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Basel 3 reforms (The concern of regulators since the global financial…

- - - - • the liquidity coverage ratio (LCR), which requires banks to have sufficient high-quality liquid assets to fund projected cash flows in a hypothetical 30-day system-wide liquidity shock; and
      - • the net stable funding ratio (NSFR) requirement, which aims to match the duration of banks’ liabilities and assets more closely by comparing liabilities considered stable (e.g. deposits and long-term debt) with longer-term assets (e.g. loans).
      - the Australian market has very low levels of government debt and other non-bank securities, which are classified as high-quality liquid assets under the Basel III regime. This would make it difficult for Australian banks to have sufficient liquid assets to meet the proposed NSFR ratio.
        
        Recognising the limited availability of government securities and a short supply of other eligible liquid assets, the Reserve Bank of Australia (RBA) and APRA jointly stated that Australian banks would be able to borrow directly from the RBA if they had insufficient liquidity to survive a major economic shock (Barry 2010). Since 1 January 2015 banks have been able to access a committed liquidity facility (CLF) created by the RBA and APRA.
        
        However, this service does not come free
        of charge. Prior to accessing this facility, banks must demonstrate to APRA that they have taken all reasonable steps towards meeting the required LCR through their own balance sheet management. Banks also need to offer collateral and pay a fee to the RBA.
        
        The proposed CLF generated some controversy in Australia in early 2013, due to the perception that the RBA and APRA were effectively creating a ‘backstop’ facility and increasing the risk of ‘moral hazards’ in the Australian financial system (Joye 2013). A ‘moral hazard’
        
        A small number of other countries may be in a similar position to Australia, in not having sufficient liquid government bonds available to satisfy the new liquidity standards, and may need to consider solutions similar to the CLF implemented in Australia.
        
        One potential solution for countries with relatively small debt markets could be covered bonds. These are debt instruments in which banks could invest and that would rank ahead of depositors in claims on banks’ assets. Since December 2010
        
        Australia has allowed such instruments to be issued. To protect the depositors, the Australian government established the Financial Claims Scheme. This scheme has attracted some criticism, but it has helped deepen the bond market and increase the availability of high-quality liquid assets in Australia (Hepworth 2010).
  - - - Basel III measures aimed at individual banks
        
        QCRS
        
        Stricter requirements on the quality of capital that banks must hold
        
        The focus of assessing whether a bank has adequate capital will be on its common equity. Previously, the definition was broader, but during the GFC it was recognised that credit and market losses are absorbed by common equity. It is this measure that market participants appear to be focusing on in assessing a bank’s resilience.
        
        Capital ratio
        
        The minimum common equity requirement is to increase from 2 per cent to 4.5 per cent, with a capital conservation buffer of 2.5 per cent, bringing the total common equity requirement to 7 per cent.
        
        Increased coverage of risks, especially related to capital market activities Some examples of the exposures that will be subject to increased scrutiny include the following:
        
        –– Trading book exposures will be subject to a stressed value at risk management.
        –– Securitisation exposures will be subject to capital charges similar to those for the banking book. (Previously, these were given a concessional treatment.) Counterparty credit risk exposures are to be stress-tested.
        –– Banks will be required to hold capital for mark-to-market losses associated with the deterioration of a counterparty’s credit quality.
        –– Higher capital requirements will apply to over-the-counter (OTC) activities, which should increase incentives to use central counterparties and exchanges. However, this will need to be appropriately managed to avoid concentrations of risk.
        
        Stronger supervision, risk management and disclosure standards
      - Basel III measures aimed at the banking system as a whole
        
        NASL
        
        Leverage ratio
        
        The intention of the leverage ratio is to provide a check mechanism against a system-wide build-up of seemingly low-risk exposures that can nonetheless pose substantial threats to broader financial stability. This measure is being phased in, but it is not yet fully known how it will be applied. The specifics of the leverage ratio were issued in January 2014, with the first disclosure by banks in 2015 and implementation by banks by 2018.
        
        Supervision of the 2.5 per cent conservation buffer
        
        Distributions and bonuses by banks will be limited if the conservation buffer falls below
        2.5 per cent. The aim is to conserve capital in a downturn and rebuild it during the upswing.
        
        Additional loss absorbency capital for systemically important banks
        
        A bank that is determined to be systemically important will be required to hold additional capital beyond the standard Basel III requirements. The Basel Committee released guidance for domestic and global systemically important banks in late 2012. Twenty-eight banks were named as globally systemically important, with the requirement that these banks should hold additional capital buffers of between 1 per cent and 2.5 per cent of Common Equity Tier
        1 (CET 1) capital, depending on how relatively globally important each bank is. The Basel Committee has adopted a less prescriptive methodology for domestic systemically important banks, stating that while it would expect these banks to also carry additional capital vis-à-vis other banks, it would be up to each national regulator (e.g. APRA in Australia) to determine exactly what the additional capital requirements would be for such banks.
        
        Non-regulation-based liquidity management tools
        
        As banks and other corporations increasingly focus on liquidity management, a number of market-originated tools have emerged to help companies with this task.
- - - - • Small-medium organisations (SMOs) feel the effect most: banks reluctant to lend to them (high credit risk).
      - Loans to SMOs are relatively high-risk assets, and banks can improve their capital adequacy ratio by limiting loans to SMOs.
      - accountants
        
        Accountants should be aware of this risk to SMOs, when giving advice on financial planning.
        Accountants should also be aware of risk and risk management when giving advice.
        They should also understand the disclosure requirements in financial reporting relating to risk and financial instruments.
        
        Risk management
        Financial reporting
        Finance planning
      - The equity market for SMEs is not well developed, making SMEs reliant mainly on debt for funding. At the same time, SMEs’ debt-funding options are generally limited to commercial banks. For example, SMEs and smaller corporates are generally not able to access debt markets such as the US high-yield debt market. The high-yield debt market allows non-bank institutions to participate directly in corporate debt issuing, but it is only open to corporations of a certain size. If SMEs experience credit rationing, it could hinder their development.
    - - Australian Banks
        
        • Main elements of liquidity reforms apply to Australian banks from January 2014.
        • APRA (2013): Australian banks have to be 100% compliant with the Basel III liquidity coverage ratio rules by 2015.
        • 2013: APRA issued Prudential Standard APS 210 Liquidity and Prudential Practice Guide APG 210 Liquidity.
      - • Raise more capital.
        • Reduce total assets (reduce lending).
        • Reduce amount of high-risk assets.
      - Banks may also increase the cost of providing funding to corporates.