Basel Accords, as they are sometimes called, are the international banking principles given by the Basel Committee on Banking Supervision(BCBS). The standards are meant to harmonize the banking rules worldwide and thereby add stability to the international banking system as a whole. It is based on the consensus among the member countries of the Basel Committee.
The Basel Committee on Banking Regulation was established in 1974 by the governors of ten nations. It acts as a symposium for the governors of Central Banks of different countries to deliberate on deciding fixed standards for the regulation of banks. The number of participants in the committee has considerably increased to reach 45 at present.
The necessity of Basel norms arises due to the prevalent risk in lending to different types of borrowers and each has its own risk. Banks deal with lending the money deposited by the public and hence, repose a great trust as an institution. A single instance of crisis has the potential to rock and ruin the complete banking system. The Basel Accords consist of 3 sets of Basel norms. Basel, Switzerland is the seat of the Bureau of International Settlement (BIS) and was set up in 1930.
The three packs of norms established under the Basel Accords are as follows 1. Basel 1 norms- The Basel Capital Accord was established in 1988 as an instrument to measure capital by the Basel Committee on Banking Supervision.
It is primarily stressed on credit risk. In simpler terms, Credit risk is the threat that the banker might not recover the money lent by it or the interest accrued. The minimum capital requirement is fixed at 8% of the Risk Weighted Assets(RWAs) for the banks. The RWAs essentially denote different risk profiles of assets.
India embraced the said norms one year after the inception I.e. 1999. In accordance with the Basel 1 norms, RBI put out policies to keep the Capital to Risk Assets Ratio(CRAR) or Capital Adequacy Ratio (CAR) at 9%. The said CAR applied to every Scheduled Commercial bank. In easy words, the Capital to Risk Assets Ratio I.e. CRAR is the ratio of a bank’s total risk-weighted assets to the capital. It assists in analyzing the ability of institutions to fulfill their commitments and debt obligations. Higher CRAR signals the strength of the banking institution to meet any failures. Its introduction has brought stability to the banking arena as the likelihood of predicting the bank’s strength amid a crisis is enhanced.
The capital with the banks is delineated into two categories
Tier 1 capital – It states the bank’s core capital, equity and reserves that appear on the bank’s financial sheet. It is used by banks to accomplish their daily basis functions. It acts as a safety net for the banks in the event of a bank failure.
On the other hand, Tier 2 capital is popularly called supplementary capital and comprises unrevealed reserves among others having a maturity of at least 5 years. Tier 1 capital is more dependable than Tier 2 capital for the simple reason that it is easy to estimate and also convert into liquid forms.
- Basel 2 norms- The second set of norms was specified in 2004. They are considered to be an improvement over the Basel 1 norms.
The Basel 2 norms are founded on three pillars
- Minimum Capital Requirement – Basel 2 embodied operational and market risk in complement to credit risk for calculating the Capital adequacy of banks. It further split up capital into three levels- Core or Tier 1 capital, Tier 2 or supplementary capital and Short term subordinates debt covering market risk.
- Supervisory Review- It works on the principle of accessing internal procedures and strategies. It works on the premises of several interrogations regarding the institution having capital assessment procedures in place, targets for capital limits etc.
- Market Discipline and Transparency- The banks we’re supposed to develop better strategies to govern the three types of risks. This method rewards the banks that have a disciplined approach but at the same time penalizes inefficient management practices. The openness of banks’ information to the general public determines the transparent operation of banks and is appreciated.
RBI gradually carried out the Basel 2 norms in India. All Scheduled Commercial Banks have to necessarily comply with Basel-2 benchmarks.
- Basel 3 norms- In December in the year 2010, the need for Basel three norms was felt. It was due to the conditions set in by the Global Financial Crisis of 2009-10. The explanation of capital differences among different jurisdictions and disclosures was insufficient. Thus Basel 3 standards helped in enhancing the required tier of regulatory capital. The disclosure prerequisites were also made more rigorous.
It considerably helped in bolstering three main aspects of Banking activities I.e. Regulation, Supervision and Risk Management.
The parameters that were decided for ensuring a resilient banking system were as follows
- Capital – Minimum Capital Adequacy Ratio(CAR) for Tier 1 and 2 was declared to be at least 10.5% of its Risk-weighed Assets (RWAs).
- Leverage – Leverage rate signifies the ratio of tier 1 capital of a bank to the average total consolidated assets.
- Funding and Liquidity- Basel 3 introduced two new liquidity ratios, namely – ● Liquidity Coverage Ratio (LCR)
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Net Stable Funding Ratio(NSFR)
India has gradually enforced Basel 3 capital norms since 2013.
In effect, Basel norms or accords assist in carving out a banking system that is more transparent, better coordinated, responsive, and strengthened. India has also taken the lead along the same lines and is expected to evolve a banking system that corresponds to high standards rooted in global systems.
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