Basel Norms

Check out the details about Basel Norms.

Basel Norms

It also refers to Basel Accords or Basel Guidelines on banking supervision. These guidelines are formulated by the Basel Committee on Banking Supervision (BCBS).
These norms are for individual banks and Systemically Important Financial Institutions (SIFI).
In India, these norms are implemented by the Reserve Bank of India. As of now, the committee has come up with Basel-I, Basel-II and Basel-III.
RBI began implementing Basel-I in 1992 and Basel-II in 2009. RBI also issued guidelines on implementing Basel-III in a phased manner.

Basel -I Norms

It is also known as the Basel Capital Accord.
As per Basel-I, all banks were required to maintain a capital adequacy ratio (CAR) of 8 %.

CAR is the minimum capital requirement of a bank and is defined as the ratio of capital to risk-weighted assets (RWA).
RWA is the assets weighted or classified according to the risk (default) profile.

Tier 1 capital is the core capital of banks and is more permanent in nature (e.g. equity capital, disclosed reserves, etc.).
Tier 2 capital is supplementary in nature and is fluctuating in nature (e.g. undisclosed reserves, cumulative non-redeemable preference shares, etc.).

Basel-II Norms

It is the revised capital framework of 1988. It comprises three pillars: Pillar 1 (Minimum Capital Requirement), Supervisory Review, and Market Discipline.

Pillar 1: Minimum Capital Requirement (MCR)

It sets MCR for credit risk, market risk and Operational risk.
As per Basel-II, the minimum capital requirement is 8% of the risk-weighted assets. Risk-weighted assets means -Classification of assets based on their risk profiles.
The capital ratio is calculated using the definition of regulatory capital and risk-weighted assets.
The total capital ratio must not be lower than 8%.
It also extends banks capital to Tier 3 capital (existing Tier 1 and Tier 2 capital).
Tier-3 capital includes short-term subordinated loans (lower in ranking).
Tier 3 capital solely to support market risks.
For short-term subordinated debt to be eligible as Tier 3 capital, it needs to be capable of becoming part of a bank’s permanent capital and thus be available to absorb losses in the event of insolvency.

Pillar 2: Supervisory review

It focuses on supervision of institution’s implementing Pillar-1 guidelines. Under it, Banks were required to develop and use better risk management techniques.

Pillar 3: Market Discipline

It is designed to promote greater stability in the financial system. It increased the disclosure requirements.
Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank.

Basel III Norms

The financial crisis of 2007-08 revealed shortcomings in the Basel norms. Therefore, the previous accords were strengthened in Basel III.
Increase the level and quality of capital: Banks are required to maintain more capital of higher quality to cover unexpected losses. Moreover, the minimum Tier 1 capital rises from 4% to 6%. It has also mandated that the Global systemically important banks (G-SIBs)are subject to additional capital requirements.

Maintain Buffer to absorb unexpected loss: Banks have to maintain a capital conservation buffer of 2.5% of RWA. Moreover, banks have to maintain a countercyclical buffer of 0-2.5%.
Improving Bank Liquidity: It created two liquidity ratios: Liquidity coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).

LCR will require banks to have sufficient high-quality liquid assets to withstand a 30-day stressed funding scenario that is specified by supervisors. This is to deal with the cash outflows encountered in an acute short term stress scenario.
NSFR requires banks to maintain a stable funding profile in relation to their off-balance-sheet assets and activities. NSFR requires banks to fund their activities with stable sources of finance (reliable over the one-year horizon).

Leverage: A non-risk based leverage ratio including off-balance sheet exposures is meant to serve as a backstop to the risk-based capital requirement.