Question

1. The Basel III accord requires financial institutions to have two types of buffers. Critically discuss what these buffers are, their differences and objectives.

Word Count (500 words)                        

Answer 1

TYPES OF BUFFERS IN BASEL III ACCORD

Basel III is an international accord with set of measures or reforms developed by Basel Committee on Banking Supervision to mitigate the risk in the international banking sector. The objective of Basel III norms is to promote financial stability. It requires banks to maintain adequate leverage ratio and reserve capital. Basel Committee on Banking Supervision is formed by banking regulatory authorities of various countries all over the world.

Basel III introduced two types of buffers. They are;

1. Capital Conservation Buffer : This buffer was introduced to ensure that the banks have adequate amount of capital that can be used when the bank incur losses. The minimum required capital is 2.5% of risk weighted assets. When the buffer falls below 2.5%, there will be constraints on capital distribution in order to replenish the buffer. Constraints increase as the buffer decreases.
2. Countercyclical Capital Buffer : This is an extension to Capital Conservation Buffer. It was introduced to protect the banks from the risk of excess credit growth. It ensures that the banks maintain a flow of risk in the economy. The buffer rate varies between 0 to 2.5% of risk weighted assets. Basel III requires banks to calculate and publish Countercyclical Capital Buffer requirements. Similar to Capital Conservation Buffer, distribution restrictions are required when this buffer falls below minimum rate.