Basel Accords, Banking Regulation & PCA Framework

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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.
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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
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Basel Accords

  • 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
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Basel I

  • 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 riskweighting 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).
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Basel II

  • It was published initially in June 2004
  • Basel II uses a “three pillars” concept –
    1. minimum capital requirements -8 % (Capital Adequacy Ratio)
    2. supervisory review
    3. Banks need to mandatorily disclose their risk exposure, etc to the central bank
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Basel III

  • 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 201011
  • These guidelines were introduced in response to the financial crisis of 2008.
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Key Principles

Capital Requirements

  • Since 2015, a minimum Common Equity Tier 1 (CET1) ratio of 4.5% must be maintained at all times by the bank

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Leverage Ratio

  • It means, buying assets with borrowed money to multiply the gain.
  • The banks are expected to maintain a leverage ratio in excess of 3%

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Liquidity Requirements

  • 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)
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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.
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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.

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Basel III Norms in India

  • BI has postponed the implementation of these norms to 2019
  • Banks need to maintain min CRAR
    • Schedule Banks9%
    • Differential Banks15%
  • Way to collect capital
    • Issue share, bond in capital market
    • Govt. will give 70k Cr. through Indradhanush Plan
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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
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Capital to Risk (Weighted) Assets Ratio (CRAR)

  • It also known as Capital Adequacy Ratio (CAR)
  • Itis 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

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CCCB
  • 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

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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
    1. NPA
    2. CRAR
    3. Profitability
    4. Leverage
  • 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.

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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.
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