2023 SEP 23
Economic Development > Indian Economy and Issues > Banking sector
Why in news?
- The RBI has introduced norms on the Basel III capital framework, fund raising, exposure guidelines, and norms on classification and valuation of investment portfolios for All India Financial Institutions (AIFIs), which will come into effect from April 2024.
What are 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.
What is the 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.
Why 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.
What are these norms?
- The Basel Committee has issued three sets of regulations which are known as Basel-I, II, and III.
- It was introduced in 1988. It focused almost entirely on credit risk.
- 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.
- 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. For example, an asset backed by collateral would carry lesser risks as compared to personal loans, which have no collateral.
- India adopted Basel-I guidelines in 1999.
- In 2004, Basel II guidelines were published by BCBS.
- These were the refined and reformed versions of Basel I accord.
- 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.
- Basel II norms in India and overseas are yet to be fully implemented though India follows these norms.
- Basel - III
- In 2010, Basel III guidelines were released.
- These guidelines were introduced in response to the financial crisis of 2008.
- 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.
- 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
- 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%.
- 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.
- 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 April 2021 in India.
- In October, RBI decided to extend Basel-III Capital framework to All India Financial Institutions (AIFIs) such as EXIM Bank, NABARD, National Housing Bank (NHB) and the Small Industries Development Bank of India (SIDBI).
The term ‘Basel Norms’, sometimes seen in news, is associated with
(a) Banking regulation
(b) Nuclear disarmament
(c) Climate change mitigation
(d) Gender justice