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    Basel Norms

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    Capital Adequacy Ratio (CAR)

    Expressed as a percentage of a bank's riskweighted credit exposures.

    Also known as "Capital to Risk Weighted AssetsRatio (CRAR).

    Ratio is used to protect depositors and promotethe stability and efficiency of financial systemsaround the world.

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    WHY CAPITAL REQUIREMENT?

    While banks assets (loans & investments) are risky andprone to losses, its liability (deposits) are certain.

    Assets = External Liabilities + Capital.Liabilities (deposits) to be honoured. Hencereduction in capital. When capital is wiped out

    Bank fails.

    Bank failures - mainly by losses in assetsdefault byborrowers (Credit Risk), losses of investment in differentsecurities (Market Risk) and frauds, system and processfailures (Operational Risk)

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    ABOUT THE BIS(Bank for InternationalSettlements)

    Established on 17 May 1930

    The BIS is theworldsoldest internationalfinancial organization

    Head office is in Basel, Switzerland andrepresentative offices in Hong Kong and inMexico City.

    The BIS currently employs around 550staff from 50 countries.

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    MEMBER CENTRAL BANKS Algeria Argentina Australia Austria Belgium Bosnia and Herzegovina Brazil Bulgaria Canada Chile China Croatia The Czech Republic Denmark Estonia Finland France Germany

    Greece Hong Kong SAR Hungary Iceland India Indonesia, Ireland Israel Italy Japan Korea Latvia Lithuania The Republic of Macedonia Malaysia Mexico the Netherlands New Zealand Norway

    the Philippines Poland Portugal Romania

    Russia Saudi Arabia Singapore Slovakia Slovenia South Africa Spain Sweden

    Switzerland Thailand Turkey The United Kingdom The United States The European Central Bank

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    BASEL COMMITTEE

    Committeea group of eleven nations

    Liquidation of Cologne-based Bank Herstatt

    To achieve this goal G-10 countries agreed in Basel,Switzerland to form a quarterly committee

    Comprising of each countrys central bank and leadbank supervisory authority

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    Basel committee on BankingSupervision (BCBS) A set of agreements

    Regulations and recommendations on Creditrisk , market risk and operational risk

    Purpose to have enough capital on account tomeet obligations and absorb unexpected losses

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    4 Sub-committees

    Standard Implementation GroupPolicy Development Group

    Accounting Task Force

    Basel Committee Group

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    What is Tier 1 Capital ? Core capital

    Includes (Equity, Perpetual Non-Convertible PreferenceShares, Disclosed Reserves) Maximum 15% usage Tier 1 Capital Ratio = Equity capital/RWA

    What is Tier 2 Capital? Supplementary Capital Includes (Undisclosed Reserves, Revaluation Reserves,

    GP,Hybrid instruments, unsecured debt.)

    100% Usage

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    Basel 1 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

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    PITFALLS Limited differentiation of credit risk

    Static measure of default risk

    No recognition of term-structure of credit risk

    Simplified calculation of potential future counterpartyrisk

    Lack of recognition of portfolio diversification effects

    Falsification of balance sheets

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    SHIFT FROM BASEL I TO BASEL II

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    Basel II Norms Basel II was intended :

    to create an international standard for banking regulators

    to maintain sufficient consistency of regulations. protect the international financial system

    Addition of operational risk in the existing norms

    Defined new calculations of credit risk

    Ensuring that capital allocation is more risksensitive

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    Objectives of BASEL II

    1. Better Evaluation of Risks

    2. Better Allocation of resources

    3. Supervisors should review each banks own

    risk assessment and capital strategies.

    4. Improved Risk management

    5. To strengthen international banking systems.

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    BASEL II FRAMEWORK

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    Failure of BASEL II Banks defined their own risk metrics and derivative investments

    Depends on good underlying data

    Most of the institutional cogs in the credit crisis arent covered

    No independent standard.

    Wrong assumptions in case of mortgage-related risk calculations.

    Inadequate level of capital required by the new discipline

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    BASEL III ACCORD

    The G20 endorsed the new Basel 3 capital and liquidity

    requirements.

    Extension of Basel II with critical additions, such as a leverage ratio,a macro prudential overview and the liquidity framework.

    Basel III accord provides a substantial strengthening of capitalrequirements.

    Basel III will place greater emphasis on loss-absorbency capacity on a goingconcern basis

    The proposed changes are to be phased from 2013 to 2015

    The creation of a conservation buffer could be set up by banks during theperiod January 2016 to 2019.

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    Basel III-Objectives

    Special emphasis on the Capital Adequacy Ratio

    Capital Adequacy Ratio is calculated as CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted Assets

    Reducing risk spillover to the real economy

    Comprehensive set of reform measures tostrengthen the banking sector.

    Strengthens banks transparency and disclosures.

    Improve the banking sectors ability to absorbshocks arising from financial and economicstress.

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    Major features of Basel III

    Revised Minimum Equity & Tier 1 Capital

    Requirements Better Capital Quality Backstop Leverage Ratio Short term and long term liquidity funding

    Inclusion of Leverage Ratio & Liquidity Ratios Rigorous credit risk management Counter Cyclical Buffer Capital conservation Buffer

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    Pillars Minimum Regulatory Capital Requirement based on Risk weighted assets

    Maintaining capital ( Credit, market and Operational Risk)

    Supervisory Review Process Regulatory Tools and Frameworks to deal with risks.

    Market Discipline. Transparency of Banks

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    Ratios Leverage Ratio 3%

    Liquidity Coverage Ratio =

    Stock of high quality liquid assets 100%

    Net cash outflows over a 30-day period

    Net Stable Funding Ratio (NSFR) =Available amount of stable funding 100%

    Required amount of stable funding

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    Comparison o Capita

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    Comparison o CapitaRequirements

    under Basel II and Basel III :Requirements Under Basel II Under Basel IIIMinimum Ratio of Total

    Capital To RWAs8% 11.50%

    Minimum Ratio of Common

    Equity to RWAs

    2% 4.50% to 7.00%

    Tier I capital to RWAs 4% 6.00%

    Core Tier I capital to RWAs 2% 5.00%

    Capital Conservation Buffers

    to RWAsNone 2.50%

    Leverage Ratio None 3.00%

    Countercyclical Buffer None 0% to 2.50%

    Minimum Liquidity Coverage

    RatioNone TBD (2015)

    Minimum Net Stable Funding

    Ratio None TBD (2018)

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    Impact on Indian banking system

    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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    Impact on Public Sector Public sector banks- needs Rs.1 trillion over 10-5

    years

    Some public sector banks are likely to fall short ofthe revised core capital adequacy requirement.

    Government to recapitalize an estimated Rs 900

    billion or be ready to reduce their equity stake inbanks below 50%.

    Increase in the requirement of capital will affect theROE of the Public banks.

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    Potential responses by banks Operational responses

    RWA optimization, Stricter credit approval processes

    Tactical responses Risk-sensitive pricing, Shift to longer-term funding

    Reduction of securitization exposures

    Strategic responses

    - Sale of business unit, Change of holdingstructure

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    Challenges of Basel 327

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    CONCLUSION

    Monetary policies of Central Banks in eachcountry (example RBIs CRR, SLR, Repo etc.)

    make it difficult to uniformly implement BASEL

    norms

    Exercising controls on the capital, liquidity andleveraging of banks will ensure that they havethe ability to withstand crises.

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