What is meant by Basel norms in banking?


Basel norms

What is meant by Basel norms or Basel accords?

  • Basel norms are international banking regulations issued by the Basel Committee on Banking Supervision (BCBS).
  • The Basel norms is an effort to coordinate banking regulations across the globe, with the goal of strengthening the International banking system.
  • The Basel Committee on Banking Supervision (BCBS) consists of representatives from central banks and regulatory authorities of 27 countries (including India).
  • Its secretariat (administrative office) is located at the Bank of International Settlements (BIS) headquartered in the city of Basel in Switzerland. Hence, the name Basel norms.
  • The Basel Committee has issued three sets of regulations as of 2018 known as Basel-I, II and III.

Basel-I

Basel-1 was introduced in the year 1988. It focussed primarily on credit (default) risk faced by the banks.

As per Basel-1, all banks were required to maintain a capital-adequacy ratio of 8 %.

The capital adequacy ratio is the minimum capital requirement of a bank and is defined as the ratio of capital to risk-weighted assets.

The capital was classified into Tier 1 and Tier 2 capital.

  • Tier 1 capital is the core capital of a bank which is permanent and reliable. It includes equity capital and disclosed reserves.
  • Tier 2 capital is the supplementary capital. It includes undisclosed reserves, general provisions, provisions against Non-performing Assets, cumulative non-redeemable preference shares etc.

The risk-weighted asset is the bank’s assets weighted according to risks.

The assets of the bank were classified into 5 risk categories of 0 % or 0, 10 % or 0.1, 20 % or 0.2, 50 % or 0.5 and 100 % or 1. Example- cash into 0 % risk category, home mortgage into 20 % risk category and corporate debt into 100 % risk category.

Lets say- a bank has Rs.100 as cash reserves, Rs.200 as home mortgage and Rs.300 as loans given out to companies. The risk-weighted assets= (Rs.100 * 0 ) + (Rs.200 * o.2) + (Rs.300 * 1) = 0 + 40 + 300 = Rs340

Therfore, this bank has to maintain 8 % of Rs.340 as minimum capital. (atleast 4 % in tier-1 capital)

India adopted Basel-1 in 1999.

Basel-II

Basel-II was issued in 2004.

This framework is based on three parameters.

  • Minimum capital requirements: Banks should continue to maintain a minimum capital adequacy requirement of 8% of risk-weighted assets. However, the definition of capital adequacy ratio was refined. Also, Basel-II divides the capital into 3 tiers. Tier-3 capital includes short-term subordinated loans. (subordinated loans means lower in ranking. It is repaid after other debts in case of bank liquidation.)
  • Regulatory supervision: According to this, banks were required to develop and use better risk management techniques in monitoring and managing all the three types of risks that a bank faces, viz. credit, market and operational risks
  • Market Discipline: It increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank.

Presently India follows Basel-II norms.

Basel-III

The financial crisis of 2007-08 revealed shortcomings in the Basel norms. Therefore, the previous accords were strengthened.

Basel-III was first issued in late 2009. The guidelines aim to promote a more resilient banking system.

  • Capital: The capital adequacy ratio is to be maintained at 8 %. The common equity (which is a component of Tier-1 capital) and the Tier-1 capital has to be maintained at 4.5 % and 6 % respectively. In addition, banks have to maintain a capital conservation buffer of 2.5%. So, total minimum capital requirement is 10.5%
  • Counter-cyclical buffer is also to be maintained at 0-2.5%.
  • The leverage rate has to be at least 3 %. The leverage rate is the ratio of a bank’s tier-1 capital to average total consolidated assets.
  • Liquidity: The liquidity coverage ratio(LCR) will require banks to hold a buffer of high quality liquid assets sufficient to deal with the cash outflows encountered in an acute short term stress scenario as specified by supervisors. The minimum LCR requirement will be to reach 100% on 1 January 2019. This is to prevent situations like “Bank Run”.

The deadline for implementation of Basel-III is March 2019 in India.

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References:

//www.moneycontrol.com/news/business/personal-finance/-1753225.html

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