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Semester 3
Banking Operations and Products III
Session 10
Basel Norms
Recapitulate
the
Last session
Key learning points
Concepts
Definitions
Session Objectives:
At the end of this session, you will be able to
Bank
for
International Settlements
(BSI)
Introduction of BIS
Established on 17 May 1930
Based in Basel, Switzerland, with representative offices in Hong
Kong and Mexico City.
BIS is an international organization of central banks
Mission is to fosters international monetary and financial
cooperation and serves as a bank for central banks".
Oldest international financial organization
60 Central banks are the member BIS
GFMP Semester 3 Banking Operations and Products III
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Basel I
Set up an international 'minimum' amount of capital that banks
should hold.
Minimum amount of capitalminimum risk-based capital
adequacy
The set of agreement- mainly focuses on
risks to banks
the financial system
To ensure that financial institutions
have enough capital on account to meet obligations
absorb unexpected losses.
Focused on credit risk.
Supervision should be adequate.
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The Accord
Divided into 4 pillars:
1. The Constituents of Capital
2. Risk Weighting
3. A Target Standard Ratio
4. Transitional and Implementing Agreements
Pitfalls of Base I
Limited differentiation of credit risk
Static measure of default risk
No recognition of term-structure of credit risk
Simplified calculation of potential future counterparty risk
Lack of recognition of portfolio diversification effects
Falsification of balance sheets
GFMP Semester 3 Banking Operations and Products III
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Basel II - Structure
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Risks
Trading Book
Market Risk
Banking Book
Operational
Other Risks
Other
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Coverage in Pillar 2:
Risks that are not fully covered by Pillar 1
Credit concentration risk
Counterparty credit risk
Risks that are not covered by Pillar 1
Interest rate risk in the banking book
Liquidity risk
Business risk
Stress testing
GFMP Semester 3 Banking Operations and Products III
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Risk information
Capital structure
Risk measurement and management practices
Capital adequacy
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Capital:
Under the Basel Accord, a bank's capital consists of tier 1
capital and tier 2 capital.
Tier 1 capital is a bank's core capital, whereas tier 2 capital is
a bank's supplementary capital.
A bank's total capital is calculated by adding its tier 1 and tier
2 capital together.
Regulators use the capital ratio to determine and rank a
bank's capital adequacy.
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Tier I Capital:
Tier 1 capital consists of
shareholders' equity and
retained earnings.
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Tier II Capital:
Tier 2 Capital
includes revaluation reserves,
hybrid capital instruments and
subordinated term debt,
general loan-loss reserves, and
undisclosed reserves.
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150,00,000
10 %
80,00,000
20 %
60,00,000
10 %
The bank's Tier 1 Capital and Tier 2 Capital are 200,000 and
300,000 respectively.
Bank's Total capital = 200,000 + 300,000 = 500,000
Risk-weighted exposures = 1.50% + 1510% + 820% +
610% = 3.7 million
Capital Adequacy Ratio = 0.5 million /3.7 million = 14 %
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Why Basel-III?
Because of the global financial crisis which begin 2008
because of:
Too much leverage
Inadequate liquidity buffers (liquidity issues)
Mispricing of credit
Liquidity risk
Excess credit growth.
Failures of Basel II being
Inability to strengthen financial stability
Insufficient capital reserve
Global financial crisis in spite of Basel I & Basel II
Liquidity issues in banking system
Inadequate comprehensive risk management approach
GFMP Semester 3 Banking Operations and Products III
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Why Basel-III?
Responding to these risk factors, the Basel Committee
did following major reforms in BASEL-III:
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Objectives Of Basel-III
To improve quality of capital
To improve liquidity of assets
To bring further transparency and market discipline under
Pillar III.
To improve the banking sector's ability to deal with financial
and economic stress
To enhancing the quantum of common equity
To improve risk management
To Improving banking sectors ability to absorb shocks (by
creating capital buffer)
To optimizing the leverage through Leverage Ratio
To reduce risk spillover to the real economy
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A. Capital reform.
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B. Liquidity Standards:
1. Short-term: Liquidity Coverage Ratio (LCR)
2. Long-term: Net Stable Funding Ratio (NSFR)
1.Short-term:LCR
The LCR is a response from Basel committee to the recent
financial crisis.
The LCR proposal requires banks to hold high quality liquid
assets in order to survive in emergent stress scenario.
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Short-term: LCR
Must be no lower than 1.
The higher the better.
High quality liquid: liquid in markets during a time of
stress and ideally be central bank eligible.
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2. Long-term: NSFR
Objectives:
To promote more medium and long-term funding activities
of banking organizations.
Ensure that the investment activities are funded by stable
liabilities.
To limit the over-reliance on wholesale short-term funding
(money market)
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Long-term: NSFR
Available stable funding (ASF) is defined as the total amount of
an institutions:
Capital.
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Profitability
Capital acquisition
Liquidity Needs
Limits on lending
Bank consolidation
Pressure on Yield on Assets
Pressure on Return on Equity
Stability in the Banking system
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Questions
Thank You