Basel Accords

The Basel Accords (see alternative spellings below) refer to the banking supervision Accords (recommendations on banking regulations)Basel I, Basel II and Basel IIIissued by the Basel Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there.

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 minimum 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 is now widely viewed as outmoded. Indeed, the world has changed as financial conglomerates, financial innovation and risk management have developed. Therefore, a more comprehensive set of guidelines, known as Basel II are in the process of implementation by several countries and new updates in response to the financial crisis commonly described as BaselIII.

Background
The Committee was formed in response to the messy liquidation of a Cologne-based bank (Herstatt Bank) in 1974. On 26 June 1974, a number of banks had releasedDeutsche Mark (German Mark) to the Bank Herstatt in exchange for dollar payments deliverable in New York. On account of differences in the time zones, there was a lag in the dollar payment to the counter-party banks, and during this gap, and before the dollar payments could be effected in New York, the Bank Herstatt was liquidated by German regulators. This incident prompted the G-10 nations to form towards the end of 1974, the Basel Committee on Banking Supervision, under the auspices of the Bank of International Settlements (BIS) located in Basel, Switzerland.

Main framework
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. The creation of the credit default swap after the Exxon Valdez incident helped large banks hedge lending risk and allowed banks to lower their own risk to lessen the burden of these onerous restrictions. 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.

Overview

Why capital management is critical to banks An overview of lessons learned from the global financial crisis. Risk management failures and best practice in the identification, monitoring and management of the different risks faced by a bank Differing perspectives: shareholders, regulators, debt providers Defining and quantifying risk for capital and risk management purposes: credit, market, liquidity, operational and others; Significance of risk groups for different banking businesses Inter-relationship between key risk groups Management objectives - risk versus return Lessons learned from recent risk management failures

Perspectives on capital: regulatory, supervisory, market and management

Accounting or common capital Economic capital: internal management assessment of unexpected loss Supervisory approach: role of capital in overall regulation Development of Basel Accord: I, II, II.5 and III Lessons learned from the global financial crisis applied to regulatory capital adequacy Structure of the Basel II and III Accords Pillar I: Minimum Capital Requirement Pillar II: Supervisory Review Process Pillar III: Market Discipline Pillar 2: Supervisory review process, ICAAP, description of risk management process specific risks, including changes to Pillar 2 effective from 2010: Interest Risk in the banking book Credit Stress testing Impact of reputation risk (e.g. on liquidity) Management of securitisation exposures Pillar 3 Principles of Pillar 3 New disclosure requirements under Basel II.5 and Basel III.

Case study:
Comparing shareholders funds, regulatory and economic capital in a major international bank.

REGULATORY CAPITAL ALLOCATION

The goal of this section is to give an understanding of the main techniques used to calculate regulatory capital under Pillar I of the Basel 2/3 accords, and give an update of the latest regulatory changes.
Credit Risk
Identifying types of credit risk and those which require specific pillar I capital allocation Standardised approach Internal ratings based approaches Credit risk: key elements - probability of default and loss given default; on and off balance sheet exposures and derivatives. Qualitative aspects of IRB approach Capital treatment for specific types of exposure under Basel 2/3 Derivatives; current exposure, standardised and advanced approach. Basel 3 changes to counterparty risk measurement including Credit valuation adjustment (CVA)


Credit

Contingent exposure: Credit conversion factors for exposure at default under the Standardised/FIRB approaches. Challenge of EAD for AIRB approach. Changes to contingent liquidity obligations under Basel II.5 Securitisation: Standardised and RBA approaches. Changes to framework for resecuritisation exposures (CDOs) Risk Mitigation Framework for Basel Netting of exposures: application of ISDA agreements or other netting occurrences for regulatory capital mitigation Collateral: Simple and comprehensive approaches Securitisation as a credit risk mitigant and the development of capital arbitrage.

Case study:
Securitisation capital arbitrage.

Market risk

Standardised approach to market risk Model based approaches: VaR models Regulatory requirements; data standards, confidence intervals and holding periods, back-testing, stress testing Basel II.5 changes to market risk Stressed inputs to VaR models Rationale for capturing credit risk in the trading book Credit risk migration in the trading book Specific rule changes for correlation trading, nth to default portfolios etc. Likely capital impact of Basel II.5

Operational risk
The challenge of allocating/quantifying capital for operational risk Basic indicator and Advanced Management Approaches Minimum regulatory standards for AMA Typical quantitative and non-quantitative methods applied under AMA Comparison of operational risk capital levels across global banks.

Case study:
Risk weighted assets and regulatory capital requirements for a large international bank.

REGULATORY CAPITAL
The goal of this section is to review the definitions of bank capital under the Accord and the key characteristics which determine the classification of capital. Particular focus will be given to the changing requirements for bank capital under Basel III.

Core capital

Criteria: permanence and loss absorbing capability Types: ordinary shares, retained earnings Levels of Core capital required under Basel III: Minimum core capital, capital conservation buffer, G_SIFI requirements, counter-cyclical buffer Swiss finish, UK ICB and other expected enhancements to requirements

Deductions from core capital in Basel II and Basel III e.g. cross holdings in other institutions, deferred tax, pension deficit; excess expected loss, retained interest etc

Other Tier One capital

Types: equity reserves, non-controllable interests (minorities and preference shares) Hybrid capital: differentiating features between regular and innovative coupon, non-cumulative, non-redeemable, convertible, call and step up etc. Performance of Tier one hybrid capital during the crisis: degree of loss absorption Contingent Capital (CoCo's) role and likely regulatory treatment as other Tier 1 capital

Tier two capital

Types: cumulative preference shares, perpetual and dated subordinated debt Typical features of dated subordinated debt: fixed coupon, ten year, five year non-call maturity, step-up, default and cross default features Criteria: Basel limitations of 50% of tier one, amortisation of capital eligibility Performance of Tier two capital during the crisis - going concern versus gone concern loss absorption.

Case study:
Effect of Basel 3 on the capital ratios of a large international bank.

Leverage Ratio
Proposed Basel III leverage ratio Existing leverage ratio requirements (e.g. USA Canada, Switzerland) Impact of accounting treatment on leverage ratios Potential implications of leverage ratio on volatile balance sheet exposures, trade finance and off-balance sheet positions.

Case study:
Impact of leverage ratio on capital requirements for contingent off-balance sheet exposures.

LIQUIDITY ACCORD
General treatment of liquidity under Basel II/III Principles for sound liquidity management: stress testing, contingency planning, risk tolerance, liquidity pricing etc. Liquidity risk tolerance (Basel Principle 2) given different business models, e.g. retail and wholesale banks, multi-nationals and investment banks Strategies, policies and practices (Basel Principle 3) Liquidity costs, benefits and risks (Basel Principle 4) Early Warning signs of unacceptable liquidity risk tolerance National regulators individual approaches to liquidity management The Liquidity Coverage Ratio: Calculation guidelines and worked example applied to a large international bank Net Stable Funding Ratio: Calculation principles and disclosure example Critique of Basel liquidity ratios and market reaction.

Rating agency Moody's today said the Reserve Bank's draft guidelines for adoption of Basel-III norms, which seek to raise the minimum equity capital of banks, are more "conservative" than those proposed globally. "We interpret these draft guidelines as more conservative than the Bank for International Settlements (BIS) norms and view them as credit positive for the banking sector," Moody's Weekly Credit Outlook said. In order to strengthen risk management mechanism, RBI issued draft guideline last month. RBI has recommended a more stringent minimum common equity Tier-I capital of 5.5 per cent against BIS's 4.5 per cent, it said. Besides, it said, the central bank has proposed an earlier deadline for the implementation of a 2.5 per cent capital conservation buffer to March, 2017, as compared to BIS's deadline of January, 2019. The draft guidelines reflect the RBI's policy of ensuring Indian banks have extra stressabsorption capacity if the operating environment worsens, it said. The proposed guidelines also prompt banks that have used hybrid securities and other innovative debt capital instruments to raise their core equity capital. In line with BIS norms, it said, the proposed guidelines also focus on quality of capital, with increased emphasis on the loss-absorption capacity of capital rather than its role in supporting business growth. Under the proposed guidelines, hybrids and other forms of innovative debt capital instruments that banks currently classify as Tier-I capital will no longer qualify as it, owing to their limited loss absorption capacity, it said. In addition, it said, the proposed guidelines end the practice of making a distinction between upper Tier-II debt capital instruments and subordinated debt in favour of one set of criteria from a capital regime perspective. Last month, RBI unveiled draft guideline for adoption of Basel-III norms and set implementation period of minimum capital requirements to begin from January 1, 2013. However, it said, the capital conservation buffer requirement is proposed to be implemented between March 31, 2014 and March 31, 2017. It also said that the instruments which no longer qualify as regulatory capital instruments will be phased out during the period beginning from January 1, 2013 to March 31, 2022.

Banks to require up to Rs 2.7 lakh cr under Basel-III

ENS ECONOMIC BUREAU

Posted: Wednesday, Jan 04, 2012 at 0103 hrs IST

Tags: Banks | Reserve Bank Of India | Credit Rating | Pawan Agrawal |Business News

Mumbai: Banks would need up to Rs 2.7 lakh crore in fresh capital in order to meet the the Basel III guidelines by the deadline set by the Reserve Bank of India, says a research report by leading credit rating firm Crisil. The report notes that the implementation of the new prudential norms will massively strengthen the domestic banks as it would entail capital requirements of banks to be increased significantly, going up to 8 per cent of their loan portfolio. The banks will need to raise equity capital of Rs 1.4 lakh crore till March 2017 to meet their growth requirements, while complying with the guidelines. This requirement can turn out to be higher (by another Rs 1.3 lakh crore) in case the investor appetite is low for non-equity tier-I capital instruments, Crisil Ratings director Pawan Agrawal said in a report here on Tuesday. He further said public sector banks will account for bulk of the requirement and will need regular infusion from the government. As per the report, domestic banks are comfortably placed to migrate to the new guidelines by March 2013. Last week, RBI issued the final draft guidelines for a staggered implementation of the Basel III regulations beginning March 2013, through March 2017. According to the proposed guidelines, the capital adequacy ratio will increase 2.5 per cent to 11.5 per cent by March 2017. Also, for the first time, banks have to maintain a leverage ratio, which will determine the extent of leverage of a bank.

The RBI norms are stricter than those proposed by the BCBS (Basel Committee on Banking Supervision), with respect to stipulated capital and leverage ratios being higher by one percent and 2 per cent, respectively, and the implementation period being shorter by two years, the report notes. India Inc interest-paying ability at five-year low Repeated interest rate hikes by the Reserve Bank of India and lower operating profits due to high input cost have pulled down India Incs interest paying ability to a five-year low. Even though the Reserve Bank of India has now hinted at a pause to its rate hike cycle, rating firm Crisil expects the interest coverage ratio to remain under pressure on the back of a dip in overall growth expectations. In the September quarter, interest costs for companies grew 36 per cent, bringing down the interest coverage ratio to 4.8 times versus the 7.8 times in the year ago period and a five-year average of 8.4 times, a study conducted by the agencys research arm revealed. At the lower end of the spectrum, companies with an interest coverage ratio below two times rose sharply to 117 in the July-September period from 69 in the same period last fiscal, it said. While interest coverage is still healthy at 4.8 times, the magnitude of drop over the past few quarters is high, Crisils chief executive and managing director Roopa Kudva said.

The government is expected to finalise a fund infusion into state-owned banks to boost their capital and its shareholding this month. Final shape is being given to capital infusion proposals of the public sector banks. The decision is expected during the month, official sources said. The capital infusion through preferential placement of equity, the quickest mode of raising equity. The government has already announced that it is committed to providing adequate capital to public sector banks so as to maintain their Tier-I capital at 8 per cent.