Tough capital requirements from Basel III

LAST year, the Bank for International Settlements (BIS) announced new, stricter regulatory capital requirements for banks. This proclamation marked the adoption of several revisions to the regulatory capital framework – collectively known as Basel III – that the Basel Committee on Banking Supervision (BCBS) had previously proposed to address some of the main issues that arose during the credit crisis.

The Basel directive requires that banks hold capital “against all of their securitisation exposures, including those arising from the provision of credit risk mitigants to a securitisation transaction, investments in asset-backed securities, retention of a subordinated tranche, and extension of a liquidity facility or credit enhancement.”

Piled on top of the existing 2006 Basel II framework, Basel III includes some specific changes to the way that banks will be required to treat securitisation exposures when calculating their capital requirements. These changes include:

Under the previous incarnation of the directive, banks were required to deduct certain unrated or non-investment grade securitisation exposures from regulatory capital – 50 per cent from tier 1 capital and 50 per cent from tier 2 capital. Under Basel III, banks will be required to apply a 1,250 per cent risk weight to some lower-rated and unrated securitisation exposures.

Under Basel II, banks may reduce their credit exposure to a counterparty if they receive eligible financial collateral. Basel III proposes the introduction of more conservative collateral haircuts (discounts) for securitisation collateral with respect to counterparty exposure.

The introduction of specific risk haircuts for securitisation exposures when calculating the capital requirement related to market risk.

Banks are expected to comply with these changes by 31 December 2011.