Basel Norms
Basel Norms
BASEL NORMS: The birth of the Basel banking norms is attributed to the incorporation of the Basel Committee on Banking Supervision (BCBS), established by the central bank of the G-10 countries in 1974. This came into being under the patronage of Bank for International Settlements (BIS), Basel, Switzerland. The Committee formulates guidelines and provides recommendations on banking regulation based on capital risk, market risk and operational risk. The Committee was formed in response to the chaotic liquidation of Herstatt Bank, based in Cologne, Germany in 1974.
Basel I: In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel I. It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks. The minimum capital requirement was fixed at 8% of risk weighted assets (RWA). RWA means assets with different risk profiles. Apart from focusing on the credit risk, the committee also issued Market Risk Amendment to the capital accord in January 1996, which came into effect at the end of 1997. The reason for such an amendment arose from banks' market risk exposures to foreign exchange, debt securities, equities, commodities and options.
Features of Basel I: The Basel I Accord attempted to create a cushion against credit risk. The norm comprised of four pillars, namely Constituents of Capital, Risk Weighting, Target Standard Ratio, and Transitional and Implementing Arrangements.
Basel II: Basel II was fundamentally conceived as a result of two triggers – the banking crises of the 1990s on the one hand, and the criticisms of Basel I itself on the other. In the year 1999, the Basel Committee proposed a new, far more thorough capital adequacy accord. Formally, the accord was known as A Revised Framework on International Convergence of Capital Measurement and Capital Standards (hereinafter referred to as Basel II). The new framework was designed to improve the way regulatory capital requirements reflect the underlying risks for addressing the recent financial innovation. Also, this framework focuses on the continuous improvements in risk measurement and control. For successful implementation of the new capital framework across borders, the committee's Supervision and Implementation Group (SIG) communicates with the supervisors outside the committee's membership through its contacts with regional associations. The new framework neatly retained the 'pillar' framework of basel 1, yet crucially expanded the scope and specifies of Basel I.
Basel II aimed to measure the risk-weighted (RWAs) of a bank more carefully. This revised framework placed forth three methodologies to determine the risk rating of a bank's assets- the Standardised Approach and two Internal Ratings Based Approaches.
Basel III: Basel II indeced had its share of criticism. To begin with, the Basel Committee declared that the committee's recommendations were for G-10 member states. This leaves out emerging economies, andoanks might not be stringent enough in regulating private banks, thus letting them raise their exposure - defeating the entire purpose. The issues surrounding Basel II together contributed to emergence of the Basel II accord. The essence of Basel III revolves around two sets of compliance:
While good quality of capital will ensure stable long-term sustenance, compliance with liquidity covers will increase ability to withstand short-term economic and financial stress.
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