sanyabasel norms

8/3/2019 Sanyabasel Norms

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BASEL NORMSBASEL NORMSSUBMITTED BY:SANYA SHARMA

BFIA-III16053


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BASEL ACCORDSBASEL ACCORDS

y The Basel Accords refer to the banking supervisionAccords (recommendations on banking regulations)

Basel I, Basel II and Basel IIIissued by the BaselCommittee on Banking Supervision (BCBS).

y The Basel Committee on Banking Supervision(BCBS) is a committee of banking supervisoryauthorities that was established by the central bank

governors of the Group of Ten countries in 1975.eight International Monetary Fund (IMF) members,Belgium, Canada, France, Italy, Japan, theNetherlands, the United Kingdom, and the UnitedStatesand the central banks of two others,Germany and Sweden.


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TH E NEED FOR BASIL ACCORDSTH E NEED FOR BASIL ACCORDS

y The Committee was formed in response liquidation of HerstattBank in 1974. On 26 June 1974, a number of banks had releasedDeutsche Mark (German Mark) to the Bank Herstatt in exchangefor dollar payments deliverable in New York. On account of differences in the time zones, there was a lag in the dollarpayment to the counter-party banks, and during this gap, andbefore the dollar payments could be effected in New York, theBank Herstatt was liquidated by German regulators.

This triggered serious disturbances in international currency and

banking markets and prompted the G-10 nations to form theBCBS towards the end of 1974.

The first meeting took place in February 1975 and meetings havebeen held regularly three or four times a year since.


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BASELBASEL- -11

y A capital measurement system commonly referred to asthe Basel Capital Accord (or the 1988 Accord), nowcommonly called the BASEL I was approved by the G10Governors and released to banks in July 1988.

y OBJECTIVES:y 1. Strengthen the stability of international banking system.

y 2. Set up a fair and a consistent international bankingsystem in order to decrease competitive inequality amonginternational banks.

y The basic achievement of Basel I has been to define thebank capital.


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TW OTW O-- T IERED CAPI T ALT IERED CAPI T AL

y Tier 1 (Core Capital) :y Includes common stock, preferred stock that is irredeemable and

non-cumulative, retained earnings and declared reserves, such asloan loss reserves set aside to cushion future losses or forsmoothing out income variations.

y Tier 2 (Supplementary Capital) :y Tier 2 capital includes undisclosed reserves, revaluation reserves,

general provisions, hybrid instruments and subordinated termdebt.

y Capital components such as gains on investment assets, long-term debt with maturity greater than five years and hiddenreserves (i.e. excess allowance for losses on loans and leases).However, short-term unsecured debts (or debts withoutguarantees), are not included in the definition of capital.


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BASELBASEL- -1 PROVISIONS1 PROVISIONS

Basel I, that is, the 1988 Basel Accord, primarily focusedon credit risk.

The Basel agreement identifies three types of credit risks:y

The on-balance sheet risk .The trading off-balance sheet risk . These are derivatives,namely interest rates, foreign exchange, equity derivatives andcommodities.

The non-trading off-balance sheet risk . These include generalguarantees, such as forward purchase of assets or transaction-related debt assets.

Implementation of the framework with a minimum capitalratio of capital to risk-weighted assets of 8 percent byend-1992.


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RISK CA T EGORIESRISK CA T EGORIES

y Assets of banks were classified and grouped in five categoriesaccording to credit risk, carrying risk weights of zero (for examplehome country sovereign debt), ten, twenty, fifty, and up to one

hundred percent (this category has, as an example, mostcorporate debt).

0% - cash, central bank and government debt and any OECDgovernment debt0% , 1 0% , 2 0% or 5 0% - public sector debt2 0% - development bank debt, OECD bank debt, OECDsecurities firm debt, non-OECD bank debt (under one yearmaturity) and non-OECD public sector debt, cash in collection5 0% - residential mortgages1 00% - private sector debt, non-OECD bank debt (maturity overa year), real estate, plant and equipment, capital instrumentsissued at other banks


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BASELBASEL- -22

y In June 1999, the Committee issued a proposal for a newcapital adequacy framework to replace the 1988 Accord,culminating in the release of the New Capital Frameworkon 26 June 2004.

y Need for Replacing BASEL I:

Ensuring that capital allocation is more risk sensitive.Enhance disclosure requirements which will allow marketparticipants to assess the capital adequacy of aninstitution;Ensuring that credit risk, operational risk and market riskare quantified based on data and formal techniques.Attempting to align economic and regulatory capital moreclosely to reduce the scope for regulatory arbitrage.


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TH E TH REE PILLARSTH E TH REE PILLARS

y TH E FIRS T PILLAR :y Maintenance of regulatory capital calculated for three components of risk that

a bank faces: credit risk, operational risk, and market risk .

y The credit risk component can be calculated in 2 ways, namely standardizedapproach and Foundation IRB or Advanced IRB. IRB stands for "InternalRating-Based Approach.

y Standardized Approach : capital requirements are equal 8% of theou tstanding amount of money. Under this approach the banks are required touse ratings from External Credit Rating Agencies to quantify required capitalfor credit risk.

y IRB : in general, banks are ought to calculate borrowers probability of defaultusing internal measures (Foundation IRB). In particular, banks can alsoestimate the loss given default and the exposure at default using their ownmethods (Advanced IRB).


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y For op erati o nal risk , there are three differentapproaches - basic indicator approach or BIA,standardized approach or STA, and the internalmeasurement approach (an advanced form of whichis the advanced measurement approach or AMA).

y For m arket risk the preferred approach is VaR (valueat risk).

y

VaR is defined as a threshold value such that theprobability that the mark-to-market loss on theportfolio over the given time horizon exceeds thisvalue (assuming normal markets and no trading inthe portfolio) is the given probability level.


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y TH E SECOND PILLAR :y much improved 'tools to regulators over those available to them under Basel I.y It also provides a framework for dealing with all the other risks a bank may

face, such as systemic risk, pension risk, concentration risk, strategic risk,reputational risk, liquidity risk and legal risk, which the accord combines underthe title of residual risk . It gives banks a power to review their riskmanagement system.

y TH E TH IRD PILLAR :y This pillar aims to complement the minimum capital requirements and

supervisory review process by developing a set of disclosure requirementswhich will allow the market participants to gauge the capital adequacy of aninstitution.

y The aim of pillar 3 is to allow market discipline to operate by requiringinstitutions to disclose details on the scope of application, capital, riskexposures, risk assessment processes and the capital adequacy of theinstitution


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ISSUES W I TH BASELISSUES W I TH BASEL- -22

y Capital Requirement : The new norms will almost invariably increase capitalrequirement in all banks across the board.

y

Profitability:

Competition among banks for highly rated corporates needinglower amount of capital may exert pressure on interest spread.y

y Risk Management Architecture : The new standards call for introduction of advanced risk management system with wider application throughout theorganization which in itself is a daunting task.

y Choice of Alternative Approaches : The new framework provides foralternative approaches for computation of capital requirement of various risks.However, competitive advantage of IRB approach may lead to domination of this approach among big banks.

y . Hence, the system as a whole may maintain lower capital than warranted andbecome more vulnerable.

y Disclosure Regime : W hile the disclosure may be useful for supervisoryauthorities and rating agencies the expertise and ability of the general publicto comprehend and interpret disclosed information is open to question


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CH ANGES..CH ANGES..

y Definition of CAPITAL:y Going by the new rules, the predominant component of capital is

common equity and retained earnings. The new rules restrictinclusion of items such as deferred tax assets, mortgage-servicing rights and investments in financial institutions to nomore than 15% of the common equity component.

y PROVISIONS:y key capital ratio changed to 7% of risky assets, according to the

new norms, Tier-I capital that includes common equity and

perpetual preferred stock will be raised from 2-4.5% starting inphases from January 2013 to be completed by January 2015. Inaddition, banks will have to set aside another 2.5% as acontingency for future stress. Banks that fail to meet the bufferwould be unable to pay dividends, though they will not be forcedto raise cash.


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TH E BIG ISSUETH E BIG ISSUE

y A McKinsey Quarterly Report on BASEL III estimates that banksin Europe and the United States will have to raise about 1.6 5trillion of new capital, about 1.9 trillion of short-term

liquidity, and about 4.5 trillion of long-term funding. The capitalshortfall is equivalent to about 60 percent of all outstanding Tier1 capital, and the short-term liquidity gap is about 50 percent of all the liquidity that banks currently hold.

y Their analysis shows that these rules could reduce return onequity (ROE) for the average European bank by between 3.7 and4.3 percentage points by 2019, from the pre-crisis ROE averageof 15 percent

y This highlights the daunting prospect that the implementation of BASEL III is, particularly in light of the incumbent financialturmoil in Europe.


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TH ANK YOU!TH ANK YOU!

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