Basel III

Basel III is a set of international banking regulations developed by the Bank for International Settlements to promote stability in the international financial system. The Basel III regulations are designed to reduce damage to the economy by banks that take on excess risk.

Problems with the original accord became evident during the subprime crisis in 2007. Members of the Basel Committee on Banking Supervision agreed on Basel III in November 2010. Regulations were initially be introduced from 2013 until 2015, but there have been several extensions to March 2019 and January 2022.

Basel III and the Banks

Banks must hold more capital against their assets, thereby decreasing the size of their balance sheets and their ability to leverage themselves. While regulations were under discussion before the financial crisis, the events magnified the need for change.

The Basel III regulations contain several important changes for banks' capital structures. First, the minimum amount of equity, as a percentage of assets, increased from 2% to 4.5%. There is also an additional 2.5% buffer required, bringing the total equity requirement to 7%. This buffer can be used during times of financial stress, but banks doing so will face constraints on their ability to pay dividends and otherwise deploy capital. Banks had until 2019 to implement these changes, giving them plenty of time to prevent a sudden lending freeze as banks scramble to improve their balance sheets.

It is possible that banks will be less profitable in the future due in part to these regulations. The 7% equity requirement is a minimum, and it is likely that many banks will strive to maintain a somewhat higher figure to give themselves a cushion. If financial institutions are perceived as safer, the cost of capital for banks would actually decrease. More stable banks can issue debt at a lower cost. At the same time, the stock market might assign a higher P/E multiple to banks that have a less risky capital structure.

Implantation of Basel III in Sri Lanka

Timeline for Implementation of Basel III capital in Sri Lanka

Ratios (%)	01.01.2017	01.01.2018	01.01.2019
CET1	4.50	4.50	4.50
Capital Conversation Buffer (CCB)	1.25	1.875	2.50
Minimum CET1 plus CCB	5.75	6.375	7.00
Additional Tier 1 Capital (AT1)	1.50	1.5	1.50
Total tier 1 Capital plus CCB	7.25	7.875	8.50
Tier 2 capital	4.00	4.00	4.00
Minimum Total Capital plus CCB	11.25	11.875	12.50
Capital surcharge for D-SIBs	0.500	1.000	1.500
Total Capital for Large Banks	11.750	12.875	14.00

Timeline for Implementation of Basel III Liquidity Standards in Sri Lanka

Ratios (%)	01.01.2017	01.01.2018	01.01.2019	01.07.2019
Liquidity Coverage Ratio (LCR)	80	90	100	100
NSFR			90	100

Timeline for Implementation of Basel III Leverage Standards in Sri Lanka

Ratios (%)	01.01.2019
Leverage Ratio	3