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.
It focused almost entirely on credit risk. The minimum capital requirement was fixed at 8% of risk-weighted assets (RWA)
The guidelines were based on three parameters:
- Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
- 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)
- Banks need to mandatorily disclose their risk exposure, etc. to the central bank.
Minimum Capital Requirements based on Risk Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational risk areas.
Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face.
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%.