FINANCE AND INVESTMENT

Finance and Investment

Part 1)

Need for Basel III

First, we would be failing in our duties to the communities we all serve if we did not learn and respond to the lessons of the recent past. With hindsight, it is easy to see that previous international minimum standards for bank capital were too low. Regulations were insufficient to act as a constraint on the natural incentive within banks to increase leverage: not only did they allow leverage to reach very high levels; they also enabled that leverage to be built on a capital base which proved somewhat illusory when needed. This lack of true resilience within the banking system led to widespread and significant financial instability when the music stopped and markets abruptly turned away from risk-taking. Basel III responds to this experience by substantially raising minimum capital requirements, focused primarily on common equity, and ensuring that other instruments that count as regulatory capital will genuinely be available in times of need (Chorafas, 2012, pp. 46).

And finally, a robust set of international banking standards is critical for the future. At a time when concern is justifiably being expressed about fragmentation of the financial system, preserving the foundation for a competitive international banking landscape in the future has never been more important. In responding to the crisis, it is critical that we avoid a patchwork of diverse national measures which act as a barrier to cross-border banking business. Full, timely and consistent implementation of internationally agreed standards makes it far easier for banks to operate and compete internationally. If we do not continue to work towards this goal, then we only make it harder to reverse the current retraction in international banking activity (Herring, 2002, pp. 13). The consistent implementation of Basel III consistently around the world will help provide the foundation on which banks can expand and compete in the international marketplace.

Part 2)

There is a fair amount of overlap between Basel III and Solvency II. The new capital and liquidity rules for banks (Basel III) and the new capital requirements for insurance companies (Solvency II) are set to be introduced in January 2013. Since insurers are major institutional investors - in bank bonds, among other things - there may well be some reciprocal effects between these two sets of regulations when they are implemented.

Solvency II will change the way in which insurance companies allocate their capital. Currently, the amount of capital that insurers are required to hold is determined by their premiums. In future, the risks that insurers take on as part of their investing activities will have to be accounted for at their fair value and will determine the capital that these institutions are required to hold.

Solvency II gives preferential treatment to bonds with good credit ratings and short maturities. Market risk, which factors in the volatility of investments, will impose more stringent capital requirements for bonds that are determined by the investments' maturity and credit rating. Government bonds issued by countries in the European Economic Area (EEA) ...