Basel III

Basel III is the third of three Basel Accords, a framework that sets international standards and minimums for bank capital requirements, stress tests, liquidity regulations, and leverage, with the goal of mitigating the risk of bank runs and bank failures. It was developed in response to the deficiencies in financial regulation revealed by the 2008 financial crisis and the idea that "markets often fail to discipline large banks to hold prudent capital levels and make sound investment decisions". Basel III builds upon the standards of Basel II, introduced in 2004, and Basel I, introduced in 1988.

The Basel III requirements were published by the Basel Committee on Banking Supervision in 2010, and began to be implemented in major countries in 2012. Implementation of the Fundamental Review of the Trading Book (FRTB), published and revised between 2013 and 2019, has been completed only in some countries and is scheduled to be completed in the United Kingdom and the European Union in 2027 and 2028 and is still subject to public comment in the United States. Implementation of the Basel III: Finalising post-crisis reforms (also known as Basel 3.1 or Basel III Endgame), introduced in 2017, is being phased in by countries between 2026 and 2028.

Key principles and requirements

Common Equity Tier 1 (CET1) capital requirements

$\frac{\text{CET1}}{\text{RWAs}}=\text{CET1}\text{ratio}$

Basel III requires banks to have a minimum CET1 ratio (Common Tier 1 capital divided by risk-weighted assets (RWAs)) at all times of:

• 4.5%

Plus:

• A mandatory "capital conservation buffer" or "stress capital buffer requirement", equivalent to at least 2.5% of risk-weighted assets, but could be higher based on results from stress tests, as determined by national regulators.

Plus:

• If necessary, as determined by national regulators, a "counter-cyclical buffer" of up to an additional 2.5% of RWA as capital during periods of high credit growth. This must be met by CET1 capital.

In the U.S., an additional 1% is required for globally systemically important financial institutions.

It also requires minimum Tier 1 capital of 6% at all times (beginning in 2015).

Common Tier 1 capital comprises shareholders equity (including audited profits), less deductions of accounting reserve that are not believed to be loss absorbing "today", including goodwill and other intangible assets. To prevent the potential of double-counting of capital across the economy, bank's holdings of other bank shares are also deducted.

Tier 2 capital requirements

Tier 2 capital + Tier 1 capital is required to be above 8%.

Leverage ratio requirements

Leverage ratio is calculated by dividing Tier 1 capital by the bank's leverage exposure. The leverage exposure is the sum of the exposures of all on-balance sheet assets, 'add-ons' for derivative exposures and securities financing transactions (SFTs), and credit conversion factors for off-balance sheet items.

Basel III introduced a minimum leverage ratio of 3%.

$\frac{\text{Tier 1 Capital}}{\text{Total exposure}}\ge 3\mathrm{\%}$

The U.S. established another ratio, the supplemental leverage ratio, defined as Tier 1 capital divided by total assets. It is required to be above 3.0%. A minimum leverage ratio of 5% is required for large banks and systemically important financial institutions. Due to the COVID-19 pandemic, from April 2020 until March 2021, for financial institutions with more than $250 billion in consolidated assets, the calculation excluded U.S. Treasury securities and deposits at Federal Reserve Banks.

In the EU, the minimum bank leverage ratio is the same 3% as required by Basel III.

The UK requires a minimum leverage ratio, for banks with deposits greater than £50 billion, of 3.25%. This higher minimum reflects the PRA's differing treatment of the leverage ratio, which excludes central bank reserves in 'Total exposure' of the calculation.

Liquidity requirements

Basel III introduced two required liquidity/funding ratios.

Liquidity coverage ratio

The liquidity coverage ratio requires banks to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days under a stressed scenario. This was implemented because some adequately-capitalized banks faced difficulties because of poor liquidity management. The LCR consists of two parts: the numerator is the value of HQLA, and the denominator consists of the total net cash outflows over a specified stress period (total expected cash outflows minus total expected cash inflows). Mathematically it is expressed as follows:

$\text{LCR}=\frac{\text{High quality liquid assets}}{\text{Total net liquidity outflows over 30 days}}\ge 100\mathrm{\%}$

Regulators can allow banks to dip below their required liquidity levels per the liquidity coverage ratio during periods of stress.

Liquidity coverage ratio requirements for U.S. banks

In 2014, the Federal Reserve Board of Governors approved a U.S. version of the liquidity coverage ratio, which had more stringent definitions of HQLA and total net cash outflows. Certain privately issued mortgage backed securities are included in HQLA under Basel III but not under the U.S. rule. Bonds and securities issued by financial institutions, which can become illiquid during a financial crisis, are not eligible under the U.S. rule. The rule is also modified for banks that do not have at least $250 billion in total assets or at least $10 billion in on-balance sheet foreign exposure.

Net stable funding ratio

Template:Main The Net stable funding ratio requires banks to hold sufficient stable funding to exceed the required amount of stable funding over a one-year period of extended stress.

$\text{NSFR}=\frac{\text{Available amount of stable funding}}{\text{Required amount of stable funding }}>100\mathrm{\%}$

Counterparty risk: CCPs and SA-CCR

A new framework for exposures to CCPs was introduced in 2017.

The standardised approach for counterparty credit risk (SA-CCR), which replaced the Current exposure method, became effective in 2017. SA-CCR is used to measure the potential future exposure of derivative transactions in the leverage exposure measure and non-modelled Risk Weighted Asset calculations.

Capital requirements for equity investments in funds

Capital requirements for equity investments in hedge funds, managed funds, and investment funds were introduced in 2017. The framework requires banks to take account of a fund's leverage when determining risk-based capital requirements associated with the investment and more appropriately reflecting the risk of the fund's underlying investments, including the use of a 1,250% risk weight for situations in which there is not sufficient transparency.

Limiting large exposure to external and internal counterparties

A framework for limiting large exposure to external and internal counterparties was implemented in 2018.

In the UK, as of 2024, the Bank of England was in the process of implementing the Basel III framework on large exposures.

Capital standards for securitisations

A revised securitisation framework, effective in 2018, aims to address shortcomings in the Basel II securitisation framework and to strengthen the capital standards for securitisations held on bank balance sheets. The frameworks addresses the calculation of minimum capital needs for securitisation exposures.

Basel III reclassifies physical gold from a Tier 3 asset to a Tier 1 asset.

Interest rate risk in the banking book

New standards for "interest rate risk in the banking book" (IRRBB) became effective in 2023. Banks are required to calculate their exposures based on "economic value of equity" (EVE) and "net interest income" (NII) under a set of prescribed interest rate shock scenarios. The standards thereby deal with the risks associated with a change in interest rates, including interest rate gaps, basis risk, yield curve risk, and option risk.

The bank's exposure to IRRBB is then equal to the largest negative change in EVE across all scenarios - in essence, the theoretical risk to the economic value of a bank's equity from a change in interest rates.

IRRBB falls under Pillar II.

Fundamental Review of the Trading Book

The Fundamental Review of the Trading Book set minimum capital requirements for market risk in the trading book based on a better calibrated standardised approach or internal model approval (IMA) for an expected shortfall measure rather than, under Basel II, value at risk.

Basel III: Finalising post-crisis reforms

Template:Prose The Basel III: Finalising post-crisis reforms standards cover further reforms in six areas:

• standardised approach for credit risk (SA-CR)
• internal ratings based approach (IRB) for credit risk
• Credit valuation adjustment risk (the process through which counterparty credit is valued, priced and hedged - using a standardised approach);
• Operational risk - A standardised approach for operational risk for a bank based on income and historical losses
• Output floor - Replaces Basel II output floor with a more robust risk-sensitive floor and disclosure requirements
• Finalised Leverage ratio framework - buffer for global systemically important banks, definitions and requirements, exposure measures for on-balance sheet exposures, derivatives, securities financing transactions and off-balance sheet items.

Other principles and requirements

• The quality, consistency, and transparency of the capital base was raised.
  • Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings. This is subject to prudential deductions, including goodwill and intangible assets.
  • Tier 2 capital: supplementary capital, however, the instruments were harmonised.
  • Tier 3 capital was eliminated.
• The risk coverage of the capital framework was strengthened.
  • Promoted more integrated management of market and counterparty credit risk
  • Added the credit valuation adjustment–risk due to deterioration in counterparty's credit rating
  • Strengthened the capital requirements for counterparty credit exposures arising from banks' derivatives, repo and securities financing transactions
  • Raised the capital buffers backing these exposures
  • Reduced procyclicality and
  • Provided additional incentives to move OTC derivative contracts to qualifying central counterparties (probably clearing houses). Where a bank acts as a clearing member of a central counterparty for its own purposes, a risk weight of 2% must be applied to the bank’s trade exposure to the central counterparty.
  • Provided incentives to strengthen the risk management of counterparty credit exposures
  • Raised counterparty credit risk management standards by including wrong way risk
• A series of measures was introduced to promote the buildup of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers").
  • Measures to address procyclicality:
    • Dampen excess cyclicality of the minimum capital requirement;
    • Promoted more forward looking provisions;
    • Conserved capital to build buffers at individual banks and the banking sector that can be used in stress; and
  • Achieved the broader macroprudential goal of protecting the banking sector from periods of excess credit growth.
    • Requirement to use long-term data horizons to estimate probabilities of default
    • downturn loss given default estimates, recommended in Basel II, to become mandatory
    • Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements.
    • Banks must conduct stress tests that include scenarios of widening yield spreads in recessions.
  • Stronger provisioning practices (forward-looking provisioning):
    • Advocates a change in the accounting standards towards an expected loss (EL) approach (usually, EL amount := LGD*PD*EAD).

U.S. modifications

In the U.S., Basel III originally applied not only to banks but also to all institutions with more than US$50 billion in assets, although later modifications increased the threshold.

• "Risk-based capital and leverage requirements" including first annual capital plans, conduct stress tests, and capital adequacy "including a tier one common risk-based capital ratio greater than 5 percent, under both expected and stressed conditions"
• Market liquidity, first based on the United States' own interagency liquidity risk-management guidance issued in March 2010 that require liquidity stress tests and set internal quantitative limits.
• The Federal Reserve Board itself conducts stress tests annually using three economic and financial market scenarios. Institutions are encouraged to use at least five scenarios reflecting improbable events, and especially those considered impossible by management, but no standards apply to extreme scenarios. Only a summary of the three official Fed scenarios including company-specific information is made public but one or more internal company-run stress tests must be run each year with summaries published.
• Single-counterparty credit limits to cut credit exposure of a covered financial firm to a single counterparty as a percentage of the firm's regulatory capital. Credit exposure between the largest financial companies is subject to a tighter limit.
• Early remediation requirements to ensure that financial weaknesses are addressed at an early stage. One or more triggers for remediation—such as capital levels, stress test results, and risk-management weaknesses. Required actions vary based on the severity of the situation, but include restrictions on growth, capital distributions, and executive compensation, as well as capital raising or asset sales.

Timelines

Implementation by the Basel Committee on Banking Supervision

In April 2014, the Basel Committee on Banking Supervision (BCBS) released the final version of its "Supervisory Framework for Measuring and Controlling Large Exposures" (SFLE) that builds on longstanding BCBS guidance on credit exposure concentrations.

In March 2016, the BCBS released the second of three proposals on public disclosure of regulatory metrics and qualitative data by banking institutions. The proposal requires disclosures on market risk to be more granular for both the standardized approach and regulatory approval of internal models.

In January 2013, the BCBS extended not only the implementation schedule to 2019, but broadened the definition of liquid assets.

In December 2017, the implementation of the market risk framework was delayed from 2019 to 2022. Implementation of the Basel III: Finalising post-crisis reforms, the market risk framework, and the revised Pillar 3 disclosure requirements were extended several times and will be phased-in by 2028.

Capital requirements timeline

Date	Milestone: Capital requirement
2014	Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital requirements.
2015	Minimum capital requirements: Higher minimum capital requirements were fully implemented.
2016	Conservation buffer: Start of the gradual phasing-in of the conservation buffer.
2019	Conservation buffer: The conservation buffer was fully implemented.

Leverage ratio timeline

Date	Milestone: Leverage ratio
2011	Supervisory monitoring: Developed templates to track the leverage ratio and the underlying components.
2013	Parallel run I: The leverage ratio and its components must be tracked by supervisors but not disclosed and not mandatory.
2015	Parallel run II: The leverage ratio and its components must be tracked and disclosed but not mandatory.
2017	Final adjustments: Based on the results of the parallel run period, any final adjustments to the leverage ratio.
2018	Mandatory requirement: The leverage ratio became a mandatory part of Basel III requirements.

Liquidity requirements timeline

Date	Milestone: Liquidity requirements
2011	Observation period: Developed templates and supervisory monitoring of the liquidity ratios.
2015	Introduction of the LCR: Initial introduction of the Liquidity Coverage Ratio (LCR), with a 60% requirement. This will increase by ten percentage points each year until 2019. In the EU, 100% will be reached in 2018.
2018	Introduction of the NSFR: Introduction of the Net Stable Funding Ratio (NSFR).
2019	LCR comes into full effect: 100% LCR.

Country-specific timelines of implementation

The Federal Reserve implemented the Basel III standards in the U.S., with some modifications, via a proposal first published in 2011. Final rules on the liquidity coverage ratio were published in 2014.

The implementing act of the Basel III agreements in the European Union was Directive 2013/36/EU (CRD IV) and Regulation (EU) No. 575/2013 on prudential requirements for credit institutions and investment firms (CRR), which was approved in 2013 and replaced the Capital Requirements Directives (2006/48 and 2006/49).

Impact

Projected macroeconomic impact

An OECD study, released in February 2011, projected that all else equal, the medium-term impact of Basel III implementation on economic growth would be in the range of −0.05% to −0.15% per year due to increased bank lending spreads of 15 to as much as 50 basis points. The study hypothesized that the effect can be negated by a decrease in monetary policy rates of 30 to 80 basis points

In June 2024, a study by PwC projected that implementation of the Basel III Endgame requirements would reduce economic growth in the U.S. by 56 basis points via reduced returns to bank shareholders and increased costs to consumers and businesses.

In the United States, higher capital requirements resulted in contractions in trading operations and the number of personnel employed on trading floors.

Shortcomings

Basel III continues to allow large banks to calculate credit risk using internal models and for setting overall minimum capital requirements too low.

While institutions have many legitimate risk reduction reasons to deal in derivatives, such as for hedging or insurance, the Basel III accords:

• treat insurance buyers and sellers equally even though sellers take on more concentrated risks (literally purchasing them) which they are then expected to offset correctly without regulation
• do not require organizations to investigate correlations of all internal risks they own
• do not tax or charge institutions for the systematic or aggressive externalization or conflicted marketing of risk—other than requiring an orderly unravelling of derivatives in a crisis and stricter record keeping

Basel III continues to propagate a "too big to fail" status among financial institutions and the required stress tests do not account for unpredictable black swan theory events.

Basel III also increases incentives of banks to game the regulatory framework.

The increased capital requirements can reduce banks' abilities to make mortgage and small business loans.

In 2019, Michael Burry noted that Basel III affects the banks' willingness to take certain risks, even if doing so would be prudent.

According to the Institute of International Finance, Basel III reduces economic growth and adds to the paper burden and risk inhibition by banks.

Further reading

• Cecchetti, Stephen, Jeremy Kress, and Kermit Schoenholtz. 2025. "Basel Endgame: Bank Capital Requirements and the Future of International Standard Setting." Journal of Economic Perspectives 39 (3): 149–70.

External links

• Basel III: A global regulatory framework for more resilient banks and banking systems, December 2010
• Basel III: International framework for liquidity risk measurement, standards and monitoring, December 2010
• Bank Management and Control, Springer Nature – Management for Professionals, 2020
• U.S. Implementation of the Basel Capital Regulatory Framework Congressional Research Service, April 9, 2014
• Revisions to the Basel Securitisation Framework, December 2012
• Basel III in India
• Basel III and SME Lending: Thematic Focus