Basel III
Candlefocus EditorThe goal of Basel III is to reduce systemic risk and the likelihood of public money being used to bail out failing banks. It contains three main components: a minimum capital ratio, a leverage ratio, and liquidity requirements.
The Basel III rules place restrictions on the amount of capital and leverage that banks can use when engaging in risky ventures, such as providing personal loans. Banks must hold a minimum of 4.5% of their total assets as a buffer against insolvency, and the amount must be based on the riskiness of those assets. In addition, the leverage ratio requires bankers to have more equity capital compared to their total assets. Higher capital requirements will also force banks to invest in safer activities.
The liquidity component outlines rules about banks’ liquidity sources and their risk management procedures for handling liquidity issues. The Liquidity Coverage Ratio (LCR) component requires banks to hold enough high-quality liquid assets to cover their outflows for 30 days. The Net Stable Funding Ratio (NSFR) component specifies that banks must have enough reliable funding sources to cover their liquidity needs without relying too heavily on wholesale money market sources.
Basel III places enhanced importance on capital, leverage, and liquidity standards, each of which are designed to foster a heightened degree of bank stability. The framework is designed to reduce the risk of overexposure to a single economic event, which could result in an economic crash, as well as strengthen the overall financial and economic stability of the banking industry. It is still in the process of implementation as of 2022.