Webinar on- Basel II and Basel III
June 16, 2020
Resurgent India Knowledge Series Presents
Webinar on- Basel II and Basel III
Moderated By: Mr. K.K. Gupta, Director- Resurgent India Limited
Speaker: Mr. Mahajan
- Bank of International Settlement was formed by a group of 10 countries and was aimed at stabilizing financial and monetary standards globally. 60 countries including India are the owners of the bank.
- Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. These regulations aimed to ensure that the more significant the risk a bank is exposed to, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.
- It was implemented in the years prior to 2008, and was only to be implemented in early 2008 in most major economies; the financial crisis of 2007–2008 intervened before Basel II could become fully effective. As Basel III was negotiated, the crisis was top of mind, and accordingly, more stringent standards were contemplated and quickly adopted in some key countries including in Europe and the US.
- These regulations lay down various guidelines that guard the capital to maintain, leverage risk, CRAR, liquidity coverage, unhedged forex exposure, technology, and balance sheet management.
- Capital consists of tier 1 capital- common equity, reserves and surplus, and innovative perpetual debt instrument and perpetual non-cumulative preference shares. Tier 2 capital includes- Revaluation Reserves, General provisioning and loss reserves, upper-tier 2 bonds, Subordinated debt (lower tier 2 bonds)
- The bank is required to maintain a more than 8% ratio of capital (tier 1 & tier 2) to a combination of credit risk, market risk, and operational risk which is known as Minimum Capital Requirement.
- The credit risk of the bank is ascertained via the weight of risk assigned to different classes of borrowers. 0% being risk-free borrowers (domestic sovereign) to 100% or more (public entities)-risky borrowers under a standardized approach.
- The RWA is assigned to on-balance sheet items and off-balance sheet items i.e BGs and LCs. These off-balance sheet assets exposure is calculated using credit conversion factor( CCF) for Bank Guarantees, Undrawn commitments for a line of credit, Credit risk mitigation for facilities backed by securities i.e gold and cash, and other financial securities and Haircut-margins prescribed by the RBI on collateral securities. Capital is mitigant for unexpected losses and provisions are the mitigants for expected losses.
- Market risk covers the risk related to loss of value of any assets due to change in general market parameters like interest rate, exchange rate, etc. Market rate comprises of specific risk and general market risk. General market risk can be calculated using standardized duration and internal models approach.
- The internal model's approach follows the calculation of Value at Risk which again can be calculated using the covariance method, historical simulation, and Monte-Carlo simulation. Majority of banks in India uses historical simulation method.
- Operational risk covers the risk of loss due to operational failures, employee fraud or misconduct, errors in models, or natural or man-made catastrophes, among others. It can be calculated via the Basic Indicator Approach, The Standardized Approach, and Advancement Measurement Approach. Most of the banks in India follow the BIA approach.
- Banks are mandated to calculate all the above three risks and show the working of the risk in detail in their books.
- Other than the three mentioned risks banks may evaluate the following risks as per their exposure and provide additional capital over and above the minimum risk requirement. Credit concentration risk, Country risk, Interest rate risk in Banking book, liquidity risk, Reputation risk, Business, and strategic risk, and additional risk measure for credit risk.
- Supervisor of the banking environment, RBI in case of India, visits for a routine check-up of banks’ books at an interval of a year, 6 months or on a quarterly basis, and examines and makes recommendations on the adequacy of MCR. For this routine, banks are directed to implement an internal process called Internal Capital Adequacy Assessment Process (ICAAP)
- Scope of ICAAP is to identify risks not fully captured under pillar 1 (Credit risk, market risk, and operational risk), measurement of quantifiable and non-quantifiable risks(Reputation, Strategic Risk), a Control mechanism in place and their application, aggregation of all risks and RWA, Allocation of Capital Charge.
- Basel norms also recommend applying stress testing to understand and study the impact of various adversity on bank’s adequacy and profitability. It involves stimulating scenarios -minor, medium, and major. It facilitates banks to understand their soundness under different scenarios and take effective steps in planning their capital requirement based on the probability of the scenarios.
- Basel III addresses issues of capital, liquidity, leverage, and additional requirements for banks. RBI has increased the quantity of total capital requirement from 9% to 11.5% as of April 1, 2020.
- Capital Conservation buffer is 2.5% under Basel III which can be drawn down at times of systematic or idiosyncratic stress as guided by the regulator.
- The liquidity coverage ratio determines the liquidity soundness of the bank and informs whether enough liquidity is maintained by the banks to meet its short-term liabilities. And for long term stability, the net stable funding ratio is calculated.
- Leverage ratios are the ratio of tier 1 capital to the total exposure. Should not be less than 4.5 as per Indian standards. A bank cannot expand its exposure if it doesn’t have enough capital.
- In India, there are only three systematically important banks-SBI, ICCI, and HDFC bank. SBI is required to keep 12.1 % of CAR instead of 11.5 %. Similarly, ICICI and HDFC are required to maintain 0.2 and 0.15% depending upon the amount of risk carried by these banks.
►Watch the webinar here: https://www.youtube.com/watch?v=g12B4_fVjQM&t=8s