Basel norms i, ii & iii

Basel

1. Basel Norms I, II & III HARESH R ASSISTANT PROFESSOR DEPARTMENT OF COMMERCE CHRIST UNIVERSITY

2. Failure of Bretton Woods System Bretton Woods System – 1944 IMF World Bank System of fixed exchange rates In 1973, Bretton Woods System led to causalities in German Banking System and UK’s Banking system with huge amount of foreign exchange exposures which was more than the capital of the banks.

3. Basel Committee - 1974 T he central bank governors of the G10 countries established a Committee on Banking Regulations and Supervisory Practices. The group of ten countries consist of Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom and the United States, Switzerland was also included as part of the group. Later renamed as the Basel Committee on Banking Supervision(BCBS). The Basel Committee on Banking Supervision provides a forum for regular 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.

4. Basel Committee on Banking Supervision (BCBS) came into being under the patronage of Bank for International Settlements (BIS), Basel, Switzerland. The Committee formulates guidelines and provides recommendations on banking regulation based on capital risk, market risk and operational risk.

5. Currently there are 27 member nations in the committee. Basel guidelines refer to broad supervisory standards formulated by this group of central banks- called the Basel Committee on Banking Supervision (BCBS). 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.

6. Credit Risk - Credit risk is most simply defined as the potential that a bank’s borrower or counterparty may fail to meet its obligations in accordance with agreed terms. Market Risk - Market risk refers to the risk to a bank resulting from movements in market prices in particular changes in interest rates, foreign exchange rates and equity and commodity prices.

7. BASEL I Risk management (Focused on Credit Risk, No recognition of operational risk) Capital adequacy, sound supervision and regulation Transparency of operations Unquestionably accepted by developed and developing countries Capital requirement 8% of assets (banks were advised to maintain capital equal to a minimum 8% of a basket of assets measured based on the basis of their risk) Tier 1 capital at 4% Tier 2 capital at 4%

8. Capital Adequacy Framework A bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital is divided into tiers according to the characteristics/qualities of each qualifying instrument. For supervisory purposes capital is split into two categories: Tier I and Tier II.

9. Tier I capital -Share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses. Tier II capital on the other hand consists of certain reserves and certain types of subordinated debt. The loss absorption capacity of Tier II capital is lower than that of Tier I capital.

10. The twin objectives of Basel I were: (a) to ensure an adequate level of capital in the international banking system & (b) to create a more level playing field in the competitive environment.

11. BASEL II – The New Capital Farmework 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 the Revised Capital Framework in June 2004. Generally known as ‟Basel II ” , The New Basel Capital Accord focused on, three pillars viz. Pillar I - Minimum capital requirement Pillar II - Supervisory review Pillar III - Market discipline

12. Pillar I - Minimum C apital R equirement The Committee on Banking Supervision recommended the target standard ratio of capital to Risk Weighted Assets should be at least 8% (of which the core capital element would be at least 4%). The minimum capital adequacy ratio of 8% was prescribed taking into account the credit risk. However, in India the Reserve Bank of India has prescribed the minimum capital adequacy ratio of 9% of Risk Weighted Assets.

13. Pillar II - Supervisory R eview The Supervisory review should be carried out in the following manner. Banks should have a process for assessing their overall capital adequacy Supervisors should review banks’ assessments Banks are expected to operate above minimum Supervisor’s intervention if capital is not sufficient

14. Pillar III: Market Discipline Role of the market in evaluating the adequacy of bank capital Streamlined catalogue of disclosure requirements Close coordination with International Accounting Standards Board I n principle, disclosure of data on semiannual basis