detailed reconciliation to the reported accounts. These requirements will be implemented
uniformly across all jurisdictions and the consistency in application will be ensured by the
Basel Committee through a peer review process. Thus, the definition of capital in terms of its
quality, quantity, consistency and transparency will improve under Basel III.
Enhancing risk coverage of capital In view of significant shortcomings noticed in the
management and capitalization of counterparty credit risk, measures have been introduced
under Basel III, to strengthen the capital requirements for counterparty credit exposures
arising from banks OTC derivatives, repo and securities financing activities. These reforms
will raise the capital set against these exposures helping to reduce systemic risk across the
financial system. They also provide incentives to strengthen the risk management of
counterparty credit exposures. Going forward, banks must determine their capital requirement
for counterparty credit risk using stressed inputs. This will address concerns about capital
charges becoming too low during periods of compressed market volatility .
The Basel Committee has, therefore, introduced a simple, transparent, non-risk-based
leverage ratio as a supplementary backstop measure 6 BIS central bankers speeches to the
risk-based capital requirements. The leverage ratio has both micro-prudential and macroprudential elements. At the micro level, it serves the purpose of containing excessive risk, as
a supplement to the risk-based capital ratio. The risk-based capital ratio does not capture the
risk of excessive leverage on account of having low risk assets. The leverage ratio as a simple
accounting measure will capture that. The Basel Committee has proposed testing a minimum
Tier 1 leverage ratio of 3% (33.33 times) to start with as a Pillar 2 measure which will
eventually be made a Pillar 1 requirement. There were no internationally agreed and
harmonized liquidity standards. The regulation of banking sector during the past two decades
largely revolved around Basel I and Basel II capital regulations.
The financial crisis has highlighted the importance of robust liquidity risk management by
banks. It was observed during the crisis that even those banks which had sufficient capital
base had experienced difficulties due to imprudent liquidity management practices by

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excessive dependence on wholesale funding markets. The crisis demonstrated that liquidity
and solvency are quite deeply interrelated. Illiquid banks can become insolvent in no time
and similarly an insolvent bank can become illiquid rapidly.
Basel III has introduced two new liquidity standards to improve the resilience of banks to
liquidity shocks. In the short term, banks will be required to maintain a buffer of highly liquid
securities measured by the Liquidity Coverage Ratio (LCR). This liquidity buffer is intended
to promote resilience to potential liquidity disruptions over a 30-day horizon. It will help
ensure that a global bank has sufficient unencumbered, high-quality liquid assets to offset the
net cash outflows it could encounter under an acute short-term stress scenario of 30 days.
Another liquidity risk measure, the Net Stable Funding Ratio (NSFR), requires a minimum
amount of stable sources of funding at a bank relative to the liquidity profiles of the assets, as
well as the potential for contingent liquidity needs arising from off-balance sheet
commitments, over a one-year horizon. The objective of the NSFR is to promote resilience
over a longer time horizon by creating additional incentives for banks to fund their activities
with more stable sources of funding on an ongoing basis.
Basel III seek to address issues relating to systemic risk through various measures including
(i)

leverage ratio;

(ii)

capital conservation buffer;

(iii)

countercyclical capital buffer;

(iv)

addressing procyclicality of provisioning requirements;

(v)

addressing interconnectedness;

(vi)

addressing the too-big-to-fail problem; and

(vii)

addressing reliance on external credit rating agencies.

Furthermore, banks will be subjected to the restrictions on distributions also if the capital
level (capital conservation buffer plus countercyclical buffer) falls below the required
levels during the periods when the countercyclical capital buffer is in force. Banks will
have to ensure that their countercyclical buffer requirements are calculated and publicly
disclosed at least with the same frequency as their minimum capital requirements.

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Addressing procyclicality of provisioning requirements Financial institutions are prone to

business cycles. In good times, banks borrowers do well and service the loans in time. In
bad times, borrowers tend to default in servicing interest and principal payment. Banks
profits go down but at the same time they are required to make higher loan loss provisions
for the non-performing loans. In order to address the procyclical issues, the Basel
Committee is working closely with the International Accounting Standards Board (IASB)
towards an expected loss approach to loan loss provisioning instead of the current
practice of incurred loss approach.
Based on policy judgment derived from various empirical analysis, the Basel Committee
has determined that the magnitude of additional loss absorbency for the highest populated
bucket should be 2.5% of risk-weighted assets at all times, with an initially empty top
bucket (fifth bucket) of 3.5% of risk-weighted assets. The magnitude of additional loss
absorbency for the lowest bucket should be 1.0% of risk-weighted assets. The magnitude
of additional loss absorbency is to be met with common equity Tier 1 capital as defined
by the Basel III framework. The G-SIBs will also be subject to tighter supervision. In
addition, liquidity standards have been introduced to reduce excessive reliance on short
term wholesale funding. Addressing reliance on external credit ratings To reduce the
reliance on external ratings of the Basel II framework, measures have been proposed that
include requirements for banks to perform their own internal assessments of externally
rated securitization exposures, the elimination of certain cliff effects (sharp increase in
applicable risk weights) associated with credit risk mitigation practices, and the
incorporation of key elements of the IOSCO Code of Conduct Fundamentals for Credit
Rating Agencies into the Committees eligibility criteria for the use of external ratings in
the capital framework.
In general, the increase in equity capital requirement is likely to increase the weighted
average cost of capital. Banks would partly pass on the increase cost of capital to the
borrowers as higher lending rates. Thus, the equilibrium lending rates are likely to be
marginally higher and as a consequence, credit growth could be a little lower than in the
last few years.

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The Bank for International Settlements (BIS) and the FSB, with a view to phase-in the
new regulations in a manner that is compatible with the global economic recovery,
undertook studies to assess the macroeconomic impact of the transition to higher capital
and liquidity requirements. The Macroeconomic Assessment Group (MAG) set up by the
Basel Committee and FSB has estimated that bringing the global common equity capital
ratio to a level that would meet the agreed minimum and the capital conservation buffer,
would result BIS central bankers speeches 9 in a maximum decline in GDP, relative to
baseline forecasts, of 0.22%, at the end of Basel III implementation period. The estimated
maximum GDP impact per percentage point of higher capital was 0.17%. In addition, the
Basel Committees study on the Long-term Economic Impact (LEI) of the stronger capital
and liquidity requirements has suggested that the net benefits in terms of the gains from
reduced probability of banking crises, and the consequential loss of growth, remain
positive.
The wide difference in estimates is attributed to different assumptions and samples.
Implications of Basel III on Indian banks In general, higher capital and tighter liquidity
requirements under Basel III will increase the capital requirements in Indian banks, as in
other countries. However, the actual impact would vary in different countries depending
upon the amount of exposures impacted under Basel III, existing capital structure of
banks, i.e., extent of reliance on non-common equity capital elements, existing rules
relating to regulatory adjustments, credit growth experienced by the economies and
existing credit to GDP ratio. The impact of these requirements on the profitability of
banks would depend upon sensitivity of lending rates to capital structure of banks and
sensitivity of the credit growth to the lending rates.
Government of India has progressively reduced its shareholding in public sector banks
and in the case of many of these banks, the Governments shareholding is close to 51%.
This means that in the future, the Government of India would provide the matching
contribution to meet the additional equity requirements of banks, in contrast to the past
when it had allowed a large part of additional equity requirements to be met from the
market by letting its shareholding fall from 100% to 51%. Thus, the demand for equity
from the capital market would be less to that extent but public sector banks dependence

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on the Government for capital support will increase. Liquidity Issues relating to SLR
and LCR In India, banks are statutorily required to hold minimum reserves of highquality liquid assets.
RBI is examining to what extent the SLR requirements could be reckoned towards the
liquidity requirement under Basel III. Profitability Studies have suggested that
internationally, Basel III requirements will have a substantial impact on profitability. One
such study conducted by McKinsey & Company suggest that all other things being equal,
Basel III would reduce return on equity (RoE) for the average bank by about 4 percentage
points in Europe and about 3 percentage points in the United States. The retail, corporate,
and investment banking segments will be affected in different ways. Retail banks will be
affected least, though institutions with very low capital ratios may find themselves under
significant pressure. Corporate banks will be affected primarily in specialized lending
and trade finance. Investment banks will find several core businesses profoundly
affected, particularly trading and securitization businesses.
At the same time, the challenges in implementation of Basel III should not be
underestimated. For every bank, working out the most cost-effective model for
implementing Basel III will be a critical issue. The comfortable capital adequacy levels at
present for the Indian banking system do provide some comfort. However, as the
economy grows, so will the credit demand requiring banks to expand their balance sheets,
and in order to be able to do so, they will have to augment their capital; more specifically
the equity capital. While implementation of Basel III would undoubtedly imply some
costs, this should not be the criterion to determine whether Basel III would add value to
the financial system. The correct measure should be whether or not Basel III would
deliver a much safer financial system with reduced probability of banking crises at
affordable costs. The impact of costs is minimized through long phase-in.
At times a question is asked whether it is appropriate for the countries which neither
contributed to the crisis nor have exposure to the toxic assets need to implement Basel III.
The answer is a clear Yes. The reason is that in the present-day globalised world it is
difficult for any local financial and economic system to completely insulate itself from the
global economic shocks.

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In addition, many provisions of Basel III address the weaknesses in the measurement of
risk under Basel II framework revealed during the crisis. Thus, Basel III would strengthen
the financial system of both developing and developed countries. It needs to be
appreciated that if the implementation of Basel III is not consistent across jurisdictions
there would be a race to the bottom to make use of arbitrage opportunities, which nobody
wins! I feel Indian banks should minimize costs by retaining maximum amount of
earnings in the initial years of implementation, even though they might meet the capital
requirements at that point in time with smaller retentions. This would avoid costs
involved in fresh issuances.
Indian banks are also comfortably placed in terms of liquidity requirements as they have
a large reservoir of liquid Government securities to meet the SLR stipulation. RBI is
considering how much of it can be allowed to be reckoned towards compliance with the
LCR. It is also expected that as the proportion of equity in the capital structure of banks
rises, it would reduce the incremental costs of raising further equity as well as noncommon equity capital. Banks will have to issue fresh capital particularly to replace the
ineligible non-equity capital towards later years of implementation. Successful issuance
of fresh capital would demand greater transparency and greater market discipline. The
Reserve Bank of India has issued the draft guidelines on capital and liquidity rules of
Basel III on 30 December 2011 and 21 February 2012, respectively. The Reserve Banks
approach has been to adopt Basel III capital and liquidity guidelines with more
conservatism and at a quicker pace. As I have discussed above, the impact of these rules
is not going to be onerous and there will be considerable advantage in adopting Basel III
by our banks.
CONCLUSION:
The crisis demonstrated that firms did not hold, nor were they required to hold, sufficient
quantity or quality of loss-absorbing capital. Causes of global financial crisis From the
macroeconomic perspective, the crisis has been attributed to the persistence of global
imbalances. It is often said that the solution to a previous crisis becomes the cause for the
next crisis.

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CHAPTER 8
CHALLENGES AND IMPLICATIONS
CHALLENGES:35
1. A New Risk and Finance Management Culture Basel III is changing the way that banks
address the management of risk and finance. The new regime seeks much greater integration
of the finance and risk management functions. This will probably drive the convergence of
the responsibilities of CFOs and CROs in delivering the strategic objectives of the business.
However, the adoption of a more rigorous regulatory stance might be hampered by a reliance
on multiple data silos and by a separation of powers between those who are responsible for
finance and those who manage risk. The new emphasis on risk management that is inherent in
Basel III requires the introduction or evolution of a risk management framework that is as
robust as the existing finance management infrastructures. As well as being a regulatory
regime, Basel III in many ways provides a framework for true enterprise risk management,
which involves covering all risks to the business.
2. Different Geographies, Different Issues Different regions and countries face different
challenges in applying Basel III. The EU has been consistent in its adoption of past Bank of
International Settlements (BIS) regulations and therefore will hope to seamlessly migrate
from Basel II to Basel III. The EU plans to deliver a unified set of rules across Europe, to
discourage gold plating, and ensure that there is a level playing field, removing scope for
regulatory arbitrage. The US effectively skipped Basel II, so it will be making a fresh start,
35

MOODYS ANALYTICS IMPLEMENTING BASEL III CHALLENGES , OPTIONS AND

OPPORTUNITIES

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building on the foundations of Basel I, facilitated by the Dodd-Frank Act. The extent to
which other countries in the world have adopted and another varies considerably: Japan,
Hong Kong, Singapore, and Australia are well advanced, on a par with the EU. The picture in
Russia and countries in Eastern Europe, the Middle East, Africa, and Asia Pacific is less clear.
Some might choose to start with a clean sheet and implement the full set of rules. Others
might opt to use Basel III merely as a direction of travel, without embracing the full package.
For example, Russia recently announced that it will move from the standardised approach to
calculating credit risk, to the internal ratings based (IRB) approach by 2015. Some Middle
Eastern countries are currently in the process of moving towards the IRB model. Some
countries might also have other regulatory legacies, which in some cases might mean that
some national regulations will be superseded by Basel III but might need to be maintained in
parallel. Some might choose to adopt the Basel III requirements in their own way, goldplating the requirements if they feel that Basel III does not meet a particular countrys
requirement. This could create idiosyncratic requirements and processes that need to be
addressed during implementation. This global complexity adds further complication because
banks might need to manage different regulations in different jurisdictions; and a bank might
be obliged to report under Basel II in one country and Basel III in another, depending on
where the bank is domiciled.
Adding further multi-national complexity, many regulators also demand banks continue to
submit reports under the Basel I framework, using the standardized model for calculating
credit risk. This allows regulators to have a consistent framework to compare all the banks
they regulate, regardless of whether the banks themselves use the IRB or standardized
models. In Europe, for banks using IRB, regulators stipulate that this Basel I floor must be
in the region of 80-90% of the calculation using the more costly standardized approach. In the
US, the floor is 100%. This may actually mean that banks have to handle compliance across a
mix of Basel I, II and III, depending on where they do business and the demands of the local
regulators. The reports will need to convey a consistent message so as not to mislead the
regulator and the market. Organizations with a fragmented data model will be burdened with
additional cost and overhead compared to those with a more centralized approach to
collecting, consolidating and submitting reports under Basel I, II and III. This diverse picture

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needs to be considered carefully when applying the principles of Basel III to a bank and
implementing a solution.
3. Managing the Data To deliver compliance against Basel III, all banks must now ensure that
risk and finance teams have quick and easy access to centralized, clean, and accurate data.
This data must reflect their banks credit, market, concentration, operational, impairment, and
liquidity risk. All banks will also need to calculate the enhanced capital, new liquidity ratios,
and new leverage ratios to be in a position to start reporting to local supervisorsin the
multiple formats that the various national regulators requirestarting as early as 2013. The
data management requirements of Basel III are significant. For the bank, the regulator, and
the wider market to get an accurate picture of the banks position, the data must be accurate,
up to date, and consistent. Delivering this cost effectively is difficult if the data is dispersed
across different silos. Furthermore, the data must be carefully defined and managed to ensure
that it delivers the correct ratio calculations for capital adequacy, leverage, and liquidity every
time. This requirement, combined with the significantly greater reporting requirements of
Basel IIIin terms of granularity and frequencymeans that the effort required to manage
data within Basel III is greater than ever. Ensuring that a banks regulatory data is of the right
quality and in the right place at the right time is probably the single most important criterion
in deciding whether a banks Basel III project meets its objectives or not.
4. Auditing the Data Once a regulatory report has been submitted, it is highly likely that a
regulator will follow up with the bank to clarify critical issues about how the results were
calculated and how the rules were applied. This will require the bank to identify, check,
approve and submit the data, quickly and accurately. These extra submissions need to be
consistent with the rest of the report, be delivered in the same format and must be completed
as cost effectively as possible, without impacting other business activities. This audit process
will be especially difficult for banks whose data is dispersed across multiple silos and
systems, as it will take longer to search for the relevant information. Banks with a centralized
data model will be able to respond faster and more efficiently to these enquiries, further
streamlining their compliance and reporting processes.

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5. Stress testingthe ability to understand the impact of significant market events on the key
ratiosreceives greater significance under Basel III. Stress testing will be required more
often, performed across more data, and delivered in more depth. This will be difficult to
deliver if organizations have their data distributed across multiple silos. It will take longer, it
will require more effort, and it will deliver less accurate results, compared with having a data
model where all the critical information is held in a central repository.
6. Taking an Integrated Approach The Basel III regulations reflect the integrated nature of
banks and banking. A Basel III management solution must enable the demands of integration;
otherwise, compliance will create significantly greater overhead than necessary. Given the
way that banks have grown, developed new services (and the systems to support them), and
merged activities, it will be challenging to deliver a truly integrated system without disrupting
the business of the bank. The ideal management solution would consolidate, calculate, and
report the organizations capital, liquidity, and leverage ratios from a single, centralized
reporting platform. It would seamlessly integrate with other source systems and have strong
data quality checking and storage capabilities.
This approach would streamline the process, allowing risk managers to focus their attention
toward primary risk management activities rather than the time-consuming data extraction,
quality, and reporting issues. Fast calculation engines would facilitate weekly and even daily
calculations and would feed integrated and comprehensive regulatory reporting that is
mapped to the local supervisors exact requirements, and provide additional business insight
for the bank. Delivering against this ideal would be demanding for any bank. When this issue
is understood in the context of the other issues highlighted above, it is clear why it is all too
easy to underestimate the challenges of implementing Basel III. Nevertheless, when these
issues are understood in the context of the way a bank is organized, it is possible to conceive
a solution that allows a bank to implement the regulations on time and on budget, given the
right approach and toolset. Implementing Basel III Multiple ApproachesOne Destination
Implementing Basel III creates a unique set of challenges for every organization, regardless
of the organizations starting point. Because Basel III is more a set of principles than a
minutely detailed set of rules, there is no cut-and-dried solution when implementing it. This
flexibility allows banks a great deal of latitude in how they adopt the requirements.

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IMPLICATIONS:
Basel III Implementation: Regional Discussion To take effect, the Basel Committee guidance,
including the Basel III framework, must be transposed into local regulatory rules, which
allow for deviations from the original guidance both in terms of requirements and timeline.
The Basel Committee proposed a phased approach to the implementation of the new
framework to give banks time to comply. BCBS intended for implementations to begin in
2013, but most jurisdictions began implementation in January 2014. In some countries,
regulators have chosen to accelerate or eliminate phase-in schedules for certain aspects of the
framework for some or all institutions. Exhibit 5 shows the standardized BCBS schedule.
Most countries are now in the process of implementing Basel III with transition arrangements
in place until 2019, in accordance with BCBS recommendations. In the EU, the Capital
Requirements Regulation (CRR) and Capital Requirements Directive IV (CRD IV)
legislation were published on 27 June 2013 and fully entered into force on 17 July 2013, with
new rules applying from January 2014. Switzerland, which is not subject to the CRR and
CRD IV, began implementation of its version of Basel III in 2013. Australia, Canada and
some countries in Asia Pacific also began implementation of Basel III in 2013.
The US began implementation in 2014 for its Basel II advanced approaches banks, and nonadvanced approaches banks are required to comply one year later in 2015. Quality of Capital
and Capital Deductions Basel III improves the quality of capital by adding new types of
deductions from capital (such as deferred tax assets that rely on future profitability) and
moving existing deductions into higher quality tiers of capital, which will be phased in by
20% a year between 2014 and 2018.8 Basel III also recommends that unrealized gains and
losses be included in CET1 capital (they were excluded under Basel II), with unrealized
losses eligible for phase-in. In terms of implementation, many countries in Asia and some in
the Middle East have tightened the deduction rules by eliminating a phase-in period or by
modifying Basels threshold (limited) deductions to full deductions, which are credit positive.
In Europe, there are more cases of rules that are less stringent than Basels recommendations
that have been driven by financial crisis effects, including a slower phase-in period for
deferred tax asset deductions.

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BASEL III IMPLICATIONS FOR BANKING INDUSTRY STRENGTH 36

Basel III attempts to address the shortcomings that were identified during the global financial
crisis and should improve the ability of banks to absorb losses to their capital and shocks to
their funding, while remaining a going concern in the event of an idiosyncratic or systemic
loss event. Basel III seeks to accomplish these aims through increased capital requirements,
the use of capital and liquidity buffers, leverage constraints and the presence of contingent
capital instruments, which may help to recapitalize banks, potentially avoiding the need to
put a bank into resolution or liquidation.
However, the banking industry is not yet in a steady state for a variety of reasons. Since June
2012, when Moodys repositioned ratings downward for many banking groups, including the
global investment banks, substantial improvements have occurred in bank fundamentals, such
as reductions in leverage, higher capital levels, and the implementation of firm-wide stress
testing and more robust liquidity and funding profiles.
Nevertheless, capital requirements under Basel III will continue to pressure many firms to
increase capital further, as buffers begin to phase in starting in 2016. In addition, firm-wide
stress testing still requires substantial investment at many firms. Moreover, constraints on
leverage pose a particular challenge for firms which have been focused on optimizing returns
on risk-adjusted capital under Basel II. Finally, tail risks, especially relating to the increasing
cost of litigation in regard to legacy businesses, still expose many firms to sizeable losses.
Consequently, other than recognizing idiosyncratic mitigation of risk or material
improvements in controls, we do not intend at this point in time to review the positioning of
the industry, despite improvements in the quality and quantity of financial resources they now
hold. Capital, leverage, and liquid asset levels are all likely to improve as a result of full
Basel III implementation, and some jurisdictions, positively, have accelerated Basel III phasein requirements.

36

http://www.btinvest.com.sg/system/assets

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However, the rules in many jurisdictions are aligned with the BCBS guidelines and will not
have full phase-in completed before 2019. At this stage of the capital reform process, many
banks are challenged to meet requirements and have not yet found sustainable, profitable
business models in the new environment, finding it difficult to generate earnings in excess of
their cost of capital. While some banks are already better positioned to meet the Basel III
requirements and will be less challenged, resulting in greater strategic flexibility, they are
already relatively higher rated.

CHAPTER 9
SUMMARISE OF BASEL III
SUMMARISE:
Basel III is a set of precautionary measures imposed on banks and are made to protect the
economy from financial crises similar to that of recent years. Principally they aim to ensure
banks accept a level of responsibility for the financial economy they operate within and to act
as a safeguard against further collapse.
WHAT IS BASEL III
The set of measures known as Basel III were designed with a much broader purpose than
merely strengthening the worlds banks. The Basel III reforms arose from the common
realisation by the worlds leading politicians, central bankers , business leaders , academics
and social organisations that entire national economics and the material well being of citizens
had been put at risk by the high risk behaviour of a handful of major banking institutions
mainly located in USA , Switzerland and some European nations.
They had grown so bih relative to the size of their national economies that they had become
too big to fail . That is , if they were not rescued whatever the cost , their collapse would
cause even more severe economic damage through job losses , housing repossessions ,
reduced GDP and lending of credit than actually occurred. Further , the burden of saving
these giant institutions cost ordinary taxpayers heavily.

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All these factors combined to trigger what has become known as the Great Recession , the
most severe economic crisis in 80 years , Thus Basel III , one of the biggest responses to
crisis, is specially designed to make sure that the banking sector supports and underpins the
worlds economies rather than threatens them.
Although at first the industry lobbied aggressively against certain aspects of the Basel III
reforms , theres mounting evidence that it sees the requirements as beneficial in the long
term . This is because they enhance the robustness of individual banks while helping
rehabilitate the industrys reputation among the investment community, depositors and law
makers.
Essentially , Basel III and related measures by national and supranational regulators will
force the banks to maintain a much bigger capital base- in effect , a foundation stone of solid
assets designed to withstand sudden market disruption. In general Basel III will force banks
to become smaller relative to the size of their national economies. Lower levels of leveragethe ratio of capital to assets will become obligatory. And they must have greater stores of
spare cash on hand to tide them over temporary difficulties.
The cumulative result is that banks will be forced to adopt a more responsible outlook that
reflects on their contribution to society at large as well as to internal goals. For instance ,
bonuses will only be paid out for longer term , sustainable performance rather than for short
lived profits. Perhaps most importantly , Basel III outlines that banks small and large have
been warned to devise a system for closing their doors without help from taxpayers if they get
themselves into trouble.
WHAT ARE THE MAIN PRINCIPLES
The worlds banking sector is involved in an obligatory flight to quality under the package of
reforms known as Basel III designed to eliminate or at least greatly reduce the danger of
another financial crisis. Produced by the Bank for International settlements the central
bankers bank based in Basel Switzerland they are intended to make the worlds banks
and especially the systematically important institutions .These far reaching global standard
must be fully implemented by 2019.

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As the BIS points out , it was the interconnectedness and vulnerability of the sector that
precipitated the crisis . One of the main reasons the economic and financial crisis became so
severe was that the banking sectors of many countries had built up excessive on and off
balance sheet leverage , it says, This was accompanied by a gradual erosion of the level
and quality of the capital base . at the same time , many banks were holding insufficiently
liquidity buffers. The banking system therefore was not able to absorb the resulting systemic
trading and credit losses.
Overall the purpose of the Basel III package , which was first unveiled in 2010 and modified
in late 2011 , is to ensure that the financial sector remains in a position to fulfil its primary
function of providing credit to individuals and businesses. The objective of the reforms is to
improve the banking sectors ability to absorb shocks arising from financial and economic
stress , whatever the source , thus reducing the risk from the financial sector to the real
economy, says the BIS.
Also include in the package is the so called shadow banking system such as hedge funds,
insurance companies and other significant firms that were linked with the front-line banks
through often complex and little understood transactions.
Although highly technical , the principle underlying Basel III is clear and simple. Namely ,
the financial community is there to serve the broader economic community. A strong and
resilient banking system is the foundation for sustainable economic growth, as banks are at
the centre of the credit intermediation process between savers and investors. Basel III points
out that banks provide critical services to consumers , small and medium sized enterprises,
large corporate firms and governments who rely on them to conduct their daily business ,
both at a domestic and international level.
HOW IT WILL WORK:
The detailed provisions of Basel III are purpose-designed to render the financial sector as
immune as possible from future upheavals both from within and outside national borders.
Thus the new standards are based on micro prudential reforms at the level of individual banks
and macro prudential reforms across the entire banking sector. And they start with the
integrity of their capital base. Individual banks must in future hold more, high-quality capital

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to protect them against unexpected losses to help them ride through any traumas in the
financial markets. These take the form of fatter buffers for capital or equity, cash and liquid
assets than were required under Basel IIIs predecessor, Basel II which the BIS admits was
not tough enough.
There are four main elements in the package.

First, capital. Banks must hold core tier one capital the highest-quality assets equal
to seven percent of their assets after theyve been adjusted for risk. The biggest
institutions the so-called systemically important financial banks must carry an
extra 1-2.5 percent in capital, giving them a total of up to 9.5 percent of risk-weighted
assets. If they dont, they face restrictions on the payment of bonuses and dividends
that might otherwise affect the firms overall integrity. If the bank is thought to be
failing or non-viable, the capital can be written off or converted to common shares
at the discretion of the local regulator. The purpose of this is to force losses on
shareholders rather than on taxpayers. Also, a countercyclical buffer can be required
to further shock-proof a firm. If authorities judge a bank has put itself in danger by
lending too much, they can order it to boost common equity by up to 2.5 percent.

Second, management of risk. Among other measures all banks must conduct much
more rigorous analysis of the risk inherent in certain securities such as complex debt
packages.

Third, leverage. Aiming to reduce the ratio of assets that banks, especially the biggest,
built up in relation to deposits, Basel III sets much tougher standards than before. In
future banks must include off-balance sheet exposures when they measure leverage.
The ratio of core tier one capital to a banks total assets, with no risk adjustment, may
not exceed three percent.

Fourth, market discipline. To improve the industrys and shareholders understanding

of the risks banks may be running, they must make far more complete disclosures
than before the crisis. This particularly applies to their exposure to off-balance sheet

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vehicles, how they are reported in the accounts, and how banks calculate their capital
ratios under the new regulations.

CHAPTER 10
CONCLUSION
Though Basel norm implementation level is quite diverse within Asia Pacific region, yet
almost all the jurisdictions in Asia Pacific, whether in advanced and developed markets or in
emerging markets have migrated to further Basel norms. Many of the institutions in these
jurisdiction have begun to move towards sophisticated and advanced approaches after using
simpler approaches. While, most of mature banking markets have already moved from
simplified to advanced approaches, many of emerging banking economies are still preparing
and developing their capabilities to migrate to advanced approaches. So, the implementation
of Basel II norms in proper sense will change regulatory landscape of the world financial
economy, but the task of contradicting and integrating it is quite challenging. To play down
the Basel II implementation issues and to get improved business benefits beyond strict
regulatory compliance, banks in Asian region need to address the challenges in an efficient
way. So, there is need to take several measures to enhance the ability of banks for its
envisaged application.
Moreover, Continuous and concerted efforts on the part of banks are required to upgrade
skills of existing staff and to attract and retain right mix of talent in banks. Basel II assigns
considerable importance to cross border coordination. Enhanced cooperation between
supervisors is indispensable especially for cross border supervision of complex international

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banking groups. Banks need to consider Basel II as a catalyst to strengthen risk management
issues but not as a panacea for all risk management problems. However, effective
implementation of Basel II will surely be a success factor for banks and would aid them to
survive and grow in the new risk sensitive environment.
Also the history of financial crises that they cannot be prevented once and for all in a
globalized monetary economy with unpredictable flows in capital movement. This history
also shows that financial markets have short memories and limited long-term learning
capacity. Thus, there need to be within the limits of human fallibility and a well designed set
of institutions capable of dealing with the tendencies towards financial instability and crisis.
Given the unevenness in the structure of the global economy , the developmental
consequences of financial crises are particularly important to analyze when designing
institutions to contain and manage such crises. In this research work, particular attention has
been given to the fact that the negative consequences for output growth, employment ,
income, distribution and poverty reduction are relatively more severe for the DCs and LDs At
least partly this occurs because of the following characteristics among others:
DCs and LDCs have fewer resources for coping with financial crises, particularly one
which is global in its scope.
Most DCs and all LDCs lack automatic stabilizers due to the embryonic of their fiscal
and social protection systems.
They have limited ability of borrow in international financial markets and this limits
their ability to pursue countercyclical policies.
These threats are often exacerbated by global financial markets integration and Free
Trade Agreements (FTAs) and bilateral investment treaties (BITs). Many WTO
commitments also affect the DCs adversely. IMF pro-cyclical Structural Adjustment
Policies can also constrict the policy space.
In areas such as the derivatives markets and portfolio capital flows, the shortfall in regulatory
capacities for these countries can leave them vulnerable. Even in banking , the wellintentioned Basel regulations can either not be implemented , or worse, as this research
illustrates, there are aspects of Basel II and Basel III that can harm the developmental
processes, there a careful rethinking of these issues and further capacity building for DCs and
LDCs will be necessary . This research also emphasizes the need for enhancing ability of

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DCs and LDCs to use fiscal and monetary policy to support the growth of their economies.
Because poor states are already fiscally constrained, Basel III further complicates the growth
and poverty reduction picture.
The analysis here leads to the conclusion that these states will need to become more reliant on
each other to implement the reforms and support regional development initiatives. Failure to
do so will then mean that these states will have to become more reliant on international
technical expertise and resources which may or may not be forthcoming. This may be the
time for multilateral agencies to devote significant resources towards building capacities in
DCs and LDCs with the help of experts with combined technical and are specializations.
Basel III is an opportunity as well as challenged for banks. It can provide a solid foundation
for the next developments in the banking sector, and it can ensure that past excesses are
avoided. The key to ensuring that Basel III is an opportunity for banks is the selection of the
technology architecture that is used to deliver the framework. This technology architecture
needs to accommodate the scale and structure, the processes, and the geographic spread of the
bank and blend all these seamlessly into the scale and scope of the regulation

LITERATURE REVIEW :

http://www.quora.com/What-are-BASEL-1-2-and-3-norms-What-are-the
basic-differences-between-these-norms - On 26 June 1974, a number of banks had
released payment of Deutsche Marks (DEM - German Currency at that time) to
Herstatt ( Based out of Cologne, Germany) in Frankfurt in exchange for US
Dollars (USD) that was to be delivered in New York. Because of time-zone
differences, Herstatt ceased operations between the times of the respective
payments. German regulators forced the troubled Bank Herstatt into
liquidation.The counter party banks did not receive their USD payments.
Responding to the cross-jurisdictional implications of the Herstatt debacle, the G10 countries, Spain and Luxembourg formed a standing committee in 1974 under
the auspices of the Bank for International Settlements (BIS), called the Basel
Committee on Banking Supervision. Since BIS is headquartered in Basel, this

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committee got its name from there. The committee comprises representatives from

central banks and regulatory authorities.

http://thediplomat.com/2014/03/surging-asean-trade-prompts-banking
realignment/-

This paper reviews recent progress and indicators of trade

facilitation in member countries of the Association of Southeast Asian Nations.

The findings show that import and export costs vary considerably in the member
countries, from very low to moderately high levels. Tariff and non-tariff barriers
are generally low to moderate. Infrastructure quality and services sector
competitiveness range from fair to excellent. Using a standard gravity model, the
authors find that trade flows in Southeast Asia are particularly sensitive to
transport This papera product of the Trade Team, Development Research Group
is part of a larger effort in the department to examine the relationships between
trade costs, business facilitation, and economic development. The work is aligned
with work under a Trust Fund of the U.K. Department for International
Development and also Multi-donor Trust Fund for Trade and Development Project
on Trade Costs.. Policy Research Working Papers are also posted on the Web at
http://

econ.worldbank.org.

[email protected]

or

The

authors

may

[email protected].

be

contacted

at

infrastructure

and

information and communications technology. The results suggest that the region
stands to make significant economic gains from trade facilitation reform. These
gains could be considerably larger than those from comparable tariff reforms.
Estimates suggest that improving port facilities in the region, for example, could
expand trade by up to 7.5 percent or $22 billion. The authors interpret this as an
indication of the vital role that transport infrastructure can play in enhancing intra

regional trade.
http://blogs.fco.gov.uk/south-east-asia-prosperity-fund/2014/11/13/financialsector-reform/- ASEAN is one of the most dynamic regions in the world

and is becoming an increasingly important driver of global growth. The

ten members of ASEAN are also working towards the launch of the
ASEAN Economic Community (AEC, single market) at the end of 2015,
with further integration planned beyond then. Collectively, the

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economies of ASEAN are predicted to become the 4th largest single

market in the world by 2030. In order for this potential to be realised, SE
Asian countries are taking further steps to reform their financial systems
and enhance regulation, as well as deepen integration between the
regions financial systems and with the global economy. Capital and
insurance markets in particular are relatively underdeveloped and/or
closed in some SE Asian countries and foreign participation in the
banking sector is restricted in several countries. Addressing these issues
is essential to ensuring strong, sustainable economic growth in ASEAN.

http://www.bnm.gov.my/index.php?rp=road-to-asean-financial-integrat

new regional community is in the making in Southeast Asia. At the 12th Summit
of the Association of Southeast Asian Nations (ASEAN) in January 2007, the
member countries affirmed their commitment to create the ASEAN Economic
Community (AEC) by 2015 and to transform ASEAN into a region with free
movement of goods, services, investment, and skilled labor, and freer flow of
capital. In creating the AEC, ASEAN will observe the principles of an open,
outward-looking,

inclusive,

and

marketdriven

economy

consistent

with

multilateral rules as well as adherence to rules-based systems for effective

compliance and implementation of economic commitments. The formation of
such a community will benefit from the successful liberalization of the capital
account and the domestic financial market in individual countries, and from the
ASEAN-wide integration of financial markets and institutions supported by
regulatory harmonization and the strengthening of policy coordination among the
member states.

http://mpra.ub.uni-muenchen.de/49513/ - This paper analyzes the following

aspects of global financial governance: Proposed BASEL III reforms for more
stringent capital requirements and their implications for the developing world in
particular.BIS proposals for better regulation of financial derivatives, including
commodities futures, by moving away from OTC transactions towards organized
exchanges. The Basel reforms and the BIS proposals for regulating the derivatives

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markets have many positive features. However, they have not been designed with
the needs of DCs and LDCs in mind. The consequences of Basel I and II and
proposed Basel III are analyzed from the perspective of the developing countries.
It turns out that specific concerns of developing countries have not received
adequate attention within the Basel Reform Initiatives and more can be and needs
to be done.

file:///F:/NLU%20SEM%202r/dissertation/ASEAN%20banking
%20realignment.html- Surging ASEAN Trade Prompts Banking RealignmentMajor banks are realigning their businesses in Southeast Asia, where a winding
back of cross-border tariffs and regulations has led to sharp rise in regional trade
ahead of the launch of the ASEAN Economic Community (AEC).

THE POLITICAL ECONOMY OF FINANCIAL DEVELOPMENT IN

SOUTHEAST ASIA- BY THOMAS B. PEPINSKY ( DEPTT OF
GOVERNMENT , CORNELL UNIVERSITY)- Over the past half century, the
emerging economies of Southeast AsiaIndonesia, Malaysia, the Philippines, and
Thailandhave seen substantial growth and deepening in their financial systems.
Today, Malaysia has one of the worlds most dynamic equity markets, along with a
large and deep banking sector that has grown rapidly since the 1960s. Thailands
financial system has also seen impressive growth since the 1960s, although it lags
somewhat behind Malaysia. Indonesia and the Philippines remain relatively
underdeveloped compared to their neighbors, but viewed in historical perspective,
financial development in these countries has been nevertheless impressive.

MOODYS ANALYTICS IMPLEMENTING BASEL III CHALLENGES ,

OPTIONS AND OPPORTUNITIES- This Whitepaper explores the most significant
challenge facing banks when they are implementing Basel IIIthe need to balance the
interests of the business against the needs of the regulator. This Whitepaper explores the
management impact on risk and finance; the implications of different countries taking
different approaches to Basel III; the issues surrounding managing data quality and stress
testing; the issue of auditing the regulatory data; the complexities of managing Basel I, II
and III side-by-side, and the challenges of integrating disparate backoffice banking
systems into a cohesive Basel III management framework. This Whitepaper explores the

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approaches that a bank might want to consider in implementing Basel III, and it outlines a
solution that accommodates all the issues highlighted, allowing a bank to implement
Basel III on time and on budget. It also highlights some of the commercial advantages
that going through the Basel III compliance process can deliver to a bank. This
Whitepaper is aimed at those involved in implementing Basel III in banking organizations
across the world. Risk managers, finance managers, and Basel III program managers are
under pressure to meet Basel III starting in 2013. The key challenge for these managers
will be deciding how to best implement a solution that allows them to comply with Basel
III, how to streamline systems and processes for improved operational effectiveness, and
how to understand and ultimately reduce their capital requirements.

EAST EASIA FORUM BANKING INTEGRATION IN ASEAN GATHERS

PACE- The ASEAN Economic Community, planned to come into effect in 2015, is
expected to liberalise goods, capital and skilled labour flows in the ASEAN region. While
there has been considerable progress in the area of trade integration, financial integration
still lags behind. The ASEAN Banking Integration Framework, which aims to liberalise
the banking market by 2020, could help pave the way for further integration and the entry
of ASEAN banks into regional banking markets.

WWW.NATIONMULTIMEDIA.COM ASEAN BANKS ON LONG ROAD

TO FINANCIAL INTEGRATION : The Nation November 10, 2014 2:53 pm
Singapore - Financial integration within the Association of Southeast Asian
Nations (Asean) is progressing, but the process won't be entirely smooth, said
Standard & Poor's Ratings Services in a report published today, titled "Asean
Financial Integration: The Long Road To Bank Consolidation."

http://www.bis.org/review/r120305b.pdf- Mahapatra: Implications of Basel III

for capital, liquidity and profitability of banks- Basel III is the regulatory response
to the causes and consequences of the global financial crisis. So, what were the
causes of the crisis and the consequence?

http://www.btinvest.com.sg/system/assets- Basel III Implementation in Full

Swing: Global Overview and Credit Implications-The Basel capital framework,
developed by the Basel Committee for Banking Supervision (BCBS), has evolved
from a regulatory reporting function under Basel I to an integrated capital, funding
and liquidity framework known as Basel III, impacting all levels of bank

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operations,. Basel III guides to better quality and quantity of capital, a leverage
ratio constraint, and short-term liquidity and longer term funding rules all
positives for bank stability. Most countries have started implementing the Basel III
risk-based capital reforms, with many implementing rules requiring full
compliance well ahead of the BCBS phase-in end-date. Most of the
implementation trends are positive for bank creditworthiness.

http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture-BeyondBasel-III.pdf%23zoom=50-

Banking Beyond Basel III: The future of high

performance in Chinese banks By Albert Chan, Ying Wan, and Jacky YangMAJOR CHANGES IN BASEL III FROM BASEL II NORM

http://www.basel-iii.worldfinance.com/- WORLD FINANCE ON BASEL IIIBasel III is a set of precautionary measures imposed on banks and are made to
protect the economy from financial crises similar to that of recent years.
Principally they aim to ensure banks accept a level of responsibility for the
financial economy they operate within and to act as a safeguard against further
collapse

APRA Insight (2008), The Implementation of Basel II in Australia,

downloaded

from:

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2_2008_implementation_baselII_aust.pdf on March 27, 2011

Aziz, Z. A. (2008), Basel II Implementation and the Development of Asia's

Financial System: Experiences, Challenges and Regional Cooperation,
Governor's Keynote Address at the 4th SEACEN/ABAC/ABA/PECC PublicPrivate

Dialogue

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Asia

Pacific

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Bank Indonesia (2008), Understanding Basel II: At a Glance, downloaded

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Cadiou, C. and Mars, M. (2008), Basel II Pillar 3: Challenges for Banks, The
Journal- Global Perspectives on Challenges and Opportunities, December, pp. 3035.

China Banking Regulation Commission, (2007), The Guidelines on the

Implementation of the New Basel Accord by China Banking Sector, downloaded
from:

http://www.cbrc.gov.cn/chinese/home/jsp/docView.jsp?

docID=200703190C3356986BEDAB3AFF45DA32BF983500 on May 15, 2011

ZENITH International Journal of Business Economics & Management Research

Vol.2

Issue

3,

March

2012,

ISSN

2249

8826

Online

available

at

http://zenithresearch.org.in/ www.zenithresearch.org.in 41

Cho, Y. ((2010), Regulatory Convergence to Basel II and the Road Ahead for
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Outstanding

Problems,

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Malaysia/Local%20Assets/Documents/02720_Basel_II_Adopting_SCRN.PDF on
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931716213871.pdf , on June 23, 2011

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Monetary

Fund

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(2010),

Australia:

Basel

II

Implementation Assessment, IMF Country Report No. 10/107, downloaded from:

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