Amity Global Business School

Hearty Welcome to the Programme on

Basel Norms
Presented by
Mr. Nagaraja. K
Visiting Faculty Amity Global Business School
Ex-Faculty Member, Canara Bank Staff Training College
Ex-Senior Faculty Member, ICFAI Academy
Visiting professorMBA , M COM and MIB classes
ConsultantCorporate Training
Visiting Professor- Christ University-- Dept of Prof Studies

Basel Norms
Basel Committee focusses on strengthening the capital
adequacy given the various risks.
Capital Adequacy requirement is one of the prudential norms
Prudential Norms refer to the guidelines to be followed by
Banks and NBFCs in respect of the quality of Asset
performance.
Guidelines are in the areas of
---Asset Classification
---Income Recognition
---Provisioning requirements
---Capital Adequacy in relation to risks (perceived and real)
---Other reforms in the financial sector affecting the banks

CAPITAL ADEQUACY
What is Capital Adequacy?
Capital should be adequate to manage all the risks attendant on the business like, Credit
Risk, Market Risk, Interest Rate Risk and Specific Risks without affecting the funds
of the depositors
List of institutions which should comply with Capital Adequacy norms

Banks,
Mutual funds,
Insurance companies,
Non-banking financial companies,
Housing finance companies,
Merchant banking companies,
Primary dealers

Source: RBI Master circular dated July 1 2013

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CAPITAL ADEQUACY
Banks are required to maintain a minimum CRAR of 9 per cent
on an ongoing basis.
CRAR means CAPTIAL TO RISK WEIGHTED ASSETS RATIO.
Capital Charge for Credit Risk
Banks are required to manage the credit risks in their books on
an ongoing basis and ensure that the capital requirements for
credit risks are being maintained on a continuous basis, i.e. at
the close of each business day. The applicable risk weights for
calculation of CRAR for credit risk are furnished by way of RBI
guidelines.

Source: RBI Master circular dated July 1 2013

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CAPITAL ADEQUACY

Capital Charge for Market Risk: banks are required to maintain

capital charge for market risk on securities included in the Held
for Trading and Available for Sale categories, open gold
position, open forex position, trading positions in derivatives and
derivatives entered into for hedging trading book exposures.

Banks are required to manage the market risks in their books on

an ongoing basis and ensure that the capital requirements for
market risks are being met on a continuous basis, i.e. at the
close of each business day. Banks are also required to maintain
strict risk management systems to monitor and control intra-day
exposures to market risks.

CAPITAL ADEQUACY

Capital Charge for Interest Rate Risk: The capital charge for
interest rate related instruments and equities would apply to
current market value of these items in banks trading book. The
current market value will be determined as per extant RBI
guidelines on valuation of investments.

The minimum capital requirement is expressed in terms of two

separate capital charges i.e. Specific risk charge for each
security both for short and long positions and General market
risk charge towards interest rate risk in the portfolio where long
and short positions in different securities or instruments can be
offset.

CAPITAL ADEQUACY

In India short position is not allowed except in case of

derivatives and Central Government Securities.

The banks have to provide the capital charge for interest rate
risk in the trading book other than derivatives for both specific
risk and general risk after measuring the risk of holding or taking
positions in debt securities and other interest rate related
instruments in the trading book.

CAPITAL ADEQUACY
Specific Risk:
This refers to risk of loss caused by an adverse price movement
of a security principally due to factors related to the issuer.

The specific risk charge is designed to protect against an

adverse movement in the price of an individual security owing to
factors related to the individual issuer.

The specific risk charge is graduated for various exposures

under three heads---a) claims on Government; b) claims on
banks and c) claims on others

CAPITAL ADEQUACY
Basic Formula for calculating Capital Adequacy Ratio:
1) Minimum CRAR should be 9% on an ongoing basis. Banks
are required to operate above the minimum level.
2) Minimum Tier I CRAR of 6% (Basel III--The final
requirements for common equity and Tier 1 capital will be: a) 3.5
and 4.5% in 2013, b) 4 and 5.5% in 2014 and c) 4.5% and 6%,
respectively, beginning in 2015).
3) Tier I CRAR = (Eligible Tier I Capital Funds) / (Credit Risk
RWA + Market Risk RWA + Operations Risk RWA)
4) Total CRAR = (Eligible Total Capital funds) / (Credit Risk RWA
+ Market Risk RWA + Operations Risk RWA)
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CAPITAL ADEQUACY
Procedure for computation of CRAR
While calculating the aggregate of funded and non-funded exposure
of a borrower for the purpose of assignment of risk weight, banks
may net-off against the total outstanding exposure of the
borrower advances collateralised by cash margins or deposits;
credit balances in current or other accounts which are not
earmarked for specific purposes and free from any lien;
in respect of any assets where provisions for depreciation or for
bad debts have been made;

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CAPITAL ADEQUACY
Procedure for computation of CRAR (contd..)
While calculating the aggregate of funded and non-funded
exposure of a borrower for the purpose of assignment of risk
weight, banks may net-off against the total outstanding
exposure of the borrower claims received from DICGC/ ECGC and kept in a separate
account pending adjustment; and
subsidies received against advances in respect of Government
sponsored schemes and kept in a separate account.
After applying the conversion factor, the adjusted off Balance
Sheet value shall again be multiplied by the risk weight
attributable to the relevant counter-party as specified.

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CAPITAL ADEQUACY
Tier I Capital

A term used to refer to one of the components of regulatory

capital. It consists mainly of share capital and disclosed
reserves (minus goodwill, if any). Tier I items are deemed to be
of the highest quality because they are fully available to cover
losses. The other categories of capital defined in Basel II are
Tier II (or supplementary) capital and Tier III (or additional
supplementary) capital.

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CAPITAL ADEQUACY
Tier II Capital

Refers to one of components of regulatory capital. Also known

as supplementary capital, it consists of certain reserves and
certain types of subordinated debt. Tier II items qualify as
regulatory capital to the extent that they can be used to absorb
losses arising from a bank's activities.
Tier II's capital loss absorption capacity is lower than that of Tier
I capital.

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CAPITAL ADEQUACY

Off-Balance Sheet exposures refer to the business activities of a

bank that generally do not involve booking assets (loans) and
taking deposits. Off-balance sheet activities normally generate
fees, but produce liabilities or assets that are deferred or
contingent and thus, do not appear on the institution's balance
sheet until or unless they become actual assets or liabilities.

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CAPITAL ADEQUACY

Off Balance Sheet itemsa conversion factor would be applied

and then risk weights are assessed. Off Balance Sheet items
again could be a) Market related and b) Non-market related
exposures
Some examples of Off-Balance Sheet items are:
---a) Direct Credit substitutesBank guarantees; Standby LCs
serving as financial guarantees; acceptances etc
---b) Other LCs, Bonds, indemnities etc
---c) With recourse agreements
---d) Underwriting, Take out financing
---e) Foreign exchange open positions etc

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CAPITAL ADEQUACY
Mortgage-backed security

A bond-type security in which the collateral is provided by a pool

of mortgages. Income from the underlying mortgages is used to
meet interest and principal repayments

Hybrid debt capital instruments

In this category, fall a number of capital instruments, which
combine certain characteristics of equity and certain
characteristics of debt. Each has a particular feature, which can
be considered to affect its quality as capital. Where these
instruments have close similarities to equity, in particular when
they are able to support losses on an ongoing basis without
triggering liquidation, they may be included in Tier II capital.

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Basel Committee
Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision provides a forum for
regular cooperation on banking supervisory matters. Its objective is
to enhance understanding of key supervisory issues and improve
the quality of banking supervision worldwide.
The Basel Committee's Secretariat is located at the Bank for
International Settlements (BIS) in Basel, Switzerland. However, the
BIS and the Basel Committee remain two distinct entities.
The present Chairman of the Committee is Mr Stefan Ingves
Governor of Sveriges Riksbank. ..
The Committee's members come from Argentina, Australia,
Belgium, Brazil, Canada, China, France, Germany, Hong Kong
SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico,
the Netherlands, Russia, Saudi Arabia, Singapore, South Africa,
Spain, Sweden, Switzerland, Turkey, the United Kingdom and the
United States.
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Basel Committee I
The Cooke ratio calculation works on a risk-weighted basis. This
means the risky assets figure is not simply a total of the assets.
Instead, each asset is placed into one of five categories and the total
of assets in that category are multiplied by a specific percentage.
Category of assets is multiplied by 0%, 10%, 20
%, 50% and 100% depending on risk perception (it should be
common for the entire countrys banking system)
These simplistic risk weights are modified over the years.
McDonagh ratio, named after a successor to Cooke as Basel
Committee chairman evolved. The McDonagh ratio keeps the same
categories, but allows banks to tweak the rating on individual assets
based on the bank's own assessment of the specific borrower.
The McDonagh ratio took over as the official method for Basel Accord
purposes from the start of 2007.

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Basel Committee II
The Basel Capital Accord is an Agreement concluded among
country representatives in 1988 to develop standardised riskbased capital requirements for banks across countries.
The Accord was replaced with a new capital adequacy
framework (Basel II), published in June 2004.
Basel II is based on three mutually reinforcing pillars that allow
banks and supervisors to evaluate properly the various risks that
banks face.
These three pillars are:
----a) minimum capital requirements, which seek to refine the
present measurement;
----b)supervisory review of an institution's capital adequacy and
internal assessment process;
---c)and market discipline through effective disclosure to encourage
safe and sound banking practices
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Basel III

In September 2010, the Group of Governors and Heads of

Supervision announced higher global minimum capital
standards for commercial banks. This followed an agreement
reached in July regarding the overall design of the capital and
liquidity reform package, now referred to as Basel III.
In November 2010, the new capital and liquidity standards were
endorsed at the G20 Leaders Summit in Seoul.
The new proposed standards were set out in Basel III:
International framework for liquidity risk measurement,
standards and monitoring, issued by the Committee in midDecember 2010. A new capital framework revises and
strengthens the three pillars established by Basel II.

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Basel III

In January 2012, the Group of Central Bank Governors and

Heads of Supervision (GHOS) endorsed the comprehensive
process proposed by the Committee to monitor members
implementation of Basel III. The process consists of the
following three levels of review:
Level 1: ensuring the timely adoption of Basel III;
Level 2: ensuring regulatory consistency with Basel III; and
Level 3: ensuring consistency of outcomes (initially focusing on
risk-weighted assets).

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Basel III

The Basel Committee has worked in close collaboration with the

Financial Stability Board (FSB) given the FSBs role in
coordinating the monitoring of implementation of regulatory
reforms. The Committee designed its programme to be
consistent with the FSBs Coordination Framework for
Monitoring the Implementation of Financial Reforms (CFIM) as
agreed by the G20.

Tightened definitions of capital, significantly higher minimum

ratios and the introduction of a macro-prudential overlay
represent a fundamental overhaul for banking regulation.

However, the Basel Committee, its governing body and the G20
Leaders have emphasised that the reforms will be introduced in
a way that does not impede the recovery of the real economy.
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Basel III

Transitional arrangements for the new standards was

announced as early as Sep 2010.
Transitions take place after national legislations which may
impose higher standards and shorten transition periods.
The new, strengthened definition of capital will be phased in
over five years: the requirements were introduced in 2013 and
will be fully implemented by the end of 2017.
Capital instruments that no longer qualify as non-common
equity Tier 1 capital or Tier 2 capital will be phased out over 10
years beginning 1 January 2013.
Turning to the minimum capital requirements, the higher
minimums for common equity and Tier 1 capital are being
phased in from 2013, and will become effective at the beginning
of 2015.

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Basel III
Implementation schedule:
The minimum common equity and Tier 1 requirements
increased from 2% and 4% levels to 3.5% and 4.5%,
respectively, at the beginning of 2013.
The minimum common equity and Tier 1 requirements will be
4% and 5.5%, respectively, starting in 2014.
The final requirements for common equity and Tier 1 capital
will be 4.5% and 6%, respectively, beginning in 2015.
The 2.5% capital conservation buffer, which will comprise
common equity and is in addition to the 4.5% minimum
requirement, will be phased in progressively starting on 1
January 2016, and will become fully effective by 1 January
2019.

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Basel III

The test (the so-called parallel run period) began in 2013 and
will run until 2017, with a view to migrating to a Pillar 1
treatment on 1 January 2018 based on review and appropriate
calibration.
The liquidity coverage ratio (LCR) will be phased in from 1
January 2015 and will require banks to hold a buffer of highquality liquid assets sufficient to deal with the cash outflows
encountered in an acute short-term stress scenario as specified
by supervisors. To ensure that banks can implement the LCR
without disruption to their financing activities, the minimum LCR
requirement will begin at 60% in 2015, rising in equal annual
steps of 10 percentage points to reach 100% on 1 January
2019.
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Amity Global Business School

THANK YOU ALL

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