3 Basel Norms and the 3 pillars

Basel Norms is quite a common name in modern parlance, but what is Basel norms and what it is aimed at.

To start with Basel is a city in Switzerland. It is headquarter of a body that promotes cooperation and regulates financial stability and provide common norms for banking regulations.  After every two months Basel hosts its meeting with the governor and senior officials of central banks. Presently there are 27 member countries. Basel Norms refer to supervisory guidelines formulated by Central Banks- also known as Basel Committee on Banking Supervision. The agreements usually focus on risk management and the whole financial system is known by the name of accord.
 

Aim of Basel Accord

The aim of Basel accord is to ensure that banks and other financial institutions have enough capital to be able to meet its financial obligations and absorb the unforeseen losses. India is a participating member of BCBS. Even RBI has taken some aggressive steps to ensure financial stability of Indian Banks doesn’t remain at the stake.

Let’s take a sneak peek on Basel norms

Basel 1- The basel1 was formed in 1988 with an aim to reduce credit risk. The credit risk can also be defined as capital adequacy and risk weights fixed for the banks. The minimum capital requirement was fixed as 8% of risk weighted assets. RWA can be defined as assets with different risk categories. For instance, assets that are backed by adequate collateral tend to have low risk as compared to not having collateral at all. India became the member of Basel 1 guidelines in the year 1999.

Basel 2- Basel 2 norms was specifically formulated to ameliorate Basel 1 norms. For Indian Banks it became mandatory to keep themselves at par with global banking standards. It was basically done with an aim to make banking system in India more reliable and transparent.

Basel II norms were based on three pillars known as Capital adequacy, supervisory review and market discipline. The Basel committee calls all these factors as a way to reduce and manage risk. Hereby we have explained all these pillars in detail.

Pillar 1- Capital Adequacy Requirements

Under this pillar bank is liable to maintain minimum capital adequacy ratio of 8 percent to risk assets. For India, RBI has made a stringent rule that defines 9 percent of capital adequacy ratio is to be maintained by banks. It is also termed as Capital to Risk Weighted ratio.

Pillar 2-Supervisory view

This pillar has classified that the bank primarily encounters three types of risks namely operational risk, credit risk and market risk. The Basel II was formed with an aim to secure banks from any of the above mentioned risks and to use better management techniques to reduce and manage the risk.

It has following key elements:

Banks should have capability to gauge their overall capital adequacy ratio in relation to risk profile and it should have a strategy to deal with it.

Supervisors should be in a position to monitor and assess internal capital adequacy strategies and it should have an ability to monitor and regulate credit ratio.

Supervisors should have a strict control and should aim that their banks work above minimum capital ratio and has the ability to require banks to hold enough capital that is able to cover the risk.

Supervisors should intervene at a nascent stage; if the capital adequacy requirements are falling below a particular level.

Pillar III-Market discipline

Market discipline lets you to conduct business in safe and secured environment. There are certain mandatory requirements that are needed to be maintained.

Now, India is heading for stricter Basel III norms, so that the banks remains more focused on the capitalization standards.