Understanding Basel Norms: Banking Regulations Explained

Basel norms, also known as Basel accords, are the international banking regulations issued by the Basel Committee. The Basel Committee was established in 1974. This Committee set standards regarding various banking supervisory matters. The main aim of these standards is to ensure the coordination of banking regulations worldwide. Read ahead to know about the three Basel norms and how they affect Indian economy.

An Introduction to Basel Norms

Basel Norms I

Basel norms are also referred to as banking supervision accords. These are simple standards aimed at increasing the capital ratios of various banks. Basel norms also provided a benchmark for analytical comparative assessment.

Why Basel Norms?

Banks around the world lend to different types of borrowers having different creditworthiness. They lend the deposits of the public and money raised from the market. This exposes the banks to a variety of risks of default. As a result, banks have to keep a certain percentage of capital as security in case of risk of non-recovery. The Basel Committee has created various norms to tackle this risk.

Basel Norms Types

The Basel Committee has issued the following sets of regulations.

1. Basel I: Basel I was introduced in 1988. This Basel norm focused on credit risk. Credit risk arises when a borrower fails to repay a loan or meet contractual obligations. This norm defined the capital and structure of risk weights for banks. The minimum capital requirement was set as 8% of risk-weighted assets. Risk-weighted assets mean a bank's assets are weighted according to risk.

2. Basel II: Basel II guidelines were issued in 2004. These norms were refined versions of Basel-I norms. These norms were based on the following three parameters.

• Banks should retain a minimum capital adequacy requirement of 8% of risk assets.

• Banks were advised to develop and use better risk management techniques.

• Banks must disclose their capital adequacy requirement and risk exposure to the central bank.
  
  

Basel II

3. Basel III: Basel III guidelines were issued in 2010. These norms were introduced in response to the financial crisis of 2008. A need was felt to strengthen the banking system across the globe. It was also felt that the quantity and quality of capital under Basel II were considered insufficient.

Basel Regulations

The following are some regulations followed by banks regarding Basel norms:

• Increasing capital requirements ensures that banks are strong enough to combat losses.

• Improving the quality of bank regulatory capital in the form of Common Equity Tier 1 capital.

• Specifying a minimum leverage ratio requirement to curb excess leverage in the banking system.

• Introducing capital buffers that are maintained in good times and can be used in times of crisis.

The Basel Committee also introduced an international framework for mitigating excessive liquidity risk through the Liquidity Coverage Ratio.

Basel 3 Guidelines

Basel 3 guidelines promote a strong banking system by focusing on four important banking parameters.

• Capital - The capital adequacy ratio should be maintained at 12.9%. The minimum tier 1 capital ratio should be 10.5%, and the tier 2 capital ratio should be 2% of risk-weighted assets. Banks are also required to maintain a capital conservation buffer of 2.5%. Counter-cyclical buffers should also be maintained at 0-2.5%.

• Leverage - The leverage rate should be at least 3%. The leverage ratio is a bank's tier 1 capital to average total consolidated assets.

• Funding And Liquidity - Basel 3 created two liquidity ratios :

i) Liquidity coverage ratio will require banks to hold a buffer of high-quality liquid assets to deal with the cash outflows. The goal is to ensure banks have enough funds.

ii) Net stable funds rate requires banks to maintain a stable funding profile for their off-balance sheet assets and activities. The minimum net stable fund rate requirement is 100%.

Basel 3 Guidelines

India on Basel Norms

• The deadline for implementing Basel-III norms was March 2019, but it was pushed to March 2020.

• Due to the pandemic, the Reserve Bank of India postponed the implementation of Basel norms for another 6 months.

• This resulted in a lower capital burden on banks regarding provisioning requirements.

• This extension would have an impact on how RBI and Indian banks are perceived by global players.

Conclusion

Basel norms are an attempt to harmonise banking regulations around the world. The goal is to strengthen the international banking system and improve the quality of banking worldwide. These norms focus on the risks to banks and the whole financial system. This will allow the banks to grab better financial opportunities and improve their profits.