How proposed Basel II changes will affect capital requirements and global liquidity risk management
A pair of long-awaited and far-reaching proposals from the Basel Committee on Banking Supervision is the second part of the committee’s response to the financial crisis, following earlier revisions to the Basel II capital framework covering trading book and securitization exposures. The two proposals are:
- Strengthening the resilience of the banking sector (changes to the regulatory capital framework).
- International framework for liquidity risk measurement standards and monitoring (defines a new liquidity standard).
Below we outline some of the important components of both the capital requirements proposal and the proposal of a global liquidity standard.
Four recommendations for a global capital framework
While the industry anticipated an increase in regulatory capital requirements in the wake of the financial crisis, the scope of the proposed changes is daunting. Here are four aims of the Basel II proposals.
- Strengthen the quality, consistency and transparency of the capital base.
- Strengthen the risk coverage of the capital framework.
- Introduce a formal leverage measure, to supplement risk based capital requirements.
- Promote the buildup of capital buffers in good times that can be drawn on in stress periods, while leaving ample capital to support lending.
There are also proposed requirements related to how collateral is to be managed, in the context of counterparty risk. Incentives encourage the move of OTC derivatives exposures to central counterparties and to exchanges.
A global liquidity standard
The committee’s proposal for an international framework for liquidity risk measurement standards and monitoring is directed at ensuring that internationally active banking organizations have:
- Ample liquidity to withstand at least a 30 day period of market wide disruptions
- An adequate ratio of stable funding, to support illiquid and hard-to-value assets
This framework includes a common set of metrics and reporting to support supervisory surveillance at both the micro and macro levels. There reporting requirements are largely consistent with industry practice, but significant investment in data and technology will be required to produce the reporting and monitor the ratios on an ongoing basis.
Meeting the structural liquidity requirement ultimately relates to governance. The liquidity oversight role will increase in importance as the institution has a role to monitor these ratios and ensure there are adequate qualifying assets and that the net stable funding ratio continues to be met.
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