On 11 and 12 November 2010, banking reform will again be on the agenda, with Basel III - the Basel Committee's proposed reforms to the banking capital rules - set to be presented at the G20 Leaders' summit for endorsement.
Basel III represents a significant strengthening of the current capital requirements on banks, intended to ensure that banks are better able to endure losses during future periods of financial stress.
Under the new proposals, banks will be required to hold a minimum level of common equity, the highest form of loss absorbing capital, of 4.5% of their total risk-weighted assets ("RWAs"). This is more than double the current 2% level. The minimum required holding of Tier 1 capital, which includes common equity and other qualifying financial instruments, is also set to increase from 4% to 6% of RWAs. The total capital requirement on banks will remain at the current 8% level.
In addition, banks will be required to maintain a capital conservation buffer of 2.5% of RWAs. This buffer is to be met with common equity. In theory a bank can eat into this buffer to absorb its losses. However, if the full buffer is not in place, the bank will be subject to restrictions on paying dividends and bonuses. As a result, most banks will regard this as a mandatory requirement, effectively raising the minimum capital requirements to 7% common equity, 8.5% Tier 1 capital and 10.5% total capital.
The new proposals don't stop there. A requirement to maintain a countercyclical buffer of 0% - 2.5% of RWAs will be introduced (the particular % of which will be set based on national circumstances). This buffer is to consist of common equity or other fully loss-absorbing capital. This is basically an extension of the capital conservation buffer which will come into effect during periods of excess credit growth and is designed to protect banks from the resulting system wide build up of risk during such periods. Therefore, when the economy is booming, banks could be required to hold as much as 9.5% common equity, 11% Tier 1 capital and 13% total capital.
The new proposals will impose even greater restrictions on certain large banks (to be known as "systematically important banks"). What these additional requirements will be or who they will apply to have yet to be decided, but it is likely that the biggest banks will have to hold significantly more capital in reserve than is outlined above.
If endorsed, national implementation by member countries will begin on 1 January 2013, with full implementation required by 1 January 2019.
While Basel III appears to be a major shake up on paper, the new requirements are likely to cause little problem for the UK's banks which are already relatively well capitalised - a recent European stress test showed that the UK's four major banks already exceed the new requirements with Barclays holding Tier 1 capital of 13.7%, followed by RBS with 11.2%, HSBC with 10.2% and Lloyds Banking Group with 9.2%.