Guidance for national authorities operating the countercyclical capital buffer

December 2010

The Basel Committee issued today the Basel III rules text, which presents the details of global regulatory standards on bank capital adequacy and liquidity agreed by the Governors and Heads of Supervision, and endorsed by the G20 Leaders at their November Seoul summit. The Committee also published the results of its comprehensive quantitative impact study (QIS).

Mr Nout Wellink, Chairman of the Basel Committee on Banking Supervision and President of the Netherlands Bank, described the Basel III Framework as "a landmark achievement that will help protect financial stability and promote sustainable economic growth. The higher levels of capital, combined with a global liquidity framework, will significantly reduce the probability and severity of banking crises in the future." He added that "with these reforms, the Basel Committee has delivered on the banking reform agenda for internationally active banks set out by the G20 Leaders at their Pittsburgh summit in September 2009".

The rules text presents the details of the Basel III Framework, which covers both microprudential and macroprudential elements. The Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards. 

Transition and implementation

The Committee has put in place processes to ensure the rigorous and consistent global implementation of the Basel III Framework. The standards will be phased in gradually so that the banking sector can move to the higher capital and liquidity standards while supporting lending to the economy.

With respect to the leverage ratio, the Committee will use the transition period to assess whether its proposed design and calibration is appropriate over a full credit cycle and for different types of business models. Based on the results of a parallel run period, any adjustments would be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.  

Both the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) will be subject to an observation period and will include a review clause to address any unintended consequences.

QIS results

The Committee today released the Results of the comprehensive quantitative impact study. The Committee conducted a comprehensive QIS exercise to assess the impact of capital adequacy standards announced in July 2009 and the Basel III capital and liquidity proposals published in December 2009. A total of 263 banks from 23 Committee member jurisdictions participated in the QIS exercise. This included 94 Group 1 banks (ie those that have Tier 1 capital in excess of €3 billion, are well diversified and are internationally active) and 169 Group 2 banks (ie all other banks).

The QIS did not take into account any transitional arrangements such as the phase-in of deductions and grandfathering arrangements. Instead, the estimates presented assume full implementation of the final Basel III package, based on data as of year-end 2009. No assumptions were made about banks' profitability or behavioural responses, such as changes in bank capital or balance sheet composition, since then or in the future. For that reason the QIS results are not comparable to industry estimates, which tend to be based on forecasts and consider management actions to mitigate the impact and which incorporate analysts' estimates where information is not publicly available.

Including the effect of all changes to the definition of capital and risk-weighted assets, as well as assuming full implementation as of 31 December 2009, the average common equity Tier 1 capital ratio (CET1) of Group 1 banks was 5.7%, as compared with the new minimum requirement of 4.5%. For Group 2 banks, the average CET1 ratio stood at 7.8%. In order for all Group 1 banks in the sample to meet the new 4.5% CET1 ratio, the additional capital needed is estimated to be €165 billion. For Group 2 banks, the amount is €8 billion. 

Relative to a 7% CET1 level, which includes both the 4.5% minimum requirement and the 2.5% capital conservation buffer, the Committee estimated that Group 1 banks in aggregate would have had a shortfall of €577 billion at the end of 2009. As a point of reference, for this sample of banks the sum of profits after tax and prior to distributions in 2009 was €209 billion. Group 2 banks with CET1 ratios less than 7% would have required an additional €25 billion; the sum of these banks' profits after tax and prior to distributions in 2009 was €20 billion. Since the end of 2009, banks have continued to raise their common equity capital levels through combinations of equity issuance and profit retention.

The Committee also assessed the estimated impact of the liquidity standards. Assuming banks were to make no changes to their liquidity risk profile or funding structure, as of end-2009:

Banks have until 2015 to meet the LCR standard and until 2018 to meet the NSFR standard, which will reflect any revisions following each standard's observation period. Banks that are below the 100% required minimum thresholds can meet these standards by, for example, lengthening the term of their funding or restructuring business models which are most vulnerable to liquidity risk in periods of stress. It should be noted that the shortfalls in the LCR and the NSFR are not additive, as decreasing the shortfall in one standard may also result in a decrease in the shortfall in the other standard.

Mr Wellink noted that "the Basel III capital and liquidity standards will gradually raise the level of high-quality capital in the banking system, increase liquidity buffers and reduce unstable funding structures. The transition period provides banks with ample time to move to the new standards in a manner consistent with a sound economic recovery, while raising the safeguards in the system against economic or financial shocks". He added that in the case of the liquidity standards, "we will use the observation period for the liquidity ratios to ensure that we have their design and calibration right and that there are no unintended consequences, at either the banking sector or the broader system level".

The Basel Committee and the Financial Stability Board (FSB) are also issuing an updated report of the Macroeconomic Assessment Group which analyses the economic impact of the Basel III reforms over the transition period. The updated report and a separate press release will be issued in the coming days.

The Committee also issued today Guidance for national authorities operating the countercyclical capital buffer as a supplement to the requirements set out in the Basel III rules text. The primary aim of the countercyclical capital buffer regime is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth that have often been associated with the build-up of system-wide risk. In addition to providing guidance for national authorities, this document should help banks understand and anticipate the buffer decisions in the jurisdictions to which they have credit exposures.

The Committee is conducting further work on systemic banks and contingent capital in close coordination with the FSB. In the coming days, the Committee will also issue a consultation paper on the capitalisation of bank exposures to central counterparties.