Basel Norms are the norms issued by the Basel Committee on Banking Supervision (BCBS) for the international banking regulations. The goal of these norms is to coordinate banking regulations around the world and strengthening the international banking system. BCBS consists of 27 representatives from countries across the globe including India. Presently the Basel Committee has issued 3 guidelines to realize its objective which are Basel I, II and III.
These rules are introduced in the year 1988 which focused originally on the credit risk faced by the banks. According to these guidelines, all the banks were necessary to maintain a capital adequacy ratio of 8% of the credit risk. The capital adequacy ratio is defined as the ratio of capital to risk-weighted assets. India adopted these guidelines in the year 1999.
The classification of capital was done into two groups i.e.:
- Tier 1 – is the core capital.
- Tier 2 – is the supplementary capital.
The risk-weighted asset is the bank’s assets weighted according to risks.
The Basel II was introduced in the year 2004 and aimed at more regulation than Basel I. India is currently following Basel II guidelines.
It introduced three pillars upon which regulation is to be conducted by the banks:
Minimum Capital Requirements:
the banks have to maintain the minimum capital of 8% of Risk-weighted assets. It also introduced Tier 3 of capital i.e. short-term subordinated loans.
Supervisory Review Process:
Generally, banks face three kinds of risk that are credit, market and operations risks, therefore the banks now have to place better risk management techniques in monitoring all three kinds of risks.
Disclosure & Market Discipline:
this requirement increased the bank’s disclosure and compliance requirements.
The introduction of Basel III guidelines happened because of the 2008 financial crisis that highlighted some serious flaws in the regulation and compliance mechanisms that were put in a place for the banks. It was introduced in 2010. Its objective was to make a resilient and transparent banking system, improve banking sector shock-absorbing capacity and more focus on Capital Adequacy Ratio.
Basel III has created 2 liquidity ratios which are Liquidity Coverage Ratio (LCR) i.e. to have a high-quality liquid asset to meet short term requirements (30 days) and Net Stable Funds Rate (NSFR) requires banks to maintain a stable funding profile to meet medium-term requirements (1 year).
The three pillars of Basel III norms were Enhanced Minimum Capital Requirements, Enhanced Supervisory Review Process and Enhanced Disclosure & Market Discipline.
India has introduced Basel III norms in March 2019 but RBI extended the deadline to March 2020 and in light of the COVID19 pandemic it was further extended by 6 months.
RBI has implemented these guidelines in the country to make bank’s regulation and compliance process on par with the other world banks so that Indian banks remain in a strong position to absorb any financial risk. Indian banks are following Basel II norms at present.
The Basel Committee should form the risk weights for credit exposure based on the individual countries rather than in general as it will help in catering the requirements on the country by country basis and reflect actual risk and not of only advanced countries characteristics.