Question

The Basel Committee on Banking Supervision is the primary global standard setter for the prudential regulation of banks and provides a forum for regular cooperation on banking supervisory matters.
Required:
Discuss what Basel is and why there are three versions. (5 marks)
b. How can an investor gain exposure to the real estate market without direct purchase of real estate? Explain. (5 marks)

Answer 1

Answer to Part (a)

The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters.

Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability.

The BCBS seeks to achieve its mandate through the following activities:

a. exchanging information on developments in the banking sector and financial markets, to help identify current or emerging risks for the global financial system;

b. sharing supervisory issues, approaches and techniques to promote common understanding and to improve cross-border cooperation;

c. establishing and promoting global standards for the regulation and supervision of banks as well as guidelines and sound practices;

d. addressing regulatory and supervisory gaps that pose risks to financial stability;

e. monitoring the implementation of BCBS standards in member countries and beyond with the purpose of ensuring their timely, consistent and effective implementation and contributing to a "level playing field" among internationally active banks;

f. consulting with central banks and bank supervisory authorities which are not members of the BCBS to benefit from their input into the BCBS policy formulation process and to promote the implementation of BCBS standards, guidelines and sound practices beyond BCBS member countries; and

g. coordinating and cooperating with other financial sector standard setters and international bodies, particularly those involved in promoting financial stability.

The BCBS does not possess any formal supranational authority. Its decisions do not have legal force. Rather, the BCBS relies on its members' commitments

BCBS members include organisations with direct banking supervisory authority and central banks.

Versions of Basel (Basel I, Basel II & Basel III)

Basel I: the Basel Capital Accord

With the foundations for supervision of internationally active banks laid, capital adequacy soon became the main focus of the Committee's activities. Backed by the G10 Governors, Committee members resolved to halt the erosion of capital standards in their banking systems and to work towards greater convergence in the measurement of capital adequacy. This resulted in a broad consensus on a weighted approach to the measurement of risk, both on and off banks' balance sheets.

The 1988 Accord called for a minimum ratio of capital to risk-weighted assets of 8% to be implemented by the end of 1992. Ultimately, this framework was introduced not only in member countries but also in virtually all countries with active international banks.

The Accord was always intended to evolve over time. It was amended in November 1991 to more precisely define the general provisions or general loan loss reserves that could be included in the capital adequacy calculation.

Basel II: the new capital framework

In June 1999, the Committee issued a proposal for a new capital adequacy framework to replace the 1988 Accord. This led to the release of a revised capital framework in June 2004. Generally known as "Basel II", the revised framework comprised three pillars:

1. minimum capital requirements, which sought to develop and expand the standardised rules set out in the 1988 Accord

2. supervisory review of an institution's capital adequacy and internal assessment process

3. effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices

The new framework was designed to improve the way regulatory capital requirements reflect underlying risks and to better address the financial innovation that had occurred in recent years. The changes aimed at rewarding and encouraging continued improvements in risk measurement and control.

Basel III: responding to the 2007-09 financial crisis

Even before Lehman Brothers collapsed in September 2008, the need for a fundamental strengthening of the Basel II framework had become apparent. The banking sector entered the financial crisis with too much leverage and inadequate liquidity buffers. These weaknesses were accompanied by poor governance and risk management, as well as inappropriate incentive structures. The dangerous combination of these factors was demonstrated by the mispricing of credit and liquidity risks, and excess credit growth.

Responding to these risk factors, the Basel Committee issued Principles for sound liquidity risk management and supervision in the same month that Lehman Brothers failed. In July 2009, the Committee issued a further package of documents to strengthen the Basel II capital framework, notably with regard to the treatment of certain complex securitisation positions, off-balance sheet vehicles and trading book exposures.

Most of the reforms are being phased in between 2013 and 2019:

• stricter requirements for the quality and quantity of regulatory capital, in particular reinforcing the central role of common equity
• an additional layer of common equity - the capital conservation buffer - that, when breached, restricts payouts to help meet the minimum common equity requirement
• a countercyclical capital buffer, which places restrictions on participation by banks in system-wide credit booms with the aim of reducing their losses in credit busts
• a leverage ratio - a minimum amount of loss-absorbing capital relative to all of a bank's assets and off-balance sheet exposures regardless of risk weighting
• liquidity requirements - a minimum liquidity ratio, the Liquidity Coverage Ratio (LCR), intended to provide enough cash to cover funding needs over a 30-day period of stress; and a longer-term ratio, the Net Stable Funding Ratio (NSFR), intended to address maturity mismatches over the entire balance sheet
• additional requirements for systemically important banks, including additional loss absorbency and strengthened arrangements for cross-border supervision and resolution

Answer to Part (b)

#1: Invest in real estate ETFs

An exchange-traded fund, also known as an ETF, is a collection of stocks or bonds in a single fund. ETFs are similar to index funds and mutual funds in the fact they come with the same broad diversification and low costs over all.

There are plenty of other ETFs that offer exposure to real estate, too, so make sure to do your research and consider the possibilities.

#2: Invest in real estate mutual funds

Just like you can invest in real estate ETFs, you can also invest in real estate mutual funds. Because its low costs and track record help him feel confident about future returns. In addition to low costs, mutual funds are backed by decades of academic research

#3: Invest in REITs

Consumers invest in REITs for the same reason they invest in real estate ETFs and mutual funds; they want to invest in real estate without holding physical property. REITs let you do exactly that while also diversifying your holdings based on the type of real estate class each REIT invests in.

#4: Invest in a real estate focused company

There are many companies that own and manage real estate without operating as a REIT. The difference is, you’ll have to dig to find them and they may pay a lower dividend than a REIT.

Companies that are real estate-focused can include hotels, resort operators, timeshare companies, and commercial real estate developers, for example. Make sure to conduct due diligence before you buy stock in individual companies

#5: Invest in home construction

If you look at real estate market growth over the last decade or longer, it’s easy to see that much of it is the result of limited housing inventory. For this reason, many predict that construction of new homes will continue to boom over the next few decades or more.

#6: Hire a property manager

While you don’t have to buy physical property to invest in real estate, there’s at least one strategy that can help you have your cake and eat it, too. Many investors who want exposure to rental real estate they can see and touch go ahead and buy rentals but then hire a property manager to do all the heavy lifting.

The key to making sure this strategy works is ensuring you only invest in properties with enough cash flow to pay for a property manager and still score a sizeable rate of return.