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 the 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 from 28 Jurisdictions, consisting of Central Banks and authorities with
responsibility of banking regulation.
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 banking supervision worldwide.
Purpose of these norms
Banks lend 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 market i.e, equity and
debt.
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.
Basel is a city in Switzerland.
It is the headquarters 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.
The Basel Committee on Banking Supervision is housed in the BIS offices in Basel,
Switzerland.
Basel Norms
The Basel Committee has issued three sets of regulations which are known as Basel-I, II, and III.
Basel-I
o It was introduced in 1988.
o It focused almost entirely on credit risk.
o 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 and interest.
o It defined capital and structure of risk weights for banks.
o The minimum capital requirement was fixed at 8% of risk weighted assets (RWA).
o RWA means assets with different risk profiles.
o For example, an asset backed by collateral would carry lesser risks as compared to
personal loans, which have no collateral.
o India adopted Basel-I guidelines in 1999.
Basel-II
o In 2004, Basel II guidelines were published by BCBS.
o These were the refined and reformed versions of Basel I accord.
o The guidelines were based on three parameters, which the committee calls it as pillars.
Capital Adequacy Requirements: Banks should maintain a minimum capital
adequacy requirement of 8% of risk assets
Supervisory Review: According to this, banks were needed to develop and use
better risk management techniques in monitoring and managing all the three types
of risks that a bank faces, viz. credit, market and operational risks.
Market Discipline: This needs increased disclosure requirements. Banks need to
mandatorily disclose their CAR, risk exposure, etc to the central bank.
o Basel II norms in India and overseas are yet to be fully implemented though India
follows these norms.
Basel III
o In 2010, Basel III guidelines were released.
o These guidelines were introduced in response to the financial crisis of 2008.
o A need was felt to further strengthen the system as banks in the developed economies
were under-capitalized, over-leveraged and had a greater reliance on short-term
funding.
o It was also felt that the quantity and quality of capital under Basel II were deemed
insufficient to contain any further risk.
The guidelines aim to promote a more resilient banking system by focusing on four vital
banking parameters viz. capital, leverage, funding and liquidity.
o Capital: The capital adequacy ratio is to be maintained at 12.9%. The minimum Tier 1
capital ratio and the minimum Tier 2 capital ratio have to be maintained at 10.5% and
2% of risk-weighted assets respectively.
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%.
o 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.
o Funding and Liquidity: Basel-III created two liquidity ratios: LCR and NSFR.
The liquidity coverage ratio (LCR) will require banks to hold a buffer of high-
quality liquid assets sufficient to deal with the cash outflows 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.
The Net Stable Funds Rate (NSFR) requires banks to maintain a stable funding
profile in relation to their off-balance-sheet assets and activities. NSFR requires
banks to fund their activities with stable sources of finance (reliable over the one-
year horizon).
The minimum NSFR requirement is 100%. Therefore, LCR measures short-term
(30 days) resilience, and NSFR measures medium-term (1 year) resilience.
The deadline for the implementation of Basel-III was March 2019 in India. It was postponed
to March 2020. In light of the coronavirus pandemic, the RBI decided to defer
the implementation of Basel norms by further 6 months.
o Extending more time under Basel III means lower capital burden on the banks in terms
of provisioning requirements, including the NPAs.
o This extension would impact the perception of Indian Banks and central banks in the
eyes of the global players.
