Basel Norms

 Basel Norms - Basel 1, 2, 3

• These are norms, not mandates. However since all the international banks are integrated, it is advisable to follow the Basel norms.
• BIS - Bank for International Settlements. (Is the Bank of Central Banks).

Some key definitions

1. Tier 1 Capital (Core capital), is made up of
1. Paid up capital: When we start a company, our own funds we pump in are called Paid Up Capital.
2. Statutory reserves: Reserve to make you solvent + If we maintain the statutory reserve, the cost of insurance will be less).
3. Disclosed reserves: Say if profit is 50 lakhs, companies disclose a part of that profit and keep a part of it as Undisclosed Reserves. The disclosed part of it is called Disclosed Reserves.
2. Tier 2 Capital (Supplementary capital) is made up of 
1. Undisclosed reserves: The undisclosed part (above) are called Undisclosed Reserves.
2. Preference shares: Shares of Preferred Shareholders are called Preference Shares. Normal shares are of least priority.
3. Subordinate debt: e.g. MBS (Mortgage Backed Security):  

Upon liquidation of a company, order of preference (of money disbursement) will be

- Bond holder (debt), for example FD holder

- Subordinate debt

- Preferential shareholder

- Ordinary shareholder

Types of Risk

• Credit risk: 
• Giving a credit carries some risk
• Giving a loan with no mortgage - huge risk
• Giving a long to Govt of India - no risk
• Giving a housing loan - some risk
• Giving a car loan - more risk
• Market risk: 
• This risk is because of the market in which a company operates. For example, if the interest grows exponentially, what will be impact on bank operation? 
• If exchange rate grows, say USD = 90 INR, then what will be its impact on the bank operations?
• Operational risk: 
• This risk is the environment in which a bank operates. Floods, fires, hacking, frauds etc. are all externalities that banks have to deal with and impact their operations. 

Basel I

• Only credit risk was considered.
• There's no difference between the various kinds of debtors. Say a bank has not created risk profile of various debtors - vijay mallya, sahara group, indigo, infosys, etc. Each debtor carries a different kind of risk.
• In India, for individuals we have CIBIL and for companies we have CRISIL.

Basel II

• Considered all risks (Credit, Market, Operational - CMO)
• Capital Adequacy Ratio, CAR = 8%. The capital adequacy ratio (CAR) is a measure of how much capital a bank has available, reported as a percentage of a bank's risk-weighted credit exposures. 
• Capital is a measure of the financial cushion available to an institution to absorb any unexpected losses it experiences in running its business. For banks losses could be loan defaults; for insurers it could be a huge number of claims in the event of natural disasters. 
• Risk-weighted assets are the loans and other assets of a bank, weighted (that is, multiplied by a percentage factor) to reflect their respective level of risk of loss to the bank. For example, mortgages secured by residential property are generally considered. The greater the amount of higher risk assets and loans that a bank has, the higher its risk-weighted assets, and therefore, the higher the amount of capital the bank must have in order to meet APRA’s minimum capital adequacy ratios.
  
  
  
• For Tier I it is 4%
• For Tier II it is 4%

Basel III (New features have been added...)

• Widened the scope of operational risk. 
• Disclosure, that is more information is needed to be shown by the bank.
• To shareholders
• To the reserve bank
• To market
• Better capital quality (Now Tier I is 6%, compared to 4% previously).
• Counter Cyclical Buffer (CCB)
• The countercyclical capital buffer (CCyB) was one of the measures designed to improve the resilience of the global banking system following the global financial crisis (GFC). It is a bank capital buffer that can be raised or lowered by jurisdictions depending on the level of risk in the financial system.
• During BOOM, there is an oversupply of money in the market, consequently inflation will rise. Banks cut down the money supply thru various measures to bring down the inflation. 
• During RECESSION,