Are Emerging Markets Prepared For BASEL 3.0 Version?

The aftermath of the 2008 global financial crisis had regulators and policymakers swing into action quickly to restructure and regulate the financial sector. One such development was the Basel Committee on Banking Supervision (BCBS) agreement for a resilient banking sector, which is referred as ‘Basel III’. Ironically, since the landmark 1988 Basel Accord, also known as Basel I regime, there have been over 30 banking crises in Basel Committee-member countries.

The Holy Grail for banks which was designed to strengthen banking sectors’ financial health, was overhauled in 2004 and version 2.0, known as ‘Basel II’ following a three pillar principle was introduced. It meant to align banking capital with evolving risk and credit management practices in the face of the recent financial innovations. However the multiple factors at work during the crisis – proliferation of complex derivative products, very high leverage, inadequate risk management and the idea of ‘too big to fail’, suggest that Basel norms have not worked as intended.

Things in the financial world have changed dramatically in the last two decades, with emerging markets leading global growth and where one in every three banks is located. Their financial markets are still evolving and solutions that fix the problems of developed markets are certainly not a good idea for emerging markets. This is certainly what the new accord,
Basel ‘III’ does. Banking sector in emerging markets is fundamentally different in nature and commonly associated with a low level of financial development. Tightening of capital and liquidity norms, both higher levels of quantity and quality of capital (common equity and retained earnings) and mandating higher liquid assets and long-term funding, could act as a drag as the financial markets are not deep enough to support capital raising. As far as designing and implementing counter-cyclical buffers is concerned, it is important to recognize the significant differences between the required rates of credit growth in advanced and emerging markets. Identifying and developing appropriate frameworks for risk measurement also remains a huge challenge for banks in emerging markets compounded by lack of quality data and knowledge to conduct meaningful stress tests.

Despite the challenges, emerging market banks have made good progress in implementing Basel III rules. Some of the African countries are already within the tier 1 capital ratio of six per cent or more of Risk-Weighted Asset (RWA), mandated by Basel III capital requirements. Most BRICS (Brazil, Russia, India, China and South Africa) nations, have already adopted the Basel III framework of capital adequacy rules for banks.

Many emerging markets have already established robust regulatory regimes for liquidity, learning the lessons from the previous financial crisis. In order to be effective there, Basel III regime should be tailored as per the local conditions. After all, the one-size-fits-all strategy is not a very good idea.

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About the Author

Avra Paul has around 9 years of experience in providing enterprise wide analytical solutions across various banks. He has functionally leaded multiple Basel implementations for banks across the globe. His focus area has been risk and compliance covering credit, market and operational risk.

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