The Basel Accords are the set of rules or agreements by Basel Committee on Bank Supervision (BCBS). It provides recommendations on banking regulation in regards to : 1) Capital Risk, 2) Market Risk, 3) Operational Risk. The purpose of the accords is to ensure that the financial institution has enough capital on account to meet obligations and absorb unexpected losses.
The objectives of record are:
- Strengthen international banking system
- Promote convergence of national capital standard.
- Iron-out competitive inequalities among banks across countries of the world.
The First Basel Accord or Basel I was issued in 1988. It focuses on the CAR (Capital Adequacy Ratio) of financial institutions.
CAR or Capital adequacy Ratio is the Risk weighted ratio or the risk faced by banks due to unexpected financial losses. It is divided into 5 categories: 0%, 10%, 20%, 50%, 100%. Banks that operate internationally operate with CAR at 8%.
The Second Basel Accord or Basel II: It is to be fully implemented by 2015. The Basel III focuses on 3 main areas : 1)Minimum capital required, 2)Supervisory review, 3) Market discipline. These are focus areas are also known as the “three pillars”.
The Third Basel Accord or Basel III is a set of reform measurements aimed at strengthening regulation, supervision and risk management in banking sector.
These measurements are targeted at :
- Improving bank’s ability to absorb shocks arising from financial and economic stress
- Improve risk management
- Strengthen bank’s transparency
In India, Basel III norms are to come into force by 31st March 2019.
Types of capital in bank
Bank’s capital has been classified in 3 categories. They are as follows:
Tier 1 Capital
- Tier 1 capital absorbs loss without bank being required to ease trading.
- It is the core measure of bank’s financial strength
- It is the most reliable form of bank’s capita.
Tier 2 Capital
- Absorb loss in event when bank ceases trading.
- Second most reliable form of bank’s capital
- It is the measure of bank’s financial strength from regulator’s point of view.
Tier 3 Capital
It is the Tertiary capital of bank which are used to meet or support a) market risk, b) commodities risk c) foreign currency risk.
Unpublished or hidden reserves of a financial institution. Though they are real assets but can not be used at the will of the bank. They are turned into secondary reserves.