BASEL Accords

Basel is 3^rd most populous city in Switzerland sharing the borders with France and Germany.  It is hub for chemical and pharmaceuticals which is located on the banks of river Rhine. Basel culture is influenced by Germany and France.

Basel Accords:

These are banking supervision records. They are issued by Basel Committee on banking supervision (BCSB). As BCSB maintains its secretariat at Bank for International Settlement, Basel, it is called Basel Accord. The committee normally refers here and have issued three accords.

1)      Basel I

2)      Basel II

3)      Basel III

Basel Committee:

The committee initially consisted of G-10 members plus Luxembourg and Spain. This has been extended to G-20 members and also Hong Kong and Singapore since 2009.

This committee does have any authority to enforce their recommendations, but the countries tend to implement the policies. This would help in maintaining a common standard and approaches across countries.

The committee is further sub-divided into four groups:

1)      Standards implementation group

2)      Policy development group

3)      Accounting task force

4)      Basel conservative group.

Basel I:

Basel I norms was first published in 1988 with the core idea of ‘Minimum capital requirement for banks’. This is also called 1988 Basel Accord and was enforced in G-10 countries. It focused on the credit risk a bank could face. So, the bank’s assets were grouped into five categories and each group was assigned with a risk weight of “Zero” for home country sovereign debt and 10%, 20% 50% upto 100%. In addition banks which have international presence have to hold a capital of 8% of the risk-weighted assets.

Soon these norms were followed by other countries apart from G-10.

Basel II:

First published in June 2004 and have been regularly updated till 2009. The main idea was how much capital a bank must keep aside to guard against financial and operational risk a bank could face. It was believed that this would help in protecting the international financial system from collapse of bank or series of banks. Due to political pressure these rules were not implemented before 2008, the progress of including these rules was very slow. These rule were based on

1)      Minimum Capital requirement

2)      Supervisory Review

3)      Market Discipline

Basel III:

These standards are on capital adequacy, stress testing and market liquidity risk. The collapse in 2008 has made the committee to introduce the Base III norms. It strengths the bank’s capital requirements with new regulatory requirements onbank liquidity and bank leverage. Before Base III rating of creditworthiness of bonds and other financial instruments were given without proper supervision by official agencies, which lead to AAA rating on mortgage-backed securities, credit default swaps, and other instruments that proved in practice to be extremely bad credit risks. Basel III has major changes on Capital conservation buffer, Liquidity ratio, Leverage ratio, countercyclical buffer and minimum common equity and tier 1 capital requirement.

Impact on India:

The guidelines of Basel III will be implemented from January 1, 2013 in a phased manner. The capital adequacy ratios of Basel III will be fully implemented by March 31, 2018 (As per RBI).

Thescheduled commercial banks (excluding LABs and RRBs) should maintain a minimum total capital of 9% against 8%, as per the guideline of Basel committee. So, Indian banks have to maintain a minimum capital of 9% of total Risk weight asset (RWA) against 8%.  Of this minimum of 5.5% common-equity Tier 1 should be maintained as against 3.6% by March 31, 2015 and 2.5% of capital conservation buffer (CCB). CCB helps in building the capital buffers during then normal time (i.e. outside the periods of stress) which can be used during the stress period. Outside the stress period the banks should maintain capital buffer above the regulatory minimum. By March 31, 2018 the Basel committee has recommend a CAR (capital adequacy ratio) of 11.5%.

The RBI has estimated that the private and public banks together require a capital of Rs. 4.75 – 5 Trillion by 2018 in order to adhere the Basel III norms (As per the RBI statement).RBI said, of this the government owned banks require a capital of Rs. 4.05 – 4.25 trillion. Majority of this is need by the PSU banks in the forms of common equity and non-equity capital (Note: These estimates don’t include the profits earned by the bank during the implementation of Basel III). The Government of India has an average stake of 58% in the public sector banks. Since the banks have to adhere to Basel II norms, the incremental equity required by the government owned banks will to raise Rs. 750 – 800 billion. Capital of Rs. 700-750 billion rupees is required by the private banks to adheretheBase III norms (Note: These estimates don’t include the profits earned by the bank during the implementation of Basel III).RBI made these polices under the assumption that the banks can maintain a minimum growth rate of 20%.

Subsequent to the Basel III norms, the capital of many banks will reduce by 60%, because of the phase removal of certain components of capital from Tier 1. In addition the RWA are also expected to grow by 200%. These two together will have a major impact on the ROE (Return on Equity) of the banks. At the same time the Basel III norms included both the micro prudential guidelines and macro prudential guidelines to increase the stability in the banking system. Micro-prudential guidelines ensure the viability and risk compliance of individual banks, while macro-prudential guidelines target the stability of the banking system as a whole.

Y.Venkata Achyuth Kumar

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