- BIS Established on 17 May 1930
- The BIS is the world’s oldest international financial organization
- Head office is in Basel, Switzerland and representative offices in Hong Kong SAR and in Mexico City.
- BCBS is termed as Basel Committee on Banking Supervision .
- BCBS is a set of agreement
- Regulations and recommendations on Credit risk , market risk and operational risk
Purpose of banking supervision is –
- To ensure that banks operate in a safe and sound manner.
- To ensure that banks "hold capital and reserves sufficient to support the risks that arise in their business".
- Sound practices for banks' risk management
Capital Adequacy Ratio (CAR) –
- Capital Adequacy provides regulators with a means of establishing whether banks and other financial institutions have sufficient capital to keep them out of difficulties. Regulators use a Capital Adequacy Ratio (CAR) to assess risk .
- Expressed as a percentage of a bank's risk weighted credit exposures.
- Also known as “ Capital to Risk Weighted Assets Ratio (CRAR)” .
- Ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world.
Why Capital Requirement ?
- While bank’s assets (loans & Investments) are risky and prone to losses, its liability (deposits) are certain.
- Assets = External Liabilities + Capital Liabilities (deposits) are to be honoured. Hence, reduction In Capital. When Capital is wiped out – Bank Fails.
History of Basel Committee –
- The breakdown of the Bretton Woods system of managed exchange rates in 1973 soon led to casualties . On 26 June 1974, West Germany's Federal Banking Supervisory Office withdrew Bankhaus Herstatt's banking licence after finding that the bank's foreign exchange exposures amounted to three times its capital.
- Basel Committee on Banking Supervision [BCBS] was established by the central-bank governors of the G10 countries in 1974.
- Meets at the Bank for International Settlements in Basel, Switzerland
- Its objective was to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.
- Formulates broad supervisory standards and guidelines
- First major result was the 1988 Capital Accord
- In 1997, developed a set of "Core Principles for Effective Banking Supervision", which provides a comprehensive blueprint for an effective supervisory system.
- Later renamed as the Basel Committee on Banking Supervision.
- The Committee was designed as a forum for regular cooperation between its member countries on banking supervisory matters.
- Its aim was and is to enhance financial stability by improving supervisory know how and the quality of banking supervision worldwide.
The Committee seeks to achieve its aims –
- By setting minimum supervisory standards.
- By improving the effectiveness of techniques for supervising international banking business.
- By exchanging information on national supervisory arrangements. And, to engage with the challenges presented by diversified financial conglomerates.
- The Committee also works with other standard-setting bodies, including those of the securities and insurance industries.
- The Committee's decisions have no legal force . Rather, the Committee formulates supervisory standards and guidelines and recommends statements of best practice in the expectation that individual national authorities will implement them.
- In this way, the Committee encourages convergence towards common standards and monitors their implementation, but without attempting detailed harmonisation of member countries' supervisory approaches.
- One important aim of the Committee's work was to close gaps in international supervisory coverage so that-
- No foreign banking establishment would escape supervision.
- That supervision would be adequate and consistent across member jurisdictions.
BASEL 1 Norms -
- In 1988, the Basel Committee (BCBS) in Basel, Switzerland, published a set of minimal capital requirements for banks, known as 1988 Basel Accord or Basel 1.
- Primary focus on credit risk
- Assets of banks were classified and grouped in five categories to credit risk weights of zero ‘0’, 10, 20, 50 and up to 100%.
- Assets like cash and coins usually have zero risk weight, while unsecured loans might have a risk weight of 100%.
- Created in 1988, Basel I Capital Accord had general purpose:
- To strengthen the stability of International Banking System
- To set up a fair and consistent international banking system in order to decrease competitive inequality among international banks.
- Focused on Credit Risk
- Set up an international ‘minimum’ amount of capital that bank should hold
- Tier I (Core Capital) : Tier I capital includes stock issues (or share holder equity) and declared reserves, such as loan loss reserves set aside to cushion future losses or for smoothing out income variation.
- Tier II (Supplementary Capital) : Tier II Capital includes all other capital such as gains on investment assets, long term debt with maturity greater than 5 years and hidden reserves. However, short-term are not included.
- Limited differentiation of credit risk
- Strategic Measure of default risk
- No recognition of term-structure of credit risk
- Simplified calculation of potential future counterparty risk
- Lack of recognition of portfolio diversification effects Pitfall of Basel – I
- According to Basel I, the total capital should represent at least 8% of the bank’s credit risk.
Purpose of Basel 1 –
- Strengthen the stability of international banking system.
- Set up a fair and a consistent international banking system in order to decrease competitive inequality among international banks
- To set up a minimum risk-based capital adequacy applying to all banks and governments in the world
Basel 2 Norms (2004) -Basel II was intended : -
- To create an international standard for banking system
- To maintain sufficient consistency of regulations
- To protect the international financial system
- To reduce scope of regulatory arbitrage
- Defined new calculation of credit Risk
- Addition of operation risk in the existing norms
- Ensuring that capital allocation is more risk sensitive Basel – II Norms (2004)
- Basel II Norms has Three Pillar Concept , These are as follows :
Basel – 3 Norms (2010) -
- The G-20 endorsed the new ‘Basel 3’ capital and liquidity requirement as remedy to overcome financial crisis of 2008-2009.
The new accord aims to: -
- Have special emphasis on Capital Adequacy Ratio
- Improve banking sectors ability to absorb shocks arising from financial and economic stress
- Strengthen banks transparency and disclosures
- The accord provides a substantial strengthening of capital requirements
- Places greater emphasis on loss-absorbency capacity on a going concern basis.
Features of Basel 3 –
- Revised Minimum Equity & Tier I Capital Requirements
- Better Capital Quality
- Leverage Ratio
- Liquidity Ratio
- Countercyclical Buffer
- Capital Conservation Buffer
- Ratio under consideration - CAR =
Impact on Indian Banking System –
- Reduced Systematic Risk and absorb economic-finance stress
- Challenge for Weaker Banks to survive
- Increased Supervisory Vigil
- Reorganisation of Institutions with more mergers & acquisitions
- Chances of increased International Arbitrage
- Bank Capital – Increased NPA, reduced Tier II CAR Ratio
- Increased Tier I capital requirement
- Presently PSU banks carry adequate CAR.
- Over next few years, Tier I Capital specially Equity Shares will be of prime importance instead of CAR.
- Public Sector Banks need Rs. 4.15 trillion additionally to meet the requirement – Rs. 2.72 trillion for non-equity capital and approx Rs. 1.43 trillion for equity capital over a period .
- Government to recapitalize an estimated Rs. 900 billion at existing stake holding position or Rs. 660 billion if reduce its shareholding down to 51% .
- Some public sector banks are likely to fall short of the revised core capital adequacy requirement .
- Increase in requirement of capital will affect the ROE of the public banks.