Basel Norms Explained: Banking Awareness Notes

BANKING AWARENESS NOTES – ALL ABOUT BASEL NORMS

Basel is a city in Switzerland. It is the headquarters of Bank for International Settlement (BIS), which fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations.

The Bank for International Settlements, the apex bank for all central banks, established on 17 May 1930, is the world's oldest international financial organisation. The BIS has 60 member central banks, representing countries from around the world that together make up about 95% of world GDP. The head office is in Basel, Switzerland and there are two representative offices: in the Hong Kong Special Administrative Region of the People's, Republic of China and in Mexico City.

The mission of the BIS is to serve central banks of different of nations in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks. The Basel Committee is the primary global standard ¬setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters.

The set of agreement by the BCBS, which mainly focuses on risks to banks and the financial system are called Basel accord. The purpose of the accord is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses. India has accepted Basel accords for the banking system. In fact, on a few parameters the RBI has prescribed stringent norms as compared to the norms prescribed by BCBS.

Basel I:

In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel 1. It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks. The minimum capital requirement was fixed at 8% of risk weighted assets (RWA). RWA means assets with different risk profiles. For example, an asset backed by collateral would carry lesser risks as compared to personal loans, which have no collateral.

The Basel I Accord, issued in 1988, has succeeded in raising the total level of equity capital in the system. Like many regulations, it also pushed unintended consequences; because it does not differentiate risks very well, it perversely encouraged risk seeking. It also promoted the loan securitization that led to the unwinding in the subprime market. India adopted Basel 1 guidelines in 1999.

Basel II:

In June ’04, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord. The guidelines were based on three parameters, which the committee calls it as pillars. - Capital Adequacy Requirements: Banks should maintain a minimum capital adequacy requirement of 8% of risk assets - Supervisory Review: According to this, banks were needed 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: This need increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank. Basel II norms in India and overseas are yet to be fully implemented.

Basel III:

In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008. A need was felt to further strengthen the system as banks in the developed economies were under-capitalized, over-leveraged and had a greater reliance on short-term funding. Also the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk. Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive. The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

IMPORTANT POINTS REGARDING TO THE IMPLEMENTATION OF BASEL-3

• Government of India is scaling disinvesting their holdings in PSBs to 52 per cent.
• Government will soon infuse Rs 6,990 crore in nine public sector banks including SBI, Bank of Baroda (BoB), Punjab National Bank (PNB) for enhancing their capital and meeting global risk norms.
• This is the first tranche of capital infusion for which the government had allocated Rs 11,200 crore in the Budget for 2014-15.
• The government has infused Rs 58,600 crore between 2011 to 2014 in the state-owned banks.
• Finance Minister Arun Jaitley in the Budget speech had said that "to be in line with Basel-III norms there is a requirement to infuse Rs 2,40,000 crore as equity by 2018 in our banks. To meet this huge capital requirement we need to raise additional resources to fulfill this obligation.