CAIIB BFM Unit 10 - BASEL (I)

Bank for International Settlements (BIS) is situated at Basel (name of the city in Switzerland). Moved by collapse of HERSTATT bank, BCBS – Basel Committee on Banking Supervision consisting of 13 members of G10 met at Basel and released guidelines on Capital Adequacy in July 1988. These guidelines were implemented in India by RBI w.e.f. 1.4.1992 on the recommendations of Narsimham Committee. The basic objective was to strengthen soundness and stability of Banking system in India in order to win confidence of investors, to create healthy environment and meet international standards.

BCBS meets 4 times in a year. Presently, there are 27 members.
BCBS does not possess any formal supervisory authority.

1996 Amendment
• Allowed banks to use Internal Risk Rating Model.
• Computation of VaR daily using 99th percentile.
• Use of back-testing
• Allowing banks to issue short term subordinate debts with lock-in clause.

Calculation of CRAR (Capital to Risk Weighted Asset Ratio)

Basel – I requires measurement of Capital Adequacy in respect of Credit risks and Market Risks only as per the following method:
Capital funds(Tier I & Tier II)/(Credit Risk Weighted Assets + Market RWAs + Operational RWAs) X 100

Minimum requirement of CRAR is as under:
As per BASEL-II recommendations 8%
As per RBI guidelines 9%
Banks undertaking Insurance business 10%
New Private Sector Banks 10%
Local Area banks 15%
For dividend declaration by the banks (during previous 2 years and current year) 9%

Tier I & Tier II Capital

Tier –I Capital
Tier –I Capital includes:
• Paid up capital, Statutory reserves, Other disclosed free reserves, Capital Reserve representing surplus out of sale proceeds of assets.
• Investment fluctuation reserve without ceiling.
• Innovative perpetual Debt instruments (Max. 15% of Tier I capital)
• Perpetual non-cumulative Preference shares
Less Intangible assets & Losses.
• Sum total of Innovative Perpetual Instruments and Preference shares as stated above should not exceed 40% of Tier I capital. Rest amount will be treated as Tier II capital.

Tier –II Capital
It includes:
• Redeemable Cumulative Preference shares, Redeemable non-cumulative Preference shares & Perpetual cumulative Preference shares,
• Revaluation reserves at a discount of 55%,
• General Provisions & Loss reserves up to 1.25 % of RWAs
• Hybrid debts (say bonds) & Subordinate debts (Long term Unsecured loans) limited to 50% of Tier –I Capital.

Tier – III Capital
Banks may at the discretion of the National Authority, employ 3rd tier of Capital consisting of short term subordinate debts for the sole purpose of meeting a proportion of capital requirements for market risks. Tier III capital will be limited to 250% of bank’s Tier –I Capital (Minimum of 28.5%) that is required to support market risks.

Tier – II capital should not be more than 50% of Total Capital.

Capital adequacy in RRBs
The committee on financial sector assessment has suggested introducing CRAR in RRBs also in a phased manner.

Two ways to improve CRAR
1. By raising more capital. Raising Tier I capital will dilute the equity stake of existing investors including Govt. Raising Tier II Capital is definitely a costly affair and it will affect our profits.

2. Reduction of risk weighted assets by implementing Risk mitigation Policy.

Risk Weights on different Assets
Cash and Bank Balance 0%
Advances against NSC/KVC/FDs/LIC 0%
Govt. guaranteed Advances 0%
Central Govt. Guarantees 0%
State Govt. Guarantees 20%
Govt. approved securities 2.5%
Balance with other scheduled banks having CRR at least 9% 20%
Other banks having CRR at least 9% 100%
Secured loan to staff 20%
Other Staff loans -not covered by retirement dues 75%
Loans upto 1.00 lac against Gold/Silver 50%
Residential Housing Loans O/S above 30 lac 75%
Residential Housing loans O/S upto 30 lac 50%
Residential property if LTV ratio is above 75% 100%
Residential Housing Loans O/S above 75 lac 125%
Mortgage based securitization of assets 77.5%
Consumer Credit / Credit Cards/Shares loan 125%
Claims secured by NBFC-non-deposit taking (other than AFCs) 100%
Venture Capital 150%
Commercial Real Estates 100%
Education Loans (Basel –II -75%) 100%
Other loans (Agriculture, Exports) 100%

Indian Banks having overseas presence and Foreign banks will be on parallel run (Basel -I) and Basel-II for 3 years commencing from 31.3.2010 up to 31.3.2013. These banks will ensure that :
Basel-II minimum capital requirement continues to be higher than 80% of Basel-I minimum capital requirement for credit Risk and Market Risk.”
Further, Tier –I CRAR should be at-least 6% up to 31.3.2010 and 8% up to 31.3.2011