Q. ‘Basel III Accord’ or simply ‘Basel III’, often seen in the news, seeks to

  • develop national strategies for the conservation and sustainable use of biological diversity
  • improve banking sector’s ability to deal with financial and economic stress and improve risk management
  • reduce the greenhouse gas emissions but places a heavier burden on developed countries
  • transfer technology from developed countries to poor countries to enable them to replace the use of chlorofluorocarbons in refrigeration with harmless chemicals

Answer: (b) improve banking sector’s ability to deal with financial and economic stress and improve risk management

Basel Norms:
  • Basel norms or Basel accords are the international banking regulations issued by the Basel Committee on Banking Supervision.
  • The Basel norms is an effort to coordinate banking regulations across the globe, with the goal of strengthening the international banking system.
  • It is the set of the agreement by the Basel committee of Banking Supervision which focuses on the risks to banks and the financial system.

Basel committee on Banking Supervision

  • The Basel Committee on Banking Supervision (BCBS) is the primary global standard setter for the prudential regulation of banks and provides a forum for regular cooperation on banking supervisory matters for the central banks of different countries.
  • It was established by the Central Bank governors of the Group of Ten countries in 1974.
  • The committee expanded its membership in 2009 and then again in 2014. The BCBS now has 45 members from 28 Jurisdictions, consisting of Central Banks and authorities with responsibility of banking regulation.
  • It 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 has issued three sets of regulations which are known as Basel-I, II, and III.
Basel III Norms
  • Basel III is the regulatory norms for setting common standards for banks across different countries. The motive of Basel III norms is to enhance the regulation, supervision, and risk management in the banking industry.
  • The Basel III norms seek to improve the ability of banks to handle stress. The norms specify leverage ratios and capital requirements to regulate the working of banks.
  • Basel III norms were introduced in 2009 post the credit crisis of 2008. The first version of Basel III was published in late 2009. It gave a window period of three years to meet the Basel III requirements.
  • Basel III norms have introduced strong capital ratios by increasing the minimum Tier 1 capital from 4% to 6%, and minimum Common Equity Tier 1 capital from 4% to 4.5%.
    • Bank’s regulatory capital is divided into Tier 1 and Tier 2. Tier 1 capital is subdivided into Common Equity Tier 1 and additional Tier 1 capital. There is the highest level of subordination in security instruments of Tier 1 capital.
  • The new standards will come into effect on January 2023
  • Risk-based capital requirements (RWAs) and interest rate risk were introduced for the first time.
  • The new standards aim at increasing capital requirements, it introduces requirements on liquid asset holdings and funding stability
  • Key difference between the Basel II and Basel III: Basel III framework prescribes more of common equity, creation of capital buffer, introduction of Leverage Ratio, Introduction of Liquidity coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).
    • Leverage Ratio: The leverage ratio is calculated by dividing Tier 1 capital by the bank’s average total consolidated assets. Banks are expected to maintain a leverage ratio in excess of 3% under Basel III
    • Liquidity Coverage Ratio: The liquidity coverage ratio (LCR) denotes to highly liquid assets held by financial institutions to meet short-term obligations. The LCR is a requirement under Basel III for a bank to hold high-quality liquid assets (HQLAs) sufficient to cover 100% of its stressed net cash requirements over 30 days. The LCR is calculated as: LCR = HQLAs / Net cash outflows.
    • Net stable funding (NSF): The net stable funding is to ensure that banks maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities.