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Basel norms

Posted by VASUDEVA REDDY on Wednesday, July 27, 2011 Under: economic articles

Basel norms, Basel committee, Basel committee on Banking Supervision.. blah.. blah.. blah. The one who has studied MBA, of course PGDM, would have definitely heard of those words irrespective of the streams they have opted for. But the people who are into the banking/finance would have definitely studied about those norms. Even though I have opted for Finance specialization, I didn’t come across those norms in my course curriculum, yet. For the people like me, who wants to know about Basel norms, a small intro on Basel committee.

Basel committee for banking supervision (BCBS) was created by central bank governors of the G-10 nations. It was created in the year 1974 and meets quarterly or four times a year. The creation of the committee followed by a few months an incident that occurred after the liquidation of a German society that had a domino effect on other banks. The name BASEL came to the committee, because, the members of that committee meet in city Basel, Switzerland. Till 2009 there were only G-10 economies used to follow the norms prescribed by Basel committee. But since 2009, all the G-20 nations, including India, started to follow the Basel norms. The purpose of this committee is therefore to stimulate the cooperation and to promote international harmonisation in terms of cautious banking control. But we must add that the Basel committee does not have any authority, and its conclusions do not rule everything.

 Banking for International settlements (BIS), is an intergovernmental organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks. It is the place where all the Basel committee members usually meet. BIS is not accountable to any government and currently it has 60 members in it, of course India is one among them.  However, BIS and Basel committee are two distinct entities.

The Basel committee has published a set of documents since 1975 related to the cautious banking control. The first of these documents was published in 1975; it was called the Basel composition agreement. In 1983, the Basel composition agreement was modified to introduce the principle of consolidation of the cautious banking control.

In 1988, the Basel Committee published a new document commonly called the Basel Agreement on equity. The Agreement of 1988 fixes the minimal demands on equity based on the risks for active banks on the international scale. From 1988, this framework has been adopted according to the member countries, but also to other countries where are the active banks on the international scale.

Missions of Basel committee:

For bank, the granting of a credit is an asset, a use that comes along with liability counterparty: a resource, which is either equity or debts in the widest sense. The higher the proportion of equity is compared to debts, the stronger the organism is and presents safety guarantees. To face the risk of defaults from the borrower, bankers have set and improved tools to evaluate, measure, control and follow the risks related to credit.

 

Some of the main missions are:

1.       The reinforcement of the security and of the reliability of the financial system.

2.       The setting up of minimal standards in terms of cautious control.

3.       The circulation and promotion of the best banking and surveillance practices.

4.       The promotion of the international cooperation in terms of cautious control.

Basel 1 norms:

This represents the set of the recommendations published by the committee in 1988. These recommendations aimed at insuring the stability of the international financial system by fixing minimum limit to the amount of equity in banks. This minimum has been fixed by setting up a minimal ratio of 8% of equity compared with all the credits granted by banks. It means that when a bank grants $1000 to a customer, it has to tie up $80 of equity and use up to $920 from other financing sources.

Basel 1 norms primarily focused on credit risk ( it is an investor's risk of loss arising from a borrower who does not make payments as promised). Assets of banks were classified and grouped in five categories according to credit risk, carrying risk weights of zero (for example home country sovereign debt), ten, twenty, fifty, and up to one hundred percent (this category has, as an example, most corporate debt).

Most other countries, currently numbering over 100, have also adopted, at least in name, the principles prescribed under Basel I. The efficiency with which they are enforced varies, even within nations of the Group of Ten.

Basel 2 norms:

Initially published in 2004 and made several changes to that afterwards (7 times in total). The purpose of Basel II is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. In theory, Basel II attempted to accomplish this by setting up risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices.

Objectives:

·         Ensuring that capital allocation (how banks must handle their capital) is more risk sensitive

·         Separating operational risk (a risk arising from execution of a company's business functions) from credit risk, and quantifying both

·         Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage.

Basel 2 uses “three pillars” concept,

1.       Minimal capital requirements to address the risks (credit, operational, and market risks)

2.       Supervisory review (regulatory response to the first pillar)

3.       Market discipline (This pillar aims to promote greater stability in the financial system)

Basel II has largely left unchanged the question of how to actually define bank capital, which diverges from accounting equity in important respects. The Basel I definition, as modified up to the present, remains in place.

Basel 3 norms:

It is very recently proposed norms, agreed by the Basel committee members. The third of the Basel Accords was developed in a response to the deficiencies in financial regulation revealed by the global financial crisis. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. The OECD (Organisation for Economic Co-operation and Development) estimates that the implementation of Basel III will decrease annual GDP growth by 0.05 to 0.15 percentage point.

Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash flows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.

 


In : economic articles 


Tags: basel  norms  accord  bank  credit  asset 

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