Basel Committee Announces Major Changes

This week, the Basel Committee on Bank Supervision released a statement regarding proposed changes to the Basel II Capital Accord that will significantly impact the capital requirements for financial institutions across the globe.  The intent of the proposal is to increase transparency into the capital reserves as well as reduce risk across a number of categories.  The following changes are slated to be assessed and implemented throughout 2010.

• Raise the quality, consistency and transparency of the Tier 1 capital base. The predominant form of Tier 1 capital must be common shares and retained earnings. Appropriate principles will be developed for non-joint stock companies to ensure they hold comparable levels of high quality Tier 1 capital. Moreover, deductions and prudential filters will be harmonised internationally and generally applied at the level of common equity or its equivalent in the case of non-joint stock companies. Finally, all components of the capital base will be fully disclosed.


• Introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework with a view to migrating to a Pillar 1 treatment based on appropriate review and calibration. To ensure comparability, the details of the leverage ratio will be harmonised internationally, fully adjusting for differences in accounting.


• Introduce a minimum global standard for funding liquidity that includes a stressed liquidity coverage ratio requirement, underpinned by a longer-term structural liquidity ratio.


• Introduce a framework for countercyclical capital buffers above the minimum requirement. The framework will include capital conservation measures such as constraints on capital distributions. The Basel Committee will review an appropriate set of indicators, such as earnings and credit-based variables, as a way to condition the build up and release of capital buffers. In addition, the Committee will promote more forward-looking provisions based on expected losses.


• Issue recommendations to reduce the systemic risk associated with the resolution of cross-border banks.


• Assess the need for a capital surcharge to mitigate the risk of systemic banks.

These changes will have a sizeable impact on the way financial institutions manage and disclose risk in the coming years.  However, given the complexity and interconnectivity of our financial markets, it is certainly the prudent course to take.