Basel2 Norms

7/29/2019 Basel2 Norms

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NARASIMHAM COMMITTEE REPORT I - 1991

Reduction in the SLR and CRR Phasing out directed credit programme

Interest rate determination

Structural reorganizations of the banking sector

Establishment of the ARF tribunal

Removal of dual control

Banking autonomy


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NARASHIMA COMMITTEE 1998

Autonomy in banking

Reform in the role of RBI

Stronger banking system Non-performing assets

Capital adequacy and tightening of provisioningnorms

Entry of foreign banks


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WHAT IS BASEL I

It defines a banks capital as two types:

Core (or tier I) capital

Supplementary (or tier II) capital comprising


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LOOPHOLES OF BASELI

Basel I accord succeeded in raising total level of equitycapital in the system.

However, it also pushed unintended consequences.

Since it does not differentiate risks very well, it perverselyencouraged risk seeking. All loans given to corporateborrowers were subject to the same capital requirement,without taking into account ability of the counterparties torepay.

It ignored credit rating, credit history, risk managementand corporate governance structure of all corporateborrowers. All were treated as private corporations.

It also promoted loan securitization that led to the

unwinding in the subprime market.


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BASEL II

A set of international banking regulations put forthby the basel committee on bank supervision, whichset out the minimum capital requirements of

financial institutions with the goal of minimizingcredit risk.


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Objectives of basell II

To create an international standard that banking regulatorscan use when creating regulations about capital

International standard can help protect the internationalfinancial system from possible problems of major bank or a

series of banks collapse.Greater the risk greater the amount of capital bank needs to

hold to safeguard its solvency and overall economic stability

Basel ii attempts to accomplish this by setting up rigorousrisk and capital management requirements to ensure that a

bank holds capital reserves appropriate to the risk the bankexposes itself to through lending and investment practices


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BASEL II

Basel II stands on three pillars:


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Pillar 1 : Minimum capital requirement

Institution's total regulatory capital must be at

least 8% (ratio same as in Basel I) of its risk

weighted assets, based on measures of THREE

RISKS


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Pillar 2 : Supervisory Review

Covers Supervisory Review Process, describing principlesfor effective supervision.

Supervisors obliged to evaluate activities, corporategovernance, risk management and risk profiles of banks todetermine whether they have to change or to allocate more

capital for their risks (called Pillar 2 capital) Deals with regulatory response to the first pillar, giving

regulators much improved 'tools' over those available tothem under Basel I

Also provides framework for dealing with all the other risksa bank may face, such as Systemic risk, pension risk,

concentration risk, strategic risk, reputation risk, liquidityrisk and legal risk, which the accord combines under thetitle of residual risk

It gives banks a power to review their risk managementsystem.


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Pillar 3 : Market Discipline Covers transparency and the obligation of banks to

disclose meaningful information to allstakeholders

Clients and shareholders should have sufficient

understanding of activities of banks, and the waythey manage their risks


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Conclusion: Basel II Framework lays down a more comprehensive

measure and minimum standard for capital adequacy

Seeks to improve on existing rules by aligning regulatorycapital requirements more closely to underlying risks that

banks face. In addition, it intends to promote a more forward-looking

approach to capital supervision, that encourages banks toidentify the present and future risks, and develop orimprove their ability to manage them.

Hence intended to be more flexible and better able toevolve with advances in markets and risk management

practices. Basel II Accord attempts to fix glaring problems with theoriginal accord. It does this by more accurately definingrisk, but at the cost of considerable rule complexity

Basel2 Norms

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