Financial and Economic stress

Basel III addresses this, with the goal of improving the banking sector’s ability to absorb shocks arising from financial and economic stress. In December 2010 the Basel Committee on Banking Supervision (BCBS) published the Basel III documents “Basel III: A global regulatory framework for more resilient banks and banking systems” (a revised version was published in June 2011) and “Basel III: International framework for liquidity risk measurement, standards and monitoring.”With this reform package, the BCBS aims to improve risk management and governance as well as strengthen banks’ transparency and disclosure. Basel III is also designed to strengthen the resolution of systemically significant cross-border banks. It covers primarily the following aspects1:Definition of capitalIntroduction of a new definition of capital to increase the quality, consistency and transparency of the capital base. As the recent crisis demonstrated that credit losses and write-downs come out of retained earnings, which is part of banks’ tangible common equity base, under Basel III common equity (i.e., common shares and retained earnings) must be the predominant form of Tier 1 capital. Further, the reform package removes the existing inconsistency in the definition of capital by harmonizing deductions of capital and by increasing transparency through disclosure requirements.Enhanced risk coverage/ Counterparty Credit RiskThe reforms to the Basel II framework by the BCBS in 2009 and the amendments made in the European Capital Requirements Directive III (CRD III)2 increased capital requirements for the trading book and complex securitization positions and introduced stressed value-at-risk capital requirements and higher capital requirements for re-securitizations for both in the banking and trading book. Basel III now adds the following reforms: calculation of the capital requirements for counterparty credit risk (CCR) based on stressed inputs; introduction of a capital charge for potential mark-to-market losses (i.e., credit valuation risk); strengthening standards for collateral management and initial margining; higher capital requirements for OTC derivatives exposures; raising CCR management standards.Recent fiscal crises have demonstrated numerous weaknesses in the global regulatory framework and in banks’ risk management practices. In response, regulatory authorities have considered various measures to increase the stability of the financial markets and prevent future negative impact on the economy. One major focus is on strengthening global capital and liquidity rules.

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