The Basel Committee’s response to the financial crisis: report to the G20

Oct 24th, 2010572 Comments

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The Basel Committee’s response to the financial crisis: Report to the G20

Executive summary

The Basel Committee on Banking Supervision and its oversight body, the Group of Governors and Heads of Supervision1, have developed a reform programme to address the lessons of the crisis, which delivers on the mandates for banking sector reforms established by the G20 at their 2009 Pittsburgh summit. This report, which the Committee is submitting to the G20, details the key elements of the reform programme and future work to strengthen the resilience of banks and the global banking system.

The depth and severity of the crisis were amplified by weaknesses in the banking sector such as excessive leverage, inadequate and low-quality capital, and insufficient liquidity buffers. The crisis was exacerbated by a procyclical deleveraging process and the interconnectedness of systemically important financial institutions. In response, the Committee’s reforms seek to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spill over from the financial sector to the real economy.

The reforms strengthen bank-level, or micro prudential, regulation, which will help raise the resilience of individual banking institutions in periods of stress. The reforms also have a macro prudential focus, addressing system wide risks, which can build up across the banking sector, as well as the procyclical amplification of these risks over time. Clearly, these micro and macro prudential approaches to supervision are interrelated, as greater resilience at the individual bank level reduces the risk of system wide shocks.

Collectively, the new global standards to address both firm-specific and broader, systemic risks have been referred to as “Basel III”. Basel III is comprised of the following building blocks, which have been agreed and issued by the Committee and the Governors and Heads of Supervision between July 2009 and September 2010:

Raising the quality of capital to ensure banks are better able to absorb losses on both a going concern and a gone concern basis;

Increasing the risk coverage of the capital framework, in particular for trading activities, securitisations, exposures to off-balance sheet vehicles and counterparty credit exposures arising from derivatives;

1 The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. It seeks to promote and strengthen supervisory and risk management practices globally. The Committee is comprised of central bank and supervisory authority representatives from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The Committee’s Secretariat is based at the Bank for International Settlements in Basel, Switzerland.

The Basel Committee’s governing body is the Group of Central Bank Governors and Heads of Supervision, which is comprised of central bank governors and (non-central bank) heads of supervision from member countries.

The Basel Committee’s response to the financial crisis: report to the G20 1

Raising the level of the minimum capital requirements, including an increase in the minimum common equity requirement from 2% to 4.5% and a capital conservation buffer of 2.5%, bringing the total common equity requirement to 7%;

Introducing an internationally harmonised leverage ratio to serve as a backstop to the risk-based capital measure and to contain the build-up of excessive leverage in the system;

Raising standards for the supervisory review process (Pillar 2) and public disclosures (Pillar 3), together with additional guidance in the areas of sound valuation practices, stress testing, liquidity risk management, corporate governance and compensation;

Introducing minimum global liquidity standards consisting of both a short term liquidity coverage ratio and a longer term, structural net stable funding ratio; and

Promoting the build up of capital buffers in good times that can be drawn down in periods of stress, including both a capital conservation buffer and a countercyclical buffer to protect the banking sector from periods of excess credit growth.

The Committee is also working with the Financial Stability Board to address the risks of systemic banks. On 12 September 2010, the Governors and Heads of Supervision agreed that systemically important banks should have loss absorbing capacity beyond the minimum standards of the Basel III framework.

The Committee’s reforms will transform the global regulatory framework and promote a more resilient banking sector. Accordingly, the Committee has undertaken a comprehensive assessment of Basel III’s potential effects, both on the banking sector and on the broader economy. This work concludes that the transition to stronger capital and liquidity standards is expected to have a modest impact on economic growth. Moreover, the long-run economic benefits substantially outweigh the costs associated with the higher standards.

Going forward, the Committee will concentrate its efforts on the implementation of the Basel III framework and related supervisory sound practice standards. It is also conducting work in the following areas:

A fundamental review of the trading book;

The use and impact of external ratings in the securitisation capital framework;

Policy response to systemically important banks;

The treatment of large exposures;

Enhanced cross-border bank resolution;

A review of the Core Principles for Effective Banking Supervision to reflect the lessons of the crisis; and

Standards implementation and stronger collaboration among bank supervisors through supervisory colleges.

In 2009 the membership of the Basel Committee doubled in size to 27 jurisdictions. It is now represented by senior officials from 44 central banks and supervisory authorities. The greater diversity of supervisory views and practices shared among members has enriched the Committee’s discussions. The broader representation has also served to enhance the Committee’s legitimacy as a global standard setter.

In the course of its standard-setting process, the Committee regularly solicits public comments on its proposals. For example, its December 2009 proposals on capital and

2 The Basel Committee’s response to the financial crisis: report to the G20

liquidity generated close to 300 comments from bankers, academics, governments, other standard setters and prudential supervisors, and various other market participants and interested parties. Such comments are carefully reviewed by the Committee and its working groups and proposed standards are modified as appropriate. Together, the transparent public consultations and comprehensive impact assessments help ensure that the Committee is developing standards on a well informed and inclusive basis.

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