XIM
UNIVERSITY
B Com 2021-
24
BASEL
GUIDELINES
CAPITAL REQUIREMENT &
SUPERVISION OF BANKS
SESSIONS: 37-40
Sibu K Das
BASEL NORMS
• Central Bank Governors of the ‘Group of Ten’ countries formed a
Committee of Banking Supervisory Authorities in 1975. This committee
usually meets at the Bank of International Settlement (BIS) in Basel,
Switzerland. Hence, it has come to be known as Basel Committee
(BCBS).
• Basel Committee (BCBS) suggested a standard framework of supervision
with a recommendation of ‘capital adequacy’ norms in banks
functioning in their respective jurisdiction. This is commonly known as
Basel Accord-I.
BASEL NORMS
• Basel Core Principle 8 says :
“An effective system of banking supervision requires the
supervisor to develop and maintain a forward-looking
assessment of the risk profile of individual banks and banking
groups, proportionate to their systemic importance; identify,
assess and address risks emanating from banks and the banking
system as a whole; have a framework in place for early
intervention”.
BASEL NORMS
• Recommended capital adequacy was put at a minimum of 8% of
the total risk-weighted assets of the bank..
• Capital Adequacy Ratio (CAR) is also known as Capital to Risk-
weighted Assets Ratio (CRAR). It is the ratio (in % terms) of
Capital that a bank was mandated to hold to its risk-weighted
assets ; i.e.
CAR = CRAR = (Capital / Total value of Risk-weighted assets) x 100
BASEL NORMS
• In India, ‘Committee on Financial System’ under the Chairmanship
of Mr. M Narasimham (also known as Narasimham Committee),
following the international practice, recommended introduction of
‘capital adequacy’ norms in Indian banks.
• RBI, our national regulator, issued guidelines on ‘capital adequacy’
for banks in India.
• From the financial year ending 31 st March 2000, banks in India were
required to maintain CAR of 9%.
BASEL NORMS
• Computation of CAR required two components : Total value of risk-
weighted assets and value of Capital.
• Assets of the bank were assigned a risk factor depending upon
their nature and perceived risks associated with them, as
prescribed by RBI.
• Risk adjusted value of the asset is calculated by multiplying the
value of the assets as shown in the Balance Sheet with the risk-
weight assigned to it.
BASEL NORMS
• All Off-Balance sheet items are to first converted notionally to
fund-based amount by multiplying with the prescribed credit
conversion factor (CCF). The risk-adjusted value of this
notional fund-based amount is then calculated by multiplying it
with the risk-weight assigned to the counter-party on whose
behalf the bank has taken exposure. Hence the formula is:
Off-Balance sheet Exposure x CCF x Risk-weight of the Counter-
party
BASEL NORMS
RISK WEIGHTS
Risk-weights of Assets:
• Zero risk-weight: (i) Cash Balance, (ii) Balance with RBI, (iii) Dues
from RBI, (iv) Advance against Deposits/NSC/KVP/LIC Policy, (v)
Advance Tax paid, (vi) Recapitalisation Bond issued by Central Govt.,
(vii) Guaranteed portion of an advance backed by CGTMSE etc.
• 2.5% risk-weight: Investment in Government securities and
securities guaranteed by the Central/State governments to take
care of market risk.
BASEL NORMS
RISK WEIGHTS
• 20% risk-weight: Exposures to banks. (i) Balances in Current
Account with other banks, (ii) Claims on other banks. Loans to staff
fully secured by superannuation benefits and mortgage of house
• 22.5% risk-weight: (i) Investment in bonds issued by other banks,
(ii) Investment in bonds guaranteed by other banks
• 50% risk-weight: (i) Loans upto ₹1 lakh against gold ornaments, (ii)
Housing loan upto ₹30 lakhs to individuals secured by mortgage.
BASEL NORMS
RISK WEIGHTS
• 100% risk-weight: (i) Investment in other than Govt. securities,
(ii) Investment in equities, (iii) Foreign Investment, (iv) Fixed
Assets, (v) Exposures to commercial real estate (vi) Education
loan (Under Basel II, the risk-weight is 75%) (vii) Housing loan
for commercial purpose, (viii) Loans guaranteed by State Govts.
• 125% risk-weight: (i) All consumer loans, (ii) Credit Card
• 150% risk-weight: (i) Housing loan above ₹30 lakhs.
BASEL NORMS
OFF-BALANCE SHEET EXPOSURES
• CCF: (i) Letter of Credit: 20%, (ii) Financial Letter of
Guarantee: 100%, (iii) Other Guarantee: 50%, (iv)
Acceptances, Endorsements, Undrawn committed credit
lines: 100%
• Risk-weight: (i) Where Govt. is the counter-party: 0%, (ii)
Where bank is a counter-party: 20%, (iii) Others: 100%
BASEL NORMS
BASEL II
Basel I guidelines were in force for about 15 years, with some
modifications from time to time. But the recommendations under
Basel I were too straightjacket to address issues which became very
apparent over time. Capital adequacy was measured on general risk-
weights without looking into strengths and weaknesses of individual
entities. The approach was ‘One-size-fit-all’. Comprehensive Market
risk & Operational risk were not addressed. So a relook was much
needed and BCBS came up with Basel II.
BASEL NORMS
BASEL II
This BCBS Accord II is known as ‘International Convergence of
Capital Measurement and Capital Standards’ or simply Basel II.
• Internationally, this accord has been implemented since 1 st
March 2006.
• In India, as mandated by RBI, banks with overseas presence
were made to implement it by 31st March 2008 and other
banks (except LABs & RRBs) by 31st March 2009.
BASEL NORMS
BASEL II
Basel II Accord rests on 3 pillars:
First Pillar: Minimum Capital
Requirements
Second Pillar: Supervisory Review
Process
Third Pillar: Market Discipline
BASEL NORMS
BASEL II
Basel II
BASEL NORMS
CAPITAL FUNDS - TIER I CAPITAL
• Capital Fund for the purpose of calculation of ‘capital adequacy’
is classified into two categories: Tier I Capital & Tier II Capital.
• Tier I capital is also called as ‘core capital’.
• Tier I capital comprises of (i) Paid-up Equity Capital, (ii)
Reserves (excluding Revaluation reserves), (iii) Innovative
Perpetual Debt Instruments (IPDI), (iv) Perpetual Non-
Cumulative Preference Shares (PNPS).
BASEL NORMS
CAPITAL FUNDS - TIER I CAPITAL
• The total amount of IPDI should not exceed 15% of the Tier I
capital.
• PNPS issued by the bank rank as Tier I capital, such that both PNPS
& IPDI, if at all, taken together can comprise 40% of the Tier I
capital only.
• The investors in both these instruments do not have the put option
whereas the bank can exercise call option to redeem them after a
period of 10 years, with prior approval of RBI.
BASEL NORMS
CAPITAL FUNDS - TIER II CAPITAL
• The total amount Tier II capital is restricted to 100% of Tier I capital.
• Tier II capital is also known as Supplementary capital.
• Tier II capital consists of (i) Revaluation reserve, (ii) General
provision & General loan-loss provision, (iii) Hybrid Capital
instruments, (iv) Subordinated debts.
(i) Revaluation Reserve: Revaluation reserve is accounted for as Tier II
capital at a discount of 55%.
BASEL NORMS
CAPITAL FUNDS - TIER II CAPITAL
(ii) General provision & General Loan-loss provision: The amount of such
provisions eligible for Tier II capital is limited to 1.25% of the total risk-
weighted assets.
(iii) Hybrid Capital Instruments: Balance of amount of IPDI & PNPS
beyond the 15% value (taken as Tier I capital) is allowed to be taken as
Tier II capital.
(iii) Subordinated debts: These are unsecured debts with fixed maturity,
subordinate to claims on banks by other creditors. It is limited to 50% of
Tier I capital. Subordinated debts with maturity of less than 5 years
cannot be included as Tier II capital.
BASEL II
FIRST PILLAR - MINIMUM CAPITAL REQUIREMENT
• Capital for Credit Risk • Capital For Market Risk • Capital for Operational Risk
Standardised Approach Standardised Method Basic Indicator Approach
IRB Approach Maturity Method Standardised Approach
Foundation Approach Duration Method Advanced Measurement
Advanced Approach Internal Models Method Approach
BASEL II
SECOND PILLAR - SUPERVISORY REVIEW
For Banks • To develop an Internal Capital Adequacy Assessment Process (ICAAP)
For Supervisor • Evaluate Risk Assessment System
• Ensure soundness and integrity of bank’s internal processes
to assess adequacy of capital
• Ensure maintenance of minimum capital with PCA for
shortfall
• Prescribe differential capital, where necessary i.e where
internal processes are slack
BASEL II
THIRD PILLAR - MARKET DISCIPLINE
• Enhanced Disclosures
• Core disclosures and Supplementary
disclosures
• Timely - at least semi-annual disclosures
BASEL
BETWEEN BASEL I & BASEL II
Basis Basel I Basel II
Complexity Simple High complexity
Approach Top Down: Supervisor Bottom Up: Banks/ECAIs
determines risk-weights determine risk-weights
Approach to risk No risk sensitivity Increased risk sensitivity
BASEL III
BASEL NORMS
BASEL III
But Basel II failed to promote frameworks for accurate and realistic
measurement of risks. Thus the regulations could not demand sufficient
loss-absorbing capital to mitigate risks caused by market dynamics. Market
risk models failed to factor in real risks from complex derivative products.
Basel II didn’t explicitly address the issues of excessive leverage and
liquidity risk in banks.
Basel II focussed on individual banks and failed to address ‘contagion’
effect.
BASEL NORMS
BASEL III
The enhancement of Basel III over Basel II are primarily on
four areas :
• Augmentation in the level and quality of capital
• Introduction of liquidity standards
• Modifications in provisioning norms
• Better & more comprehensive disclosures
BASEL NORMS
BASEL III CAPITAL REQUIREMENTS VIS-À-VIS BASEL II
Capital as % of RWA
Details Basel II Basel III
A=(B+D Minimum Total Capital 8.0 8.0
)
B Minimum Tire-I Capital 4.0 6.0
C of which Minimum Common Equity (Tier-I) 2.0 4.5
(CET 1)
D Maximum Tier-II Capital (Within Total Capital) 4.0 2.0
E Capital Conservation Buffer (CCB) Nil 2.5
F=(C+E) CET I + CCB 2.0 7.0
G=(A+E Minimum Total Capital + CCB 8.0 10.5
)
BASEL NORMS
COMPOSITION OF CAPITAL BASEL II VIS-À-VIS BASEL III
Major Capital Components
Details Basel II Basel III
CET I Basel II does not explicitly Equity Shares, Share premium,
Capital prescribe CET I Retained Earnings
Tier I CET I, Hybrid Debt Capital This is ‘Additional Tier I Capital’.
Capital Instruments(Max 15% of Tier I
Capital)
Tier II Limited to 100% of Tier I Capital Instruments of Tier I Capital held
Capital Revaluation Reserves, Loan-loss in excess of permissible Tier I
reserves, Subordinated Debts, requirement
Subordinated Debt max 50% of
Tier I Capital
Tier III Short term Subordinated debts No Tier III Capital
Capital only to cover market risk. Tier III
Capital limited to 250% of Tier I
Capital
BASEL III
ADDITIONAL CAPITAL REQUIREMENTS
Capital Conservation Buffer:
Basel III requires higher and better quality capital. Although minimum
capital remains unchanged at 8% of RWA, Basel III stipulates CCB of 2.5% of
RWA over and above the capital requirement of 8%, raising the total capital
requirement to 10.5%.
This buffer capital is intended to enable banks to absorb losses without
breaching the minimum capital requirement of 8% and are able to carry on
business even in a downturn with deleveraging. The buffer is not part of the
regulatory minimum; however the level of CCB will determine dividend
distribution & bonus to staff.
BASEL III
ADDITIONAL CAPITAL REQUIREMENTS
Countercyclical Capital Buffer:
Basel III remains very pro-active to a possible slump after a
credit boom.. In a booming market it is easier to raise capital
but during a slump it is equally difficult to hold on to capital.
So it is required that an additional capital defence is put in
place. In the shape of CCCB of 0-5% of RWA in periods of
high credit growth. This buffer requirement should be met
entirely from CET I capital.
CORE CAPITAL
SIMPLIFIED
BASEL III
OTHER IMPORTANT STIPULATIONS
Leverage Ratio:
2007 financial crisis demonstrated that strong risk-based capital
ratios in accordance with Basel II, could also be excessively
leveraged. So, ‘a leverage ratio was introduced to act as a credible
supplementary measure to risk-based capital requirement’. The
leverage limit is set at 3%. It implies the bank’s assets (both On &
Off BS) should not be more than 33 times of the bank’s capital. It is
to be calculated as: Tier I Capital / Total exposure.
The ratio should be ≥ 3 per cent.
BASEL III
OTHER IMPORTANT STIPULATIONS
Liquidity Ratios:
1. Liquidity Coverage Ratio (LCR): It is designed to improve
the short-term resilience of the liquidity risk profile of the bank. It
requires the bank to hold a buffer of high quality liquid assets to
match net liquidity outflows during a 30-day period of stress; i.e. if
the bank can survive an acute stress scenario lasting for a month.
LCR = High quality liquid assets / Total net liquidity outflows ≥ 100%
BASEL III
OTHER IMPORTANT STIPULATIONS
Liquidity Ratios:
2. Net Stable Funding Ratio (NSFR): It is designed to improve
resilience in the longer term. It requires the bank fund their
activities with more stable sources of funding on an ongoing basis.
Assets currently being funded and any other contingent obligations
that may require funding must be matched by sources of stable
funding over a one year horizon.
NSFR = Available Stable Funding / Required Stable Funding ≥ 100%
BASEL III
OTHER IMPORTANT STIPULATIONS - (G-SIB)
The financial crisis of 2007 was an eye-opener on many accounts.
Contrary to the view ‘ Too-Big-To-Fail’, the world saw the fall or impairment
of very large banks/ financial institutions. Basel III took cognizance of this
contagion effect and mandated that G-SIBs/ G-SIFIs hold a higher capital
(CET I) on the basis of their importance in the global financial system.
A set of indicators was selected to identify them; the size of the banks,
their interconnectedness, the lack of readily available substitutes for the
services they provide, their global (cross-jurisdictional) activity and their
complexity.
BASEL III
OTHER IMPORTANT STIPULATIONS - (G-SIB)
The Basel Committee grouped G-SIBs into different categories
(buckets) of systemic importance based on the score produced by the
indicator-based measurement.
Bucket Score Range Minimum additional Loss
Absorbency Capital Required
(CET I)
5 (Empty) D 3.5%
4 C–D 2.5%
3 B–C 2.0%
2 A–B 1.5%
1 Cut-off Point A 1.0%
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