Basel Norms - Presentation Transcript

1. Presented By: Finance Department Finhance Pvt Ltd. 2. About the BIS o Established on 17 May 1930 o The BIS is the world’s oldest international financial organization o Head office is in Basel, Switzerland and representative offices in Hong Kong SAR

and in Mexico City. o The BIS currently employs around 550 staff from 50 countries.

3. List of Member Central Banks 4. Basel committee on Banking Supervision – (BCBS) o A set of agreements o Regulations and recommendations on Credit risk , market risk and operational risk o Purpose – to have enough capital on account to meet obligations and absorb

unexpected losses 5. BASEL 1 o In 1988, the Basel Committee(BCBS) in Basel, Switzerland, published a set of

minimal capital requirements for banks, known as 1988 BaselAccord or Basel 1. o Primary focus on credit risk o Assets of banks were classified and grouped in five categories to credit risk weights

of zero ‘0’, 10, 20, 50 and up to 100%. o Assets like cash and coins usually have zero risk weight, while unsecured loans

might have a risk weight of 100%. 6. Capital Adequacy Ratio (CAR) o Expressed as a percentage of a bank's risk weighted credit exposures. o Also known as "Capital to Risk Weighted Assets Ratio (CRAR). o Ratio is used to protect depositors and promote the stability and efficiency of

financial systems around the world. 7.  8. Purpose of Basel 1 o 1. Strengthen the stability of international banking system. 2. Set up a fair and a

consistent international banking system in order to decrease competitive inequality among international banks

o Achievement : to set up a minimum risk-based capital adequacy applying to all banks and

governments in the world 9. Basel Norms & Indian Banking System o Basel Accord I. was established in 1988 and was implemented by 1992 in India. o over 3 years – banks with branches abroad were required to comply fully by end

March 1994 and the other banks were required to comply by end March 1996. o RBI norms on capital adequacy at 9% are more stringent than Basel Committee

stipulation of 8%. o Commercial Banks , Cooperative Banks and Reginal rural banks banks have

different RBI guidelines

10.Pitfalls of Basel I o Limited differentiation of credit risk (0%, 20%, 50% and 100%) o Static measure of default risk The assumption that a minimum 8% capital ratio is

sufficient to protect banks from failure does not take into account the changing nature of default risk .

o No recognition of term-structure of credit risk The capital charges are set at the same level regardless of the maturity of a credit exposure.

o Simplified calculation of potential future counterparty risk The current capital requirements ignore the different level of risks associated with different currencies and macroeconomic risk. In other words, it assumes a common market to all actors, which is not true in reality.

o Lack of recognition of portfolio diversification effects In reality, the sum of individual risk exposures is not the same as the risk reduction through portfolio diversification . Therefore, summing all risks might provide incorrect judgment of risk

11.Conclusion o Basel 1- Milestone in Finance and Banking History o It launched the trend toward increasing risk modeling research o However, its over-simplified calculations, and classifications have simultaneously

called for its disappearance, paving the way for the Basel II Capital Accord o It led to further agreements as the symbol of the continuous refinement of risk and

capital

14 Sep, 2010, 04.18AM IST,ET Bureau

What are the Basel-III norms?

Indian banks are unlikely to be affected but may face some negative impact due to shifting some deductions from Tier-I & Tier-II capital to common equity, says RBI Governor Subbarao.

What are the Basel-III norms?

These are rules written by the Bank of International Settlement’s Committee on Banking Supervision (BCBS) whose mandate is to define the reform agenda for the global banking community as a whole. The new rule prescribes how to assess risks, and how much capital to set aside for banks in keeping with their risk profile.

What are the changes which have been made to the way in which capital is defined?

Going by the new rules, the predominant component of capital is common equity and retained earnings. The new rules restrict inclusion of items such as deferred tax assets, mortgage-servicing rights and investments in financial institutions to no more than 15% of the common equity component. These rules aim to improve the quantity and quality of the capital.

What do these new rules say?

While the key capital ratio has been raised to 7% of risky assets, according to the new norms, Tier-I capital that includes common equity and perpetual preferred stock will be raised from 2-4.5% starting in

phases from January 2013 to be completed by January 2015. In addition, banks will have to set aside another 2.5% as a contingency for future stress. Banks that fail to meet the buffer would be unable to pay dividends, though they will not be forced to raise cash.

How different is the approach now?

The new norms are based on renewed focus of central bankers on macro-prudential stability. The global financial crisis following the crisis in the US sub-prime market has prompted this change in approach. The previous set of guidelines, popularly known as Basel II focused on macro-prudential regulation. In other words, global regulators are now focusing on financial stability of the system as a whole rather than micro regulation of any individual bank.

How will these norms impact Indian banks?

According to RBI governor D Subbarao, Indian banks are not likely to be impacted by the new capital rules. At the end of June 30, 2010, the aggregate capital to risk-weighted assets ratio of the Indian banking system stood at 13.4%, of which Tier-I capital constituted 9.3%. As such, RBI does not expect our banking system to be significantly stretched in meeting the proposed new capital rules, both in terms of the overall capital requirement and the quality of capital. There may be some negative impact arising from shifting some deductions from Tier-I and Tier-II capital to common equity.

Basel Norms & Indian Banking SystemBy Anand Wadadekar

Amidst globalisation Banking System in India has attained vital importance. Day by day there has been increasing banking complexities in banking transactions, capital requirements, liquidity, credit and risks associated with them.

The World Trade Organisation (WTO), of which India is a member nation, requires the countries like India to get their banking systems at par with the global standards in terms of financial health, safety and transparency, by implementing the Basel II Norms by 2009.

BASEL COMMITTEE:

The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. The Committee's Secretariat is located at the Bank for International Settlements (BIS) in Basel, Switzerland.

NEED FOR SUCH NORMS:

The first accord by the name .Basel Accord I. was established in 1988 and was implemented by 1992. It was the very first attempt to introduce the concept of minimum standards of capital adequacy. Then the second accord by the name Basel Accord II was established in 1999 with a final directive in 2003 for implementation by 2006 as Basel II Norms. Unfortunately, India could not fully implement this but, is now gearing up under the guidance from the Reserve Bank of India to implement it from 1 April, 2009.

Basel II Norms have been introduced to overcome the drawbacks of Basel I Accord. For Indian Banks, its the need of the hour to buckle-up and practice banking business at par with global standards and make the banking system in India more reliable, transparent and safe. These Norms are necessary since India is and will witness increased capital flows from foreign countries and there is increasing cross-border economic & financial transactions.

FEATURES OF BASEL II NORMS:

Basel II Norms are considered as the reformed & refined form of Basel I Accord. The Basel II Norms primarily stress on 3 factors, viz. Capital Adequacy, Supervisory Review and Market discipline. The Basel Committee calls these factors as the Three Pillars to manage risks.

Pillar I: Capital Adequacy Requirements:

Under the Basel II Norms, banks should maintain a minimum capital adequacy requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated maintaining of 9% minimum capital adequacy requirement. This requirement is popularly called as Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).

Pillar II: Supervisory Review:

Banks majorly encounter with 3 Risks, viz. Credit, Operational & Market Risks. Basel II Norms under this Pillar wants to ensure that not only banks have adequate capital to support all the risks, but also to encourage them to develop and use better risk management techniques in monitoring and managing their risks. The process has four key principles:

a) Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for monitoring their capital levels.

b) Supervisors should review and evaluate bank's internal capital adequacy assessment and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios.

c) Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.

d) Supervisors should seek to intervene at an early stage to prevent capital from falling below minimum level and should require rapid remedial action if capital is not mentioned or restored.

Pillar III: Market Discipline:

Market discipline imposes banks to conduct their banking business in a safe, sound and effective manner. Mandatory disclosure requirements on capital, risk exposure (semiannually or more frequently, if appropriate) are required to be made so that market participants can assess a bank's capital adequacy. Qualitative disclosures such as risk management objectives and policies, definitions etc. may be also published.

CONCLUSION:

Basel II Norms offers a variety of options in addition to the standard approach to measuring risk. Paves the way for financial institutions to proactively control risk in their own interest and keep capital requirement low. But . . .

Requires strategizing risk management for the entire enterprise, building huge data warehouses, crunching numbers and performing complex calculations and poses great challenges of compliance for banks and financial institutions.

Increasingly, banks and securities firms world over are getting their act together.