Regulatory Alerts2013-12-11 | BSD/DIR/CIR/GEN/LAB/06/053/7Guidance Notes on Pillar III: Market Discipline
The Basel III framework enhances the capital adequacy, liquidity, and risk management of banks through various enhancements in regulatory requirements. This includes higher quality and quantity of Common Equity Tier 1 (CET1) capital, increased minimum capital conservation buffers, a net stable funding ratio to ensure adequate long-term funding, as well as stricter Liquidity Coverage Ratio and Net Stable Funding Requirements. Furthermore, Basel III also strengthens risk management by imposing new standards for measuring, monitoring, and controlling the capital adequacy of banks through specific quantitative and qualitative requirements related to credit risk, market risk, operational risk, interest rate risk, and counterparty credit risk. These include: - For credit risk, a more forward-looking approach is used with a focus on the average lifetime probability of default (PD) and loss given default (LGD). The risk weighted assets methodology for calculating capital requirements is replaced by a more advanced internal ratings-based approach. - For market risk, the minimum capital requirements are increased using the standardized or internal model approaches. The margin period of risk for derivatives is also introduced to ensure that banks have sufficient capital to cover potential market movements. - For operational risk, a three-pillar approach is employed, which includes a more quantitative approach in assessing and managing this risk, with the introduction of Advanced Measurement Approaches (AMA). - For interest rate risk, Basel III introduces a floor for net interest income sensitivity to interest rate changes. This ensures that banks maintain a certain level of resilience against interest rate fluctuations. In addition, Basel III requires greater disclosure by banks regarding their capital adequacy and risk management practices, including the use of insurance for mitigating operational risks. This transparency aims to enhance market discipline and improve the overall stability and soundness of the banking sector.