Basel III strengthens bank resilience through complementary safeguards: risk-based capital with usable buffers, a simple non‑risk‑based leverage backstop, and liquidity standards that protect short‑term and structural funding positions across cycles and systemic stress.
General
Basel III introduced higher‑quality capital, explicit buffers, a leverage ratio, and two liquidity ratios to remedy weaknesses revealed in the global financial crisis and to embed a macroprudential lens in bank regulation. These elements operate together so banks can absorb losses, sustain lending, and avoid destabilizing deleveraging in stress.
Definition
- Capital buffers are layers of Common Equity Tier 1 (CET1) above minimums that can be drawn down in downturns, with automatic distribution constraints when breached to rebuild capital.
- The leverage ratio is a simple Tier 1 to exposure measure that serves as a risk‑insensitive backstop to risk‑weighted metrics and curbs model risk and excess balance‑sheet expansion.
- Liquidity standards comprise the Liquidity Coverage Ratio (LCR) for 30‑day stress and the Net Stable Funding Ratio (NSFR) for one‑year structural funding resilience.
Objectives of capital buffers
Buffers ensure banks pre‑position high‑quality capital in benign periods and use it in stress while preserving going‑concern viability and market confidence. They also support macroprudential aims by leaning against credit booms and mitigating system‑wide deleveraging in downturns.
Capital Conservation Buffer framework
The Capital Conservation Buffer (CCB) is set at 2.5% of RWAs and must be composed entirely of CET1, sitting above the minimum risk‑based requirements. If a bank’s CET1 falls within the buffer range, automatic constraints limit dividends, share buybacks, and discretionary bonuses until the buffer is rebuilt, without forcing a halt to core operations.
Counter‑cyclical Capital Buffer
The Counter‑cyclical Capital Buffer (CCyB) ranges from 0–2.5% of RWAs in CET1 and is activated by authorities when aggregate credit growth signals systemic risk buildup, then released in downturns to maintain credit supply. A reciprocity mechanism requires banks to apply foreign jurisdictions’ CCyB rates to relevant exposures, with the bank’s effective CCyB calculated as a weighted average across jurisdictions.
Domestic systemically important banks
Systemically important banks carry additional risk‑based capital surcharges to reflect their size, interconnectedness, and substitutability, thereby reducing the probability and impact of failure. These surcharges complement global or domestic systemic frameworks and sit on top of minimums and other buffers in the stack.
Leverage ratio
Basel III adds a non‑risk‑based leverage ratio that compares Tier 1 capital to total exposures, including off‑balance‑sheet items, as a backstop to risk‑weighted measures and a check on model variability. The simplicity of the leverage metric helps restrain excessive balance‑sheet growth and complements buffers during periods when risk weights may understate true risk.
Liquidity standards
Basel III liquidity reforms introduced two complementary ratios: the LCR to ensure sufficient high‑quality liquid assets to withstand a 30‑day stress, and the NSFR to promote stable one‑year funding of assets and activities. Together they reduce rollover risk, fire‑sale dynamics, and maturity transformation vulnerabilities that amplified previous crises.
Net Stable Funding Ratio
The NSFR requires available stable funding to exceed required stable funding over a one‑year horizon, calibrated by asset and activity characteristics and their funding stickiness. By aligning asset profiles with durable funding, NSFR curbs excessive reliance on short‑term wholesale markets and enhances structural resilience.
Putting it together: the prudential stack
In practice, a bank’s stack comprises minimum risk‑based capital, CCB, any CCyB in force, and systemic surcharges, all complemented by the leverage ratio and LCR/NSFR liquidity standards for multi‑dimensional resilience. Distribution constraints tied to buffer use create incentives to rebuild capital in recovery phases while avoiding abrupt credit cutbacks in stress.
India implementation note
India implemented Basel III buffers and phased the CCB to the full 2.5% level, with transitional adjustments during COVID‑19 that deferred the final tranche before completion in 2021, aligning with global objectives while supporting recovery. Domestic expectations on quality of capital and distribution constraints mirror Basel’s emphasis on CET1 usability and conservation in stress.
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