Capital Adequacy Norms


NPA And Basel Norms - Concepts
Class - Bank PO Prelims Subjects
 
 
Concept Explanation
 

Capital Adequacy Norms

Capital Adequacy Norms: In 1988, The Basel Committee on banking supervision created a historical document that has since set the ground rules for international banking around the globe. The central issue of the Basel Accord, as it is called, was the stability of banking systems and the emphasis was solidly on capital adequacy of banks.

Capital was categorised into different tiers and minimum limits were set for adequacy of each tier of capital depending upon the quality of the loan portfolio of the bank.

  • The Basel Accord is not a one-time deal. Minor amendments and revisions have continued since its initiation. The accord went a long way increasing the capital adequacy of banks around the world, with most changes, often painful for individual banks as well as economies, coming in the transitional period between 1988 and 1992. However, a decade or so since its adoption, a need was felt to substantially alter the framework, to come up with a largely new system. It was clear that developments and innovations in financial markets had changed the nature of risks faced by banks and the risk definitions of the 1988.
  • After years of long and intense discussions and negotiations, the Basel Committee finally came up with a revised set of regulations in June 2004, popularly called "Basel-II". There are three major pillars of Basel-II: Minimum capital requirements, supervisory review, and market discipline.
  • Regarding minimum capital requirements, Basel-II moves beyond the "one-size-fits-all" approach of the 1988 agreement to allow banks to follow one of two choices. They can either use external credit-rating agencies to assess operational risks of the borrowers or use their internal models to develop an Internal Ratings Based (IRB) approach to determining appropriate minimum capital requirements.The second pillar stresses oversight and monitoring of banks' risk management by the top management and board of the bank. It allows regulators room to review the banks' choices of capital adequacy and risk management practices, and require them to hold more capital if necessary.
  • Finally, the third pillars pertains to periodic reporting of specific variables by banks so as to allow for the financial market appropriately value and discipline them. This covers key information about major borrowers, the types of  capital of the bank, capital adequacy, credit risk evaluation methods, outside rating agencies if any details of the credit risk assessment by the banks. In the years to come, Indian banks, like their counterparts around the world, will be required to ensure conformance to Base II parameters.
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