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Basel III is the latest set of international financial regulations put forth by the Basel Committee on Banking Supervision. Like the previous two sets of regulations, the Basel III accords were formulated to help deal with the evolving world financial crisis that began in 2008. Basel III puts even more stringent requirements on banks and financial institutions to keep them solvent.
The Basel II accords required banks to hold up to two percent of their common equity in reserve. The new Basel III requirements are that banks hold up to 4.5 percent in reserve. In addition, banks will now have to hold up to six percent of tier 1 capital held in less-than-sound investments in reserve, increased from the four percent required under Basel II. The financial term for such insecure investments is risk-weighted assets.
Tier 1 capital, one central determinant of a bank's financial strength, is made of various types of investments. Among them are common stock, preferred stock and other types of equity. Banks can't hold too much risk-weighted assets or they might find themselves in precarious financial straits. The purpose of the Basel III capital requirements is to minimize the chance of future international financial crises, such as the one that gripped the world in the late 2000s. Indeed, that crisis is not yet entirely finished.
Basel III capital requirements have more stipulations. It requires that banks have no more than a three percent debt to equity ratio. It also requires banks to have sufficient capital on hand at any given time to cover all net cash outflow for 30 days. Basel III requirements include transparent accounting procedures for so-called tier 2 capital, that is, supplementary capital. Tier 2 capital cannot exceed the amount of tier 1 capital. Tier 3 capital, which by definition can be up to 250 percent of the value of tier 1 capital, is eliminated under Basel III.
The Basel III requirements will be phased in on a schedule. By 2015, the requirement for higher minimums will be completed. By 2019, the 30 day buffer of money, called the conservation buffer, to absorb losses must be in place. Liquidity requirements are being phased in now, with final requirements to be met globally in 2018.
The result of the Basel III regulations will be banks and financial institutions that are flexible, meaning they can rise to meet fiscal challenges because they retain adequate capital on hand for contingencies.