Professional Documents
Culture Documents
RESEARCH PAPER
ON
BASEL ACCORD 3
09416603909
TABLE OF CONTENTS
OBJECTIVES
LITERATURE REVIEW
INTRODUCTION
CHALLENGES
CONCLUSION
OBJECTIVES
The committee does not have the authority to enforce recommendations, although
most member countries as well as some other countries tend to implement the
Committee's policies. This means that recommendations are enforced through
national (or EU-wide) laws and regulations, rather than as a result of the committee's
recommendations - thus some time may pass between recommendations and
implementation as law at the national level.
The Committee is often referred to as the BIS Committee after its meeting location.
However, the BIS and the Basel Committee remain two distinct entities.
The Basel Committee formulates broad supervisory standards and guidelines and
recommends statements of best practice in banking supervision in the expectation
that member authorities and other nations' authorities will take steps to implement
them through their own national systems, whether in statutory form or otherwise.
The Basel committee along with its sister organizations, the International
Organization of Securiti9es Commissions and International Association of Insurance
Supervisors together make up the Joint Forum of international financial regulators.
LITERATURE REVIEW
Mr Henry is also concerned that the UK, in the form of the Financial
Services Authority, could start "gold plating" the requirements by
imposing tougher rules. UK standards are already higher than those
agreed at Basel, although to be fair, Switzerland's banks may also find
themselves in this position after Finma, the main financial regulator, and
the Swiss National Bank indicated they may impose tougher rules to
prevent the failure of a major bank dragging down the economy. Tough
break for UBS and Credit Suisse then.
Mr Henry called on the FSA not to follow suit "now things are calming
down" with all the UK banks currently holding capital in excess of the 4.5
per cent of "at risk assets" together with a 2.5 per cent "buffer" required
by the Basel supervisors. He, and the bigger banks, are also nervous
about the ill-defined additional requirement for "systemically significant"
banks to hold a further buffer in "good times", which in theory affects all
of the UK players and which will very much be under the control of
national regulators.
Lord Turner, the chairman of the FSA did not have much to say on that,
limiting himself to a brief statement hailing the Basel deal as "a major
tightening of global capital standards" that "will play a significant role in
creating a more resilient global banking system." He also said the
transition timescale would "ensure that banking systems can play their
role in supporting economic recovery". By lending.
There is plenty in the accord to admire. Plainly, the higher tier one capital
requirements are to be welcomed – though note that just four of 50-odd
decent-sized European banks do not already pass muster – as is the
"liquidity coverage ratio", which will act as a brake on gearing.
Indeed, it is worth remembering that Basel III, across the board, is not
quite the unbreakable law some would have you believe. The Basel
Committee has no power to actually implement its new rules, or to
sanction those banks which break them. And while the next G20 meeting
in November will no doubt adopt the regulations with great enthusiasm,
many of the countries sending delegates to that summit have yet to
implement all the conclusions of Basel II, which were made in the
summer of 2004.
Meanwhile, time continues to fly – every day that goes past without a
final blueprint for banking regulation in all those countries where it
matters is a day on which memories fade a little further of just how close
the world came to the financial abyss.
BASEL 1
Basel I is the round of deliberations by central bankers from around the world, and in
1988, the Basel Committee (BCBS) in Basel, Switzerland, published a set of minimal
capital requirements for banks. This is also known as the 1988 Basel Accord, and
was enforced by law in the Group of Ten (G-10) countries in 1992.
Basel I, that is, the 1988 Basel Accord, primarily focused on credit risk. Assets of
banks were classified and grouped in five categories according to credit risk, carrying
risk weights of zero (for example home country sovereign debt), ten, twenty, fifty,
and up to one hundred percent (this category has, as an example, most corporate
debt). Banks with international presence are required to hold capital equal to 8 % of
the risk-weighted assets. However, large banks like JPMorgan Chase found Basel I's
8% requirement to be unreasonable and implemented credit default swaps so that in
reality they would have to hold capital equivalent to only 1.6% of assets.
Since 1988, this framework has been progressively introduced in member countries
of G-10, currently comprising 13 countries,
namely, Belgium, Canada, France, Germany, Italy, Japan, Luxembourg,
Netherlands, Spain, Sweden, Switzerland, United Kingdom and the United States of
America.
Most other countries, currently numbering over 100, have also adopted, at least in
name, the principles prescribed under Basel I. The efficiency with which they are
enforced varies, even within nations of the Group of Ten.
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. The
purpose of Basel II, which was initially published in June 2004, is to create an
international standard that banking regulators can use when creating regulations
about how much capital banks need to put aside to guard against the types of
financial and operational risks banks face. Advocates of Basel II believe that such an
international standard can help protect the international financial system from the
types of problems that might arise should a major bank or a series of banks collapse.
In practice,
OBJECTIVES OF BASEL 2
Introduction of Basel II has given incentives to many of the best practices banks, to
adopt better risk management techniques and to evaluate their performance relative
to market expectations and relative to competitors.
Market discipline – risk exposure, migration assets from standard to NPA etc
These are – the ‘Basic Indicators Approach’ that employs a single proxy
for the entire bank such as trading volumes, the ‘Business Line Approach’
that uses the committee imposed capital ratios for different business lines
(such as retail banking, corporate financial services, payment and
Settlement, etc) and the ‘Advanced Measurement Approach’ that uses a
bank’s own loss data within a supervisory specified framework. ‘Pillar 2’ is
represented by the effective supervisory review of ‘Pillar 1’, whereby bank
supervisors are expected to evaluate the activities and risk profiles of
individual banks in order to determine whether those banks have provided
adequate capital under ‘Pillar 1’ and suggest ways to set right the
discrepancies, if any. ‘Pillar 3’ is represented by the market discipline to
ensure prudent management by banks by enhancing the degree of
transparency in banks’ public reporting.
First, the quality, consistency, and transparency of the capital base will be
raised.
Tier 1 capital: the predominant form of Tier 1 capital must be common
shares and retained earnings
Tier 2 capital instruments will be harmonized
Tier 3 capital will be eliminated
Second, the risk coverage of the capital framework will be strengthened.
Strengthen the capital requirements for counterparty credit exposures
arising from banks’ derivatives, repo and securities financing transactions
Raise the capital buffers backing these exposures
Provide additional incentives to move OTC derivative contracts to
central counterparties (probably clearing houses)
Provide incentives to strengthen the risk management of counterparty
credit exposures
The Committee also is reviewing the need for additional capital, liquidity or
other supervisory measures to reduce the externalities created by systemically
important institutions.
The RBI has accepted in principle the New Capital accord (Basel II) in
April 2003. To begin with, banks in India will adopt standardized approach
for credit risk and basic indicators approach for operational risk. But
eventually the system as a whole (banks and the supervisor) will
migrate to the IRB approach. The task is intimidating given the fact
that 100 Indian banks will have to move to the new system by
December 2006. The preparation at the bank level is being influenced
by a number of factors such as the state of existing data, IT
architecture and risk management systems, degree of pressure
exerted by the RBI, competitor banks’ actions, and the possibilities of
‘mergers and acquisitions’ within the system.
The RBI is trying to resolve a number of regulatory issues
keeping in mind developmental priorities (especially issues like
adequacy of credit flows to critical sectors like agriculture, SMEs and
infrastructure), readiness of the system in terms of the legal and
regulatory framework (efficacy of Securitization Act, etc), accounting
standards (domestic versus US GAAP), soundness of corporate
governance (especially in a context of recent episodes of bank
failures), market discipline and most importantly, a competitive or
level playing field issues among banks of different strengths. Given the
monolithic scale of the task involved, it will be best for the RBI and the
banks to move at a measured pace – to commit to a time table that is
appropriate given our specific set of circumstances. However, at the
bank level, the entire effort should be directed towards the ultimate
goal of achieving the advanced IRB and advanced measurement
approaches to credit and operational risks.