The banks in a country must be strong enough to come through any tough situations. The reality is we have seen in the 2008 crisis, worlds largest banks needs bailout from the govt. to survive. If the banks itself have such a problems, then how a country’s economy can be stable enough to challenge a crisis?. All the banks in a country is controlled by the central bank of that country. In India it is Reserve Bank, Federal Reserve is for USA likewise each country has its own central bank. Above all, there is a committee formed by all the central banks around the world to monitor the global economy and regulate the banking norms like capital maintenance, etc.
In 1974, Basel Committee (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks. The Basel Committee formulates broad supervisory standards and guidelines and recommends statements of best practice in banking supervision. The current norms created under the Basel – III is bank capital adequacy, stress testing and market liquidity risk.
What is Basel Committee?
A group of central banks around the world has formed a committee in Basel, Switzerland to regulate and monitor the banks in their respective countries. This committee would discuss the problematic areas for the banks and come up with the new set of rules to strengthen the banks. The main intention of this committee is to strengthen the banks to come through any kind of difficult situations like happened in the 2008 crisis.
Basel – I
Basel I, that is, the 1988 Basel Accord is focused on the credit risk. It is the initial step by the Basel committee after the 1974 incident of Herstatt Bank‘s bankrupt. Assets of the banks are grouped and categories based on the risk level. Banks with the international exposure must have the 8% capital. Basel I is outdated and it is not suitable for the modern trend of banks with the huge transactions around the world.
Basel – II
Basel II, which is created on 2004, is focused on to create the international banks regulations for the banks. It wants to address the problem of capital adequacy based on its risk. The problem was that Basel II is very slowly adopted by the banks, the 2008 crisis could not be avoided because banks are not followed the Basel II regulations.
What is Basel III norms?
Basel III is the response to 2008 financial crisis. Basel committee is well understood the problem happened in the 2008, it wants to enforce the set of regulations for the banks and made the Basel III norms. It is created in the year 2010-11. It is expected that all the banks must adhere to the regulations by 2018. The following are the summary of things needs to be addressed in the Basel III:
- The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods and higher during the later years.
- The implementation of the capital adequacy guidelines will start from January 1, 2013.
- The guideline says that banks to maintain a minimum total capital of 9 per cent against 8 per cent prescribed by the Basel committee of total risk weighted assets.
- Common Equity Tier 1 (CET1) capital must be at least 5.5 per cent of RWAs.
Basel III in India
Reserve Bank on India (RBI) is taking the Basel III norms as serious measure and asking the banks to increase the liquidity by the given dead lines. The milestone given by the Basel Accord is:
- 2013 Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital requirements.
- 2015 Minimum capital requirements: Higher minimum capital requirements are fully implemented.
- 2016 Conservation buffer: Start of the gradual phasing-in of the conservation buffer.
- 2019 Conservation buffer: The conservation buffer is fully implemented.
- 2011 Supervisory monitoring: Developing templates to track the leverage ratio and the underlying components.
- 2013 Parallel run I: The leverage ratio and its components will be tracked by supervisors but not disclosed and not mandatory.
- 2015 Parallel run II: The leverage ratio and its components will be tracked and disclosed but not mandatory.
- 2017 Final adjustments: Based on the results of the parallel run period, any final adjustments to the leverage ratio.
- 2018 Mandatory requirement: The leverage ratio will become a mandatory part of Basel III requirements.
The additional capital requirements of the public banks could be around 3 lakhs crore to meet the basel norms. The Basel III capital ratios will be fully implemented on March 31, 2018. Banks have to maintain Tier I capital, or core capital, of at least 7 per cent of their risk weighted assets on an ongoing basis.
Under the current Basel II norms, banks have to maintain the Tier I capital of at least 6 per cent of their risk weighted assets. The total capital ratio including Tier -I and Tier-II is 9%. Here Tier I is cash and Tier – II is bonds.
The good thing is we have time till 2018 to achieve the target. When it comes to the public sector banks, if the banks are not able to raise the capital then govt. has to infuse the money into the system. It is going to be another burden for the govt. which already suffering from the current account deficit.
If you look on the Basel III norms, over all it is very good for the banks. In the initial period, banks (mainly public sector banks) would be under more pressure to raise the capital which would reduce the number of loans sanctioned. It is good for the future. If you are investor choosing the banking stocks, for the long term basel norms would be beneficial. There is no reason to panic. If you have queries on this, please post it in the comments section.