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Basel III and Our Banks: Overhaul, or Overdraft?

We look at how the tough, new Basel III rules may impact the largest U.S. banks.

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Basel III is an international accord whose objective is to standardize some banking safety requirements in a worldwide economy. The failure of Lehman Brothers, Northern Rock, and persistent troubles in Greece, Spain, Italy, Ireland and Portugal underscore how shock waves from one nation's problems can reverberate worldwide. Basel III may not be a panacea: It will not necessarily prevent a subsequent global financial crisis, in our opinion, nor will it completely insulate financial institutions from the unsettling effects of one. However, what Basel III will do is require banks to better prepare themselves for the unknown, including requiring them to bolster their balance sheets by holding additional capital.

For Basel III, capital requirements are front and center. Basel III will implement tougher capital requirements on banks � and both the quality and quantity of capital is being addressed. With regard to quality, banks will need to maintain Tier 1 common capital ratios now � eliminating the sometimes questionable ability of hybrid capital to absorb loan losses. The definition of core capital is also being tightened, and will exclude some items such as deferred tax assets. Second, the quantity of capital needed is going up. Minimum common equity will not need to be 7% of risk weighted asset by 2019, up from the current 2% standard. Tier 1 capital will need to reach 10.5%, up from the current 6% rate. The leverage ratio requirement remains rather modest at 3%, and should not be an issue for any of the U.S. banks. Institutions deemed to be systemically important will have to hold an additional buffer on top of these levels.

Jaime Peters does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.