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Basel Accord I,II and IIIBasel is a city in Switzerland which is also the headquarters of Bureau of International Settlement (BIS). BIS fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations. Currently there are 30 member nations in the committee. Basel guidelines refer to broad supervisory standards formulated by this group of central banks- called the Basel Committee on Banking Supervision (BCBS). The set of agreement by the BCBS, which mainly focuses on risks to banks and the financial system are called Basel accord. The purpose of the accord is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses. India has accepted Basel accords for the banking system. Basel I is the round of deliberations by central bankers from around the world, and in 1988, the Basel Committee on Banking Supervision (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Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992 Basel I is now widely viewed as outmoded/outdated. The world has changed as financial conglomerates, financial innovation and risk management have developed, and a more comprehensive set of guidelines, known as Basel II, are in the process of implementation by several countries. Basel III was developed in response to the financial crisis.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 released Deutsche Mark (German Mark) to the Herstatt Bank 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 counterparty banks, and during this gap, and before the dollar payments could be effected in New York, the Herstatt Bank was liquidated by German regulators.This incident prompted the G-10 nations to form the Basel Committee on Banking Supervision, towards the end of 1974, under the auspices of the Bureau of International Settlements (BIS) located in Basel, Switzerland.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 efficacy with which the principles are enforced varies, even within nations of the Group.Committee founded in 1974.By Central Bank Governors of G10.Focus Banking Supervision.Objective - Adequate supervision.Meet 4 Times in a year.Around 30 working groups/Task Force.Location at Secretariat : Basel, Switzerland.4 Sub-committeesStandard Implementation GroupPolicy Development GroupAccounting Task ForceBasel Committee Group

Basel I

In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel 1. It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks. The minimum capital requirement was fixed at 8% of risk weighted assets (RWA). RWA means assets with different risk profiles. For example, an asset backed by collateral would carry lesser risks as compared to personal loans, which have no collateral. India adopted Basel 1 guidelines in 1999.

Basel I, that is, the 1988 Basel Accord, is primarily focused on credit risk and appropriate Risk Weighting of Assets. Assets of banks were classified and grouped in five categories according to credit risk, carrying risk weights of 0% (for example cash, bullion, home country debt like Treasuries), 20% (securitisations rated AAA) 50%-100% (for example, most corporate debt), and some assets given No Rating. Banks with an international presence are required to hold capital equal to 8% of their risk-weighted assets.The Tier 1 Capital Ratio = Tier 1 Capital / All RWAThe Total Capital Ratio = (Tier 1 + Tier 2 + Tier 3 Capital) / All RWALeverage Ratio = Total Capital/Average Total Assets

What is Tier 1 Capital ?Core capital Includes (Equity, Perpetual Non-Convertible Preference Shares, Disclosed Reserves)Maximum 15% usageTier 1 Capital Ratio = Equity capital/RWA

What is Tier 2 Capital?Supplementary CapitalIncludes (Undisclosed Reserves, Revaluation Reserves, GP,Hybrid instruments, unsecured debt.)100% Usage

Objectives of Basel Accord 1 are as follows: To ensure an adequate level of capital in the international banking system.

To strengthen the competitive markets, under which banks could no longer build in adequate business volumes without adequate capital backing.

According to Basel 1, banks are required to hold capital equal to 8% of the risk-weighted assets.

Basel Accord 1Capital = 8% of Risk Weighted AssetTier 1: Shareholders Equity and Reserves and Surplus

Tier 2: Undisclosed Reserves, Hybrid Instruments and Revaluation AssetsRisk Weighted Assets=Assets classified in the baskets of 10%, 20%, 50%, 100% (on the basis of quality of assets)THE RESERVE BANK OF INDIAS GUIDELINES FOR BASELCAPITAL COMPLIANCEAccording to Section 17 of the Banking Regulation Act (1949) every bank incorporated in India is required to create a reserve fund and transfer a sum equal to but not less than 20 per cent of its disclosed profits, to the reserve fund every year. The RBI has advised banks to transfer 25 per cent and if possible, 30 per cent to the reserve fund. The First Narasimham Committee Report recommended the introduction of a capital to risk-weighted assets system for banks in India since April 1992.This system largely conformed to international standards. It wasstipulated that foreign banks operating in India should achieve a CRAR of 8 per cent by March 1993 while Indian banks with branches abroad should comply with the norm by March 1995. All other banks were to achieve a capital adequacy norm of 4 per cent by March 1993 and the 8 per cent norm by March 1996.In its mid-term review of Monetary and Credit Policy in October1998, the RBI raised the minimum regulatory CRAR requirement to 9 per cent, and banks were advised to attain this level by March 31, 2009. The RBI responded to the market risk amendment of Basel I in 1996 by initially prescribing various surrogate capital charges such as investment fluctuation reserve of 5 per cent of the banks portfolio and a 2.5 per cent risk weight on the entire portfolio for these risks between 2000 and 2002. These were later replaced with VaR-based capital charges, as required by the market risk amendments, which became effective from March 2005.India went a step ahead of Basel I in that banks in India were required to maintain capital charges for market risk on their available for sale portfolios as well as on their held for trading portfolios from March 2006 while Basel I requires market risk charges for trading portfolios only. Drawbacks of Basel Accord 1:

The measures were seen to be in conflict with sophisticated internal measures of economic capital

The bucket approach with a flat 8% charge for claims on private sector , has led the banks to move high quality assets off their balance sheet, thus reducing the average asset quality

Unable to recognize credit risk mitigation tech

BASEL Accord IIBasel II

In 2004, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord. The guidelines were based on three parameters. Banks should maintain a minimum capital adequacy requirement of 8% of risk assets, banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks that is credit and increased disclosure requirements. Banks need to mandatorily disclose their risk exposure, etc to the central bank. Basel II norms in India and overseas are yet to be fully implemented.

The RBI announced the implementation of Basel II norms in India for internationally active banks from March 2008 and for the domestic commercial banks from March 2009. Issues-In May 2004, RBI announced that banks in India should examine the options available under Basel II for revised capital adequacy framework. In February 2005, RBI issued the first draft guidelines on Basel II implementations in which an initial target date for Basel II compliance was set for March 2007 for all commercial banks, excluding Local Area Banks (LABs) and Regional Rural Banks (RRBs). This deadline was, however, postponed to March 2008 for internationally active banks and March 2009 for domestic commercial banks in RBIs mid-year policy announcement of October 30,2006.Although RBI and the commercial banks have been preparing for the revised capital adequacy framework since RBIs first notification on Basel II compliance, the complexity and intense data processing requirement of Basel II have thrown up several challenges in its implementation. Given the limited preparation of the banking system for Basel II implementation, this postponement was not surprising. The final RBI guidelines on Basel II implementation were released on April 27, 2007. According to these guidelines, banks in India would initially adopt Standardized Approach for credit risk and Basic Indicator Approach for operational risk. RBI provided the specifics of these approaches in its guidelines. After adequate skills are developed, both by banks and the RBI, certain banks would be allowed to migrate towards the more sophisticated approach Internal Ratings Based Approach (IRBA).Under the revised regime of Basel II, Indian banks were required to maintain a minimum CRAR of 9 per cent on an ongoing basis. Further, banks were encouraged to achieve a tier I CRAR of at least 6 per cent by March 2010. In order to ensure a smooth transition to Basel II, RBI advised banks to have a parallel run of adhering to the revised norms as well as compliance with the currently applicable norms.Basel II stands on three pillars:(1) Minimum regulatory capital (Pillar 1): This is a revised andcomprehensive framework for capital adequacy standards, whereCRAR is calculated by incorporating credit, market and operational risks.(2) Supervisory review (Pillar 2): This lays down the key principles for supervisory review, risk management guidance andsupervisory transparency and accountability.(3) Market discipline (Pillar 3): This pillar instils market discipline through disclosure requirements for market participants to assess key information on risk exposure, risk assessment process and banks capital adequacy.BASEL ACCORD II

PILLAR I- Minimum Capital RequirementCapital for Credit RiskStandardized approachRisk weights assigned by borrowers credit rating agencies.Internal Ratings based approach Foundation and AdvancedInternal ratings by banks are used.Capital for Operational RiskBasic Indicator ApproachFixed percentage of the average of gross income for 3 yearsStandardized ApproachRisk measured based on division of Banks business into 8 lines and respective exposureAdvanced Measurement ApproachRisk measure generated by internal operational risk measurement systemCapital for Market RiskVaR measure

Value At Risk measure is calculated on the banks current portfolio to measure the impact of the current market factors on the portfolio.Based on historical data for past 12 monthsCapital to Risk Weighted Asset RatioCRAR = (TIER 1 Capital + TIER 2 Capital) /(Credit RWA + Market RWA + Operational RWA)

*RWA- Risk Weighted Assets

As per RBI, banks in India must maintain a CRAR of 9%

Pillar 2SUPERVISORY REVIEW PROCESSIt is a regulatory response to the first pillar.

Ensures maintenance of minimum capital by banks.

Monitors and guides banks on risk management of its assets.Functions of supervisorEnsuring banks have a process to assess minimum capital requirements. Reviewing these assessments.Ensure banks maintain capital above the minimum requirement.Prevent capital from falling below the minimum levels.Pillar 3 : Market Discipline This is meant to complement the other two pillars.The banks disclosures need to be consistent with how senior management and the Board of Directors assess and manage the risks of the bank.

MD Framework

Basel III

In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008 (in US and Europe). A need was felt to further strengthen the system as banks in the developed economies were under-capitalized, over-leveraged and had a greater reliance on short-term funding. Also the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk. Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive. The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

Around 10 public sector banks (PSBs) will get a total capital infusion of Rs 12,517 crore from the government before this financial year ends. This is to enable a step-up of lending at this time of slowing economic growth, as well as meeting the capital adequacy norms. In the light of this development here is a short primer on Basel banking norms.

We are aware that originally Basel Committee was formed in 1974 by a group of central bank governors from 10 countries. Earlier guidelines were known as Basel I and Basel II accords. Later on the committee was expanded to include members from nearly 30 countries , including India. Inspite of implementation of Basel I and II guidelines, the financial world saw the worst crisis in early 2008 and whole financial markets tumbled. One of the major debacles was the fall of Lehman Brothers. One of the interesting comments on the Balance Sheet of Lehman Brothers read : Whatever was on the left-hand side (liabilities) was not right and whatever was on the right-hand side (assets) was not left. Thus, it became necessary to re-visit Basel II and plug the loopholes and make Basel norms more stringent and wider in scope. BCBS, through Basel III, put forward norms aimed at strengthening both sides of balance sheets of banks viz. enhancing the quantum of common equity; improving the quality of capital base creation of capital buffers to absorb shocks; improving liquidity of assets optimising the leverage through Leverage Ratio creating more space for banking supervision by regulators under Pillar II and (g) bringing further transparency and market discipline under Pillar III. Thus, Basel III norms were released by BCBS and individual central banks were asked to implement these in a phased manner. RBI (India's central bank) too issued draft guidelines in the initial stage and then came up with the final guidelines

Over View of the RBI Guidelines for Implementation of Basel III guidelines :The final guidelines have been issued by Reserve Bank of India for implementation of Basel 3 guidelines on 2nd May, 2012. Full detailed guidelines can be downloaded from RBI website, by clicking on the following link : Implementation of Base III Guidelines. Major features of these guidelines are :(a) These guidelines would become effective from January 1, 2013 in a phased manner. This means that as at the close of business on January 1, 2013, banks must be able to declare or disclose capital ratios computed under the amended guidelines. The Basel III capital ratios will be fully implemented as on March 31, 2018(b) The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods and higher during the later years. Banks needs to keep this in view while Capital Planning;

(c) Guidelines on operational aspects of implementation of the Countercyclical Capital Buffer. Guidance to banks on this will be issued in due course as RBI is still working on these. Moreover, some other proposals viz. Definition of Capital Disclosure Requirements, Capitalisation of Bank Exposures to Central Counterparties etc., are also engaging the attention of the Basel Committee at present. Therefore, the final proposals of the Basel Committee on these aspects will be considered for implementation, to the extent applicable, in future.(d) For the financial year ending March 31, 2013, banks will have to disclose the capital ratios computed under the existing guidelines (Basel II) on capital adequacy as well as those computed under the Basel III capital adequacy framework.(e) The guidelines require banks to maintain a Minimum Total Capital (MTC) of 9% against 8% (international) prescribed by the Basel Committee of Total Risk Weighted assets. This has been decided by Indian regulator as a matter of prudence. Thus, it requirement in this regard remained at the same level. However, banks will need to raise more money than under Basel II as several items are excluded under the new definition. (f) of the above, Common Equity Tier 1 (CET 1) capital must be at least 5.5% of RWAs;

(g) In addition to the Minimum Common Equity Tier 1 capital of 5.5% of RWAs, (international standards require these to be only at 4.5%) banks are also required to maintain a Capital Conservation Buffer (CCB) of 2.5% of RWAs in the form of Common Equity Tier 1 capital. CCB is designed to ensure that banks build up capital buffers during normal times (i.e. outside periods of stress) which can be drawn down as losses are incurred during a stressed period. In case suchbuffers have been drawn down, the banks have to rebuild them through reduced discretionary distribution of earnings. This could include reducing dividend payments, share buybacks and staff bonus.(h) Indian banks under Basel II are required to maintain Tier 1 capital of 6%, which has been raised to 7% under Basel III. Moreover, certain instruments, including some with the characteristics of debts, will not be now included for arriving at Tier 1 capital;(i) The new norms do not allow banks to use the consolidated capital of any insurance or non financial subsidiaries for calculating capital adequacy.

(j) Leverage Ratio : Under the new set of guidelines, RBI has set the leverage ratio at 4.5% (3% under Basel III). Leverage ratio has been introduced in Basel 3 to regulate banks which have huge trading book and off balance sheet derivative positions. However, In India, most of banks do not have large derivative activities so as to arrange enhanced cover for counterparty credit risk. Hence, the pressure on banks should be minimal on this count.

(k) Liquidity norms: The Liquidity Coverage Ratio (LCR) under Basel III requires banks to hold enough unencumbered liquid assets to cover expected net outflows during a 30-day stress period. In India, the burden from LCR stipulation will depend on how much of CRR and SLR can be offset against LCR. Under present guidelines, Indian banks already follow the norms set by RBI for the statutory liquidity ratio (SLR) and cash reserve ratio (CRR), which are liquidity buffers. The SLR is mainly government securities while the CRR is mainly cash. Thus, for this aspect also Indian banks are better placed over many of their overseas counterparts.(l) Countercyclical Buffer: Economic activity moves in cycles and banking system is inherently pro-cyclic. During upswings, carried away by the boom, banks end up in excessive lending and unchecked risk build-up, which carry the seeds of a disastrous downturn. The regulation to create additional capital buffers to lend further would act as a break on unbridled bank-lending. The detailed guidelines for these are likely to be issued by RBI only at a later stageOn the day of release of these guidelines, analysts felt that India may need at least $30 billion (i.e. around Rs 1.6 trillion) to $40 billion as capital over the next six years to comply with the new norms. It was also felt that this would impose a heavy financial burden on the government, as it will need to infuse capital in case it wanst to continue its hold on these PS Banks. RBI Deputy Governor, Mr Anand Sinha viewed that the implementation of Basel II may have a negative impact on India's growth story. In FY 2012-13, Government of India is expected to provide Rs 15888 crores to recapitalize the banks. as to maintain capital adequacy of 8% under old Basel II norms.