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The member states of the Group of twenty (G20) in 2010 certified Basel III framework which aimed at increasing the quality and quantity of capital that banks should have. Basel III replaced Basel I and II after they seemed to be collapsing under the pressure of the financial crisis in various countries (Gromova-Schneider & Niziolek 2011).
Regulatory institutions are given the authority to have a large-scale-prudential approach in ensuring that Basel III re-establishes better quality liquidity and capital (Lyngen 2012). The purpose of this paper is to examine the key features of Basel III and how it varies from Basel II.
Features of Basel III
This section focuses on the main features of Basel III and their components which the committee has put forward to enable financial institutions to combat the financial crisis. The first feature is concerned with increasing the quality and quantity of capital (Walker 2011).
Three stages will be used to advance the value, precision as well as the stability of Capital bases. The first stage involves efforts to stabilise ordinary shares in addition to increasing common shares and the earnings that are retained. The second stage involves harmonising capital instruments and the final tier is concerned with eliminating capital.
The second feature is the establishment of additional buffers (Walker 2011).The committee proposes the following approaches to be used to reinforce the coverage of any threats to bank assets, counterparty credit risk and management of market integration. Lastly, capital requirements for counterparty must be reinforced in addition to raising the capital buffer that supports this coverage.
The third feature of Basel III is the introduction of Leverage ratio as an added appraisal of Basel II risk based structures. The leverage ration is intended to establish a base to build up leverage in the banking industry, increase efforts to strengthen against model risk. And inaccurate measurement by supplementing the risk based measure with a simplified standard founded on gross exposures (Lyngen 2012).
The Fourth feature is managing Counterparty risks by promoting countercyclical buffers. This is also proposed in Basel III as a strategy to advance the build up of capital buffers in appropriate periods which can be relied upon during periods of crisis.
Countercyclical would be advanced through the following means reducing surplus cyclicality of the least amount of capital prerequisite as well as advancing provisions that aim at capital stability in the future (Gromova-Schneider & Niziolek 2011).
The fourth element is also concerned with efforts to amass a vast amount of information and data over time which can be of help in determining the likelihood of defaulting as had been envisaged in Basel II. The banking industry must also provide support to banks to carry out stress tests so that they develop proper mechanisms to address crises.
The Fifth feature involves improving liquidity. Here, the committee has advanced a world wide approach for internationally active banks to achieve the least standard of liquidity (Delahaye 2011). The committee held that banks internationally will be able to borrow more during periods of stress and crises. The Sixth feature deals with the SIFIs or the too big to fail institutions.
The committee recognises the fact that these institutions are a threat to other banks in the banking industry (Walker 2011). As a result of this realisation, the committee links with the financial stability board which was also established by G20 to advance several strategies that can be used to address issues in the SIFIs.
Such approaches include tighter large exposure restrictions, mandatory recovery and resolution plans. All these features are to be considered during the implementation of Basel III.
The differences between Basel III and Basel II
The main difference between Basel II and Basel III is the increase in the capital buffer by setting up the minimum quality and quantity of Capital which internationally active banks must have in their possession (Danila 2012). This is evident in the features discussed above since, they all intend to address the issue of ensuring that banks are stable and can survive during periods of stress or financial crises.
Basel III expands on the explanations of fliers and provides a clear understanding of capital as an asset to guard against unforeseeable future conditions.Therefore, Basel III adopts these strategies and emphasises on them through the features discussed above to ensure banks have a sustained growth even during times of crises.
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Basel III is a framework that was developed to put in operation the components of Basel II in addition to helping banks expand the base for sustainability in the banking industry. This is a relevant step since banks have suffered in times of crises and such effects are always transferred to customers.
Customers may move to more secure banks and this may have greater impact on the survival of the banks they leave. It is therefore appropriate for a framework to be developed to aid such banks against collapsing specifically during times of stress. This is what Basel III intends to do.
Danila, O 2012, ‘Impact and Limitations Deriving from Basel II within the Context of the Current Financial Crisis’, Theoretical & Applied Economics, Little, Brown and Company, NY.
Delahaye, B. P 2011, Basel III: Capital Adequacy and Liquidity After The Financial Crisis / Bernd P. Delahaye, World Scientific, London.
Gromova-Schneider, A, & Niziolek, C 2011, ‘The Road to Basel III — Quantitative Impact Study, the Basel III Framework and Implementation in the EU’, Financial Stability Report (Oesterreichische Nationalbank), Cengage Learning, UK.
Lyngen, N 2012 ‘Basel III: Dynamics of State Implementation’, Harvard International Law Journal, vol. 53, pp 519. Web.
Walker, G.A 2011, ‘Basel III market and regulatory compromise’, Banking Regulation, vol. 20 no. 1, pp. 53-69.