Basel III aims to resolve the weaknesses and fill in the loopholes of the current Basel II framework that became apparent in the recent financial crisis. Basel III introduces significant reforms to the Basel II framework addressing both firm-specific risk as well as system-specific systemic risk factors. These reforms will come into full effect in January 2019 but there is a long period of transition into the revised framework that will begin from January 2013. These improvements should lead to a stronger capital position for the global financial system which should help it withstand significant periods of economic stress as experienced in the recent past which resulted in numerous bank failures and huge taxpayer bailouts.
On a micro-prudential, firm specific level the Basel III changes include a much stricter definition for capital including a capital conservation buffer and limitations on bonus and dividend distributions, stronger liquidity requirements, and improved & enhanced levels of risk coverage.
Basel III: Enhancements to Basel II: Firm-specific changes
Basel III also incorporates a macro-prudential system-wide layer, introducing measures such as a Leverage Ratio, a countercyclical capital charge to address the pro-cyclicality present within the Basel II framework, and specific requirements for systemically important financial institutions (SIFIs) and systemically important markets and market infrastructures (SIMIs) such as the OTC derivatives market.
Improvements to the process also include a much larger role for stress testing to capture risks of tail events and other systemic risk factors.
Basel III: Enhancements to Basel II: System-wide changes & Increased Stress Testing