Hailey Johnson
Basel III is a set of global standards for capital adequacy and liquidity for banking organizations. While it is principally aimed at banks, these standards also apply to other financial institutions. The Basel Committee on Banking Supervision developed Basel III to supplement and replace the existing Basel II standards. The US and EU rules implementing Basel III closely follow many aspects of Basel III, but there are some key differences. The proposed Basel III Endgame banking rules have been a cause for concern for US banks, as they would increase capital requirements and limit their capacity for loans.
| Characteristics | Values |
|---|---|
| Applicability | Basel III applies to both US and non-US banks. |
| Objective | Basel III aims to establish a new set of global standards for capital adequacy and liquidity for banking organizations. |
| Regulatory Body | The Basel Committee on Banking Supervision developed Basel III. |
| Flexibility | Basel III is not legally binding but serves as a general basis for national or regional rule-making. It allows country regulators to adapt the guidelines to their needs. |
| Capital Requirements | Basel III increases the minimum requirement for Tier 1 Capital and introduces additional buffers for capital conservation and countercyclical needs. |
| Liquidity Standards | Basel III introduces a Liquidity Coverage Ratio and a Net Stable Funding Ratio to ensure banks have sufficient liquid resources and resilient funding sources. |
| Leverage Ratio | Basel III introduces a supplemental Non-risk Based Leverage Ratio as a backstop to Tier 1 Capital measures. |
| US Implementation | The US has implemented Basel III with certain differences from the EU approach, particularly in the treatment of residential mortgages and the scope of application. |
| Industry Response | US banks have lobbied against certain Basel III proposals, arguing that they are unnecessary and harmful to the industry and the economy. |
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What You'll Learn
US banks' concerns about the Basel III Endgame
Basel III Endgame is the final round of capital adequacy proposals from the Bank for International Settlements in Switzerland. The latest rules are part of a series aimed at keeping the banking industry safer after the 2008 Great Financial Crisis and the March 2023 regional banking crisis caused by the collapse of Silicon Valley Bank and First Republic Bank. The rules will require large U.S. banks, or those with $100 billion or more in total assets, to increase their capital by an aggregate of 16%, varying across banks based on their activities and risk profiles.
US banks have expressed concerns about the potential impact of the Basel III Endgame on their operations and the economy. They argue that additional capital requirements are unnecessary and will hurt lending and the economy. Banks have also questioned the need for stricter capital requirements, citing their resilience during the COVID-19 pandemic and their ability to pass the Fed's annual stress tests. They have aggressively lobbied against the proposals, including through advertising campaigns, and have threatened legal action.
Another concern for banks is the standardization of the capital framework related to different types of risks, including credit risk, market risk, operational risk, and financial derivative risk. Banks have warned that the proposed standardized approach could lead to significantly higher costs for some banks, particularly those that rely heavily on non-interest fee income, such as credit card and investment banking fees. There are worries that this could result in higher capital requirements for certain firms if not properly capped.
Furthermore, there are concerns about the potential constraints on residential mortgage lending due to the new rules. It is argued that this could lead to banks exiting the residential mortgage space, leaving non-banks to underwrite most home mortgages in the U.S., a trend that has already been observed since 2016.
In response to industry pressure, the U.S. Federal Reserve has made significant changes to the Basel III Endgame proposal. The Federal Reserve vice-chair for supervision, Michael Barr, announced plans to reduce Tier 1 capital requirements for globally systemically important banks to a 9% increase, down from the initially proposed 19%. This relaxation of the proposed capital measures has been welcomed by US banks.
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The impact of Basel III on US banks
Basel III Endgame (B3E) represents a significant shift for the US banking industry, introducing substantial changes to the regulatory capital regime. The proposal, scheduled to take effect in July 2025, grants US banks a two-year transition period to interpret and adapt to the new rules. During this period, banks must address new data and technology needs and adjust their business strategies and models.
The impact of B3E on US banks is expected to be profound, with the rules mandating a substantial increase in capital requirements. Large US banks, or those with $100 billion or more in total assets, will be required to increase their capital by an aggregate of 16%, with specific percentages varying based on their activities and risk profiles. This increase in capital buffers is intended to enhance the resilience of the banking industry and protect against future financial crises.
However, the proposed capital requirements have been met with resistance from big US banks, which argue that the higher standards are unnecessary and detrimental to their lending capacity. They assert that the stringent rules will limit their ability to provide mortgages, car loans, credit cards, and small business loans, ultimately increasing borrowing costs for individuals, governments, and businesses. Additionally, some banks contend that they have already demonstrated their ability to withstand various crises and that the new requirements will impose unnecessary constraints on their operations.
In response to these concerns, regulators highlight the recent bailouts of SVB and First Republic Bank, which cost taxpayers significant amounts. They argue that while the largest banks may appear stable, the broader banking sector remains vulnerable to potential risks. By standardizing the capital framework related to credit risk, market risk, operational risk, and financial derivative risk, regulators aim to enhance the industry's ability to manage diverse risks effectively.
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How Basel III differs from Dodd-Frank and Volker Rule
Basel III, which builds on the previous Basel accords, introduced new rules on liquidity, leverage, and systemic risk factors. Basel III requires banks to satisfy all of its enhanced requirements by 2019. However, formal implementation has not yet begun in the United States.
The Dodd-Frank Act, on the other hand, eliminates references to credit ratings in federal financial regulation. This may complicate the adoption of subsequent phases of the Basel framework, including Basel III. The Dodd-Frank Act also introduces several capital-related provisions unique to US financial institutions that are inconsistent with, and stricter than, the Basel III framework. For example, the criteria for capital instruments to qualify as regulatory capital differ from—and are stricter than—existing qualification standards.
Additionally, Section 616 of the Dodd-Frank Act requires a countercyclical buffer, similar to the optional countercyclical capital buffer proposed under Basel III. However, Section 165 of the Dodd-Frank Act includes a leverage requirement that differs from the leverage ratio requirement proposed under Basel III.
The Volcker Rule, as it relates to the Dodd-Frank Act, requires the mandatory deduction from capital of investments in hedge funds and private equity funds “organized and offered” by US banking entities.
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Basel III capital requirements and US banks' opposition
The Basel III agreement, introduced following the 2008 financial crisis, sets out minimum standards for internationally active banks. The US partially adopted Basel III in 2013 and later proposed the 'Basel Endgame' to implement the final rules agreed in 2017 and 2019.
The Basel Endgame, which includes a nearly 20% increase in capital requirements for the largest banks, has faced opposition from US banks. They argue that it would disproportionately harm non-publicly listed companies, middle-market private entities, and small businesses. There are also concerns about negative impacts on affordable housing, mortgage lending, and consumer lending. The proposal has faced opposition from both Democrats and Republicans, with some arguing that the additional capital requirements are unnecessary given the current resilience of the banking system.
Banks generally want to have just enough capital to satisfy regulators and other stakeholders, as higher capital requirements can lead to lower profits. While some argue that the US should raise large banks' capital requirements, opponents of the Basel Endgame worry that the changes would drive financial activity abroad and shift financial activity to non-banks.
Despite the opposition, US regulators have continued to move towards adopting the final Basel III standards. In 2023, the Fed, OCC, and FDIC published proposed changes to bank capital rules intended to align with Basel III. In 2024, the Federal Reserve outlined plans to reduce Tier 1 capital requirements under the Basel Endgame standards regime, a move welcomed by US banks.
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Basel III's implementation in the US and EU
Basel III is a comprehensive set of reform measures developed by the Basel Committee on Banking Supervision (BCBS) to strengthen regulation, supervision, and risk. The BCBS, of which the United States is a participating member, has developed international regulatory capital standards through a number of capital accords and related publications that have been in effect since 1988.
In July 2013, the Federal Reserve Board finalized a rule to implement Basel III capital rules in the United States. The reform package is designed to ensure that banks maintain strong capital positions, allowing them to lend to creditworthy entities even after unforeseen losses and during economic downturns. The final rule increases both the quantity and quality of capital held by U.S. banking organizations.
The implementation of Basel III in the EU is set to begin on January 1, 2025. The EU has already implemented the majority of the 2017 Basel III global standards, enhancing the resilience of its banking sector and increasing financial stability. The final elements for implementation in the EU were agreed upon in October 2021 and endorsed by the Council and Parliament. The EU's implementation introduces phase-in periods and adjustments to accommodate different banking structures and practices across member states.
The US implementation of Basel III is facing potential delays. US regulators have proposed July 2025 for compliance, with a multiyear transition period. Banks are given time to interpret the new rules, assess their impact, and adjust their business strategies. The implementation timeline in the US is uncertain as the final rules have not been published, and there is no definite timeline for their release.
In summary, while the US was an early adopter of Basel III standards, the EU is now leading the way with its comprehensive implementation, ensuring the resilience and stability of its banking sector. The US implementation is facing delays, and the final timeline is yet to be determined.
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Frequently asked questions
Basel III establishes a new set of global standards for capital adequacy and liquidity for banking organizations. Although principally aimed at banks, these standards also apply to certain other types of financial institutions.
The Basel III Endgame refers to the proposed banking rules that could impact U.S. banks. The rules would call for a nearly 20% increase in capital over already robust requirements.
The Basel III regulations require three main changes that Central Banks, including those in the US, are required to phase in over ten years. The first change increases the minimum requirement for Tier I Capital. The second change creates new liquidity standards. The third change creates a supplemental 3% Non-risk Based Leverage Ratio.
US banks have lobbied against the implementation of Basel III, arguing that the increased capital requirements are unnecessary and harmful for working families and small businesses.
