BASEL NORMS

PRESESTERS:MOHD RAFEEQ BHATSOURAV BOSE PRINCY AGGARWALNAVDEEP SINGHAMAR KUMAR

Basel Committee on Banking Supervision

• Basel Committee was constituted by the Central Bank Governors of the G-10 countries

• Established in 1975 in Basel, Switzerland

• The committee’s Secretariat is located at the Bank for International Settlements in Basel, Switzerland

• Its objective is to enhance understanding of key supervisory issues and quality improvement of banking supervision worldwide

• Published a set of minimal capital requirements for banks: Bank capital essentially provides a cushion against failure. The protection against becoming insolvent.

• Up until the 1990s bank regulators based their capital adequacy policy principally on the simple leverage ratio defined as:

Leverage ratio= Capital/Total Assets

• Basel committee on banking supervision Introduced the Basel 1 also known as the 1998 Basel Accord to pact with the weaknesses in the leverage ratio as a measure for solvency

The 1998 Accord requires: .To hold capital equal to at least 8% of total assets measured in different ways according to their riskiness. .The definition of capital is set in two tiers: Tier 1 being of shareholder’s equity and retained earnings. .Tier 2 being additional internal and external resources available to the bank. Cont…..

• The bank has to hold at least half of its measured capital in Tier 1 form

• A portfolio approach was taken to the measure of risk, classified into four buckets(0%, 20%, 50%, 100%) according to the debtor category.

.0%(Central bank & Govt debt).

.20%(Development bank debt, OECD bank debt, OECD securities firm debt , non OECD bank debt & non OECD public sector debt). .50%(residential mortgages). .100%(private sector debt, non-OECD bank debt real estate, plant & equipment , capital instrument issued at other banks).

BASEL –II• Basel II is second the of the Basel Accords.

• Published in June 2004

• Which recommendations on banking laws and

regulations.

• Basel II is a voluntary agreement between the

banking authorities of the major developed countries

NEED OF BASEL II• Much better capital framework was required than

Basel I.

• Basel does not reflect credit quality gradations in asset quality.

• Banking has become too complex to be addressed by Basel I simplistic approach.

• Basel I had too little risk-sensitivity and it did not give bankers, supervisors, or the marketplace, meaningful measure of risk.

BASEL II

The new accord Basel II consists of three pillars

• Minimum Capital Requirement.

• Supervisory Review.

• Market Discipline

Risk Based Capital Ratio=Capital/Credit Risk+ Market Risk+ Operational Risk

The First Pillar –Minimum Capital Requirement..Minimum capital requirement based on Market, Credit, Operational risk. CREDIT RISKPillar I of Basel II sets out the quantitative and qualitative requirement & formula to calculate capitalfor credit risk.A meaningful differentiation of risk, and reasonablyAccurate and consistent quantitative estimates of risk.

Operational Riskoperational risk (for example, the risk of loss from computer failures, poor documentation or fraud). Many major banks now allocate 20% or more of their internal capital to operational risk.

Market Risk.Market risk is the risk of financial loss relating to a banks trading activities, where the bank may act on its own account or on behalf of its clients in the commodity, foreign exchange, equity, capital and money markets.

.Market risk arises where there are adverse movements in market prices e.g. interest and foreign exchange rates, equity, bond and commodity prices

The First Pillar• The definition of capital in Basel 2 will not modify

and that the minimum ratios of capital to risk-weighted assets including operational and market risks will remain 8% for total capital.

• Tier 2 capital will continue to be limited to 100% of tier 1 capital.

• The main changes will come from the inclusion of the operational risk and the approaches to measure the different kinds of risks. The following diagram summarizes these

approaches:

Cont.…

The Second Pillar: Supervisory Review Process

In Basel 2 the bank can choose from a menu of approaches to measure the credit, market and operational risks. This process of choosing the approach requires the review of the availability of the minimum requirements to implement the approach.The Third Pillar: Market Discipline

The third pillar in Basel 2 aims to bolster market discipline through enhanced disclosure by banks. Effective disclosure is essential to ensure that market participants can better understand banks’ risk profiles and the adequacy of their capital positions.

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