Basel Norms

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Basel Norms
• The Basel Norms are designed to establish a common
framework for regulating and supervising banks' activities,
with the primary goal of promoting financial stability and
ensuring that banks maintain adequate capital to withstand
economic downturns and financial crises.
• The Basel Committee on Banking Supervision (BCBS)
created the Basel Accords. Banks and financial institutions
worldwide follow Basel Accords standards of capital
requirements and risk management.

• The three landmark updates are called the Basel I, Basel

II, and Basel III accords, among multiple revisions. Basel
III was released in November 2010.
Basel I
Basel I (1988): Basel I, also known as the Basel Capital
Accord, introduced a basic framework for assessing and
regulating banks’ capital adequacy.
It focused primarily on credit risk and set a minimum capital
requirement for banks based on their risk-weighted assets.

India adopted Basel 1 guidelines in 1999.

It introduced three pillars: minimum capital requirements

(similar to Basel I but with more risk sensitivity),
supervisory review, and market discipline. Basel II
emphasised the need for banks to have adequate risk
management practices in place.
Basel II
In June ’04, Basel II guidelines were published by BCBS, which
were considered to be the refined and reformed versions of
Basel I accord.
The guidelines were based on three parameters, which the
committee calls as pillars. –
 Capital Adequacy Requirements: Banks should maintain a minimum
capital adequacy requirement of 8% of RWA
 Supervisory Review: According to this, banks were needed to develop
and use better risk management techniques in monitoring and managing
all the three types of risks that a bank faces, viz. credit, market and
operational risks
 Market Discipline: This needs increased disclosure requirements. Banks
need to mandatorily disclose their CAR, risk exposure, etc to the central
bank. The
Basel III
• According to the Basel Committee on Banking
Supervision, "Basel III is a comprehensive set of
reform measures, developed by the Basel
Committee on Banking Supervision, to strengthen
the regulation, supervision and risk management
of the banking sector".
• Basel III or Basel 3 released in December 2010 is
the third in the series of Basel Accords.
• These accords deal with risk management
aspects for the banking sector.
Capital Adequacy under Basel-III
Banks are required to maintain a minimum
Pillar 1 Capital to Risk-weighted Assets Ratio
(CRAR) of 9% on an ongoing basis.
 Common Equity Tier 1 (CET1) capital must be at least 5.5% of risk-
weighted assets (RWAs) on an ongoing basis.
 Tier 1 capital must be at least 7% of RWAs on an ongoing basis.
Thus, within the minimum Tier 1 equity capital, Additional Tier 1
capital can be admitted a maximum of 1.5% of RWAs.
 Total Capital (Tier 1 Capital plus Tier 2 Capital) must be at least 9%
of RWAs on an ongoing basis. Thus, within the minimum CRAR of
9%, Tier 2 capital can be admitted a maximum of up to 2%a
Conti….
Components of Capital
Total regulatory capital will consist of the sum
of the following categories:
(i) Tier 1 Capital
(a) Common Equity Tier 1
(b) Additional Tier 1
(ii) Tier 2 Capital
Tire 1 and Tire 2 Capital
Tier 1 Capital: Tier 1 capital is considered the core
capital of a bank, representing the most reliable and
loss-absorbing capital that can be used to absorb
losses without the bank becoming insolvent.
Under Basel III, Tier 1 capital is further divided into
two components:
 Common Equity Tier 1 (CET1) Capital: CET1 capital is the
highest quality and most reliable form of regulatory capital. It
primarily consists of common equity and retained earnings.
 i.e Perpetual Bonds, Preference Share
Common Equity Tier 1 (CET1)
Capital
Common Equity Tier 1 (CET1) Capital: CET1
capital is the highest quality and most reliable form
of regulatory capital. It primarily consists of
• Common shares (paid-up equity capital)
• Stock surplus (share premium) resulting from the issue of
common shares
• Capital reserves representing surplus arising out of sale
proceeds of assets
• Balance in Profit & Loss Account at the end of the previous
financial year
• Statutory reserves
Additional Tier 1 Capital
Additional Tier 1 capital is a subcategory of Tier 1
capital, but it represents instruments with certain
loss-absorbing features, such as the ability to
convert into common equity or be written down in
times of financial stress.
• Perpetual Non-Cumulative Preference Shares
• Stock surplus (share premium) resulting from the issue of
instruments included in Additional Tier 1 capital
• Any other type of instrument generally notified by the
Reserve Bank from time to time for inclusion in Additional
Tier 1 capital
Tier 2 capital

Tier 2 capital represents a supplementary form of regulatory

capital for banks and is considered less secure and less
permanent than Tier 1 capital.
Tier 2 capital provides additional loss-absorbing capacity but
is subject to stricter conditions and limitations. Under Basel
III, the key components of Tier 2 capital may include:
 Subordinated Debt
 General Provisions
 Redeemable Non-Cumulative Preference Shares
 Stock surplus (share premium) resulting from the issue of
instruments included in Tier 2 capital
Conti…
Capital Conservation Buffer: Another key feature
of Basel III is that now banks will be required to hold
a capital conservation buffer of 2.5%.

The aim of asking to build conservation buffer is to

ensure that banks maintain a cushion of capital that
can be used to absorb losses during periods of
financial and economic stress.
Capital Adequacy Norms
Minimum standards to address
funding liquidity risk:
• Liquidity Coverage Ratio (LCR) : The LCR is
designed to ensure that banks have sufficient
high-quality liquid assets (HQLA) to meet their
short-term liquidity needs during a 30-day stress
scenario.

• Net Stable Funding Ratio (NSFR): The NSFR is

designed to address longer-term funding liquidity
risk. It assesses the stability of a bank's funding
sources relative to its assets and off-balance-
sheet exposures over a one-year time horizon.
Liquidity Coverage Ratio
Stock of high quality liquid assets (HQLAs) / Total net
cash outflows over the next 30 calendar days

The LCR requirement is binding on banks from January 1, 2015.

However, to provide a transition time for banks, Reserve Bank of India
has permitted a gradual increase in the ratio starting with a minimum
60% for the calendar year 2015 as per the time-line given below:

January 1 January 1 January 1 January 1 January 1

2015 2016 2017 2018 2019
Minimum 60% 70% 80% 90% 100%
LCR
High Quality Liquid Assets
Liquid assets comprise of high quality assets
that can be readily sold or used as collateral
to obtain funds in a range of stress
scenarios.
 Cash: Actual cash held by the bank, including physical
currency and deposits at central banks.
 Central Bank Reserves: Deposits held with a country's
central bank, which are typically the most liquid and
secure form of reserves.
 Government Securities: Debt instruments issued or
guaranteed by the government.
Net Stable Funding Ratio (NSFR)
• The NSFR requires banks to maintain a stable funding profile in
relation to their off-balance sheet assets and activities. The goal is to
reduce the probability that shocks affecting a bank’s usual funding
sources might erode its liquidity position, increasing its risk of
bankruptcy

• (Available Stable Funding (ASF))/Required Stable Funding (RSF)) x

100 = Should be 100% or above.

• Available stable funding means the proportion of own and third-party

resources that are expected to be reliable over the one-year horizon
(includes customer deposits and long-term wholesale financing).
Therefore, unlike the LCR, which is short term, this ratio measures a
bank’s medium and long term resilience. Basel III requires the NSFR
to be equal to at least 100% on an ongoing basis