BASEL NORMS

Basel norms or Basel accords are the international banking

regulations issued by the Basel Committee on Banking
Supervision.

The Basel norms is an effort to coordinate banking

regulations across the globe, with the goal of strengthening
the international banking system.

It is the set of agreement by the Basel Committee of Banking Supervision

which focuses on the risks to banks and the financial system.

Basel Committee on Banking Supervision

The Basel Committee on Banking Supervision (BCBS) is the primary global

standard setter for the prudential regulation of banks and provides a forum
for regular cooperation on banking supervisory matters for the central banks of
different countries.

It was established by the Central Bank governors of the Group of Ten

countries in 1974.

The committee expanded its membership in 2009 and then again in 2014. The
BCBS now has 45 members, consisting of Central Banks and authorities with
responsibility of banking regulations.

It 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 supervision worldwide.

BanksWhylendthese norms??
to different types of borrowers, and each
carries its own risk.

They lend the deposits of the public as well as money

raised from the equity, i.e., equity and debt. 2
This exposes the bank to a variety of risks of default and
as a result they fall at times.

Therefore, Banks have to keep aside a certain percentage

of capital as security against the risk of non recovery.

The Basel Committee has produced norms called Basel Norms for Banking to
tackle this risk.

Till date 3 Basel Norms have been released which are collectively called Basel
Accords.

WHY THE NAME BASEL?

It is the headquarter of the Bureau of
International Settlement (BIS), which
fosters cooperation among central banks with
a common goal of financial stability and
common standards of banking regulations.

It was founded in 1930.

Basel is a city in Switzerland.
The Basel Committee on Banking Supervision is housed in the BIS offices in
Basel offices in Basel, Switzerland.

❑ Till now, three Basel Norms have been released by BIS-

Basel Norms

Basel – II Basel – III

Basel- I Norms
Norms Norms

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Basel I Norms
In 1988, the Basel Committee on Banking Supervision (BCBS)
introduced capital measurement system called Basel Capital
Accord, also known as Basel-I

It focused only on credit risk.

Key Word:

Credit risk is the possibility of a loss resulting from a

borrower’s failure to repay a loan or meet contractual
obligations. Traditionally, it refers to the risk that a
lender may not receive the owed principal or interest.

It prescribed minimum capital requirement at 8% of the Risk

Weighted Assets (RWAs) for banks

Key Word:
• RWA means assets with different risk profiles.
• For example, an asset backed by collateral would carry lesser risks as
compared to personal loans, which have no collateral.

India adopted Basel - I norms in the year 1999. Under Basel – I,

the RBI issued guidelines to maintain CRAR (Capital to Risk
Assets Ratio) or CAR (Capital Adequacy Ratio) of 9% by every
Schedule Commercial Banks.

Key Words:

CRAR – It is defined as the proportion of bank’s total risk-weighted assets

to capital, that are held in the form of shareholders equity and certain
other defined class of capital.

Tier 1 Capital: It refers to a bank’s core capital, equity, and the disclosed
reserves that appear on the bank’s financial statements.
• In the event that a bank experiences significant losses, Tier 1 capital
provides a cushion that allows it to weather stress and maintain a
continuity of operations. 4
 Tier 2 Capital: It refers to a bank’s supplementary capital, such as
undisclosed reserves and unsecured subordinated debt instruments that
must have an original maturity of at least five years.

• Tier 2 capital is considered less reliable than Tier 1 capital because it is

more difficult to accurately calculate and to liquidate.

Basel II Norms

BCBS published the Basel-II norms in 2004

Basel-II was considered to be a refined and reformed version of

Basel-I.

It took a three-pillar approach:

Pillars of Basel I

Pillar I Pillar II Pillar III

Minimum
Supervisory Market
Capital
Review Discipline
Requirement

Pillar 1 – Minimum Capital Requirement

Basel II incorporated operational risk and market risk in addition to credit

risk for capital adequacy purpose.

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 Key Words:
• Market Risk: Market risk involves the risk of changing conditions in the
specific marketplace in which a company competes for business.
• Operational Risk: Operational risk refers to various risks that can arise
from a company’s ordinary business activities.

It divided capital into there Tiers-

Core Capital Supplementary Short term

Capital subordinated
(Tier 1 Capital) (Tier 2 Capital) debt covering
market risk

Pillar II – Supervisory Review of capital adequacy

Focuses on bank’s internal processes and systems.

Does the bank have an INTERNAL CAPITAL ASSESSMENT PROCESS??
Does the bank have defined capital targets??
Does the bank comply with minimum standards and makes required
disclosures??
Does the bank cover risks ignore under Pillar 1??

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Pillar III – Market Discipline & Transparency

Under it, the banks were needed to develop and use better risk management
techniques in monitoring and managing all the three types of risks.
Market Discipline- market mechanism that rewards disciplined banks and
penalizes weak management through primary and secondary markets.
Transparency- Disclose bank related information timely to the public

Implementation of Basel-II norms were done in India by RBI

following a gradual approach.

As per RBI, all SCBs were bound to comply with Basel-II norms.

Basel III Norms

The 2007-09 Global Financial Crisis (GFC) revealed several

weaknesses in the capital bases of internationally active banks,
definitions of capital varied widely between jurisdictions,
regulatory adjustments were generally not applied to the
appropriate level of capital and disclosures were either deficient
or non-comparable. These factors contributed to the lack of
public confidence in capital ratios during the Global Financial
Crisis.

To address these weaknesses, the Basel Committee on Banking

Supervision (BCBS) published the Basel III Norms in December
2010 with the aim of strengthening the quality of bank’s capital
bases and increasing the required level of regulatory capital.

In addition, the BCBS instituted more stringent disclosure

requirements.
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 According to Basel Committee on Banking Supervision-
• “Basel III is a comprehensive set of reform measures,
developed by the Basel Committee on Banking Supervision,
to strengthen the regulation, supervision and risk
management of the banking sector”

The guidelines aim to promote a more resilient banking system by

focusing on four vital banking parameters-

Capital Leverage Funding and

Liquidity

Capital

• A bank’s Tier 1 and Tier 2 minimum capital adequacy ratio (including the
capital conservation buffer) must be at least 10.5% of its Risk-weighted
Assets (RWAs). That combines the total capital requirement of 8% with
the 2.5% capital conservation buffer.

The capital adequacy ratio is calculated by its risk-weighted assets. The capital
used to calculate the capital adequacy ratio is divided into two tiers:
𝑻𝒊𝒆𝒓 𝟏 𝑪𝒂𝒑𝒊𝒕𝒂𝒍+𝑻𝒊𝒆𝒓 𝟐 𝑪𝒂𝒑𝒊𝒕𝒂𝒍
CAR =
𝑹𝒊𝒔𝒌 𝑾𝒆𝒊𝒈𝒉𝒕𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔

• In addition, banks have to maintain a capital conservation buffer of 2.5%.

Counter- cyclical buffer is also to be maintained at 0-2.5%

Key Words:
• Capital Conservation Buffer: It was introduced to ensure that banks
have an additional layer of usable capital that can be drawn down when
losses are incurred.
• Counter-Cyclical Buffer: The purpose of it is to ensure that banks build
up capital buffers during normal times (i.e., outside period of stress)
which can be drawn down as losses are incurred during a stressed
period/down cycles.
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 Leverage

The leverage rate has to be at least 3%. The leverage rate is the ratio of a
bank’s tier 1 capital to average total consolidated assets.

Tier 1 capital are those assets that can be easily liquidated if a bank needs
capital in the event of a financial crisis. The Tier 1 leverage ratio is thus a
measure of a bank’s near-term financial health.

The Tier 1 leverage ratio is frequently used by regulators to ensure the capita
adequacy of banks and to place constraints on the degree to which a financial
company can leverage its capital base.

Funding and liquidity

Basel III created two liquidity ratios: LCR and NSFR

Liquidity Coverage Ratio (LCR)

The Liquidity Coverage Ratio (LCR) will require banks to hold a buffer of
high-quality liquid assets sufficient to deal with the cashflows encountered in
an acute short term stress scenario as specified by supervisors.

This is to prevent situations like “Bank run”. The goal is to ensure that banks
have enough liquidity for a 30-days stress scenario if it were to happen.

Key Word:

Bank Run: It occurs when a large number of customers of a bank or other

financial institution withdraw their deposits simultaneously over concerns of
the bank’s solvency. As more people withdraw their funds, the probability of
default increases, prompting more people to withdraw their deposits.

𝑆𝑡𝑜𝑐𝑘 𝑜& '()' 𝑞𝑢𝑎𝑙(𝑡𝑦 𝑙(𝑞𝑢(𝑑 𝑎𝑠𝑠𝑒𝑡𝑠

LCR = = 100% 9
𝑇𝑜𝑡𝑎𝑙 𝑛𝑒𝑡 𝑐𝑎𝑠' &𝑙𝑜4𝑠 𝑜𝑣𝑒𝑟 𝑡'𝑒 𝑛𝑒𝑥𝑡 89 𝑐𝑎𝑙𝑒𝑛𝑑𝑒𝑟 𝑑𝑎𝑦𝑠
 Net Stable Funding Ratio (NSFR)

The Net Stable Funding Ratio (NSFR) requires banks to maintain a stable
funding profile in relation to the composition of their assets and their off-
balance-sheet activities.

NSFR requires banks to fund their activities through stable sources of finance
(reliable over the one-year horizon).

A sustainable funding structure is intended to reduce the likelihood that

disruptions to a bank’s regular sources of funding will erode its liquidity
position in a way that would increase the risk of its failure and potentially
lead to broader systemic stress.

The minimum NSFR requirement is 100%. Therefore, LCR measures short-term

(30 days resilience) and NSFR measures medium-term (1 year) resilience.

𝐴𝑣𝑎(𝑙𝑎𝑏𝑙𝑒 𝑆𝑡𝑎𝑏𝑙𝑒 𝐹𝑢𝑛𝑑(𝑛)

NSFR = = 100%
𝑅𝑒𝑞𝑢(𝑟𝑒𝑑 𝑆𝑡𝑎𝑏𝑙𝑒 𝐹𝑢𝑛𝑑(𝑛)

A % of Risk
Regulatory Requirement
Weighted Assets
Minimum Common Equity Capital Ratio 4.5%

Minimum Tier 1 Capital 6%

Tier 2 Capital 2%

Minimum Total Capital (6%+2%) 8%

Capital Conservation Buffer 2.5%

Minimum total capital plus capital conservation buffer 10.5%

Liquidity Coverage Ratio 100%

Net Stable Funds Ratio 100% 10

 Basel III and India

The Base III capital regulations have been implemented in India since 1st April
2013 in a phased manner-

The above numbers are subject to change according to the most r11ecent
guidelines of RBI.