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Basel Norms and its implications for banks’ treasurers

Prof. MishuTripathi Assistant ProfessorFinance

Importance of Capital in Banks
• Capital provides the funds necessary to commence banking operation much before mobilization of deposits. • It acts as a buffer or cushion against failure and absorbs temporary unexpected losses. • Permanent source of revenue for the shareholders and funding for a bank. It provides ready access to capital market. • It supports growth of business of bank • Capital provides confidence to depositors and reassures other stakeholders in a bank. • Capital regulates the growth in assets of a bank.

Basel. • Back drop: bank failures in the 80s . • A committee of central bank governors of Group of 10(G-10) countries had addressed issue of capital adequacy. Switzerland.Capital Accord 1988 • Basel Committee on Banking Supervision (BCBS) under the aegis of Bank for International Settlement (BIS).

. • Over 140 countries including India have adopted the accord and applied it uniformly across banks. Peter Cooke released a document titled “ The agreed framework on international convergence of capital measures and standards”.Capital Accord 1988 • In July 1988. the committee headed by Mr. • the accord was meant for G-10 countries.

The accord prescribed capital adequacy norms and sought to make regulatory capital more sensitive to differences in risk profiles among banks Take into account off balance sheet exposure explicitly in determining capital adequacy Lower disincentives to hold liquid and low risk assets. Strengthen the soundness of banks by boosting capital position.Objectives of Capital Accord a. c. Promote stability of global banking system Create a level playing field for banks by removing competitive inequality in the form of differing national capital adequacy standard. . b. c. • a. b.

Need for Basel II • The regulatory measures were seen to be in conflict with increasingly sophisticated internal measures of economic capital • Since each banks had separate risk measurement approach and appetite. the one size-fits-all approach was disruptive • The approach did not sufficiently recognize credit risk mitigation technique .

Three pillars of the Basel II framework Minimum Capital Requirements Supervisory Review Process •Bank’s own capital strategy •Supervisor’s review Market Discipline •Credit risk •Operational risk •Enhanced disclosure •Market risk .

g. undisclosed reserves. people and systems or from external events Market Risk Operational Risk . provisions) The risk of loss arising from default by a creditor or counterparty The risk of losses in trading positions when prices move adversely The risk of loss resulting from inadequate or failed internal processes.Pillar I – Minimum Capital Requirements Total capital Credit risk + Market risk + Operational risk = Bank’s capital ratio (minimum 9%) Total Capital Credit Risk Total capital = Tier 1 + Tier 2 Tier 1: Shareholders’ equity + disclosed reserves Tier 2: Supplementary capital (e.

differential capital wherever • Intervention by the respective Country’s Central Bank .PILLAR II . • Evaluation of risk assessment. • Prescribe necessary.SUPERVISORY REVIEW PROCESS • To ensure robust internal processes for risk management for adequacy of capital.

• Timely disclosures.MARKET DISCIPLINE • Disclosure norms about risk management practices and allocation of regulatory capital. • To enhance disclosuresCore and discretionary. .PILLAR III .

Market and Operational risks. Market and Operational Risks Capital Charge dependant on Risk rating of assets Capital Charge to include risks arising out of Credit. Not a broad brush approach Quantitative approach for calculation of Market and Operational risks as for Credit Risk. .Differences between the Accords I & II o Talks of Credit Risk only o o o o o Capital Charge for Credit Risk – 8% Does not mention separate Capital charge for Market and Operational Risk No mention about market Discipline No effort to quantify Market and Operational Risk o o o Talks of Credit.

standards and monitoring .The Basel III • December 17. 2009 Basel Committee issued two consultative documents: – Strengthening the resilience of the banking sector – International framework for liquidity risk measurement.

The Basel III • The proposals were finalized and published on December 16. standards and monitoring . 2010: – Basel III: A global regulatory framework for more resilient banks and banking systems – Basel III: International framework for liquidity risk measurement.

The Basel III • Objectives – Improving banking sector’s ability to absorb shocks – Reducing risk spillover to the real economy • Fundamental reforms proposed in the areas of – Micro prudential regulation – at individual bank level – Macro prudential regulation – at system wide basis .

Raising quality (Tier 1 – 6%. of which TCE . Improving/enhancing risk coverage on account of counterparty credit risk 3.5%).4. consistency (deductions mostly from TCE) and transparency of capital base 2. Supplementing risk based capital requirement with leverage ratio (discretion of supervisory authority) .The Building Blocks of Basel III 1.5% CCB). level (8+2.

Reducing pro-cyclicality and introducing countercyclical capital buffers (0-2.The Building Blocks of Basel III 4.5%) 6. Minimum liquidity standards . Addressing systemic interconnectedness risk and 5.

Characteristics of Basel III • Key characteristic of the financial crisis was inaccurate and ineffective management of liquidity risk • Two standards/ratios proposed – Liquidity Coverage Ratio (LCR) for short term (30 days) liquidity risk management under stress scenario – Net Stable Funding Ratio (NSFR) for longer term structural liquidity mismatches .

Characteristics of Basel III • Liquidity Coverage Ratio (LCR) – Ensuring enough liquid assets to survive an acute stress scenario lasting for 30 days – Defined as stock of high quality liquid assets / Net cash outflow over 30 days > 100% – Stock of high quality liquid assets – cash + central bank reserves + high quality sovereign paper (also in foreign currency supporting bank’s operation) + state govt..(A) – Level 2 liquid assets with a cap of 40% . & PSE assets and high rated corporate/covered bonds at a discount of 15% .

half the impact of 1% increase in TCE – However. Euro Area and Japan) on full implementation during 2011-15 – Basel Committee study – likely to have modest impact of 0. long term gains will be immense . for 25% increase in liquid assets.2% on GDP for each year for 4 years for 1% increase in TCE – Similarly.Implications of Basel III • Impact on economy – IIF study – loss of output of 3% in G3 (US.

so little impact • Most of our banks are not trading banks. so not much increase in enhanced risk coverage for counterparty credit risk • Indian banks are generally not as highly leveraged as their global counterparts • The leverage ratio of Indian banks would be comfortable .Impact on Indian banks • Most of deductions are already mandated by RBI.