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As said earlier, the Basel Committee makes these norms. The Committees
decisions have no legal force. Rather, the Committee formulates supervisory
standards and guidelines and recommends statements of best practice in the
expectation that individual national authorities will implement them. In this
way, the Committee encourages convergence towards common standards
and monitors their implementation, but without attempting detailed
harmonisation of member countries supervisory approaches.
So, India can either accept them or reject them depending on the kind of
financial system it wants. So far, we have implemented or wished to
implement all Basel norms.
Basel I
In 1988, BCBS introduced capital measurement system called Basel capital
accord, also called as Basel 1. It focused almost entirely on credit risk. It
defined capital and structure of risk weights for banks. Naturally if the capital
with the banks is adequate to cover the risks ( e.g. a power plant) they have
invested in, then the bank is safe.
The minimum capital requirement was fixed at 8% of risk weighted assets
(RWA). RWA means assets with different risk profiles. For example, an asset
backed by collateral would carry lesser risks as compared to personal loans,
which have no collateral. India adopted Basel 1 guidelines in 1999. The Basel
norms are set up by the Basel committee on Banking supervision.
It is important to understand that the Basel accords have been the result of
cooperation by the countries over the years.
Basel II
In 2004, Basel II guidelines were published by BCBS, which were
considered to be the refined and reformed versions of Basel I
Basel III
In 2010, Basel III guidelines were released. These guidelines were introduced in response to the
financial crisis of 2008.
A need was felt to further strengthen the system as banks in the developed
economies were under-capitalized, over-leveraged and had a greater reliance
on short-term funding. Too much short-term funding makes the banks prone
to risks. Banks generally rely on short-term funding because it is profitable.
Also the quantity and quality of capital under Basel II were deemed
insufficient to contain any further risk. This was because the banking system
was growing. The world economy was growing too. Hence, what is sufficient
earlier was not sufficient now.
Basel III norms aim at making most banking activities such as their trading
book activities more capital-intensive. The guidelines aim to promote a more
resilient banking system by focusing on four vital banking parameters viz.
capital, leverage, funding and liquidity.
Again we need not go in technicalities, just the broad picture.
This is how it was broadly done.
Capital
The capital requirement (as weighed for risky assets) for Banks was more
than doubled. ( e.g. 4.5% from 2% in Basel-II accord for common equity)
Leverage
Leverage basically means buying assets with borrowed money to multiply
the gain. The underlying belief is that the asset will return the investor more
than the interest he has to pay on the loan.
Obviously doing so is risky business. Thus the Basel III puts a limit on the
banks for doing this. The numbers are not important here. Getting the
concept is important.
Conclusion
It is clear that the banking system in the coming times will have to go
through a lot of rough weather. Increasing operational complexities, global
interconnectedness and high economic growth worldwide will present several
challenges for the banks. While strategies like Basel III will of course address
these challenges, what is even more important is their proper
implementation. More than this, the banks will need to have a wider outlook.
They must anticipate changes in the Indian economic system and react
accordingly. Indian banking regulations are one of the most stringent and
consequently one of the safest in the world. Let us evolve each time better
and stronger.