BASEL III Deviations

It’s here, finally. With a minimum Bank Capital Ratio (CRAR) of 7 per cent.

{Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of
view. It consists of the types of financial capital considered the most reliable and liquid,
primarily equity. Examples of Tier 1 capital are common stock, preferred stock that is
irredeemable and non-cumulative, and retained earnings.

The theoretical reason for holding capital is that it should provide protection against
unexpected losses. Note that this is not the same as expected losses -- provisions and
reserves are for expected losses.

Tier 2 capital is a measure of a bank's financial strength with regard to the second most
reliable forms of financial capital, from a regulator's point of view. It consists of accumulated
after-tax surplus of retained earnings, revaluation reserves of fixed assets and long-term
holdings of equity securities, general loan-loss reserves, hybrid (debt/equity) capital
instruments, and subordinated debt.

Tier 1 capital is the most reliable form of capital

[Capital adequacy ratios ("CAR") are a measure of the amount of a bank's core capital
expressed as a percentage of its assets weighted credit exposures.

Capital adequacy ratio is defined as

TIER 1 CAPITAL -A) Equity Capital, B) Disclosed Reserves

TIER 2 CAPITAL -A) Undisclosed Reserves, B) General Loss reserves, C) Subordinate Term
Debts where Risk can either be weighted assets ( ) or the respective national regulator's
minimum total capital requirement. If using risk weighted assets,

≥ 10%.

The percent threshold varies from bank to bank (10% in this case, a common requirement for
regulators conforming to the Basel Accords) is set by the national banking regulator of
different countries.
Two types of capital are measured: tier one capital (T1 above), which can absorb losses
without a bank being required to cease trading, and tier two capital (T2 above), which can
absorb losses in the event of a winding-up and so provides a lesser degree of protection to
depositors.]

The world’s central bankers and regulators confirmed new capital and liquidity standards for
the banking system on Sunday.

Here are the all-important details on both the reforms’ substance and their implementation
dates, via the Basel Committee release.

First — a Core Tier 1 capital ratio of 4.5 per cent, broadening to overall Tier 1 capital of 6 per
cent:

Under the agreements reached today, the minimum requirement for common equity, the
highest form of loss absorbing capital, will be raised from the current 2% level, before the
application of regulatory adjustments, to 4.5% after the application of stricter adjustments.
This will be phased in by 1 January 2015. The Tier 1 capital requirement, which includes
common equity and other qualifying financial instruments based on stricter criteria, will
increase from 4% to 6% over the same period. (Annex 1 summarizes the new capital
requirements.)

This will begin implementation from 2013 to 2018:

National implementation by member countries will begin on 1 January 2013. Member

countries must translate the rules into national laws and regulations before this date. As of 1
January 2013, banks will be required to meet the following new minimum requirements in
relation to risk-weighted assets (RWAs):

 3.5% common equity/RWAs;

 4.5% Tier 1 capital/RWAs, and
 8.0% total capital/RWAs.

The minimum common equity and Tier 1 requirements will be phased in between 1 January
2013 and 1 January 2015. On 1 January 2013, the minimum common equity requirement will
rise from the current 2% level to 3.5%. The Tier 1 capital requirement will rise from 4% to
4.5%. On 1 January 2014, banks will have to meet a 4% minimum common equity
requirement and a Tier 1 requirement of 5.5%. On 1 January 2015, banks will have to meet
the 4.5% common equity and the 6% Tier 1 requirement. The total capital requirement
remains at the existing level of 8.0% and so does not need to be phased in. The difference
between the total capital requirement of 8.0% and the Tier 1 requirement can be met with
Tier 2 and higher forms of capital.
This includes a complex set of deductions from allowable capital, to be phased in by
regulators:

The regulatory adjustments (i.e. deductions and prudential filters), including amounts above
the aggregate 15% limit for investments in financial institutions, mortgage servicing rights,
and deferred tax assets from timing differences, would be fully deducted from common
equity by 1 January 2018.

In particular, the regulatory adjustments will begin at 20% of the required deductions from
common equity on 1 January 2014, 40% on 1 January 2015, 60% on 1 January 2016, 80% on 1
January 2017, and reach 100% on 1 January 2018. During this transition period, the remainder
not deducted from common equity will continue to be subject to existing national
treatments.

__________________________

Capital conservation Buffer (CCB) – New Concept)

Next, details on the capital conservation buffer on top of Tier 1 capital:

The Group of Governors and Heads of Supervision also agreed that the capital conservation
buffer above the regulatory minimum requirement be calibrated at 2.5% and be met with
common equity, after the application of deductions. The purpose of the conservation buffer is
to ensure that banks maintain a buffer of capital that can be used to absorb losses during
periods of financial and economic stress. While banks are allowed to draw on the buffer
during such periods of stress, the closer their regulatory capital ratios approach the minimum
requirement, the greater the constraints on earnings distributions. This framework will
reinforce the objective of sound supervision and bank governance and address the collective
action problem that has prevented some banks from curtailing distributions such as
discretionary bonuses and high dividends, even in the face of deteriorating capital positions.
That takes banks’ minimum regulatory capital to 7 per cent. The conservation buffer will be
implemented no later than 2019: Banks will be required to hold a capital conservation buffer
of 2.5% to withstand future periods of stress bringing the total common equity requirements
to 7%. Capital Conservation Buffer of 2.5 percent, on top of Tier 1 capital, will be met with
common equity, after the application of deductions.
Capital Conservation Buffer before (Phase wise Increase)

1st January 2016 = 0%,

1st January 2016 = 0.625%,

1st January 2017 = 1.25%,
1st January 2018 = 1.875%,
1st January 2019 = 2.5%
The capital conservation buffer will be phased in between 1 January 2016 and year end 2018
becoming fully effective on 1 January 2019. It will begin at 0.625% of RWAs on 1 January
2016and increase each subsequent year by an additional 0.625 percentage points, to reach its
final level of 2.5% of RWAs on 1 January 2019. Countries that experience excessive credit
growth the countercyclical buffer. National authorities have the discretion to impose shorter
transition periods and should do so where appropriate.

Banks that already meet the minimum ratio requirement during the transition period but
remain below the 7% common equity target (minimum plus conservation buffer) should
maintain prudent earnings retention policies with a view to meeting the conservation buffer
as soon as reasonably possible.

*The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital
that can be used to absorb losses during periods of financial and economic stress. While
banks are allowed to draw on the buffer during such periods of stress, the closer their
regulatory capital ratios approach the minimum requirement, the greater the constraints on
earnings distributions.*

__________________________________________________________________________

Countercyclical capital buffer (New Concept)

Banks’ Tier 1 capital and conservation buffers will also be joined by a new countercyclical
capital buffer:

A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss
absorbing capital will be implemented according to national circumstances. The purpose of
the countercyclical buffer is to achieve the broader macro-prudential goal of protecting the
banking sector from periods of excess aggregate credit growth. For any given country, this
buffer will only be in effect when there is excess credit growth that is resulting in a system
wide build up of risk. The countercyclical buffer, when in effect, would be introduced as an
extension of the conservation buffer range.

And last, but not least, details on the implementation of a capital-to-leverage ratio alongside
the mainstream capital ratios, to be applied in full in 2018:

These capital requirements are supplemented by a non-risk-based leverage ratio that will
serve as a backstop to the risk-based measures described above. In July, Governors and
Heads of Supervision agreed to test a minimum Tier 1 leverage ratio of 3% during the parallel
run period. Based on the results of the parallel run period, any final adjustments would be
carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1
January 2018 based on appropriate review and calibration.
Along with freshly agreed implementation dates for a whole host of other Basel changes,
including the phasing-out and grandfathering of certain types of equity for the purposes of
defining what is allowed to count as Tier 1 capital. They’re in the full release.

A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss
absorbing capital will be implemented according to national circumstances.
Banks that have a capital ratio that is less than 2.5%, will face restrictions on payouts of
dividends, share buybacks and bonuses.
The buffer will be phased in from January 2016 and will be fully effective in January 2019.
Countercyclical Capital Buffer before 2016 = 0%,

1st January 2016 = 0.625%,

1st January 2017 = 1.25%,

1st January 2018 = 1.875%,

1st January 2019 = 2.5%

_________________________________________________________________________

Capital for Systemically Important Banks only

Systemically important banks should have loss absorbing capacity beyond the standards
announced today and work continues on this issue in the Financial Stability Board and
relevant Basel Committee work streams.

The Basel Committee and the FSB are developing a well integrated approach to systemically
important financial institutions which could include combinations of capital surcharges,
contingent capital and bail-in debt.

Hence -

Total Regulatory Capital Ratio = [Tier 1 Capital Ratio]

+ [Capital Conservation Buffer]
+ [Countercyclical Capital Buffer]
+ [Capital for Systemically Important Banks]

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