Meaning: Basel guidelines (norms) visit broad supervisory standards formulated by the groups of central banks- referred to as the Basel Committee on Banking Supervision(BCBS). The set of guidelines by the BCBS, which mainly focuses on risks to banks and also the financial set-up is termed Basel accords/Basel Norms.’
Need for Basel Norms: The Basel Committee (BCBS)- initially referred to as the Committee on Banking Regulations and Supervisory Practices – was established by the financial organization Governors of the Group of Ten countries at the top of 1974 within the aftermath of significant disturbances in international currency and banking markets (notably the failure of Bankhaus Herstatt in West Germany).
Purpose : it was established to reinforce financial stability by improving the standard of banking supervision worldwide, and to function as a forum for normal cooperation between its member countries on banking supervisory matters.
At the outset, one important aim of the Committee’s work was to shut gaps in international supervisory coverage so that (i) no banking establishment would escape supervision; and (ii) supervision would be adequate and consistent across member jurisdictions.
The BCBS regulates the danger of banks located internationally and to try and do so it issues the Basel Norms and modifies, strengthening it to tackle the forever changing attributes in banking around the globe. thus far BCBS has majorly modified these norms thrice and these are referred to as Basel I, Basel II and Basel III.
Basel I: the Basel Capital Accord
In 1988, BCBS introduced a capital measurement system called Basel capital accord, also called Basel 1. It focused almost entirely on credit risk. 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 eg. An asset-backed by collateral would carry lesser risks as compared to private loans, which don’t have any collateral.
Assets of banks were classified and grouped into four categories in keeping with credit risk, carrying risk weight of:
- 0% – for cash, Treasuries
- 20% – for securitizations like MBS rated AAA
- 100% for much corporate debt
India adopted Basel 1 guidelines in 1999.
The twin objectives of Basel 1 was:
- To ensure an adequate level of capital within the international banking industry.
- To create a more level playing field during a competitive environment.
Basel II: The new capital framework
2004, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel 1 accord. These 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 three styles of risks.
- Banks have to mandatorily disclose their risk exposure etc. to the financial organization.
Basel III: responding to the 2007-09 financial crisis
Basel III or Basel 3 released in December 2010 is the third within the series of Basel Accords. These guidelines were introduced in response to the financial crisis of 2008. These accords cope with risk management aspects for the banking sector. In a nutshell, we can say that Basel III is the global regulatory standard on bank capital adequacy, stress testing, and market liquidity risk.
Objectives/aim of Basel III:
- Improve the banking sector’s ability to soak up shocks arising from financial and economic stress, regardless of the source.
- Improve risk management and governance
- Strengthen banks’ transparency and disclosures
How do Basel Norms affect us as individual:
Basel Norms work on Capital Adequacy Ratio (CAR) that is the ratio of Total Capital to Risk-Weighted Assets(RWA), out of this the quantity of RWA and CAR is initially predetermined that the Total capital has to be gathered by the state-run banks to attain this desired ratio. In some cases the RWA is additionally artificially decreased by providing regulated loans that hamper the economic development of the country. So, this CAR encompasses direct regard to the loans and credit banking industry of the state, it also affects the economy to an outsized extent. the govt. also infuses its resources during this total capital on maintaining the predetermined CAR. A stable Capital Adequacy Ratio ensures the minimum risk of economic instability within the country and further helps to attain people’s confidence within the banking industry which is the backbone of each country’s economy.