Regulatory Alerts2016-07-21
Instructions for managing liquidity risks in accordance with Basel III decisions
The Basel Committee on Banking Supervision, which is a part of the Bank for International Settlements (BIS), has established several key principles and standards related to prudential regulation of banks. These include capital requirements, risk management, governance, and transparency. The Basel III framework, introduced in response to the global financial crisis, is a comprehensive set of reforms aimed at strengthening the resilience of the banking sector. It includes the following key components: 1. Capital requirements: Banks must hold a minimum amount of high-quality capital, known as Common Equity Tier 1 (CET1) capital, to absorb losses and ensure their stability. The minimum CET1 requirement is set at 4.5% for internationally active banks and will gradually increase to 6.75% by January 2023, with a 2.5% buffer to absorb potential losses from economic downturns or other adverse events. 2. Liquidity requirements: Banks must maintain sufficient liquid assets, such as cash and highly liquid securities, to meet their short-term funding needs. The Basel III framework sets out several minimum liquidity standards, including the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). 3. Large exposures: Banks must limit their exposure to a single counterparty or group of connected counterparties to mitigate the risk of concentration. The large exposure measure sets a limit on the amount of credit that can be extended to a single counterparty, which is currently set at 25% of Tier 1 capital for most banks and may increase up to 30% by January 2023. 4. Market risk: Banks must establish effective risk management processes to measure, monitor, and control market risk arising from their trading activities and other investments. The Basel III framework includes a revised market risk framework that incorporates more risk-sensitive approaches for measuring and capitalizing market risk. 5. Operational risk: Banks must identify, assess, and manage operational risks related to their business activities, such as fraud, cybersecurity incidents, and technology failures. The Basel III framework introduces a revised operational risk framework that replaces the Standardized Measurement Approach (SMA) with an Internal Model Approach (IMA), which allows banks to use their own risk models for calculating operational risk capital requirements. 6. Governance and accountability: Banks must establish robust governance structures, effective internal control systems, and strong corporate cultures that promote integrity, ethical behavior, and a commitment to compliance with applicable laws and regulations. The Basel III framework emphasizes the importance of board oversight, executive responsibility, and ongoing training and development for bank employees. 7. Transparency: Banks must disclose relevant financial information, risk exposures, and other material facts to their shareholders, regulators, and other stakeholders in a timely and transparent manner. The Basel III framework encourages banks to adopt international accounting standards, such as International Financial Reporting Standards (IFRS), and to provide more granular disclosures about their risk profiles, capital adequacy, and liquidity management practices. 8. Stress testing: Banks must conduct regular stress tests to assess their resilience under adverse economic conditions and to identify potential weaknesses in their capital and liquidity positions. The Basel III framework includes guidelines for conducting stress tests and recommends that banks use a variety of scenarios to test the effectiveness of their risk management policies and practices. 9. Resolution planning: Banks must develop resolution plans that outline how they would be wound down or restructured in the event of financial distress, insolvency, or bankruptcy. The Basel III framework emphasizes the importance of cross-border cooperation among regulators and authorities, as well as the need for banks to maintain sufficient loss-absorbing capacity to facilitate an orderly resolution process. By implementing these key components, the Basel Committee on Banking Supervision seeks to enhance the stability and resilience of the global banking system while preserving its competitive nature.