Basel
Committee on Banking Supervision:
i. The Basel Committee on Banking Supervision is an institution of
Governors of the Central Banks of “G-10” nations and was formed in 1974.
ii. The Committee is a forum for discussion on the handling of
specific supervisory problems.
iii. It coordinates the sharing of supervisory responsibilities among
national authorities in respect of banks' foreign establishments with the aim
of ensuring effective supervision of banks' activities worldwide.
iv. The committee operates from Basel in Switzerland.
What is
CAR?
Capital adequacy provides
regulators with a means of establishing whether banks and other financial
institutions have sufficient capital to keep them out of difficulty. Regulators
use a Capital Adequacy Ratio (CAR), a ratio of a bank’s capital to its assets,
to assess risk.
CAR = (Bank’s
Capital)/(Risk Weighted Assets) =
(Tier I Capital + Tier II Capital) / (Risk
Weighted Assets)
Concepts
of Capital Adequacy Norms
- Tier
I Capital
- Tier
II Capital
- Risk
Weighted Assets
- Subordinated Debts
Basel –
I Norms
In 1988, the Basel I
Capital Accord was created. The general purpose was to:
1. Strengthen the stability
of international banking system.
2. Set up a fair and a
consistent international banking system in order to decrease competitive
inequality among international banks.
Basis of
Capital in Basel – I
Tier I
(Core Capital): Tier I
capital includes stock issues (or share holders equity) and declared reserves,
such as loan loss reserves set aside to cushion future losses or for smoothing
out income variations.
Tier II
(Supplementary Capital): Tier II
capital includes all other capital such as gains on investment assets,
long-term debt with maturity greater than five years and hidden reserves (i.e.
excess allowance for losses on loans and leases). However, short-term unsecured
debts (or debts without guarantees), are not included in the definition of
capital.
Risk
Categorization
According to Basel I, the
total capital should represent at least 8% of the bank’s credit risk. Risks can
be:
The on-balance sheet risk
(like risks associated with cash & gold held with bank, government bonds,
corporate bonds etc.)
Market risks including
interest rates, foreign exchange, equity derivatives & commodities.
Non Trading off-balance
sheet risks like forward purchase of assets or transaction related debt assets
Limitations
of Basel – I Norms
- Limited
differentiation of credit risk
- Static
measure of default risk
- No
recognition of term-structure of credit risk
- Simplified
calculation of potential future counter party risk
- Lack
of recognition of portfolio diversification effects
Basel –
II Norms
Basel – II norms are based
on 3 pillars:
Minimum
Capital – Banks
must hold capital against 8% of their assets, after adjusting their assets for
risk
Supervisory
Review – It is the
process whereby national regulators ensure their home country banks are
following the rules.
Market
Discipline – It is
based on enhanced disclosure of risk
|
Pillars of Basel Norms II
|
Risk Categorization
- In
the Basel – II accord, Credit Risk, Market Risk and Operational Risks were
recognized.
- Under
Basel – II, Credit Risk has three approaches namely, standardized,
foundation internal ratings-based (IRB), and advanced IRB
- Operational
Risk has measurement approaches like the Basic Indicator approach,
Standardized approach and the Advanced Measurement approach.
Advantages
of Basel II over I
- The
discrepancy between economic capital and regulatory capital is reduced
significantly, due to that the regulatory requirements will rely on banks’
own risk methods.
- More
Risk sensitive
- Wider
recognition of credit risk mitigation.
Pitfalls
of Basel – II norms
- Too
much regulatory compliance
- Over
Focusing on Credit Risk
- The
new Accord is complex and therefore demanding for supervisors, and
unsophisticated banks
- Strong
risk differentiation in the new Accord can adversely affect the borrowing
position of risky borrowers
Basel –
III Norms
Basel – III norms aim to:
- Improve
the banking sectors ability to absorb shocks arising from financial and
economic stress
- Improve
risk management and governance
- Strengthen
banks transparency and disclosures
Structure
of Basel – III Accord
- Minimum Regulatory Capital Requirements based on Risk
Weighted Assets (RWAs): Maintaining
capital calculated through credit, market and operational risk areas.
- Supervisory Review Process: Regulating tools
and frameworks for dealing with peripheral risks that banks face
- Market Discipline: Increasing the
disclosures that banks must provide to increase the transparency of banks
Major
changes in Basel – III
- Better
Capital Quality
- Capital
Conservation Buffer
- Counter
cyclical Buffer
- Minimum
Common Equity and Tier I Capital requirements
- Leverage
Ratios
- Liquidity
Ratios
- Systematically
Important Financial Institutions
Important Points:
- In
accordance with Basel III norms, Indian banks will have to maintain their
capital adequacy ratio at 9 per cent as against the minimum recommended
requirement of 8 per cent.
- Under
Basel III accord, banks have to maintain Tier-one capital (equity and
reserves) at 7 per cent of risk weighted assets (RWA) and a capital
conservation bugger of 2.5 per cent of RWA.
- According
to the recent RBI financial stability report, Indian banks will require an
additional capital of Rs.5 trillion (5lakh crore) to comply with Basel III
norms, including Rs 3.25 trillion (Rs 3.25 lakh crore) as non-equity
capital and Rs 1.75 trillion(Rs 1.75 lakh crore) in the form of equity
capital over the next five years.
- To
ensure that PSU Banks meet the Basel III regulations regarding capital
adequacy, the government will infuse Rs 14,000 crore in public sector
banks in next fiscal (2013-14). The Basel III capital ratios will be fully
phased in as on March 31, 2018.