Basel Norms

BASEL NORMS
BASEL NORMS
• BASEL IS A CITY IN SWITZERLAND.
• IN 1974, THE BASEL COMMITTEE ON BANKING AND
SUPERVISION WAS ESTABLISHED IN BASEL.
• IT PROVIDES A FORUM FOR REGULAR COOPERATION
ON BANKING SUPERVISORY MATTERS.
• ITS OBJECTIVE IS TO IMPROVE THE QUALITY OF
BANKING SUPERVISION WORLDWIDE.
• IN 1974, IT STARTED WITH 10 MEMBER COUNTRIES.
CURRENTLY IT HAS 45 MEMBERS INCLUDING INDIA.
WHY BASEL NORMS ?
• BANKS LEND TO DIFFERENT TYPES OF BORROWERS
AND EACH CARRIES ITS OWN RISK.
• THEY TAKE DEPOSITS FROM THE GENERAL PUBLIC AND
ALSO RAISE MONEY FROM OTHER SOURCES.
• THIS EXPOSES THEM TO A VARIETY OF RISKS OF
DEFAULT.
• HENCE, BANKS HAVE TO KEEP ASIDE CERTAIN PORTION
OF THEIR CAPITAL AS SECURITY AGAINST RISK OF NON
RECOVERY.
• THE BASEL COMMITTEE HAS COME OUT WITH NORMS
KNOWN AS THE BASEL NORMS TO TACKLE THIS RISK.
BASEL-I
• IT WAS INTRODUCED IN 1988 AND FOCUSED ENTIRELY ON CREDIT
RISK.
• CREDIT RISK IS THE POSSIBILITY OF A LOSS RESULTING FROM THE
BORROWER’S FAILURE TO REPAY A LOAN OR MEET ITS OBLIGATION.
• IT DEFINED THE CAPITAL AND RISK WEIGHT STRUCTURE FOR
BANKS.
• RISK WEIGHTED ASSETS MEANS ASSETS CARRYING DIFFERENT
RISK PROFILES.
• FOR E.G. A PERSONAL LOAN WOULD CARRY A HIGHER RISK WHILE A
HOME LOAN WOULD CARRY A LOWER RISK.
• THE MINIMUM CAPITAL REQUIREMENT WAS FIXED AT 8% OF THE
RISK WEIGHTED ASSETS.
• INDIA ADOPTED THE BASEL-I GUIDELINES IN 1999.
TYPES OF CAPITAL
TIER 1 CAPITAL TIER 2 CAPITAL
• IT CONSISTS OF THE • IT CONSISTS OF
SHAREHOLDERS REVALUATION
EQUITY AND RESERVES, HYBRID
RESERVES, INNOVATIVE CAPITAL INSTRUMENTS
PERPETUAL DEBT AND SUBORDINATED
INSTRUMENTS, DEBT.
DISCLOSED FREE • IT IS CONSIDERED AS
RESERVES. THE SUPLEMENTARY
• IT IS CONSIDERED AS CAPITAL.
THE CORE CAPITAL. • IT IS LESS RELIABLE
• IN CASE OF LOSSES IT SINCE IT IS DIFFICULT
RISK WEIGHTED ASSETS
• A RISK PERCENTAGE WAS ASSIGNED TO EACH OF THE
ASSETS IN THE BANKS PORTFOLIO.
• FOR CASH AND GOVERNMENT BONDS – 0%
• FOR OTHER SEMI GOVERNMENT BONDS – 20%
• FOR MORTGAGES – 50%
• FOR ALL OTHER INDIVIDUAL OR CORPORATE DEBT –
100%
• AS PER THE BASEL – I NORMS, BANKS HAVE TO
MAINTAIN A CAPITAL ADEQUACY OF 8%.
FORMULA OF CAPITAL
ADEQUACY RATIO
CALCULATION OF CAR
ASSUME THE FOLLOWING
• TIER 1 CAPITAL – 3000
• TIER 2 CAPITAL – 1000
• INVESTMENT IN CASH & GOVT BONDS – 9000
• MORTGAGE ADVANCES – 45000
• CORPORATE ADVANCES – 4000
EXAMPLE OF CAPITAL
ADEQUACY RATIO
TIER 1 CAPITAL 3000
TIER 2 CAPITAL 1000
TOTAL(A) 4000
RISK WEIGHTED ASSETS RISK WT AMOUNT
CASH & GOVT BONDS 9000 0% 0
MORTGAGES 45000 50% 22500
CORP AND IND LOANS 4000 100% 4000
TOTAL (B) 26500
CAP ADEQ RATIO A/B% 15.09%

BASEL-II NORMS
• THEY WERE INTRODUCED IN 2004 AND WERE CONSIDERED
TO BE A REFINED VERSION OF BASEL-I NORMS.
• BANKS SHOULD MAINTAIN A MINIMUM CAPITAL ADEQUACY
OF 8% OF RISK ASSETS. RBI MANDATED THAT INDIAN BANKS
SHOULD HAVE CAR OF 9%. TIER 1 CAPITAL HAS TO BE 4% OF
WHICH THE CORE EQUITY CAPITAL HAS TO BE 2%
• BANKS NEED TO DEVELOP AND USE BETTER RISK
MANAGEMENT TECHNIQUES TO MANAGE OPERATION RISK
AND CREDIT RISK.
• BANKS NEED TO MANDATORILY DISCLOSE THEIR RISK
EXPOSURE TO THE CENTRAL BANKS.
• IT WAS IMPLEMENTED IN INDIAN BANKS IN 2009.
PILLARS OF BASEL II NORMS
• CAPITAL ADEQUACY REQUIREMENTS – Banks should maintain a
minimum capital adequacy requirements of 8% of risk assets.
• SUPERVISORY REVIEW- Banks were required to develop and use
better risk management techniques in monitoring and managing all
three types of risk – credit, market and operational risks.
• MARKET DISCIPLINE – Banks need to mandatorily disclose their CAR,
risk exposoure to the central banks.
THREE PILLARS OF BASEL-II
NORMS
BASEL III NORMS
• In 2010, the BASEL III guidelines were released.
• These guidelines were in response o the financial crisis of 2008.
• A need was felt to to further strengthen the system as banks in the
developed countries were under capitalized, over leveraged and had a
greater reliance on short term funding.
• It was also felt that the quantity and quality of capital under Basel II
was insufficient to contain any further risk.
• The guidelines amim to promote a more resilient banking system by
focusing on four vital parameters – capital, leverage, funding and
liquidity.
MAJOR CHANGES IN BASEL III
• BETTER CAPITAL QUALITY – It has a stricter definition of capital. Better
quality capital means the higher loss absorbing capacity, allowing them to
better withstand periods of stress.
• CAPITAL CONSERVATION BUFFER – Banks will now be required to hold a
CCB of 2.5% of Tier 1 equity. The aim of the CCB is to ensure that banks
maintain a cushion of capital that can be used to absorb losses during
period of financial and economic stress.
• COUNTERCYCLICAL BUFFER – This has been introduced to increase capital
in good times and decrease it in bad times. The buffer will slow down
banking activity when it is overheated and encourage lending in bad
times. The buffer will range from 0% to 2.5% of common equity.
• TIER 1 CAPITAL REQUIREMENTS – The minimum requirement for
common equity has been raised from 2% to 4% of RWA. The overall
TIER 1 capital will also increase from 4% to 6%. The minimum CAR sill
remain at 8% but combined with capital conservation buffer, it will go
up to 10.5%
• In India, since RBI has mandated CAR at 9%, the CAR under BASEL III
norms will go upto 11.5%
• LEVERAGE – It is the ratio of the bank’s tier 1 capital to average total
assets. It has to be atleast 3%
• LIQUIDITY COVERAGE RATIO – It requires the bank to hold a buffer of
high quality liquid assets sufficient to deal with the cash flows
encountered in acute short term stress scenario. Banks should have
enough liquidity for a 30 days stress scenario
• NET STABLE FUNDS RATE – NSFR requires banks to maintain a stable
funding profile in relation to their balance sheet. Banks have to
increase their focus on long term financing and reduce short term
debt.

Basel Norms

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BASEL NORMS

RISK WEIGHTED ASSETS RISK WT AMOUNT

CASH & GOVT BONDS 9000 0% 0

MORTGAGES 45000 50% 22500

CORP AND IND LOANS 4000 100% 4000

TOTAL (B) 26500

CAP ADEQ RATIO A/B% 15.09%

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