Financial Innovations



Financial Innovations

Financial Innovation Proposed

The Basel III agreement should force banks to increase their capital reserves to protect themselves from attacks. Banks will have to triple to 7%, the total of their reserves to protect against a future crisis (Duffie, 1995).

The minimum capital of high quality, which only includes common shares and retained earnings, will increase from 2% to 4.5% of assets weighted by risk gradually between 2013 and 2015.  Moreover, banks will have to be gradually between 2016 and 2019, two "capital cushions" to be used in times of crisis:

1 - The mattress conservation of capital is equivalent to 2.5% of risk-weighted assets. With this, the capital of high quality added to the mattress conservation will, at the end of 2019, to 7%. Have a minimum requirement of Tier I capital of 8% remains - but, considering the mattress conservation, passes to 10.5%. The banks may use, in certain circumstances, the capital of this mattress. But, if the bank is close to the minimum percentage required, which will reduce the distribution of profits and dividends. Thus, the supervision is to prevent institutions continue to pay high dividends and bonuses even when they suffer deterioration of capital (Lerner, 2004).

2 - The countercyclical capital cushion of high quality will be between 0% and 2.5% and may be required according to the needs of each country signatory to the Agreement. This second mattress will depend on the level of market capitalization and is intended to protect the banking system in periods of credit expansion - when banks will have to save a portion of their capital to form mattresses (Ross, 1990). The reform was motivated by the observation that the severity of the crisis is explained largely by the overgrowth of the values ??presented in the balance sheets of banks (and also out of balance in derivatives , for example), while the falling level and quality of own funds to cover the risks . In addition, many institutions did not have enough reserves to cope with a crisis of liquidity .In this context, the banking system has proved, at first, unable to absorb the losses that affected the structured products of securitization and to assume, then re-intermediation of some of the off-balance sheet exposures.

The financial crisis had shown that the global banking system had insufficient high-quality equity. Basel III is thus amplified to the purest form of capital, the so-called core capital focused ("Common Equity"). It consists of public companies primarily from the payment of capital and retained earnings together (Philip, 2011).

The following measures are taken to strengthen the capital:

Innovative hybrid capital with repayment incentives, which can account for under Basel II is up to 15%, no more than Tier 1 capital are accepted.

Tier 2 capitals will be harmonized, i.e. national definition should give way to an international standard.

Tier 3 capital will be abolished completely.

The reason why it is selected are as follows (Philip, 2011):

Increase the capital requirements for credit and market risks , as well as complex securitizations (Pillar I)

Tougher standards for the supervisory review process (Pillar II)

Increased standards for disclosure (Pillar III)

Revision of the rules for the trading book (not yet completed)

Increase the capital requirements for counterparty exposures arising from derivatives - repo - and securities transactions ; and reducing incentives for the settlement of OTC contracts through central counterparties

Reducing ...