Basel III

Key takeaways

• Basel III is an international regulatory framework that strengthens banks’ capital, leverage, and liquidity standards to reduce systemic risk.
• It was developed after the 2007–2008 financial crisis and builds on earlier Basel I and II accords.
• The most recent phase—often called the Basel III Endgame—tightens capital rules, changes how risk-weighted assets are calculated, and raises liquidity and leverage requirements for large, internationally active banks.
• Implementation timelines vary by jurisdiction and remain subject to adjustment.

What is Basel III?

Basel III is a set of international banking standards created by the Basel Committee on Banking Supervision to make banks more resilient to financial stress. It raises the quantity and quality of capital banks must hold, introduces capital buffers, and adds new leverage and liquidity requirements. The aim is to reduce the likelihood that a bank’s failure will threaten the wider financial system.

Short history and context

• Basel I (1988) introduced a simple risk-weighted capital requirement (8% of risk-weighted assets).
• Basel II (2004) expanded risk measurement to include operational and market risks and encouraged internal risk models.
• The 2007–2008 crisis revealed shortcomings in capital quality, leverage controls, and liquidity standards. Basel III (initiated in 2009 and revised subsequently) responded with stricter, higher-quality capital definitions and new liquidity and leverage rules.
• The most recent package of final reforms—often referred to as the Basel III Endgame—refines risk calculations and further tightens standards for the largest, internationally active banks.

Core elements of Basel III

Capital quality and minimums

Banks must hold higher-quality capital with an emphasis on common equity (CET1). Key ratios:
* CET1 minimum: 4.5% of risk-weighted assets (RWA).
Capital conservation buffer (CET1): 2.5% of RWA, bringing a common effective CET1 requirement to 7% when applied.
Minimum Tier 1 capital: 6% of RWA (includes CET1 and certain other high-quality instruments).
* Total capital (Tier 1 + Tier 2): at least 8% of RWA.

Basel III Endgame also changes how RWA are calculated and limits certain forms of lower-quality capital, which can increase effective capital needs even when headline minimums remain similar.

Capital buffers

• Capital conservation buffer (CCB): 2.5% CET1 to absorb losses and limit payouts (dividends, buybacks) when depleted.
• Countercyclical capital buffer (CCyB): 0–2.5% of RWA, deployed by regulators during periods of excess credit growth and releasable in stress.
• G-SIB surcharge: an additional risk-based buffer for globally systemically important banks, typically 1%–3.5% of RWA depending on systemic score.

Leverage and liquidity

• Leverage ratio: Tier 1 capital divided by total (non-risk-weighted) assets, with a common minimum of 3% (higher for G-SIBs in some frameworks).
• Liquidity Coverage Ratio (LCR): banks must hold sufficient high-quality liquid assets (HQLA) to survive a 30-day severe stress scenario. HQLA typically includes cash, central bank reserves, and certain government securities.
• Net Stable Funding Ratio (NSFR): requires stable funding sources over a one-year horizon with a target of at least 100% to encourage longer-term funding and reduce reliance on short-term wholesale funding.

Basel III Endgame specifics

The Endgame package refines methodologies for calculating credit risk and operational risk, tightens model use for internal risk assessments, and changes the composition of capital and RWAs. It generally targets very large banks—often cited as institutions with assets above $100 billion or globally systemically important banks—but some elements affect national implementation choices and could influence broader markets.

Implementation and timing

Implementation timing differs by country. Regulators have proposed phased timelines (for example, a start date followed by a multi-year phase-in), but these timelines have shifted in several jurisdictions due to industry feedback, economic disruptions, and political decisions. As a result, effective dates remain subject to change.

Implications

For large banks

• Higher capital and buffer requirements may reduce return-on-equity in the short term because more capital sits unleveraged.
• Over the long term, better capitalization can lower funding costs and improve investor confidence, potentially offsetting some profit impacts.
• Banks may adjust business models, pricing, and balance-sheet composition to meet new standards.

For lending and the broader economy

• Critics argue stricter requirements could reduce credit availability and slow growth if banks curtail lending.
• Supporters contend a better‑capitalized banking sector is more stable and can sustain lending through downturns, reducing the severity of recessions.

For smaller banks

• Basel III is primarily targeted at large, internationally active banks, but indirect effects—such as higher costs from counterparties—could spill over to smaller institutions. Regulators typically allow flexibility to reflect the risk profiles of smaller banks.

For investors

• A stronger, more resilient banking system can reduce systemic risk and market volatility—benefits for equity and fixed‑income investors.
• In the near term, bank profitability, dividend policies, and valuation multiples may adjust as institutions adapt.

Conclusion

Basel III represents a major evolution in global bank regulation aimed at making financial institutions more resilient through higher-quality capital, stricter buffers, and stronger liquidity and leverage controls. Its final phases refine risk measurement and increase the capital and liquidity that large banks must hold. While implementation timelines and national details differ, the overarching goal remains the same: reduce the probability and systemic consequences of future banking crises.