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The Supervisor of Banks today distributed draft copies of new Proper Conduct of Banking Business Directives to the Advisory Committee on Banking Issues. The draft directives relate to the computation of banking corporations' capital adequacy ratios. The distribution of the drafts is part of the process of adoption of the Basel III recommendations in Israel, following the publication of a guideline in March 2012 regarding the minimum core capital ratio targets. (According to the guideline, the core capital ratio must be not less than 9 percent by January 1, 2015 for the overall banking system, and not less than 10 percent by January 1, 2017, for the two largest banking corporations in Israel.
Basel III is a new international framework which was formulated on the basis of the lessons from the 2007-09 global crisis, and the weaknesses which were revealed in the global banking system during those years. Adopting the Basel III recommendations is part of the ongoing activities by the Banking Supervision Department to strengthen the robustness of the banking system in Israel, to improve the quality of capital, and measure risks.
The following are the main issues dealt with in the draft Proper Conduct of Banking Business Directives:
The directive establishes the minimum capital targets, which all the banking corporations are required to meet, and delineates the supervisory capital structure. In continuation of the guideline issued in March 2012, the draft establishes that the total capital ratio (consisting of Common Equity Tier 1 capital, additional Tier 1 capital, and Tier 2 capital) shall not be less than 12.5 percent for the overall banking system, and not less than 13.5 percent for the two largest banking corporations in Israel.
The directive establishes eligibility criteria for capital instruments at each pillar. The new criteria include, among other things, a requirement that every capital instrument included in regulatory capital should include stipulation of conversion into common shares of the banking corporation when the core capital ratio declines below 7 percent (regarding a capital instrument in additional Tier 1 capital) or below 5 percent (for a Tier 2 capital instrument). In addition, every such capital component shall include the conversion aspect at the point of non-viability, as defined in the Directive. This is in order to strengthen the resilience of the banking corporation and its ability to absorb losses in light of the development of negative trends, to the extent that there will be any.
The adjustments and deductions which need to be made in the computation of regulatory capital in accordance with Basel III regulations. Among other things, it was established that most adjustments and deductions will be made in Tier 1 capital.
The directive includes a long list of amendments in the computation of risk assets which are part of the capital adequacy calculation. Among other things, as part of the capital requirements for counterparty credit risk, an additional capital requirement was added, in respect of losses from credit valuation adjustments.
In order to allow banks to prepare for the new framework and to continue providing credit for economic activity as needed, instructions were set beyond the issue of adjustments and deductions from capital, according to which the implementation of the changes will be spread out until 2017. Likewise, it was established that existing capital instruments that do not meet the new criteria will be deducted from capital gradually, over a transition period of 10 years.
The Supervisor of Banks, David Zaken, said, upon distribution of the draft, "Although the banking system in Israel displayed resilience during the past global crisis, we must take care to learn the lessons of the global crisis and carry out the adjustments and changes necessary in order to continue standing at the top tier of advanced banking systems, and to be a stable and central channel for economic growth."