Basel III capital adequacy requirements FAQs
The Reserve Bank’s Regulatory Impact Assessment (RIA) of Basel III implementation in New Zealand shows that adjusting existing requirements to the Basel III standards can be easily justified.
The key benefit of higher capital ratios is the reduced probability that there will be a financial crisis. Higher capital ratios also increase the taxable income of New Zealand banks and reduce the potential for government payments to creditors in a bank bailout scenario. On the cost side, consideration was given in the RIA to the possibility that bank lending rates may increase in the short term as banks seek to maintain their return on capital. This effect is assumed to be temporary, as shareholders gradually adjust their expectations downward.
The Basel III standards for bank capital distinguish between Tier 1 and Tier 2 capital. Tier 1 capital is permanently and freely available to absorb losses without the bank being obliged to cease trading, while Tier 2 capital generally only absorbs losses in a winding up. Within Tier 1 capital, Common Equity Tier 1 (CET1) has greater loss absorbing capability than the other Tier 1 instruments referred to as Additional Tier 1 (AT1) capital.
Capital ratios are used to define minimum capital requirements for each of: common equity, tier 1 capital (CET1 plus AT1), and total capital (tier 1 plus tier 2), as a percentage of risk-weighted assets. In addition to the minimum capital requirements, Basel III introduces a capital conservation buffer of 2.5 percent of risk-weighted assets. There are increasing constraints on capital distributions where a bank’s capital level falls within the buffer range. The table below shows the Reserve Bank’s capital ratio requirements prior to 1 January 2013 and the Basel III capital ratios that have been adopted by the Reserve Bank.
New capital ratio requirements and buffers
(as a percentage of risk weighted assets)
|Common equity||Tier 1 capital||Total capital|
|RBNZ minimum ratios prior to 1 Jan 2013||4.0%||8.0%|
|New minimum ratios||4.5%||6.0%||8.0%|
|New minimum ratio plus conservation buffer||7.0%||8.5%||10.5%|
Consistent with the Basel III standard, the Reserve Bank will also have the discretion to apply a countercyclical buffer of common equity during periods of excessive credit growth. The purpose would be to help protect the financial system during the subsequent downturn. The countercyclical buffer, when in effect, would be an extension of the conservation buffer. While this buffer is indicatively expected to vary between 0 and 2.5% of risk-weighted assets, no formal limit will be set on the maximum size of the buffer (i.e. the size of the buffer will be determined according to circumstances).
To qualify as regulatory capital, an instrument must satisfy various criteria set out in the Reserve Bank’s capital adequacy requirements. Separate criteria are specified for the different types of capital instrument (i.e. Common Equity Tier 1 capital, Additional Tier 1 capital and Tier 2 capital). A key difference between the Basel II requirements, in place before 1 January 2013, and Basel III is the loss absorbency criteria that apply to Additional Tier 1 capital and Tier 2 capital instruments. These criteria mean that the terms and conditions of all non-common equity regulatory capital instruments must contain a provision that requires such instruments to be written off or convert into ordinary shares upon the occurrence of a trigger event. The trigger event is when the bank is, in the opinion of the Reserve Bank, non-viable. Also, for a bank in statutory management, the statutory manager could trigger the requirement.
The Reserve Bank’s implementation of Basel III capital requirements took effect from 1 January 2013. However some transitional measures apply. In particular the conservation buffer and the countercyclical buffer framework will not apply until 1 January 2014.
Also existing regulatory capital instruments that do not meet the Reserve Bank’s Basel III requirements may be included in regulatory capital on a transitional basis from 1 January 2013 subject to certain eligibility requirements and in line with the amortisation schedule shown below. The amortisation schedule applies separately for the sum of all Tier 1 instruments that no longer meet the criteria for recognition as Tier 1 capital, and for the sum of all Tier 2 instruments that no longer meet the criteria for recognition as Tier 2 capital.
|Year commencing||Percentage of instruments that may be included in regulatory capital|
|1 January 2014||80|
|1 January 2015||60|
|1 January 2016||40|
|1 January 2017||20|
|1 January 2018||0|
Other aspects of Basel III not discussed above are the counter-party credit risk requirements and Basel III disclosure requirements. These requirements took effect from 31 March 2013.