Basel2 Norms
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Transcript of Basel2 Norms
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NARASIMHAM COMMITTEE REPORT I - 1991
Reduction in the SLR and CRR Phasing out directed credit programme
Interest rate determination
Structural reorganizations of the banking sector
Establishment of the ARF tribunal
Removal of dual control
Banking autonomy
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NARASHIMA COMMITTEE 1998
Autonomy in banking
Reform in the role of RBI
Stronger banking system Non-performing assets
Capital adequacy and tightening of provisioningnorms
Entry of foreign banks
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WHAT IS BASEL I
It defines a banks capital as two types:
Core (or tier I) capital
Supplementary (or tier II) capital comprising
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LOOPHOLES OF BASELI
Basel I accord succeeded in raising total level of equitycapital in the system.
However, it also pushed unintended consequences.
Since it does not differentiate risks very well, it perverselyencouraged risk seeking. All loans given to corporateborrowers were subject to the same capital requirement,without taking into account ability of the counterparties torepay.
It ignored credit rating, credit history, risk managementand corporate governance structure of all corporateborrowers. All were treated as private corporations.
It also promoted loan securitization that led to the
unwinding in the subprime market.
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BASEL II
A set of international banking regulations put forthby the basel committee on bank supervision, whichset out the minimum capital requirements of
financial institutions with the goal of minimizingcredit risk.
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Objectives of basell II
To create an international standard that banking regulatorscan use when creating regulations about capital
International standard can help protect the internationalfinancial system from possible problems of major bank or a
series of banks collapse.Greater the risk greater the amount of capital bank needs to
hold to safeguard its solvency and overall economic stability
Basel ii attempts to accomplish this by setting up rigorousrisk and capital management requirements to ensure that a
bank holds capital reserves appropriate to the risk the bankexposes itself to through lending and investment practices
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BASEL II
Basel II stands on three pillars:
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Pillar 1 : Minimum capital requirement
Institution's total regulatory capital must be at
least 8% (ratio same as in Basel I) of its risk
weighted assets, based on measures of THREE
RISKS
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Pillar 2 : Supervisory Review
Covers Supervisory Review Process, describing principlesfor effective supervision.
Supervisors obliged to evaluate activities, corporategovernance, risk management and risk profiles of banks todetermine whether they have to change or to allocate more
capital for their risks (called Pillar 2 capital) Deals with regulatory response to the first pillar, giving
regulators much improved 'tools' over those available tothem under Basel I
Also provides framework for dealing with all the other risksa bank may face, such as Systemic risk, pension risk,
concentration risk, strategic risk, reputation risk, liquidityrisk and legal risk, which the accord combines under thetitle of residual risk
It gives banks a power to review their risk managementsystem.
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Pillar 3 : Market Discipline Covers transparency and the obligation of banks to
disclose meaningful information to allstakeholders
Clients and shareholders should have sufficient
understanding of activities of banks, and the waythey manage their risks
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Conclusion: Basel II Framework lays down a more comprehensive
measure and minimum standard for capital adequacy
Seeks to improve on existing rules by aligning regulatorycapital requirements more closely to underlying risks that
banks face. In addition, it intends to promote a more forward-looking
approach to capital supervision, that encourages banks toidentify the present and future risks, and develop orimprove their ability to manage them.
Hence intended to be more flexible and better able toevolve with advances in markets and risk management
practices. Basel II Accord attempts to fix glaring problems with theoriginal accord. It does this by more accurately definingrisk, but at the cost of considerable rule complexity