Basel I was an international accord that set minimum capital level requirements for banks for the first time, with the intent of ensuring lenders were well capitalized and depositors well protected in the event of economic downturns. As the sophistication of the financial system increased overtime, regulators recognized the necessity to update Basel I to align required minimum capital levels more closely with financial institutions’ real risk profiles. This resulted in the release of Basel II, which allowed lenders to use their own risk measurement models to calculate required regulatory capital.
As a result of the financial crisis of 2007-2008, updates to the Basel Accords were released again as Basel III, which addresses deficiencies in financial regulation. The intent of Basel III is to establish minimum standards that would protect financial institutions from requiring public support in the form of government bailouts if a financial crisis of the same magnitude occurred again. The two overriding changes from Basel II to III are an increase in capital requirements and the introduction of a minimum leverage ratio, both of which serve to raise the quality and transparency of financial institutions’ capital bases.
Basel III will require banks to hold 4.5% of common equity and 6% of Tier I capital, an increase from 2% and 4%, respectively. In addition to the common equity and Tier I capital increases, Basel III also introduces a discretionary countercyclical conservation buffer where national regulators can require an additional 2.5% capital increase during periods of high credit growth. The timeline for implementation stretches to 2019 when all capital requirements will be in effect. Minimum capital requirements (i.e. common equity and Tier 1 capital) will be gradually phased-in starting 2013 and fully implemented by 2015, while the conservation buffer phasing-in period begins 2016 and is fully implemented in 2019.
The timeline for implementing the new capital requirements are clearly defined by the Committee, however, the minimum leverage ratio requirements are still being determined. Testing by regulators is scheduled to occur through 2015 with final adjustments to any decisions made by 2017. The leverage ratio requirement will become mandatory under Basel III in 2018.