Canada: Basel Committee Releases Basel III Rules Text

Last Updated: December 22 2010
Article by Blair W. Keefe

The Basel Committee yesterday issued the Basel III rules text, which contains details of the global regulatory standards for bank capital adequacy and liquidity agreed to by the Governors and Heads of Supervision (GHOS) and endorsed by the G20 leaders at their November Seoul summit. The Committee also published the results of its comprehensive quantitative impact study.

The rules text is consistent with the September 12 agreement reached by GHOS on capital, but includes some important clarifications and further details on the operation of the new requirements.

This bulletin highlights some of the more important clarifications related to deductions from capital and the transition provisions relating to non-qualifying capital instruments.

The rules text does not include the additional entry criteria relating to "gone concern" or non-viability contingent capital (NVCC) features that are expected to be required for all non-common capital instruments at a future date. These criteria are expected to be approved at the GHOS meeting in January 2011 and will then be added to the Basel III rules text. In addition, the Basel Committee continued to indicate that systemically important banks should have additional loss-absorbing capacity beyond the minimum requirements set out in Basel III; this capacity could include a combination of capital surcharges, contingent capital and bail-in debt. The Committee, working with the Financial Stability Board, intends to make some proposals in this regard in the first half of 2011.

Significant Clarifications and Additional Details

Minority (non-controlling) interests and other capital issued by consolidated subsidiaries that is held by third parties

As previously announced, minority interests arising from the issue of common shares to third parties by a fully consolidated banking subsidiary may be recognized as common equity at the parent bank level (i) if the instruments otherwise qualify; and (ii) only to the extent of the minimum capital requirements of that subsidiary. The rules text also provides that non-common tier 1 and tier 2 capital instruments will be afforded similar treatment in a banking subsidiary and other consolidated non-bank subsidiaries. More detail is also provided for the determination of the minimum capital requirements of a banking subsidiary, and a helpful illustrative example is included in Annex 3 to the rules text.

Portfolio investments in capital instruments of other financial institutions

As previously proposed, investments held by banks in capital instruments of other banks and financial and insurance entities must be deducted using the "corresponding deduction approach" for each component of capital to the extent that the aggregate of these investments exceeds 10% of the corresponding capital component of the bank. Investments for this purpose include direct, indirect and synthetic holdings of capital (including the relevant portion held through any index securities), in both the banking book and the net long positions in the trading book.1 However, investments in non-capital instruments (e.g., senior debt instruments) are not included and underwriting positions held for five working days or less can also be excluded from the calculation.

Minority investments and non-consolidated (for regulatory purposes) subsidiaries

If a bank owns more than 10% of the issued common shares of any financial institution that does not consolidate for regulatory capital purposes, the amount of the investment must, generally, also be deducted using the corresponding deduction approach. However, as set out in the September agreement, instead of a full deduction, these investments may receive limited recognition in the calculation of the common equity tier 1 capital up to 10% of the bank's common share equity. However, these investments – when aggregated with mortgage servicing rights and deferred tax assets that arise from temporary differences – must continue to be deducted on a phased basis commencing on January 1, 2013, to the extent that the aggregate of the three items exceeds 15% of the common share equity.

Treatment of non-qualifying capital instruments

As previously announced, capital instruments that no longer qualify as capital will be phased out beginning January 1, 2013. Recognition of these instruments will be capped at 90% of the aggregate amount outstanding on that date, with the cap reducing by 10 percentage points in each subsequent year. The calculation of the cap will be applied to non-common tier 1 and tier 2 capital separately and will refer to the total amount of instruments outstanding that no longer meet the relevant criteria. If an instrument is redeemed after January 1, 2013, the nominal amount serving as the base will not be reduced. Therefore, through an orderly redemption of non-qualifying capital after 2013, banks should be able to significantly mitigate the amount of any capital "haircut" that will be required under these transition rules. In addition, in general,2 an instrument that has a call or a step-up, and that is not called at its effective maturity date, will continue to be recognized as that tier of capital, provided that it subsequently meets the new criteria for that type of capital. However, if it does not meet the new criteria and is not called, it will generally be fully derecognized from that tier of capital on January 1, 2013 or on its effective maturity date.

The Office of the Superintendent of Financial Institutions (OSFI) indicated, in a letter to banks yesterday, that since the Basel III rules currently provide that the cap on non-qualifying capital will be applied to tier 1 and tier 2 capital instruments separately and refers to the total amount of non-qualifying capital, the finalization of the rules related to NVCC may affect the operation of the cap on tier 1 and tier 2 nonqualifying instruments. In addition, OSFI indicated that when the NVCC requirements have been finalized, it intends to issue guidance clarifying the phasing out of all non-qualifying instruments and stating its expectations regarding the rights of redemption under regulatory event clauses.

Capital Conservation Buffer

The rules text also provides additional clarification on the operation of the capital conservation buffer. In particular, earnings will be defined as distributable profits calculated after the tax that would have been reported had none of the distributions been paid. In addition, a bank that does not have positive earnings and has a common tier 1 ratio of less than 7% would be restricted from making any distributions. The rules text indicates that the framework is intended to be applied at a consolidated level, although national supervisors have the option of applying a regime at a solo level to conserve resources in a particular part of the group. Finally, the rules text indicates that, in normal times, banks should not choose to operate in the buffer range simply to compete with other banks and win market share. To ensure that this does not happen, supervisors have the additional discretion to impose time limits on banks operating within the buffer range on a case-by-case basis.

Countercyclical Capital Buffer

Despite growing controversy,3 yesterday the Committee also issued Guidance for national authorities operating the countercyclical capital buffer as a supplement to the requirements set out in the Basel III rules text. The primary aim of the countercyclical capital buffer regime is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth that have often been associated with the buildup of system-wide risk. In addition to providing guidance for national authorities, the Guidance is intended to help banks understand and anticipate the buffer decisions in the jurisdictions to which they have credit exposures. The Basel rules text also indicates that the Basel Committee is further reviewing whether the countercyclical capital charge must be satisfied by common equity tier 1 or whether it could also be satisfied with other fully loss-absorbing capital (and, if so, what form that would take).

Footnotes

1 Investments in capital instruments of the bank will need to be fully deducted, calculated in a similar manner.

2 Important specific transition issues depend on when the instrument is callable or has a step-up.

3 For example, Nick Le Pan, former OSFI Superintendent and a former vice chairman of the Basel Committee, has been quoted as follows:

"We ... have not proven we can forecast turning points in the credit cycle with a reasonable degree of accuracy. So implementing the buffer will likely act as a permanently higher minimum, and will detract from, not support financial stability."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions