To strengthen global capital standards, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, have agreed to require banks to hold levels of common equity equal to at least 7% of their assets, much higher than the roughly 2% international standard or 4% standard for large U.S. banks.
Jean-Claude Trichet, President of the European Central Bank and Chairman of the Group of Governors and Heads of Supervision, said that “the agreements reached today are a fundamental strengthening of global capital standards...Their contribution to long term financial stability and growth will be substantial.”
The Committee's package of reforms, known as Basel III, will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. This reinforces the stronger definition of capital agreed by Governors and Heads of Supervision in July and the higher capital requirements for trading, derivative and securitisation activities to be introduced at the end of 2011.
A countercyclical buffer within a range of 0% - 2.5% of common equity or other fully loss absorbing capital will also be implemented according to national circumstances. The purpose of the countercyclical buffer is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth. For any given country, this buffer will only be in effect when there is excess credit growth that is resulting in a system wide build up of risk. The countercyclical buffer, when in effect, would be introduced as an extension of the conservation buffer range.
"The combination of a much stronger definition of capital, higher minimum requirements and the introduction of new capital buffers will ensure that banks are better able to withstand periods of economic and financial stress, therefore supporting economic growth," says Nout Wellink, Chairman of the Basel Committee on Banking Supervision and President of the Netherlands Bank.
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