Basel Norms

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Basel Norms
The Basel Committee on Banking Supervision (BCBS) have formulated certain rules and regulations for supervision which are formed by a group of central banks. These norms set regulations in regard to three main risks: 
  • Capital Risk, 
  • Operational Risk and 
  • Market Risk. 
The requirement of these accords is mainly to secure public funds and their utilisation. This is basically to ensure optimum utilisation of funds and absorb losses.
Establishment of Basel norms:
The development of Basel norms happened over years beginning from 1980s. The aim of Basel norms were capital adequacy, monitoring and ensuring fund , enhanced supervision over the banking system and financial stability. Over the years, three norms are established, which are as follows:
Basel 1:
This regulation focuses on the capital adequacy of the bank. The capital adequacy is the minimum capital that a bank should hold. This is usually measured using a Capital Adequacy Ratio (CAR). It is the measure of bank’s financial strength using capital and assets. It categorises the assets into five risks categories namely 0%, 10%, 20%, 50%, and 100%. Banks conducting foreign operations are required to secure their risk of 8% or less.

Basel 2:
Also known as the Revised Capital Framework is an extension to Basel 1. The three factors that are determined in this norm are: 
  • Capital Adequacy,
  • Minimum Capital Requirement and
  • Disclosure effectiveness to strengthen banking practices. 
The capital is divided into three tiers:
Tier 1: shareholders’ equity +disclosed reserves + retained earnings+ capital instruments
Tier 2: Tier 1+ bank reserves + hybrid instruments+ medium and long term loans
Tier 3: Tier 2+ short term loans

Basel 3:
The collapse of Lehman Brothers in 2008 and financial crisis proved that regulation of liquidity was also important.  Poor governance, inappropriate incentives and weak risk management led to the downfall of the system. This urged the BCBS to extend the three pillars to safeguard design of capital and liquidity ratio.  The implementation of Basel 3 began in 2013 and is expected to be completed by January 2019.
Thank You
Regards
Author: Kaushal Shah
Kautilya 
IBS Mumbai

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