A New Basel Bank Capital Framework

Abstract

We discuss the new Basel bank capital framework and the central bank's general approach to its practical implementation in the home-host context of Australia and New Zealand. Bank capital plays an important role in absorbing large financial losses, especially under severe downturn conditions. Financial regulators have an active interest in the actual quantum of bank capital and therefore set the minimum capital-adequacy requirements for banks. The new Basel bank capital regime refreshes the previous set of regulatory requirements and in turn serves as a new framework for thinking about the important role of capital in the banking system.

The primary policy objective of the new Basel bank capital framework is to increase the relative sensitivity of regulatory capital requirements to changes in the typical systemically important bank's exposure to financial risk. Specifically, marginal changes in regulatory capital-adequacy requirements should manifest in marginal changes in the typical bank's exposure to financial risk. The main types of financial risk include credit risk, operational risk, market risk, as well as procyclicality risk and strategic risk, the latter of which may or may not be part of the financial risk toolkit for practitioners. This risk modeling enhancement provides incentives for banks to upgrade their internal risk models, risk management systems, and operational processes.

The central bank is responsible for setting regulatory capital requirements for banks. For those locally-incorporated banks that have offshore banking operations, the central bank liaises closely with the relevant foreign supervisors to ensure a smooth and efficient Basel capital implementation for synchronous home-host coordination. For the purpose of this policy discussion, we pay particular attention to the major implications of risk parameter adjustment throughout the macroeconomic cycle. This insight connects macroprudential risk management and bank capital adequacy to the monetary policy sphere.

Keywords: Basel capital framework, bank capital adequacy, risk parameter adjustment, macroeconomic cycle, market risk, credit risk, operational risk, procyclicality risk, strategic risk

JEL Classification: E50, E58, E60, E61, G20, G28