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Basel Accords, Banking Regulation & PCA Framework
Bank for International Settlements (BIS)
- It is an international financial institution owned by central banks
- Its fosters international monetary and financial cooperation and serves as a bank for central banks
- It is based in Basel, Switzerland
- Established in 1930
- BIS is owned by 60 central banks, representing countries from around the world that together account for about 95% of world GDP.
Basel Committee on Banking Supervision (BCBS)
- It is a committee of banking supervisory authorities
- It was established by the central bank governors of the Group of Ten countries in 1974
- It refers to the banking supervision Accords – Basel I, Basel II and Basel III, issued by the Basel Committee on Banking Supervision (BCBS)
- It is a set of recommendations for regulations in the banking industry
- It is the round of deliberations by central bankers from around the world, in 1988
- BCBS published a set of minimum capital requirements for banks
- Enforced by law in the Group of Ten (G-10) countries in 1992
- The primarily focused on credit risk and appropriate risk–weighting of assets.
- Assets of banks were classified and grouped in five categories according to credit risk
- Banks with an international presence are required to hold capital equal to 8% of their risk-weighted assets (RWA).
- It was published initially in June 2004
- Basel II uses a “three pillars” concept –
- minimum capital requirements -8 % (Capital Adequacy Ratio)
- supervisory review
- Banks need to mandatorily disclose their risk exposure, etc to the central bank
- It is a global, voluntary regulatory framework on bank capital adequacy, stress testing, and market liquidity risk.
- It was agreed upon by the members of the BCBS in 2010–11
- These guidelines were introduced in response to the financial crisis of 2008.
- Since 2015, a minimum Common Equity Tier 1 (CET1) ratio of 4.5% must be maintained at all times by the bank
- It means, buying assets with borrowed money to multiply the gain.
- The banks are expected to maintain a leverage ratio in excess of 3%
- Banks can be subjected to a lot of risk if all depositors come and ask all their money at the same time.
- This is a hypothetical situation but it has happened in real with Lehman Brothers – the bank whose collapse gave us the 2008 recession.
- It was issued in December 2010 which presented the details of global regulatory standards on liquidity.
- Two minimum standards
- Liquidity Coverage Ratio (LCR)
- Net Stable Funding Ratio (NSFR)
Liquidity Coverage Ratio
- It promotes short-term resilience of banks to potential liquidity
- Need to ensure with high quality liquid assets (HQLAs) to survive an acute stress scenario lasting for 30 days.
Net Stable Funding Ratio
- It promotes resilience over longer term time horizons by requiring banks to fund their activities with more stable sources of funding on an ongoing basis.
Basel III norms in India
- BI has postponed the implementation of these norms to 2019
- Banks need to maintain min CRAR
- Schedule Banks – 9%
- Differential Banks – 15%
- Way to collect capital
- Issue share, bond in capital market
- Govt. will give 70k Cr. through Indradhanush Plan
Risk-weighted asset (RWA)
- It is a bank’s assets or off-balance-sheet exposures, weighted according to risk.
- This sort of asset calculation is used to determine capital requirement
- Different classes of assets have different risk weights associated with them.
- Corporate loan, Debentures are assigned a higher risk than cash or government securities
Capital to Risk (Weighted) Assets Ratio (CRAR)
- It also known as Capital Adequacy Ratio (CAR)
- It is the ratio of a bank’s capital to its risk
- RBI track a bank’s CRAR to ensure that it can absorb a reasonable amount of loss
- Capital adequacy ratio is the ratio which determines the bank’s capacity to meet the time liabilities and other risks such as credit risk, operational risk etc.
- There are 2 types of CRAR
- Tire1 – common shares, preferential shares
- Tire2 – debt, hybrid instruments
- It is aimed to protect the banking sector against losses from changes in economic conditions.
- Banks may face difficulties in phases like recession when the loan amount doesn’t return.
- Banks should have own additional capital to keep flowing the economy
- This is an important theme of the Basel III norms.
- Its not using now, when needed RBI need to notify 4 quarters ahead
- Max 2.5% of RWA as common shares
Prompt Corrective Action (PCA) framework
- Its a mechanism to ensure that banks don’t go bust.
- RBI has put some points to assess, monitor, control and take corrective actions on banks which are weak and troubled.
- It was introduced by Bimal Jalal in 2002 in India and was tightened by RBI governor Urjit Patel in April 2017
- There are some parameter to measure the Banks risk situation
- Maximum tolerance limit, sets at
- net NPA over 12%
- negative return on assets for 4 consecutive years
- 2 type of restrictions is there
- Mandatory – Restrictions on dividend, branch expansion, directors compensation
- Discretionary – Restrictions on lending and deposit
- It’s a Direct action by RBI under qualitative tools
- It imposed only on Scheduled Commercial Banks except RRB
- Banks are not allowed to re-new or access costly deposits or increase their fee-based income
- Banks will also have to launch a special drive to reduce the stock of NPAs
- They will also not be allowed to enter into new lines of business and borrow from interbank market
Society for Worldwide Interbank Financial Telecommunication (SWIFT)
- Provides a network to financial institutions worldwide to send and receive information about financial transactions
- It is popularly known as “SWIFT codes“.
- Established in 1973
- Now operates in 210 countries, linking more than 10,000 financial institutions
- Each financial organization has a unique code of 8 or 11 characters
- The code is interchangeably called the Bank identifier code (BIC), SWIFT code, SWIFT ID, or ISO 9362 code
- Users of SWIFT are – Banks, money brokers, security broker dealers, clearing systems, corporates, NBFCs and more
- SWIFT network doesn’t actually transfer funds
- It sends payment orders between institutions’ accounts, using SWIFT codes
- SWIFT transaction will need to go through intermediary banks, each of them levy their own fee