The Basel Banking Accords are the norms brought forward by the Basel Committee on Banking Supervision (BCBS), formed under the patronage of Bank of International Settlements (BIS), situated in Basel, Switzerland.
The committee devises guidelines & makes suggestions on best practices in banking industry. The Basel Accords, which oversee capital adequacy norms of banking sector, aspire to guarantee financial stability & thus augment risk absorbing capability of banks.
The initial set of Basel Accords is called Basel I. Basel I was issued in the year 1988, with main focus on credit risk. It placed the basis of risk weighting of assets & set targets of capital to be sustained. Basel II was issued in the year 2004 with the purpose of being more inclusive. It aimed at escalating capital adequacy by imposing a barrier for a larger spectrum of risk.
Basel I: Capital adequacy against credit risk
Basel I Accord aims to produce a cushion against credit risk. It contains 4 pillars, which are:
i. Constituents of Capital: It sets down the nature of capital that is entitled to be treated as reserves.
ii. Risk Weighting: Risk Weighting formulated an inclusive system to present weights to dissimilar categories of assets of bank because of relative riskiness.
iii. Target Standard Ratio: This acted as an amalgamating factor between the first 2 pillars. A universal standard of 8 percent coverage of risk weighted assets by Tier I & II capital was set, with no less than 4 percent being covered by Tier I capital alone.
iv. Transitional and implementing arrangements: Phase wise implementation deadlines were set in which a target of 7.25 percent was to be attained by the end of the year 1990 and 8 percent by the end of year 1992.
Basel II: Comprehensive framework with buffer for greater spectrum of risks
Basel II kept hold of the ‘pillar’ framework of Basel I, yet significantly expanded the scope & specifics of Basel
The 4 pillars that were amended were as follows
i. Minimum Capital Requirements, target adequacy ratio and risks: The main authorization of extending the scope of regulation was attained by mounting the definition of banking institutions to embrace them on a fully consolidate basis. Reserves requirement were explained as follows:
Reserves = 8% * Risk-Weighted Assets + Market Risk Reserves + Operational Risk Reserves
ii. Regulator Bank Interaction: This sanction to regulators in management & dissolution of banks, giving them liberation to set buffer capital prerequisite above the minimum capital requirement according to pillar I.
iii. Banking Sector Discipline: It intends to stimulate discipline by directing sufficient disclosures about capital & risk profile to the regulators & public.
Basel III: The new set of norms
There were number of limitations of Basel II. It was suggested for G 10 counties, thus leaving out the budding economies. The range of responsibilities for regulators in rising economies may be too much for them to handle.
The core of Basel III revolves around conformity regarding liquidity and capital. While good class of capital will facilitate stable long term sustenance, conformity with liquidity covers will augment ability to endure short term financial and economic stress.
i. Liquidity Rules
a. Liquidity Coverage Ratio: This is to look after banks against sustained financial stress for thirty days period.
b. Net Stable Funding Ratio: The purpose of long-term stability of financial liquidity risk profile is met by upholding a ratio of amount obtainable of stable funding to requisite amount of stable funding at a minimum of 100 percent.
ii. Capital Rules: Augmentation of risk coverage is attained by preface of Countercyclical Buffer and Capital Conservation Buffer.