Basel Norms- Definition, Types, Regulation and Guidelines
Basel norms are global banking rules issued by the Basel Committee on the supervision of banks. Read the complete blog to learn more!
Izhar Ahmad18 Nov, 2023
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The Basel Committee on Banking Supervision (BCBS) established the Basel Norms to serve as the benchmarks for international banking regulations. These standards are designed to unify global financial laws and fortify the worldwide banking infrastructure.
Comprising 27 individuals from various countries, including India, the BCBS oversees this initiative. The committee has introduced three sets of guidelines, namely Basel I, II, and III, with the overarching objective of enhancing the resilience of the global banking system.Basel Norms Definition
The Basel Norms are a set of international banking rules aimed at promoting financial stability and lowering risks within the banking sector. Named after the city of Basel in Switzerland, where the Basel Committee on Banking Supervision developed these standards, they offer advice on capital stability, risk management, and regulatory oversight for banks. Renowned as Basel I, Basel II, and Basel III, these rules have gained prominence, with each new version bringing more strict laws and heightened standards for risk management. The Basel Norms set forth basic capital standards for banks, taking into account the risk connected with their assets and operations. Additionally, they outline the methods for determining credit, market, and operating risks.Basel Norms Regulations
Basel norms entail certain rules adhered to by banks, including:- Elevating capital requirements to bolster banks against potential losses.
- Enhancing the standard of bank regulatory capital, particularly in terms of Common Equity Tier 1 capital.
- Prescribing a minimum leverage ratio to mitigate excessive leverage within the banking system.
- Introducing capital buffers that banks are required to uphold during stable periods and can utilize during times of crisis.
Basel Norms Guidelines
The Basel 3 guidelines aim to fortify the banking system by emphasizing four crucial parameters. Capital - Banks are mandated to uphold a capital adequacy ratio of 12.9%, with a minimum tier 1 capital ratio of 10.5% and a tier 2 capital ratio of 2% based on risk-weighted assets. Additionally, a capital conservation buffer of 2.5% and counter-cyclical buffers ranging from 0-2.5% must be maintained. Leverage - The leverage ratio should not fall below 3%. This ratio is determined by a bank's tier 1 capital in relation to the average total consolidated assets. Funding And Liquidity - Basel 3 introduces two liquidity ratios:- The Liquidity Coverage Ratio necessitates banks to reserve a buffer of high-quality liquid assets to address cash outflows, ensuring they possess adequate funds.
- The Net Stable Funding Ratio obliges banks to sustain a stable funding profile for off-balance sheet assets and activities, with a minimum requirement of 100%.
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Series of Basel Norms
The Basel Committee has implemented three sets of regulations known as Basel-I, Basel-II, and Basel-III.Basel-I:
Introduced in 1988, Basel-I primarily concentrated on credit risk. It defined the capital and risk weight structure for banks, setting a minimum capital requirement of 8% of risk-weighted assets (RWA). RWA considers assets with different risk profiles, such as collateral-backed assets carrying lower risks compared to unsecured personal loans. India adopted Basel-I guidelines in 1999.Basel-II:
In 2004, the Basel Committee released Basel-II guidelines as refined and reformed versions of Basel-I. These guidelines were built on three pillars. First, banks were required to maintain a minimum capital adequacy of 8% of risk assets. Second, a supervisory review mandated banks to enhance risk management for credit, market, and operational risks. Third, market discipline necessitated increased disclosure requirements, compelling banks to disclose capital adequacy ratios, risk exposure, and more. Although India follows Basel-II norms, full implementation remains pending.Basel-III:
Released in 2010 as a response to the 2008 financial crisis, Basel-III aimed to fortify the banking system. This was prompted by concerns that banks in developed economies were under-capitalized, over-leveraged, and excessively reliant on short-term funding. Basel-III focuses on four crucial banking parameters: capital, leverage, funding, and liquidity. The guidelines aspire to create a more resilient banking system by addressing these key aspects.3 Pillars of Basel III
The Basel III Norms outline key principles, or pillars, which include:1. Minimum Capital Requirements:
Under the Basel III Accord, the minimum capital requirements for banks have been raised from 2% in Basel II to 4.5% of common equity as a percentage of the bank's risk-weighted assets. An additional buffer capital requirement of 2.5% is imposed, bringing the total to 7% for Basel compliance. Banks can utilize this buffer during financial stress, but doing so poses challenges in terms of financial constraints on dividend payments.2. Leverage Ratio:
Basel III introduces a non-risk-based leverage ratio to complement the risk-based capital requirements. Banks must maintain a leverage ratio exceeding 3%, calculated by dividing Tier 1 capital by the average total consolidated assets of a banking company.3. Liquidity Requirements:
The Basel III Accord introduces the Liquidity Coverage Ratio and the Net Stable Funding Ratio. The Liquidity Coverage Ratio mandates banks to hold sufficient highly liquid assets to withstand a 30-day stressed funding situation, as prescribed by supervisors. Initially set at 60% in 2015, this requirement is expected to increase by 10% annually until it reaches full effect in 2019. The Net Stable Funding Ratio (NSFR) requires banks to maintain stable funding above the required amount for one year during prolonged stress.Advantages of Basel Norms
- Implementation of Basel 3 norms in Indian banks will enhance stability, reducing the likelihood of closures.
- A more advanced approach facilitated by Basel 3 can assist banks in effectively managing their capital and boosting profitability.
- Adopting Basel 3 norms opens doors for banks to access improved financial opportunities.
Disadvantages of Basel Norms
- The heightened credit demand under Basel III norms poses challenges for banks to meet increased capital requirements, as having a mandatory capital backup becomes a hindrance.
- Basel III norms entail additional implementation costs, impacting both the returns and profitability of banks.
- Given that Indian banks have not fully transitioned to Basel II norms, reaping the benefits of Basel III norms requires a gradual upgrade. This is particularly crucial for banks with an international presence.
Basel Norms FAQs
What are the types of Basel norms?
Basel I, Basel II, and Basel III are the main types of Basel norms.
What are the Basel regulations?
Basel regulations are a set of international banking standards formulated by the Basel Committee on Banking Supervision.
What are Basel 3 norms guidelines?
Basel 3 norms guidelines focus on strengthening the banking system through increased capital requirements, a leverage ratio, and liquidity requirements.
What is the full form of CRR?
CRR stands for "Cash Reserve Ratio," a percentage of a bank's total deposits that it must hold as reserves with the central bank.
What is bank risk?
Bank risk is the exposure of financial institutions to potential losses or uncertainties, including credit risk, market risk, operational risk, and liquidity risk.
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