What is it about?
This paper considers the progress of the Basel Committee on Banking Supervision in respect of the risk based capital adequacy framework - particular its efforts in addressing flaws inherent in Basel II - namely, pro cyclicality.
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Why is it important?
The need for introduction of: Increased level of capitals (Minimum common equity Tier One ratio of 4.5% (excluding buffers) - Minimum Tier One ratio of 6%) Conservation buffers Counter cyclical buffers Additional buffers for GSIBs Both the capital conservation and counter cyclical buffers did not exist under Basel II. Under Basel III, additional capital requirements have also been stipulated for systemically relevant financial institutions. The CRD IV is also aimed at: - Increasing the quality of eligible capital - Increasing the quantity of capital held by establishing significantly higher minimum capital ratios and reducing pro cyclicality through the introduction of the new capital buffers - Increasing the capital requirements for Counterparty Credit Risk - including a new capital charge for potential mark-to-market losses on OTC derivatives - Introduction of a non risk based leverage ratio to safeguard build-up of leverage in the system Key CRD IV provisions in relation to increased quality of capital, include the following: - Common equity Tier One becomes the primary measure of capital adequacy - Basel II deductions are applied in full to common equity Tier One rather than 50:50 -Exclusion of hybrid instruments from common equity Tier One (with stricter criteria for inclusion of instruments in additional Tier One) - Harmonised and stricter requirements for Tier 2 - Tier 3 capital no longer eligible Key CRD IV provisions in relation to increased quantity of capital, include the following: - Minimum common equity Tier One ratio of 4.5% (excluding buffers) - Minimum Tier One ratio of 6% (excluding buffers) - Minimum total capital of 8% (excluding buffers) - Introduction of three capital buffers: namely, the capital conservation buffer, counter-cyclical buffer and the systemic buffer
Perspectives
As well as addressing risks attributed to pro cyclicality, the introduction of two important liquidity standards, namely the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) were introduced to address liquidity risks - particularly those attributed to short term funding and maturity mismatches. Leverage ratios, further complemented the liquidity standards and capital framework - and were introduced subsequently as supplementary leverage ratios and enhanced supplementary leverage ratios.
Prof Marianne Ojo
Northwestern University
Read the Original
This page is a summary of: Measures Aimed at Mitigating Pro Cyclical Effects of the Capital Requirements Framework: Counter Cyclical Capital Buffer Proposals, SSRN Electronic Journal, January 2016, Elsevier,
DOI: 10.2139/ssrn.1664627.
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