OVERVIEW Central bank governors of G10 countries Capital adequacy framework Risk weighted capital adequacy framework
FOUNDATION Established on 17 May 1930 The BIS is the world’s oldest international financial organization Head office is in Basel, Switzerland and representative offices in Hong Kong SAR and in Mexico City. The BIS currently employs around 550 staff from 50 countries.
LIST OF MEMBER CENTRAL BANKS Algeria Iceland Russia Argentina India Saudi Arabia Australia Indonesia, Singapore Austria Ireland Slovakia Belgium Israel Slovenia Bosnia and Herzegovina Italy South Africa Brazil Japan Spain Bulgaria Korea Sweden Canada Latvia Switzerland Chile Lithuania Thailand China The Republic of Turkey Croatia Macedonia The United Kingdom The Czech Republic Malaysia The United States Denmark Mexico The European Central Estonia the Netherlands Bank Finland New Zealand France Norway Germany the Philippines Greece Poland Hong Kong SAR Portugal Hungary Romania
BASEL COMMITTEE ON BANKING SUPERVISION A set of agreements Regulations and recommendations on Credit risk , market risk and operational risk Purpose – to have enough capital on account to meet obligations and absorb unexpected losses
1. Credit risk2. Market risk a) Interest risk b) Equity risk c) Foreign exchange risk3. Large exposure risk a) Counter party risk
PURPOSE OF BASEL 1 Strengthen the stability of international banking system. Set up a fair and a consistent international banking system in order to decrease competitive inequality among international banks
STRUCTURE OF BASEL I Minimum Capital Adequacy ratio was set at 8% and was adjusted by a loan’s credit risk weight. Credit risk was divided into 5 categories viz. 0%, 10%, 20%, 50% and 100%. Commercial loans, for example, were assigned to the 100% risk weight category. To calculate required capital, a bank would multiply the assets in each risk category by the category’s risk weight and then multiply the result by 8%. Thus, a Rs 100 commercial loan would be multiplied by 100% and then by 8%, resulting in a capital requirement of Rs8.
BASEL NORMS V/SINDIAN BANKING SYSTEM Basel Accord I. was established in 1988 and was implemented by 1992 in India. over 3 years – banks with branches abroad were required to comply fully by end March 1994 and the other banks were required to comply by end March 1996. RBI norms on capital adequacy at 9% are more stringent than Basel Committee stipulation of 8%. Commercial Banks , Cooperative Banks and Regional rural banks have different RBI guidelines
PITFALLS OF BASEL I Negotiated risk weights Overemphasis of trading account risk (not included hedging, diversification, differences in risk management techniques) Static measure of default risk The assumption that a minimum 8% capital ratio is sufficient to protect banks from failure does not take into account the changing nature of default risk.
OBJECTIVES Ensuring that capital allocation is more risk sensitive; Separating operational risk from credit risk, and quantifying both; Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage.
The three pillar approach Pillar 1 sets out the minimum capital requirements firms will be required to meet to cover credit, market and operational risk. Pillar 2 sets out a new supervisory review process. Requires financial institutions to have their own internal processes to assess their overall capital adequacy in relation to their risk profile. Pillar 3 cements Pillars 1 and 2 and is designed to improve market discipline by requiring firms to publish certain details of their risks, capital and risk management as to how senior management and the Board assess and will manage the institutions risks.
The First Pillar Minimum Capital RequirementCapital Adequacy Ratio is defined as the amount of regulatory capital to bemaintained by a bank to account for various risks inbuilt in the bankingsystem. The focus of Capital Adequacy Ratio under Basel I norms was oncredit risk and was calculated as follows:Capital Adequacy Ratio = Tier I Capital Tier II Capital Risk Weighted AssetsBasel Committee has revised the guidelines in the year June 2001 known as Basel IINorms.Capital Adequacy Ratio in New Accord of Basel II:Capital Adequacy Ratio = Total Capital (Tier I Capital Tier II Capital) Market Risk(RWA) + Credit Risk(RWA) + Operation Risk(RWA)*RWA = Risk Weighted Assets
The Third Pillar Market Discipline Covers transparency and the obligation of banks to disclose meaningful information to all stakeholders Clients and shareholders should have sufficient understanding of activities of banks, and the way they manage their risks