Important Points about Basel 1, 2 and 3 Committee

    Important Points about Basel 1, 2 and 3 Committee
    Important Points about Basel 1, 2 and 3 Committee:
    Important points that we have to know about Basel 1, 2 and 3 Committee was given here, which will be more helpful for the candidates those who are preparing for the upcoming exams.

    Basel 1, 2 and 3 committee:

    1). On26 June 1974 a number of banks had releasedDeutschmarks (the German currency) to theHerstatt Bank in exchange for dollar payments deliverable in New York

    2). Due to differences in the time zones,Herstatt Bank ceased operations between the times of the respective payments and  before the dollar payments could be effected in New York, the Herstatt Bank wasliquidated by German regulators

    3). TheG-10 nations responded to this incident by forming theBasel Committee onBanking Supervision in late 1974, under theBank for International Settlements(BIS) located inBasel, Switzerland

    BASEL-I

    1). In1988 theBasel Committee onBanking Supervision (BCBS) in Basel published a set of minimum capital requirements for banks known as Basel I norms

    2). Features of Basel I
    ·        It mainly focused on credit or default risk i.e., the risk of counter party failure
    ·        It defined the capital requirement and structure of risk weights for banks

    3). Assets of banks were classified and grouped in five categories according to credit risk, carrying the following risk weights
    ·        0%– cash, bullion, home country debt like Treasuries
    ·        20%– securitizations such as mortgage-backed securities (MBS) with the highest AAA rating
    ·        50%– municipal revenue bonds, residential mortgages
    ·        100%– most corporate debt

    4). Banks with an international presence are required to hold capital equal to8% of theirrisk-weighted assets (RWA).
    ·        At least4% inTier I Capital
    ·        More than4% inTier I andTier II capital

    5). From 1988 this framework was introduced within the G-10 nations initially and then over 100 countries adopted the rules prescribed by the Basel I

    BASEL II

    1). Basel II was introduced in2004 with more refined definitions for capital adequacy, risk management and disclosure requirements

    2). It used external rating agencies to set the risk weights for corporate and banks

    3). Disclosure requirements allowed market participants to access the capital adequacy of the institution based on information on the following aspects
    ·        Scope of application
    ·        Capital
    ·        Risk exposure
    ·        Risk assessment processes

    4). In Basel II normsOperational Risk has been defined as the risk of loss resulting from inadequate or failed internal processes, people and systems

    5). Basel II uses a“three pillars” concept namely

    ·        minimum capital requirements
    a.   The credit risk component can be calculated in three different ways of varying degree of sophistication, namely standardized approach, Foundation IRB, Advanced IRB and General IB2 Restriction. IRB stands for “Internal Rating-Based Approach”
    b.   For operational risk, there are three different approaches – basic indicator approach or BIA, standardized approach or TSA, and the internal measurement approach
    c.   For market risk the preferred output its value at risk
    ·         supervisory review
    a.   This is a regulatory response to the first pillar, giving regulators better ‘tools’ over those previously available
    b.   It also provides a framework for dealing with systemic risk, pension risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk, which the accord combines under the title of residual risk
    c.   Banks can review their risk management system
    d.   TheInternal Capital Adequacy Assessment Process (ICAAP) is a result of Pillar 2 of Basel II accords
    ·        Market discipline – it supplements regulation as sharing of information facilitates assessment of the bank by others, including investors, analysts, customers, other banks, and rating agencies, which leads to good corporate governance

    BASEL III

    1). The Basel II regulations did not have any explicit norm on the debt that banks could take but focused on financial institutions ignoring the systematic risks

    2). Therefore to ensure that banks don’t take excessive debt and not rely on short term funds the Basel III norms were proposed in2010

    3). Basel III promoted a more resilient banking system on the following 4 important banking parameters namely

    o  Capital
    o  Leverage
    o  Funding
    o  Liquidity

    4). Requirements ofcommon equity andTier 1 capital will be 4.5% and 6% respectively

    5).Leverage ratio calculated by dividing Tier 1 capital by the bank’s average total consolidated assets will be greater than3%

    6). Theminimum Liquidity Coverage Ratio (LCR) will reach upto100% by 1stJanuary 2019 to prevent situations likeBank Run

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