Cookies on the Investment International website
We use cookies to ensure that we give you the best experience on our website. If you continue without changing your settings, we'll assume that you are happy to receive all cookies on this website. However, if you would like to, you can change your cookie settings at any time.
Continue

New to Investment International?

Welcome, and thank you for visiting our website.

Investment International is the leading publication for investors interested in the world of international investment.

Our aim is to give you intelligent commentary on the most important financial stories, and help you to profit from them. If you've enjoyed what you've read so far why not sign up for our FREE investment alert.

Every week the Investment International team sends out a hard-hitting newsletter packed with news and analysis of the top stories this week plus the best investment opportunities on the market. We always look at the bigger picture like the Eurozone Crisis, and explain how this will affect YOUR investments.


Ask me later
No thanks

Measuring Risk: Basel III and Capital Adequacy PDF Print E-mail
Friday, 19 August 2011 10:37

Banks are currently preparing for Basel III's higher capital requirements. Speculation about the impact these changes could have are widespread throughout the markets. Given the implications of the Basel III agreements it is imperative to understand the strengths and weaknesses of the new standards.

In addition, it is important for investors to note that Standard & Poor’s (S&P) will continue making assessments according to its Risk Adjusted Capital Framework (RACF). Developed, like Basel III, to address the problems found in Basel II, the RACF is S&P’s independently developed primary metric for assessing capital adequacy in financial institutions.

Basel III

The Basel III agreements are focused on strengthening the liquidity and capital adequacy of financial institutions. Over the course of their implementation, the minimum common equity regulatory capital ratio will gradually increase to 7% in 2019 from its current 2%. Banks will also be subject to a variable countercyclical buffer set by national authorities of up to 250 basis points (bps). However, despite some improvements, S&P believes Basel II’s difficulties in relation to comparability between regulatory national ratios will persist under Basel III.

Despite Basel III ratios being subject to numerous assumptions, some banks have started to estimate them. A sample of these banks reveals that the average risk adjust capital ratio after diversification is comparable to the common equity tier 1 (CET1) ratio estimated under Basel III. There is, however, significant volatility around this average. Higher levels of operational risk have the potential to translate into higher charges from regulators.

S&P believes that asset managers' operational risk has increased significantly during the past decade. In particular, we apply a heavier capital charge for cash and money-market funds to reflect the financial support many independent asset managers (or parent banking companies) might provide to their funds. RAC ratio already addresses some enhancements of Basel III

Trading-book market-risk capital requirement will triple under “Basel II.5”

Banks in most mature markets, including the US, will have to increase their regulatory capital requirements with regard to the trading book at year-end 2011. Overall, S&P is of the opinion that the average capital requirements for market risk in the trading book will triple with the implementation of these increased requirements (“Basel II.5”). S&P believes reported Basel II.5 ratios will begin to converge to our RAC ratio. As the stress value at risk and the incremental risk charge metrics become publicly available, we expect the improved disclosure to help market participants' analysis of trading-book market risks.

Comparability issues will persist under Basel III

The Basel recommendations are not planned to be implemented according to a single blueprint. Instead, each country will have the right to exercise its own national discretions. This opens up the possibility of "goldplating" (i.e., adding rules from local regulators) when translating the recommendations from the Basel Committee on Banking Supervision (BCBS) into local regulation.

Even within the same jurisdiction, we expect differences in regulatory risk weights to remain as much driven by differences in banks' risk profiles as by variation in the methodology and models they use to assess the risk weights.

By contrast, the RACF has its own globally consistent definition of capital and risk-weighted assets. A significant part of Basel III is devoted to raising the quality, consistency, and transparency of the capital base. However, S&P  expects this to neutralize only some, not all, of the national discretions affecting the numerators of the capital ratios.

Concentration matters

The RACF embeds explicit adjustments for concentration and diversification of credit, market, operational, and insurance risks. The range of concentration and diversification adjustments are extremely varied and significantly affect the RAC ratio for most banks.

On the contrary, the Basel formula and hence Basel risk-weighted assets assume infinite granularity of the exposures and does not make any adjustment for institution specific concentration or diversification.
 
Basel III is a step in the right direction, but not yet a solution

While it is a move towards comparability in regulatory capital ratios, Basel III appears only to be a step. The statement made by the Basel Committee in 2005, in relation to Basel II, still holds true – “Basel is not a destination but a journey.”

 

Most Read

Latest Guides

New Build UK Student Investment
New Build UK Student Investment
Download

UK Airport Car Park Investment
UK Airport Car Park Investment
Download

UK Airport Car Park Investment
Hever Hotel
Download

Holiday Home Rental Guide
Holiday Home Rental
Download

Investing in Buy-to-let
Investing in buy-to-let
Download

Investing in buy-to-let
Investing in buy-to-let
Download

Discover the real power behind your pension
Hever Hotel
Download

Self Invested Personal Pension Guide for UK Expatriates
key
Download

Offshore Banking Guide
Offshore banking Guide 2010-2011
Download
Pension Planning Guide
International Pension Planning Guide 2010-2011
Download
Eurozone Crisis
Eurozone Crisis Report 2010-2011
Download
Tax Guide
International Tax Guide 2010-2011
Download
Follow us on Twitter
Find us on Facebook