Most of these initiatives can be grouped into three major categories:   Actions to significantly reduce the probability of failure of large systemically important financial institutions.   Measures to broaden the oversight of the financial system to include activities that occur outside of the core banking system. The shadow banking system, which is composed of the wide range of financial intermediation activities that occur outside  2  BIS central bankers’ speeches  of the traditional purview of bank regulators, needs greater attention. In particular, shadow banking activities that involve maturity transformation are vulnerable to shocks because such activities do not have the support of bank deposit guarantees or access to central bank liquidity and, thus, are vulnerable to funding runs.   Steps to strengthen the resolution regime and the core financial market infrastructure to ensure that when a large complex financial firm fails, the failure doesn’t threaten to bring down the entire financial system. Turning to the first set of initiatives designed to reduce the probability of failure of large, systemically important financial institutions (SIFIs), the tougher capital and liquidity regimes that the Basel Committee has devised are probably the most important elements. On the capital side, Basel III significantly increases requirements with respect to both the quantity and quality of capital. On the quantity side, there have been two important changes.
First, the capital requirements have been raised so that internationally active banks must have common equity ratios of at least 7 percent of risk-weighted assets when the standards are fully phased in by 2019. This 7 percent standard consists of a 4.5 percent minimum plus a 2.5 percent capital conservation buffer. Banks whose capital ratios fall into the buffer range will face increasingly stringent restrictions on capital distributions such as dividends and share repurchases and discretionary bonus payments to staff. This should act as a form of “automatic stabilizer” to their capital resources and change the incentives banks face during periods of stress. Second, for many globally active banks, the amount of capital required will also rise because the amount of risk-weighted assets against which the capital ratios are calculated will increase. Explicit capital requirements for operational risk and counterparty credit risk, as well as increased requirements for certain trading activity and transactions between financial institutions should result in a significant rise in risk-weighted assets. On the quality side, capital requirements have been toughened by narrowing the definition of what can be counted toward common equity capital for regulatory capital purposes. The emphasis has been put on common equity because of the superior loss-absorbing capacity of this type of capital on a going concern basis.