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Mayuri Gabani 11228 Karan Mehta 11229 Rayees Mohammad 11240 Amitkumar Sarvade 11244
Contents
BIS Basel committee Basel I Basel II Basel III
Objectives
The G10 countries recognized the need to strengthen the solvency of the international banking system and to remove the competitive inequality that arose from differences in national capital requirements. In response, the Basel Committee introduced in 1988 a new capital adequacy framework the Basel Capital Accord The Accord should continue to promote safety and soundness in the financial system The Accord should contain approaches to capital adequacy that are appropriately sensitive to the degree of risk involved in a banks positions and activities.
Basel norms
Basel I 1988 Accord Basel II 2004 Accord Basel III 2010-2011 Accord
Basel I
Requires the banks to hold capital equal to at least 8% of its Risk Weighted Assets CAR Capital is broadly into two tiers Tier 1 and Tier 2 Weights are assigned to each asset depending on its riskiness. Assets are classified into four buckets (0%, 20%, 50%, 100%) according to their debtor category.
Tier I Capital
Consists of :
Paid up capital Statutory reserves Disclosed free reserves Capital reserves representing surplus arising out of sale proceeds of asset
Tier II Capital
Consists of : Undisclosed reserves and Cumulative perpetual preference shares
Revaluation reserves
Subordinated debt
Composition of Capital
Composition of Risk Weighted Assets Assigning Risk Weights
Basel I Criticisms
Following are the criticisms of the First Basel Accord (Basel I): It took too simplistic an approach to setting credit risk weights Ignoring other types of risk. Risks weights were based on what the parties to the Accord negotiated rather than on the actual risk of each asset. Risk weights did not flow from any particular insolvency probability standard, and were for the most part, arbitrary.
Basel II
The minimum capital requirement remains set at 8% of RWA However, the calculation procedures used in establishing the risk weights have been modified to incorporate Credit risk Market risk Operational risks. Three methods to calculate credit risk
3 methods
Basel II includes three options for calculating credit risk and three methods for measuring operational risk. The credit risk estimation options are Standardized approach
Credit assessment Risk-weight AAA to AA20% A+ to A50% BBB+ to Below BB- Unrated BB100% 150% 100%
3 pillars
Pillar I - Minimum Capital Requirement (Addressing Credit Risk, Operational Risk & Market Risk) Pillar II - Supervisory Review (Provides Framework for Systematic Risk, Liquidity Risk & Legal Risk) Pillar III - Market Discipline & Disclosure (To promote greater stability in the financial system)
Tier III Capital includes subordinate debt with a maturity of at least 2 years. This is addition or substitution to the Tier II Capital to cover market risk alone. Tier III Capital should not cover more than 250% of Tier I capital allocated to market risk.
Basel II merits
The revised framework keeps the key elements of the 1988 framework Contains further risk-sensitive capital requirements Paying due regard to particular features of the present supervisory and accounting systems in individual member countries. Introduces significant innovations, including a greater reliance on the use of participating banks own internal risk assessments as inputs to capital requirement calculations It is designed to establish minimum levels of capital reserves for internationally active banks and will allow national authorities the discretion to adopt arrangements that set higher levels of minimum capital
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Range of options for determining capital requirements for credit, market and operational risk, Allowing greater latitude for banks and regulators to select the methods best suited to their operations and their financial market infrastructure Greater attention to the supervisory review and market discipline Aggression towards development of the existing standards by banks. Strong regulatory impact by central bank to all the banks for implementation
Basel II criticism
For some developing countries, the new capital adequacy rules may unduly restrict access to credit. Unfairly favors the larger financial institutions Implementation of the capital accord may be delayed as financial institutions struggle to upgrade their systems, practices and procedures. The recruitment of qualified staff with adequate knowledge and experience to implement the new capital adequacy regime Some financial institutions may sidestep by shifting riskier assets off their balance sheet to subsidiaries, or may employ similar strategies to transfer risk to third parties.
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The implementation of Basel II raises a number of challenges that need to be addressed in the areas of risk identification, measurement and monitoring, it concerns the management of operational risk Pillar 3 purports to enforce market discipline through stricter disclosure requirement. While admitting that such disclosure may be useful for supervisory authorities and rating agencies The expertise and ability of the general public to comprehend and interpret disclosed information is open to question. Too much disclosure may cause information overload and may even damage financial position of bank.
Basel III
RBI's version Migrate fully by Risk capital Tier I capital Particulars March 31, 2018 11.5% 5.5% Basel III January 1, 2019 10.5% 4.5% % of its risky assets
Tier I
Tier II Additional equity Capital conservation buffer Counter cyclical buffer Total capital that banks need to set aside
5.5%
2% 1.5% 2.5% 2.5% 14%
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The risk capital to be set aside by Indian banks is 11.5 per cent of all its risky loans in the form of common equity whereas the global requirement is 10.5 per cent. Indian banks are required to set aside minimum common equity of 5.5 per cent (TierI) capital for its risky assets (loans). Banks also have to set aside two per cent Tier-2 capital. Banks also have to bring in additional equity at a minimum of 1.5 per cent of its risky assets (loans). To counter liquidity crunch, banks have to set aside a capital conservation buffer of 2.5 per cent in the form of common equity.
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Banks have to build this buffer when they make bumper profits. This buffer would be drawn down when banks face losses due to a downturn in business. Finally, banks are also expected to counter the cyclical nature of their business by setting aside 2.5 per cent common equity as counter cyclical buffer. So, the total capital that banks need to set aside is 14 per cent. Rs 2.5 lakh crore of additional equity under the Basel III capital regulations announced by the RBI 75 per cent needed to be added between 201516 and 2017-18
The quality, consistency, and transparency of the capital base Tier 3 capital will be eliminated capital conservation buffer of 2.5 per cent in the form of common equity. 2.5 per cent common equity as counter cyclical buffer. Basel III introduces a minimum 3% leverage ratio and two required liquidity ratios Liquidity requirement
References
BIS website rbi-guidelines-on-basel-iii financialexpress.com thehindubusinessline parl.gc.caResearchPublications