Understanding Basel III, What Is Different After February 2015

Today we will start with the Basel Committee's work programme for 2015 and 2016 that is structured around four themes:

1. Policy development;

2. Ensuring an adequate balance between simplicity, comparability and risk sensitivity across the regulatory framework;

3. Monitoring and assessing implementation of the Basel framework; and

4. Improving the effectiveness of supervision.

During 2014 the Basel Committee published a number of final standards and consultative documents.

Policy development

The Committee will continue to pursue its post-crisis reform agenda, with a focus on restoring confidence in capital ratios.

This includes revisions to existing methods of measuring risk-weighted assets.

For example, revisions of the standardised approaches for credit, market and operational risk have been published for consultation.

In addition, other policy development work is well advanced.

This includes a capital floor based on standardised approaches, consideration of simple, transparent and comparable criteria for securitisations, the fundamental review of the trading book and interest rate risk in the banking book.

There is also ongoing work with the Financial Stability Board related to the adequacy of loss-absorbing capacity of global systemically important banks (G-SIBs) in resolution.

In addition to existing policy initiatives, there are three policy-related issues which the Committee is undertaking:

1. Assessing the interaction, coherence and overall calibration of the reform policies;

2. Reviewing the regulatory treatment of sovereign risk; and

3. Assessing the role of stress testing in the regulatory framework, in light of national developments.

Interaction, coherence and overall calibration

Now that the major elements of the reform agenda have been agreed, the Committee will assess the interaction, coherence and overall calibration of the reform policies.

The aim of the Committee's work on coherence is to consider how the various regulatory metrics interact and whether the calibration and design of the various elements of the framework are consistent with their intended objectives.
The regulatory framework that has emerged following the crisis is one with multiple metrics.

Compared with the pre-crisis framework - which relied only on the risk-weighted capital ratio - the revised regulatory framework now includes a leverage ratio, large exposure limits, the liquidity coverage ratio, net stable funding ratio and forthcoming loss-absorbing capacity requirements for G-SIBs in resolution.

In addition, as described in more detail below, stress testing has played an increasingly important role in a number of jurisdictions.

The Committee will further assess the potential interactions among these metrics, including the extent to which the various measures bind across different banks and drive bank behaviour.

This shift to multiple metrics and greater reliance on stress testing reflects the importance of an eclectic regulatory framework, relying on a range of complementary regulatory measures and supervisory judgement.

Such an approach is more robust to arbitrage and erosion over time, as each measure offsets the shortcomings and adverse incentives of the others.

For example, the leverage ratio provides an absolute cap on leverage, but, by itself, could incentivise banks to increase their holdings of higher risk assets.

The risk-weighted framework compensates for this as it constrains any bank that materially increases its risk profile without any commensurate regulatory capital to fund its balance sheet.

The LCR requires banks to maintain a prudent buffer of high quality liquid assets.

The Committee is committed to finalising the calibration of the leverage ratio, revising the standardised approaches and implementing a capital floor.