Thursday, December02, 2021 / 12:28 PM / by Meristem Research / Header ImageCredit: Ecographics

Introduction

Basel III is the second phase of agreements reached bythe Basel Committee on Banking Supervision in response to the Global FinancialCrisis of 2007 - 2009. With Basel III comes increased minimum requirements forcapital adequacy, liquidity, and risk coverage. According to the Bank forInternational Settlement, the overall aim of Basel III is to strengthen theregulation, supervision, and risk management measures of banks. Basel III isalready operational in some countries, although the transition window is opentill 2028. In Nigeria, implementation (initially planned for 2020), was delayeddue to the outbreak of COVID-19. According to Nigeria's central bank however,the adoption of the Basel will commence in November 2021 and will runconcurrently with the preexisting (Basel II) regulatory framework for a periodof six months, extendable by three (3) months.

Capital Adequacy

Under the preexisting (Basel II) regulatory framework,Nigerian banks were required to maintain minimum total capital equal to 10%(15% for banks with international licence) of total risk-weighted assets. Thishas been retained under the new (Basel III) framework, however, the definitionof total capital has changed. While total capital was defined as the sum ofTier 1 and Tier 2 capital, the new definition splits Tier 1 capital into CommonEquity Tier 1 (CET1) and Additional Tier 1 (AT1) capital with required minimumratios for each class of Tier 1 capital. Generally, the capital requirementsunder Basel III are more stringent. In addition to raising the minimum CET1capital ratio from 2.50% (under Basel II) to 4.50%, Basel III requires banks tomaintain AT1 capital of 2.50%. This brings the minimum required total Tier 1capital ratio to 7.00%. AT1 capital however, need not exist. In which case,Tier 1 capital must be at least 7.50% of total risk-weighted assets for bankswith national license, and 11.25% for banks with international authorization.

Furthermore, the new regulatory guidelines requirebanks to maintain two additional buffers viz. Capital Conservation Buffer(CCB1) and Countercyclical Capital Buffer(CCB2). The CCB1 (pegged at 1.00% oftotal risk-weighted assets) is aimed at building capital buffers during normal('business as usual') times which could be drawn from in times of crisis. ForCCB2, the purpose is to enable banks build-up capital ahead of a systemicstress period. This will be determined by CBN from time to time, but will rangebetween 0% and 2.50% of total risk weighted assets.

Liquidity Requirements

Unlike the former Basel accords, Basel III containsspecific requirements for liquidity in the banking system with the introductionof the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR).The overall objective of the liquidity requirements is to ensure that banksmaintain enough liquidity to meet short term funding needs.

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