The Basel norms, also known as the Basel accords, serve as international banking regulations. These are established by the Basel Committee on Banking Supervision. They aim to harmonize banking regulations globally to fortify the international banking system by addressing risks to banks and the financial sector. In India, these norms are enforced by the Reserve Bank of India (RBI), which began implementing Basel-I in 1992. RBI has also issued phased guidelines for the implementation of Basel-III.
Basel Norms and BCBS:
The Basel Committee on Banking Supervision (BCBS) stands as the primary global authority for establishing standards in the prudential regulation of banks and serves as a platform for ongoing collaboration among central banks worldwide on matters of banking supervision.
Initially formed in 1974 by the Central Bank governors of the Group of Ten nations, its membership has since grow. Now encompassing 45 members from 28 jurisdictions, including central banks and regulatory authorities.
The committee’s core objective remains the enhancement of comprehension regarding critical supervisory issues and the elevation of banking supervision quality across the globe.
Notably, the committee has been instrumental in formulating the Basel I, Basel II, and Basel III accords. Headquartered in Basel, Switzerland, the secretariat of the Basel Committee on Banking Supervision (BCBS) operates within the Bank for International Settlements (BIS).
Role of Basel Norms in Banking
- To safeguard against risks, banks are required to allocate a portion of their capital as a buffer against potential losses stemming from non-recovery of loans.
- The Basel Committee on Banking Supervision has developed a set of standards known as Basel Norms specifically aimed at addressing these risks and ensuring the stability and resilience of the banking sector.
Basel Committee has issued three sets of regulations known as Basel-I, II, and III.
Basel-I
- Basel-I was introduced by the Basel Committee on Banking Supervision in 1988.
- Its primary focus was on addressing credit risk, which is the potential for loss arising from a borrower’s inability to repay a loan or fulfill contractual obligations.
- Credit risk traditionally pertains to the risk of lenders not receiving the owed principal and interest.
- Basel-I outlined the definition of capital and established a framework for assigning risk weights to different types of assets held by banks.
- The minimum capital requirement set by Basel-I was 8% of risk-weighted assets (RWA).
- Risk-weighted assets refer to assets with varying levels of risk exposure. For instance, assets backed by collateral carry lower risks compared to unsecured personal loans.
- India adopted the Basel-I guidelines in 1999, aligning its banking regulations with the international standards outlined by the Basel Committee.
Basel -II
- The BCBS introduced Basel II guidelines in 2004 as refined and reformed versions of the Basel I accord.
- The committee structured the guidelines around three key parameters, which it refers to as pillars.
- The first pillar, Capital Adequacy Requirements, mandates banks to maintain a minimum capital adequacy requirement of 8% of risk assets.
- The second pillar, Supervisory Review, entails banks to enhance risk management techniques for monitoring and managing credit and operational risks effectively.
- The third pillar, Market Discipline, emphasizes increased disclosure requirements. It necessitating banks to disclose their Capital Adequacy Ratio (CAR), risk exposure to central banks.
- The guidelines represent a comprehensive framework aimed at bolstering the stability and resilience of the banking sector. This is aimed by addressing various risks and enhancing transparency and accountability.
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Basel-III
- Basel III aims to strengthen the international banking system in response to the deficiencies exposed during the 2007-08 financial crisis.
- It focuses on promoting resilience in banks by addressing capital, leverage, funding, and liquidity aspects.
- Basel III norms has following components:
- Minimum Capital Requirements: Basel III introduced stricter capital requirements to enhance the resilience of banks. This includes maintaining a capital adequacy ratio of 12.9%, with minimum Tier 1 and Tier 2 capital ratios set at 10.5% and 2% of risk-weighted assets respectively. In addition, regulatory authorities mandate banks to maintain a capital conservation buffer of 2.5% and to hold a counter-cyclical buffer ranging from 0 to 2.5%.
- Leverage Ratio: Basel III mandates a minimum leverage ratio of 3%. Leverage Ratio is ratio of bank’s tier-1 capital to average total consolidated assets. This measure aims to limit excessive leverage within the banking system, reducing the likelihood of systemic risk.
- Liquidity Requirements: two key liquidity ratios: the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). The LCR requires banks to hold a buffer of high-quality liquid assets sufficient to cover cash outflows during short-term stress scenarios. This is for mitigating the risk of bank runs. The NSFR, ensures that banks maintain a stable funding profile over a one-year horizon. This requires them to fund their activities with reliable sources of finance.
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