Until I heard of Basel III yesterday, I didn’t know there was a Basel I or a Basel II. The three Basel accords exist to give banking systems around the world a framework in which they can operate successfully, and the latest of these accords introduces new requirements for managing risk.
For the most part, the banking industry around the world would like to prevent a new collapse like the recent meltdown that affected the entire world. Through the Basel accords, governments will be encouraged to adopt the standards set forth and codify them into law. This is a long process; Basel II, published initially in June 2004, is still not recognized withing local regulation across the globe.
Don’t worry about the banks, however. They have sufficiently lobbied the committee developing Basel III. Banks will be able to implement new requirements over time, phasing in any changes that might result in lower net profits. For example, banks must keep a cash reserve to offset risky investments. Today, banks need to have only 2% of their balance sheet reserved, but with Basel III, this requirement of Tier 1 capital would increase to 4.5% in 2013 and finally 6% in 2019. In addition, banks will need to hold onto an addition 2.5% in a rainy-day fund that will help keep the bank alive in barren years.
Banks that are too big to fail — noted in Basel III as “systemically important banks” — may have stricter regulations, as well.
Basel III will change the way derivatives are traded. While there may not be much difference from an investor’s point of view, derivatives will most likely require a clearinghouse. You should be able to easily locate a price for a derivative, just like you can for a stock that is traded on an exchange like the NYSE.
There be no way to know if Basel III and other regulations are successful. Another financial meltdown and accompanying recession is likely to happen some time in the future. Either regulations will become lax and allow the banking system to fail or the collapse will occur in some other form that governments have yet to prepare for.
New bank rules to curb risk, CNNMoney, September 12, 2010
Global banking rules aim to balance safety, growth, Greg Keller, AP, September 12, 2010
Updated February 10, 2011 and originally published September 13, 2010. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.