BASEL NORMS :The journey continues

Banking & Finance are the two crucial aspect of an economy.The question that Bank leads to finance or vice versa is the most debatable question. Well we will not waste our time going in that debate & refrain ourselves from it.

Why do we need Banks in first place?Banks are there to facilitate transactions in market, lend money in times of crisis,keep money in market. to maintain liquidity, to keep people’s money secure & provide value to it .. & what not.The list is long.But what if Banks starts taking extra risks lending more money in market, receiving less? In short  manages capital inadequately. The bubble will burst sometimes or other, resulting in outcomes like Economic crisis of 2007 or Oil crisis of 1970.

So what should be done to prevent such situations.This became a global concern of many nations .Governors of National Banks of 10 developing nations, commonly called G10  met & came up with a recommendation to form a regulatory & supervising committee called Basel committee on Banking supervision  which gave norms known as Basel Norms.It should be taken care that these norms doesn’t hold any legal jurisdiction,they are voluntary.

The committee came up with Basel Norm 1 in 1988, focus was on standardization of capital & adequate capital should be lended in market , under this assets were divided into 5 different categories and then risks were assigned to them from 0 to 100 based on that  Risk weighted asset was calculated by multiplying risk with summation of assets in that category.

It was stated that CAPITAL : RWA should be 8%.

But these approach has various drawbacks like RWA ignored various other factors like Market,Consumer base etc.Risk assessment considered only internal factors.Even the main purpose of capital adequacy framework could not be established.

In order to overcome they came up with Basel Norms 2 in 2004   laid down guidelines for capital adequacy (with more refined definitions), risk management (Market Risk and Operational Risk) and disclosure requirements. which failed in crisis of 2007 as they considered banks  not banking industry as a whole while calculating risk.The process was complex & homogeneous one size fits all approach was followed for big players also.Eventually they were also discarded.

It is  felt that  the shortcoming in Basel II norms  led to the global financial  crisis of 2008. That is because Basel II did not have any explicit  regulation on the debt that banks could take on their books, and focused  more on individual financial institutions, while ignoring systemic  risk. To ensure that banks don’t take on excessive debt, and that they  don’t rely too much on short term funds, Basel III norms were proposed  in 2009-10 by group of G-20 Nation in Pittsburgh  summit.

The Reserve Bank of India has given timeline for full implementation of the Basel III capital regulations by a year to March 31, 2019.

Aim of Basel3 Norms are

1.Adequate capital in terms of quality & quantity

2.Closing loopholes in risk assessment

3.More disclosure Norms

4.Overcoming individual approach, promoting Macro Prudential approach

Focus were given to Adequate capital, Liquidity & Risks in Banking Industries & there assessment.

Recommendations are

1.To hold 4.5 %  of common equity

2.To keep 6% of tier 1 Capital of Risk weighted asset as reserved.

3.2 capital buffers were introduced 1 being mandatory(2.5% of capital conservation)& other being optional (2.5 % conservation for difficult period)

4.Minimum leverage & liquidity coverage ratio to be maintained.

leverage ratio=Tier1 capital/ banks average total consolidated asset

liquidity coverage ratio-Banks should maintain minimum liquid assets which can fulfill there net cash outflow for 30 days.

Some of the drawbacks of Basel3 Norms

1.Micro solution to macro problem

2.Relative Risk weighted assessment or change in RWA is not considered at nay point of time

3.Impact of interaction of Banks with Banking system is not considered.

 

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