Financial Risk Management

CHAPTER 5A Guided Tour of the Basel III Framework

THE RATIONALE FOR A NEW REGULATORY FRAMEWORK

The BCBS (2010) document is the Basel Committee's reform package to address the market failures revealed by the financial crisis. The aim is to “improve risk management and governance as well as strengthen banks' transparency and disclosures” (BCBS, 2010, p. 1).

At the peak of the financial crisis, the markets lost confidence in the solvency and liquidity of the banking sector as a whole. As a result, many banking institutions weakened and, due to spillover effects, this weakness in the banking system was quickly transmitted to the global economy. It should be noted, however, that a regulatory reform such as Basel III, focused on higher capital and liquidity requirements, affects banks' lending rates and, in so doing, affects the path of economic activity. This spillover effect or transmission belt is illustrated in Figure 6.

FIGURE 6 Tracing the real economy implications of tighter financial conditions

The Basel III international regulatory framework initiates both micro‐ and macro‐prudential regulation measures. Both approaches share the same goal of strengthening the banking system’s resilience. The micro‐prudential measures aim to increase the bank‐level resilience to periods of stress. They deal with individual banking institutions. In contrast, the macro‐prudential approach ...