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BASEL

Basel Committee on Banking Supervision was established by the central-bank

governors of the G10 countries in 1974 which is named after the city of Basel, in Switzerland.

The Committee objective was by setting the prudential regulation of banks for minimumsupervisory standards, by improving the effectiveness of techniques for supervising

international banking business and provides a forum for cooperation by exchanging

information on banking supervisory arrangements worldwide.

Basel Committee formulates broad supervisory standards and guidelines. An important

aim of the Committee's work was to close gap in international supervisory coverage so that:

i. No foreign banking establishment would escape supervision; andii. That supervision would be adequate and consistent across member jurisdictions.

Capital Accord was the first major result in 1988. In 1997 it developed a set of "Core

Principles for Effective Banking Supervision", which provides a comprehensive blueprint for

an effective supervisory system.

Basel Accord I Basel 1 was designed to incorporate within the capital requirement for the market risks

arising from banks' exposures to foreign exchange, traded debt securities, equities,

commodities and options. Basel Capital Accord I also called the 1988 Accord.

Basel 1 framework was to address risks other than credit risk; it was a minimum capital ratioof capital to risk-weighted assets also to increase in International presence of banks.

The banks were allowed to use internal value-at-risk models as a basis for measuring theirmarket risk capital requirements, subject to strict quantitative and qualitative standards.

The Committee issued the so-called Market Risk Amendment to the Capital Accord1997.

Problems

Problem was divergence between risk weights and actual economic risks and inadequate recognitionof advanced credit risk mitigation techniques (securitization and CDS).

Two approaches like Advance Internal Rating Based (AIRB) and Advanced Measurement Approach(AMA) for credit and operational risk was very complex implemented by only large banks in U. S.

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Basel AccordIII The global economic crisis provides an opportunity for restructuring the approach to risk

& regulation in financial sector. Basel Accord III endorsed by G20 in November 2010.

The framework is the voluntary regulatory standard on bank capital adequacy, stresstestingand market liquidityrisk.

Basel III is to strengthen the regulation, supervision and risk management of the bankingsector. The new rules prescribe how to assess risks, and how much capital to set aside for

banks in keeping with their risk profile.

Two Main Objectives:1. To strengthen global capital and liquidity regulations with the goal of promoting a more resilient

banking sector2. To improve the banking sectors ability to absorb shocks arising from financial and economic

stress which in turn would reduce the risk of a spillover from financial sector to the real

economy.

Breakdown of Basel III proposals in three main parts: Capital Reforms Includes quality and quantity of capital, complete risk coverage, leverage ratio

and the introduction of capital conservation buffers along with counter-cyclical capital buffer.

Liquidity- Reform a short term (liquidity coverage ratio, LCR) and long term (Net-stable FundingRatio, NSFR).

Other elements relating to general improvements to the Stability of the financial system. Basel III was supposed to strengthen bank capital requirementsby increasing bank

liquidity and decreasing bank leverage.

The changes highlights of Basel III :1. Increase quality & quantity of capital.2. Reduced leverage through introduction of backstop leverage ratio.3. Increase short-term liquidity coverage.4. Increase stable long-term balance sheet funding.5. Strengthened risk capture, notably counterparty risk.

The Islamic Banking transactions creating the debts like Ijarah, these financial modeswere not mention in Basel Accord II.

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Difference between Basel II& Basel III

Basel accord III the common equity increase from 2% to 4.5%. The Tier 1 capital reserve is also increase from 4% to 6% to meet the liquidation problemof the banks.

The additional reserve is require to maintain by the banks which becomes the part ofBasel Accord III which was not included in Basel Accord II is Countercyclical Buffer which

is not fixed it vary from 0% to 2.5%.

The minimum total capital requirements has increased from 8% to 10.5% (including theconversation buffer)

The capital ratio (ratio of equity capital to risk-weighted assets) from 2% to 4.5%. They willhave to hold core capital equal to 7% of their risk-weighted assets.

A leverage ratio - a minimum amount of loss-absorbing capital relative to all of a bank'sassets and off-balance-sheet exposures regardless of risk weighting.

The leverage limit for banks has been set to 3%, i.e., a banks total assets (including bothon and off-balance sheet assets) should not exceed than 33 times capital.

Basel Committee develop liquidity framework for two minimum standards: Increased Short-term Liquidity Coverage. Increased Long-term Liquidity Coverage.

Additional requirements includes for augmented contingent capital and strengthenedarrangements for cross-border supervision and resolution introduced in Basel III.

The Basel Accord III framework provides the more comprehensive and effectivetreatment of risk associated with the banks then Basel accord II.