BASEL norms are a set of global norms, which set certain common standards for banks across the different countries of the world. BASEL III or BASEL 3 released in the month of December in the year 2010. It is the third part of the series of BASEL Accords, which deal with the banking sector’s risk management aspects. Simply put, BASEL III is the global regulatory standard on the adequacy of bank capital, in addition to stress testing and the risk of market liquidity. Its precedents, namely BASEL I and BASEL II were similar versions of BASEL III, however, they were quite less stringent. The BASEL III norms started getting implemented from March 31st, 2015 in phases. However, it would be fully implemented from March 31st, 2018 onwards.
WHAT IS BASEL III?
According to the BASEL Committee on Banking Supervision, BASEL III is a comprehensive set of reform measures, which have been developed by the committee to strengthen the regulation, supervision as well as the risk management of the banking sector across the world. This will not only help the banking sector to deal with the economic and financial stress but also eventually improve risk management as well as strengthen the transparency of the banks.
OBJECTIVES OF BASEL III:
The measures of BASEL III have the following objectives:
- Improve the ability of the banking sector to absorb the changes which arise due to the financial and economic instability of the world market.
- Improve the banking sector’s governance as well as risk management capabilities.
- To improve and strengthen the disclosures and transparency of the banks.
HOW WILL BASEL III NORMS BE HELPFUL?
The BASEL III norms can be helpful to banks around the world in the following ways:
- BASEL III will introduce a much stricter definition of capital. It will introduce a better-quality capital to banks, which will lead to the banks having a higher loss-absorbing capacity. This will not only make the banks stronger but also allow them to withstand and handle periods of stress in a much better way.
- With the BASEL III norms, banks will now be required to hold a capital conservation buffer of 2.5%. This will ensure that banks maintain a buffer cushion of capital which they can use to absorb and tackle losses during times of economic and financial stress.
- BASEL III also introduces the countercyclical buffer, with an aim to increase capital requirements and decrease the same in good and bad financial times respectively. A countercyclical buffer will slow all banking activities in good times, and will thereby increase lending when times are not good. This buffer will mostly range anywhere between 0 to 2.5 per cent and will include common equities or other reforms of capital which are fully loss-absorbing.
- BASEL III has also raised the minimum requirement for common equity from 2 per cent to 4.5 per cent of the total risk-weighted assets. This means that the overall Tier 1 capital requirement, which consists not only of common equities but other qualifying financial instruments as well, will also increase from its minimum of 4 per cent to 6 per cent now. And even though the minimum total capital requirement will most likely remain at 8 per cent, the total required capital will increase to 10.5 per cent when it is combined with the conservation buffer.
- Under BASEL III, a set framework for liquidity risk management will also be created. A new Liquidity Coverage Ratio, as well as a Net Stable Funding Ratio, were introduced in 2015 and 2018 respective. Now, as part of the macro-prudential framework, Systemically Important Financial Institutions will be created so that they have a loss-absorbing ability beyond the requirements stated in BASEL III. They will also include implementations for capital surcharges, bail-in-debt as well as contingent capital.
- BASEL III norms also include a leverage ratio which will serve as a safety net to banks. This leverage ratio is the relative amount of capital to the total number of assets which are not risk-weighted. This ratio will put a cap on leverage swelling in the banking sector across the globe.
BASEL III NORMS AND INDIAN BANKS:
As per guidelines issued by the Reserve Bank of India, Indian banks need to implement the BASEL III norms as well. In saying so, this implementation will not be challenging only for the banks, but also for the Government of India as well. Studies suggest that Indian banks will be required to raise an amount totalling to INR 6,00,000 Crores in external capital by the end of the 2020 financial year.
However, an expansion of capital to this limit will affect the returns on the equities of the banks in the country, especially those that are public sector. And since banks in India have to meet both the LCR as well as the Statutory Liquidity Ratio and Cash Reserve Ratio set by the RBI, they will have to set aside more money, thereby stressing their balance sheets.