Basel Accord

Basel Accord
Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee on Banking Supervision (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks under the auspices of the Bank of International Settlements(BIS) . This is also known as the 1988 Basel Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992

Basel Accord
Basel I, that is, the 1988 Basel Accord, primarily focused on Credit Risk. Assets of banks were classified and grouped in five categories according to credit risk Since 1988, this framework has been progressively introduced in member countries of G-10, currently comprising 13 countries, namely, Belgium, Canada, France, Germany, Italy, Japan, Luxenbourg, Netherland, Spain, Sweden, Switzerland, United Kingdom and the united States of America.

Basel Accord
Basel II, initially published in June 2004, was intended to create an International Standard for Banking Regulators to control how much capital banks need to put aside to guard against the types of financial and operational risks banks (and the whole economy) face.

Basel Accord
RBI issued guidelines to all banks(excluding RRBs) in April 2007 for implementation by March 31, 2009. Banks needed RBI permission to move to Internal Rating Based Approach but prohibited to shift back. Banks to make parallel run on quarterly basis from Basel I to Basel II.

Basel Accord
Banks to maintain minimum total CRAR of 9% and within that Tier I capital of 6% to be achieve by 31.03.2010. As per Basel I the Tier II capital can not be more than 50% of the total capital. Under Basel II the Tier I should be 6% out of minimum 9%

Basel Accord
Tier I Capital Paid up capital Statutory Reserve Other disclosed free reserve Investment fluctuation reserve Innovative perpetual Debt Instruments Cap reserve out of sale proceeds of assets Perpetual Non Cumulative Preference Shares Minus- (i) equity investment in subsidiaries (ii) intangible assets (iii) losses

Basel Accord
Tier II Capital Un disclosed reserve and cum perpetual Preference shares Revaluation Reserve General provisions and loss Reserve up to max 1.25% of risk assets Hybrid debts Subordinate Debts Redeemable preference shares Perpetual cumulative preference shares

Basel Accord

Objectives Ensuring that Capital Allocations is more risk sensitive; Enhance disclosure requirements which will allow market participants to assess the capital adequacy of an institution; Ensuring that Credit Risk, Operational Risk and Market Risk are quantified based on data and formal techniques; Attempting to align economic and regulatory capital more closely to reduce the scope for Regulatory Arbitrage. While the final accord has largely addressed the regulatory arbitrage issue, there are still areas where regulatory Capital Requirements will diverge from the Economic Capital.

Basel Accord
Basel II uses a "three pillars" concept (1) Minimum Capital Requirements (addressing risk), (2) Supervisory Review and (3) Market Discipline.

Basel Accord
Pillar I (Minimum Capital Requirement) The first pillar deals with maintenance of regulatory capital calculated for three major components of risk that a bank faces: credit risk, operational risk, and market risks. Other risks are not considered fully quantifiable at this stage. The credit risks component can be calculated in three different ways of varying degree of sophistication, namely Standardised approach, Foundation IRB, Advanced IRB and General IB2 Restriction. IRB stands for "Internal Rating-Based Approach". For operation risk, there are three different approaches basic indicator approach or BIA, standardised approach or STA, and the internal measurement approach (an advanced form of which is the advanced measurement approach or AMA). For market risk the preferred approach is VaR (value at risk).

Basel Accord
Pillar II (Supervisory Review Process) The second pillar deals with the regulatory response to the first pillar, giving Regulators much improved 'tools' over those available to them under Basel I. It also provides a framework for dealing with all the other risks a bank may face, such as Systemic risk, pension risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk, which the accord combines under the title of residual risk. It gives banks a power to review their risk management system. It is the Internal Capital Adequacy Assessment Process (ICAAP) that is the result of Pillar II of Basel II accords.

Basel Accord
Pillar III ( Market Discipline) This pillar aims to complement the minimum capital requirements and supervisory review process through disclosures such as assessment of the bank by others, including investors, analysts, customers, other banks, and rating agencies, which leads to good corporate governance and to allow market discipline to operate by requiring institutions to disclose details on the scope of application, capital, risk exposures, risk assessment processes, and the capital adequacy of the institution.

Basel Accord
In India, Reserve Bank of India has implemented the Basel II standardized norms on 31 March 2009 and is moving to internal ratings in credit and AMA(Advanced Measurement Approach) norms for operational risks in banks. Existing RBI norms for banks in India (as of September 2010): Common equity (incl of buffer): 3.6%(Buffer Basel 2 requirement requirements are zero.); Tier 1 requirement: 6%. Total Capital : 9% of risk weighted assets. According to the draft guidelines published by RBI the capital ratios are set to become: Common Equity as 5% + 2.5% (Capital Conservation Buffer) + 02.5% (Counter Cyclical Buffer), 7% of Tier 1 capital and minimum capital adequacy ratio (excluding Capital Conservation Buffer) of 9% of Risk Weighted Assets. Thus the actual capital requirement is between 11 and 13.5% (including Capital Conservation Buffer and Counter Cyclical Buffer).[11]

Basel Accord
Basel III (or the Third Basel Accord) is a global regulatory standard on bank Capital Adequecy, Stress Testing and Market Liquidity Risk agreed upon by the members of the Basel Committee on Banking supervision in 201011, and scheduled to be introduced from 2013 until 2018 Basel III strengthens bank Capital Requirements and introduces new regulatory requirements on bank liquidity and bank leverage.

Basel Accord
Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces additional capital buffers, ( i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary counter cyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum leverage ratio and two required liquidity ratios. [The leverage ratio is calculated by dividing Tier 1 capital by the bank's average total consolidated assets; the banks are expected to maintain the leverage ratio in excess of 3%. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.[

Basel Accord
Summary of proposed changes 1. The quality, consistency, and transparency of the capital base will be raised.
Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings Tier 2 capital instruments will be harmonised

2. The risk coverage of the capital framework will be strengthened.

Promote more integrated management of market and counterparty credit risk Add the CVA (credity valuation adjustment)-risk due to deterioration in counterparty's credit rating Strengthen the capital requirements for counterparty credit exposures arising from banks derivatives, repo and securities financing transactions Raise the capital buffers backing these exposures Provide incentives to strengthen the risk management of counterparty credit exposures Raise counterparty credit risk management standards by including wrong-way risk

Basel Accord
Summary of proposed changes (cont) 3. The Committee will introduce a leverage ratio as a supplementary measure to the Basel II riskbased framework to achieve the following objectives:
Put a floor under the build-up of leverage in the banking sector Introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simpler measure that is based on gross exposures.

Basel Accord
Summary of proposed changes (cont)
The Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality and promoting countercyclical buffers"). Dampen any excess cyclicality of the minimum capital requirement; Achieve the broader macro prudential goal of protecting the banking sector from periods of excess credit growth. Promoting stronger provisioning practices (forward looking provisioning):

4.

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Summary of proposed changes (cont) 5. The Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio called the Net Stable Funding Ratio. The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions

Basel Accord
Implementation Schedule Capital Requirement 2014 Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital requirements. 2015 Minimum capital requirements: Higher minimum capital requirements are fully implemented. 2016 Conservation buffer: Start of the gradual phasing-in of the conservation buffer. 2019 Conservation buffer: The conservation buffer is fully implemented. Leverage Ratio 2011 Supervisory monitoring: Developing templates to track the leverage ratio and the underlying components.

Basel Accord
Leverage Ratio( cont) 2011 Supervisory monitoring: Developing templates to track the leverage ratio and the underlying components. 2013 Parallel run I: The leverage ratio and its components will be tracked by supervisors but not disclosed and not mandatory. 2015 Parallel run II: The leverage ratio and its components will be tracked and disclosed but not mandatory. 2017 Final adjustments: Based on the results of the parallel run period, any final adjustments to the leverage ratio. 2018 Mandatory requirement: The leverage ratio will become a mandatory part of Basel III requirements. Liquidity Requirements 2011 Observation period: Developing templates and supervisory monitoring of the liquidity ratios. 2015 Introduction of the LCR: Introduction of the Liquidity Coverage Ratio (LCR). 2018 Introduction of the NSFR: Introduction of the Net Stable Funding Ratio (NSFR).