RESEARCH PAPER SUBMITTED IN THE FULFILLMENT OF THE COURSE TITLED BANKING LAW - I FOR

OBTAINING THE DEGREE B.A. LL.B. (HONS) DURING THE ACADEMIC YEAR 2023 - 2024

ASSIGNMENT ON BASEL NORMS

SUBMITTED BY: SUBMITTED TO:

MITALI ARYAN DR. ANURAG AGRAWAL
CUSB2013125070 ASSISTANT PROFESSOR
B.A. L.L.B(HONS) DEPARTMENT OF LAW
7TH SEMESTER SCHOOL OF LAW AND
SESSION: 2020 -2025 GOVERNANCE

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 ACKNOWLEDGEMENT

I would like to express my thanks and gratitude to our faculty of Corporate Governance, Dr.
Anurag Agrawal for providing me the chance to work on this particular assignment on the
topic “Basel Norms”. I am obliged to thank our faculty in the respective subject to provide me
with the necessary support required while making this assignment and for mentoring me
throughout this assignment. The whole journey of completing the assignment was quite
interesting, I was completely engrossed and dived deeper to seek more information related to
the topic. I would not have been able to complete this assignment without the help of my
friends, colleagues, and my family members, so I would like to express my gratitude and thank
them as well.

Thank you!!

Mitali Aryan
CUSB2013125070
7TH SEMESTER
B.A. LL.B. (Hons.)

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 Declaration

I hereby declare that the work reported and the research done in the process of making the
assignment on the topic, “Basel Norms” is done in Good Faith and it is an authentic record of
my work carried under the supervision of Dr. Anurag Agrawal I have not submitted the
assignment elsewhere and I take responsibility for my work, which has been carried out while
completing the assignment.

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 INTRODUCTION
The need for banking regulation conceives its roots in the concern towards the socio-economic
costs that arise out in case of breakdown of the banking system or that of bank failures and
systemic crises. As a result, the major aim of banking industry regulation is to maintain
financial stability in order to ensure a safe and sound banking system to protect the interest of
depositors in particular and to promote a healthy investment environment in general.

The banking industry is one of the major key areas responsible for economic growth of a nation,
but, with the globalization of the same, there comes a phenomenon of sequential prostration
calling for the implementation of minimum global banking regulation standards to avoid cross-
country impact of banking disruptions or crises. Therefore, following the Herstatt Bank
debacle and for harmonize the banking activities internationally, the Basel Committee on
Banking Supervision (BCBS) issued the “International Convergence of Capital Measurements
and Capital Standards”, which are popularly known as “Basel I Capital Accords of 1988”. After
their release, a framework for maintaining the capital structure of the banks came into the
picture.

The establishment of the Basel Committee on Banking Supervision (BCBS) by the central
banks of the G-10 countries in 1974 is credited with giving rise to the Basel banking standards.
This was established under the auspices of Basel, Switzerland's Bank for International
Settlements (BIS). Based on capital risk, market risk, and operational risk, the Committee
develops policies and makes recommendations for banking regulation. The disorganised 1974
liquidation of the Herstatt Bank, a Cologne, Germany-based financial institution, prompted the
formation of the Committee. The event demonstrated how settlement risk exists in international
finance.

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HISTORICAL BACKGROUND OF BASEL COMMITTEE:

Historically, in 1973, the sudden failure of the Bretton Woods System resulted in the occurrence
of casualties in 1974 such as withdrawal of banking license of Bankhaus Herstatt in Germany,
and shut down of Franklin National Bank in New York1. In 1975, three months after the closing
of Franklin National Bank and other similar disruptions, the central bank governors of the G-
10 countries took the initiative to establish a committee on Banking Regulations and
Supervisory Practices in order to address such issues. This committee was later renamed as
Basel Committee on Banking Supervision. The Committee acts as a forum where regular
cooperation between the member countries takes place regarding banking regulations and
supervisory practices. The Committee aims at improving supervisory knowhow and the quality
of banking supervision quality worldwide. Currently there are 27 member countries in the
Committee since 2009. These member countries are being represented in the Committee by the
central bank and the authority for the prudential supervision of banking business. Apart from
banking regulations and supervisory practices, the Committee also focuses on closing the gaps
in international supervisory coverage.2

The first set of Basel Accords, known as Basel I, was issued in 1988 with the primary focus on
credit risk. It proposed creation of a banking asset classification system on the basis of the
inherent risk of the asset. Basel II, the second set of Basel Accords, was published in June 2004
– in order to control misuse of the Basel I norms, most notably through regulatory arbitrage.

1
CFI’s Basel I; Available at: https://corporatefinanceinstitute.com/resources/career-map/sell-side/risk-
management/basel-i/ (Last visited at 28th October,2023 at10:53 AM)
2
BIS, “History of Basel Committee and Membership; Available at: https://www.bis.org/publ/bcbsc101.pdf (Last
visited on 28th October 2023 at 11:00 AM)

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The Basel II norms were intended to create a uniform international standard on the amount of
capital that banks need to guard themselves against financial and operational risks. This again
would be achieved through maintaining adequate capital proportional to the risk the bank
exposes itself to (through its lending and investment practices). It also laid increased focus on
disclosure requirements. The third instalment of the Basel Accords (Basel III) was introduced
in response to the global financial crisis, and is scheduled to be implemented by 2018. It calls
for greater strengthening of capital requirements, bank liquidity and bank leverage. However,
critics argue that these norms may further hamper the stability of the financial system by
providing higher incentive to circumvent the regulations.

The global financial crisis has not severely affected the Indian banking sector. This is mostly
due, among other reasons, to Indian banks' comparatively high capitalization. Starting in April
2013, the Reserve Bank of India (RBI) set a 6-year timeline for the adoption of Basel III
standards. A dire picture is painted by the current demand for the infusion of additional stock
given the slow economic growth and rising non-performing assets of Indian banks.

WHAT IS BASEL – I?3

Basel I, also known as the Basel Capital Accord is an agreement, in the banking sector that was
developed by the Basel Committee on Banking Supervision. It was introduced in 1988 with
the goal of establishing a framework to regulate and supervise banks capital adequacy
ultimately ensuring stability in the financial system.

The primary aim of Basel I was to create a framework for determining the capital requirements
for banks specifically focusing on credit risk. According to Basel I banks were required to hold
an amount of capital to their risk weighted assets. The assigned risk weights varied based on

3
IBM, “Basel I Summary Available at: https://www.ibm.com/docs/en/bfmdw/8.10?topic=accord-basel-i-
summary (Last visited on 29th October 2023)

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asset types and loans. Were often simplistic and did not always accurately reflect the actual
level of risk associated with those assets.

Under this framework assets were classified into five risk categories. Government bonds had a
0% risk weight while most corporate loans carried a 100% risk weight. Banks were mandated
to maintain a minimum capital adequacy ratio (CAR) of 8%. This meant that their capital had
to be equivalent to 8% of their risk weighted assets. Such regulations aimed at providing
consistency and stability, within the banking system.

Although Basel I was a milestone, in regulating the banking sector and ensuring financial
stability it did have a few shortcomings. Its risk-weighting system was seen as too simplistic
and did not adequately capture the true risk of various assets. This led to concerns that some
banks were undercapitalized, particularly in the face of financial crises.

As a result, efforts were made to improve and update the Basel framework, leading to the
development of Basel II and later Basel III, which introduced more sophisticated risk
assessment methodologies and capital requirements. These subsequent accords aimed to make
the banking system more resilient and responsive to financial shocks.

Basel I has been largely phased out and replaced by subsequent Basel agreements, but it played
a crucial role in setting the foundation for international banking regulation and risk
management.

Benefits of Basel I:4

Basel I was developed to mitigate risk to consumers, financial institutions, and the economy at
large. Basel II, brought forth some years later, lessened the capital reserve requirements for
banks. That came under some criticism, but because Basel II did not supersede Basel I, many
banks continued to operate under the original Basel I framework, later supplemented by Basel
III addendums.

• Significant increase in Capital Adequacy Ratios of internationally active banks

• Competitive equality among internationally active banks
• Augmented management of capital
• A benchmark for financial evaluation for users of financial information

4
CFI, “Basel I; Available at: https://corporatefinanceinstitute.com/resources/career-map/sell-side/risk-
management/basel-i/” (Last Visited on 28th October 2023)

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Criticism of Basel I

Basel - I has drawn criticism for impeding bank operations and decelerating global economic
growth by reducing the amount of capital accessible for lending. On the other hand, detractors
of the Basel I reform contend that they were insufficient. The Great Recession and financial
crisis of 2007–2009, which served as a trigger for Basel III, were blamed on both Basel I and
Basel II.

Requirements for Basel I:5

The Basel I classification system groups a bank's assets into five risk categories, labelled with
the percentages 0%, 10%, 20%, 50%, and 100%. A bank's assets are assigned to these
categories based on the nature of the debtor.

The 0% risk category consists of cash, central bank and government debt, and any Organisation
for Economic Co-operation and Development (OECD) government debt. Public sector debt
can be placed in the 0%, 10%, 20%, or 50% category, depending on the debtor.

Development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt
(under one year of maturity), non-OECD public sector debt, and cash in collection all fall into
the 20% category. The 50% category is for residential mortgages, and the 100% category is
represented by private sector debt, non-OECD bank debt (maturity over a year), real estate,
plant and equipment, and capital instruments issued at other banks.

The bank must maintain capital (referred to as Tier 1 and Tier 2 capital) equal to at least 8% of
its risk-weighted assets. This is meant to ensure that banks hold an adequate amount of capital
to meet their obligations. For example, if a bank has risk-weighted assets of $100 million, it is
required to maintain capital of at least $8 million. Tier 1 capital is the most liquid type and
represents the core funding of the bank, while Tier 2 capital includes less liquid hybrid capital
instruments, loan-loss and revaluation reserves, as well as undisclosed reserves.

What is Basel II?6

The Basel Committee on Banking Supervision originally published Basel II, a collection of
international banking standards, in 2004. It created new disclosure criteria for evaluating the

5
Investopedia Basel II Definition, Purpose & Regulatory Reform; Available at:
https://www.investopedia.com/terms/b/baselii.asp#citation-1” (Last visited on 30th October 2023)
6
IBID

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capital adequacy of banks, broadened the guidelines for minimum capital requirements set
down under Basel I, the first international regulatory treaty, and provided a framework for
regulatory supervision7.

KEY TAKEAWAYS:8

• The core principles of Basel II, the second of the three Basel Accords, are regulatory
oversight, market discipline, and minimum capital requirements.
• Basel II expanded on Basel I by establishing standards for determining minimum
regulatory capital ratios and reaffirming the need for banks to retain a capital reserve
equivalent to no less than 8% of their risk-weighted assets.
• The framework for handling systemic risk, liquidity risk, and legal risks, among other
hazards, is provided by the second pillar of Basel II, regulatory oversight, to national
regulatory authorities.
• As it became evident that Basel II had overestimated the risks associated with present
banking practises and that the financial sector was both overleveraged and
undercapitalized, a weakness of the framework surfaced during the subprime mortgage
crisis and the Great Recession of 2008.

Acknowledging Basel II:

The second of the three Basel Accords is called Basel II. Its three primary "pillars" are market
discipline, regulatory oversight, and minimum capital requirements. The most significant

7
BIS, “History of the Basel Committee; Available at: https://www.bis.org/bcbs/history.htm“ (Last visited on 30th
October 2023 at 11:09 AM)
8
Investopedia, James Chen’s “Basel II: Definition, purpose & Regulatory reforms; Available at:
https://www.investopedia.com/terms/b/baselii.asp#citation-1 " (Last visited on 30th October 2023 at 11:46 AM)

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aspect of Basel II is its minimum capital requirements, which force banks to maintain specific
capital-to-risk-weighted asset ratios.

Before the Basel Accords were introduced, banking laws differed greatly between nations.
Therefore, the uniform framework of Basel I (and later, Basel II) helped nations standardize
their regulations and reduce market anxiety surrounding risks in the banking system. There are
now 14 standards that make up the Basel Framework.9

The Basel Committee is made up of 45 members from 28 countries and other jurisdictions,
representing central banks and supervisory authorities.10It has no legal authority to enforce its
rules but relies on the regulators in its member countries to do so. Those regulators are expected
to follow the 4 Basel rules in full but also have the discretion to impose even stricter ones.11
For example, in the United States, the regulators are the Board of Governors of the Federal
Reserve System, the Federal Reserve Bank of New York, the Office of the Comptroller of the
Currency, and the Federal Deposit Insurance Corporation.12

Enforcement of Regulations and Market Discipline:

The second pillar of Basel II is regulatory supervision, which gives national regulatory bodies
a framework for managing a range of risks, such as legal, liquidity, and systemic concerns.

A number of transparency requirements about banks' risk exposures, risk assessment

procedures, and capital sufficiency are introduced by the market discipline pillar. Its goals are
to make banks more transparent about how solid their business practises are and to provide
investors and other stakeholders with an even playing field when comparing banks.

Pros and Cons of Basel II:

On the plus side, Basel II clarified and expanded the regulations introduced by the original
Basel I Accord. It also helped regulators begin to address some of the financial innovations and
new financial products that had come along since Basel I's debut in 1988.

9
BIS, Background to the Basel Framework; Accessed at https://www.bis.org/baselframework/background.htm”
(Last visited on 30th October 2023)
10
BIS, “Basel Committee Membership; Available at: https://www.bis.org/bcbs/membership.htm “(Last visited on
30th October 2023)
11
BIS, “Basel Committee Charter; Available at: https://www.bis.org/bcbs/charter.htm “(Last Visited on 30th
October 2023
12
Business Information Industry Association, “Basel II a Failure? BIS is working on Basel III; Available at:
https://www.biia.com/basel-ii-a-failure-bis-is-now-working-on-basel-iii/ (Last visited 30th October)

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Basel II was not entirely successful, however, and has even been called a miserable failure in
its central mission of making the financial world safer.13 The subprime mortgage meltdown and
Great Recession of 2008 showed that Basel II underestimated the risks involved in current
banking practices and that the financial system was overleveraged and undercapitalized,
despite Basel II's requirements.

Even the Bank for International Settlements, the organization behind the Basel Committee on
Banking Supervision, today acknowledges, "The banking sector entered the financial crisis
with too much leverage and inadequate liquidity buffers. These weaknesses were accompanied
by poor governance and risk management, as well as inappropriate incentive structures. The
dangerous combination of these factors was demonstrated by the mispricing of credit and
liquidity risks and excess credit growth."

What is Basel III?14

Basel III is an international regulatory accord that introduced a set of reforms designed to
mitigate risk within the international banking sector by requiring banks to maintain certain
leverage ratios and keep certain levels of reserve capital on hand. Begun in 2009, it is still being
implemented as of 2022.

Key Takeaway:

• Basel III is an international regulatory accord that introduced a set of reforms designed
to improve the regulation, supervision, and risk management of the banking sector.
• Basel III is an iterative step in the ongoing effort to enhance the banking regulatory
framework.
• A consortium of central banks from 28 countries devised Basel III in 2009, largely in
response to the financial crisis of 2007–2008 and ensuing economic recession.15 As of
2022, it is still in the process of implementation.16

13
IBID
14
Investopedia, Andrew Bloomenthal’s “What is Basel III, Capital Requirement and Implementation; Available
at: https://corporatefinanceinstitute.com/resources/career-map/sell-side/risk-management/basel-i/ “ (Last
visited on 30th October 2023)
15
Supra note 10
16
Bank of International Settlement, “Basel III: International Regulation Framework for Banks; Available at:
https://www.bis.org/bcbs/basel3.htm (Last visited on 30th October 2023)

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Understanding Basel III:

Basel III was rolled out by the Basel Committee on Banking Supervision—a consortium of
central banks from 28 countries, based in Basel, Switzerland—shortly after the financial crisis
of 2007–2008.17

During that crisis, many banks proved to be overleveraged and undercapitalized, despite earlier
reforms.

Also referred to as the Third Basel Accord, Basel III is part of a continuing effort to enhance
the international banking regulatory framework begun in 1975.18

It builds on the Basel I and Basel II accords in an effort to improve the banking system’s ability
to deal with financial stress, improve risk management, and promote transparency. On a more
granular level, Basel III seeks to strengthen the resilience of individual banks to reduce the risk
of system-wide shocks and prevent future economic meltdowns.

17
Supra note 10
18
Supra note 7

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 CONCLUSION

In conclusion, the Basel norms, encompassing Basel I, Basel II, and Basel III, represent a
critical framework in the world of international banking and finance. These regulations were
developed in response to the need for greater stability in the global financial system,
particularly in the wake of various financial crises.

Basel I, established in 1988, laid the foundation for regulatory standards by introducing a
minimum capital requirement for banks. It provided a straightforward approach to risk
assessment, but it had limitations, particularly in its inability to account for the varying degrees
of risk across different assets.

Basel II, introduced in the early 2000s, addressed some of these shortcomings by adopting a
more risk-sensitive approach. It allowed for better risk assessment through the use of more
advanced risk models and greater attention to credit, operational, and market risk. However, it
was criticized for being complex and pro-cyclical, meaning it could exacerbate financial crises.

Basel III, developed in the aftermath of the 2008 financial crisis, aimed to strike a balance
between risk sensitivity and simplicity. It introduced more stringent capital and liquidity
requirements, along with enhanced risk management practices, to make the banking sector
more resilient to economic downturns. Basel III emphasizes the need for banks to hold
sufficient capital to absorb losses and reduce the risk of insolvency.

While Basel III is a significant improvement over its predecessors, it is not without its
challenges, including the potential for increased compliance costs and the ongoing need for
harmonization across different jurisdictions. Nonetheless, the Basel norms represent an
ongoing effort to strengthen the stability and resilience of the global banking system and
minimize the risk of systemic financial crises.

In the years ahead, these regulations will continue to evolve, and global financial institutions
will need to adapt to remain compliant while navigating the complex landscape of international
finance. The Basel norms will remain a vital component of the ongoing efforts to strike a
balance between risk management and economic growth in the world of banking and finance.

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 BIBLIOGRAPHY

WEBSITES:
https://www.investopedia.com/terms/b/basel_i.asp
https://corporatefinanceinstitute.com/resources/career-map/sell-side/risk-management/basel-i/
https://www.bis.org/publ/bcbsc101.pdf
https://gargicollege.in/wp-content/uploads/2020/03/BASEL-NORMS.pdf
https://www.investopedia.com/terms/b/baselii.asp#citation-1
https://www.anujjindal.in/wp-content/uploads/2022/09/Basel-Norms-.pdf
https://www.ibm.com/docs/en/bfmdw/8.10?topic=accord-basel-i-summary

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