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International Regulation of Banking: Basel II: Capital and Risk Requirements

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Articles Written by Gonzalo Fernandez Dionis

Moreover, the system's Tier 1 capital ratio rose by 1. The sizes of these capital ratio increases are similar to the experience of the early s, during which Australia had a recession and the banking sector also faced strong market pressures to improve its capital position. In contrast to some of their international peers, these issues were at only modest discounts to the market price, and were entirely to the private sector; there was no injection of public money into Australian bank capital.

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New equity raisings were the key driver of increases to the Australian banking sector's Tier 1 capital in the early s as well. Having reported solid profits throughout the turmoil, the Australian banking sector was also able to generate Tier 1 capital organically, through increases in retained earnings. The effect of these initiatives in increasing Tier 1 capital was somewhat offset by a rise in deductions, partly because a number of acquisitions generated new goodwill through the purchase price exceeding the book value of assets.

The financial crisis has highlighted that there can be strong disincentives for banks to use them as loss absorption tools, so they have become less highly regarded as sources of bankruptcy protection by markets and regulators. The BCBS has signalled that the status of these securities is being reviewed in forthcoming revisions to international capital standards.

With a number of governments overseas having recently demonstrated their willingness to shore-up banks' balance sheets before their Tier 2 capital takes losses, markets are also placing less emphasis on this form of capital. One reason for this decline is the relatively slow growth in Australian banking sector lending over this period, as banks tightened their lending standards and businesses worked to reduce their leverage. There has also been a shift in the composition of banks' loan portfolios, towards housing lending, which typically attracts much lower risk weights than business and personal lending.

Basel I, II, III: evolution of global banking regulation

The amount of banks' off-balance sheet credit commitments has been falling recently as well. The slower growth in credit and the change in its composition are similar to the patterns of the early s recession, when credit growth of the Australian banking sector fell significantly and the share of credit devoted to housing increased strongly. Credit risk-weighted assets, though measured differently at the time, fell by 6.

These recent size and compositional changes to bank lending have been partly offset by an increase in the average risk weight of banks' business exposures. Their average probability of default estimates for residential mortgages have increased only very slightly and remain at a little over 1 per cent.

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There were also some rises in loss given default estimates across these categories. With the financial crisis revealing a number of inadequacies in the capital held by banks globally, there has been a strong push by national regulators to tighten global capital regulations, particularly in those countries most affected by the crisis. The BCBS has been the main driver of international reforms in this area over the past year or so and has released a number of consultative documents suggesting major changes to its Basel II capital standards.

Most of these reforms will inevitably raise the cost of intermediation above pre-crisis levels, and it will be important to ensure an appropriate balance between this cost and the benefit of financial systems being subject to stronger standards. In order to help policymakers assess this balance, the BCBS undertook a detailed quantitative impact study of some of these proposed changes during the first half of APRA led Australia's contribution to this work and consulted with Australian banks involved in the study.

Articles Written by Gonzalo Fernandez Dionis

APRA will consider the agreed international timetable when implementing the new standards, which on the basis of the latest proposals would see the first of the new requirements in place from the start of , with some longer phase-in periods for certain elements of the package. The BCBS has committed to issue details of finalised capital reforms and transition arrangements later this year. APRA will provide further guidance on Australian transition arrangements around that time, but currently does not expect that banks in Australia will need an extensive transition period to meet the new capital requirements.

Australian banks appear to be better placed to meet the new capital criteria than banks in a number of other countries, partly because APRA's existing capital rules are based on a relatively more conservative application of the Basel II standards. The Australian banking system has significantly increased its capital buffer against potential losses in recent years.

Australian Bank Capital and the Regulatory Framework | Bulletin – September Quarter | RBA

To a large extent this has been driven by the financial crisis, which prompted markets, regulators and rating agencies to reappraise appropriate levels and forms of capital. Australian banks responded by issuing considerable amounts of new equity — the highest quality form of capital — while changes to the growth and composition of their loan portfolios limited increases in their risk-weighted assets. Unlike banks in a number of other countries, at no point was there any injection of public money into Australian bank capital.

During the drafting process, the CBRC has taken into consideration the changing economic and banking conditions at home and abroad, conducted extensive public consultations, assessed potential consequences through QIS and adjusted the relevant provisions where appropriate.

With such efforts, a new capital regulatory framework both in line with the global standards and domestic conditions has taken shape. The Regulation contains 10 chapters, altogether articles, along with 17 annexes, laying out general provisions on regulatory capital requirements, capital adequacy ratio calculation, definition of capital, calculation of credit risk, market risk, operational risk, ICAAP and Pillar II capital charge, as well as Pillar III requirement on information disclosure. Generally, the Regulation embodies the following requirements:.

Establishment of a multi-layered framework. In addition, the Pillar II requirement constitutes the last tier. The CBRC determines that a total capital requirement at The multi-layered rules are not only in line with the new requirements in international standards, but also largely consistent with the current capital requirements. Capital definition. In accordance with international standards, the Regulation defined qualifying criteria for various capital instruments, and enhanced their loss absorbency.

Expansion of risk coverage. According to the Regulation , the risk coverage includes both credit risk, market risk and operational risk.