CH 8: Basel Norms for Banking

Basel Norms

Banks lend to different types of borrowers and each carries its own risk. They lend the deposits of public as well as money raised from the market – equity and debt. Therefore, Banks have to keep aside a certain percentage of capital as security against the risk of non – recovery. Basel committee has produced norms called Basel Norms for Banking to tackle the risk.

Basel I:

It focused almost entirely on credit risk. The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA)

Basel II:

The guidelines were based on three parameters:

  1. Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
  2. Banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks (credit, market and operation)
  3. Banks need to mandatorily disclose their risk exposure, etc. to the central bank.

Basel III

Pillar 1:

Minimum Capital Requirements based on Risk Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas.

Pillar 2:

Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face.

Pillar 3:

Market Discipline: Increasing the disclosures that banks must provide to increase the transparency of banks

Capital Conservation Buffer: Another key feature of Basel iii is that now banks will be required to hold a capital conservation buffer of 2.5%. The aim of asking to build conservation buffer is to ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and economic stress.

Minimum Common Equity and Tier 1 Capital Requirements

As per BASEL Minimum capital adequacy ratio (CRAR) is 8% of total RWAs. As per RBI it is 9% of total RWAs for Indian banks.

As per RBI Min CRAR for Indian banks with capital conservation buffer is 9% + 2.5% = 11.5%. As per BASEL it is 10.5%.

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