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Basel

The Basel Committee on Banking Supervision released a near-final version of its new bank capital and liquidity standards in December 2010 and issued subsequent guidance in January 2011.

The measures, known as Basel III, are designed to make the banking system more resilient to shocks by strengthening regulation, supervision, risk management and transparency.

Stronger regulatory capital and risk management

As well as increasing the ratios for Tier 1 and core Tier 1 capital, Basel III enhances the quality, consistency and transparency of the capital base through stricter rules on the eligibility of instruments included in core Tier 1 capital.

Basel III also targets better risk management through improved firm-wide governance to capture the risk of off-balance sheet exposures and securitisations and ensure more effective management of risk concentrations.

Higher capital requirements are imposed for resecuritisation exposures - that is, when securitisation assets have at least one underlying exposure that is also a securitisation.

The new regime also significantly strengthens rules on counterparty credit risk so that exposure at default for counterparties and repo-style transactions reflects stressed market volatilities.

Market risk is targeted through an Incremental Risk Charge to cover default and migration risk of issuers in the trading book and a stressed Value at Risk charge.

Basel III also requires banks to build countercyclical capital buffers through forward-looking provisioning and additional capital. Risk-based capital requirements will be supplemented by a gross leverage ratio to discipline against excessive growth.

The new measures introduce global liquidity standards including a stressed liquidity coverage ratio under extreme scenarios and a longer-term structural liquidity ratio.

Timetable and challenges

Regulators have adopted a staggered, extended timetable for the implementation of Basel III. Some banks have begun implementation while others are awaiting finalization of the rules.

The key dates are 1 January 2012, when higher risk weights for resecuritisations and increased market risk charges must be implemented; and 1 January 2013, when measures covering counterparty risk must be in place

In assessing the impact of Basel III, individual banks will have to review the effect on their overall business strategy, cost structure and policy on shareholder returns.

Banks’ funding strategy may change significantly because of new liquidity requirements and the potential effect of higher capital requirements on funding costs.

Institutions will need to examine the impact on particular business activities, particularly in investment banking, and to what extent increased costs may be passed on to clients. Cost structures may also undergo further changes, for example to remuneration.

Banks should also review their customer base to decide whether to focus on less capital-intensive, high-quality borrowers or riskier, high-margin assets.

At the heart of these challenges is the return on capital banks target to meet shareholders’ expectations.

The impact of Basel III and other other regulatory changes will span many businesses, functions and aspects of strategy. Deloitte offers a multi-dimensional, coordinated service designed to meet this challenge.

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