Basel-III approved in response to global financial meltdown

BIS announced a substantial strengthening of capital requirements for international banks.

KARACHI: The Bank for International Settlements (BIS) has announced a substantial strengthening of capital requirements for international banks. The programme, colloquially dubbed Basel-III after its predecessor Basel-II, will force banks to more than double capital requirements and give them eight years to finish the task.

Total common equity requirements in Basel-III are at seven per cent and include a four per cent basic requirement and a 2.5 per cent capital conservation buffer. The minimum requirement for common equity has risen from two per cent to 4.5 per cent and its implementation constitutes the first phase of the programme. Member countries are required to complete the first phase by January 2015.

Requirements for Tier 1 capital, which is made up of common equity, the bank’s reserves and other financial instruments, are scheduled to increase from four per cent to six per cent. The conservation buffer renders resilience to the bank’s operations in times of financial and economic turmoil. There is a further countercyclical buffer of between zero and 2.5 per cent that may be added to minimum equity requirements according to national circumstances. The percentages are relative to bank’s risk weighted assets.

These reforms have been widely considered as a response to the recent financial crisis. The BIS has sought to curtail ownership of risky assets, debt-laden balance sheets and payments of huge bonuses and high dividends in the face of disintegrating profitability. It is believed that the financial crisis propagated with the bank’s acquisition of highly risky assets in the developed world, especially in subprime mortgages.

Basel-III requirements, both financial and those related to governance, seek to minimise the probability of another financial meltdown.

Paid-up capital

Although the State Bank of Pakistan (SBP) is not a member of the BIS and is not bound to implement the new reforms, the SBP did implement the Basel-II reforms in principle in 2005. Metrics instituted by Basel-II for the measurement of risk are now in place. Thus, there remains a possibility that Basel-III reforms might be implemented, in principle once again, in the Pakistani financial markets.

Banks are required to have paid-up capital of Rs7 billion by the end of 2010 and Rs10 billion by the end of 2013. If the SBP were to immediately implement a proportional increase in minimum capital requirements by the same ratio as the change between Basel-II and Basel-III, capital requirements would be around Rs25 billion by 2013.

Interestingly, the SBP revised minimum capital requirements downwards in April 2009 from a requirement of Rs23 billion to Rs10 billion by the end of 2013. These requirements have also caused a wave of mergers and acquisitions in financial markets as smaller banks struggle to meet these requirements.

Recent mergers have resulted in the birth of Silkbank and Summit Bank. A decision to implement Basel-III in principle will have to consider at least the existing resilience of the financial sector to negative shocks, the ability of existing financial institutions to enhance their capital portfolio through the open market or through buyouts and mergers and the possibility of a cartelisation of the financial industry.

Published in The Express Tribune, September 14^th, 2010.