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Key difference between Basel II & Basel III framework

Key difference between Basel II & Basel III framework


The key difference between the Basel II and Basel III are that in comparison to Basel II framework,  the Basel III framework prescribes more of common equity, creation of capital buffer, introduction of Leverage Ratio, Introduction of Liquidity coverage Ratio(LCR) and Net Stable Funding Ratio (NSFR).

Leverage Ratio: The leverage ratio is calculated by dividing Tier 1 capital by the bank’s average total consolidated assets (sum of the exposures of all assets and non-balance sheet items). The banks are expected to maintain a leverage ratio in excess of 3% under Basel III.

Liquidity Coverage Ratio: The liquidity coverage ratio (LCR) denotes to highly liquid assets held by financial institutions to meet short-term obligations. The ratio is a generic stress test that aims to anticipate market-wide shocks. The LCR is a requirement under Basel III for a bank to hold high-quality liquid assets (HQLAs) sufficient to cover 100% of its stressed net cash requirements over 30 days. The LCR is calculated as: LCR = HQLAs / Net cash outflows.

Net stable funding (NSF):  The net stable funding is to ensure that banks maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities.

Creation of capital buffer: The creation of adequate capital buffer is a mechanism to build up additional capital during periods of excessive credit growth. The Basel Committee on Banking Supervision by promoting the creation of countercyclical buffers as set forth in the Basel III regulatory reforms to enable banks to absorb losses and continue lending in the subsequent downturn.

Counter cyclical buffer is another support system for Capital Conservation Buffer recommended by BASLE- III on the basis of weighted average of capital conservation buffer built up in earlier years

(The risk weighted asset (RWA) refer to the fund based assets such as cash, loans, investments and other assets but their value is assigned a risk weight and credit equivalent amount of all off-balance sheet activitis.The higher the credit risk of an asset, the higher its risk weight. Basel III uses credit ratings of certain assets to establish their risk coefficients).

The Basel III framework also prescribes higher ratio in respect of minimum ratio of total capital to RWAs, Minimum Ratio of common equity to RWAs ,Tier I capital to RWAs ,  Core tier 1 Capital RWAs ,Capital Conservation Buffers to RWAs,Countercyclical Buffer etc.which are as under.

a) Minimum Ratio of total capital to RWAs 8% under Basel II increased to 10.50%

b) Minimum Ratio of common equity to RWAs 2% under Basel II increased to (4.50% to 7.00%) under Basel III

c) Tier I capital to RWAs 4% under Basel IIto 6% under Basel III

d) Core tier 1 Capital RWAs 2% under Basel II to 5% under Basel III

e) Capital Conservation Buffers to RWAs none under Basel II increased to 2.50% under Basel IIIf) Leverage ratio under Basel IIfrom none to 3.00% under Basel III

g) Countercyclical Buffer from none under Basel II to (0% to 2.50%) under Basel III

The risk weighted asset (RWA) refer to the fund based assets such as cash, loans, investments and other assets but their value is assigned a risk weight and credit equivalent amount of all off-balance sheet activitis.

Furthermore, in view of Basel III norms, RBI has modified the following existing Basel II framework, which includes the modifications and enhancements announced by BCBS in July 2009. RBI made amendments to, Basel II guidelines in respect of definition of Capital, Risk Coverage, Capital Charge for Credit Risk, External Credit Assessments, Credit Risk Mitigation and Capital Charge for Market Risk. Supervisory Review and Evaluation Process under Pillar 2, is also being modified.

Salient features of Basel I accord & Basel II accord

The aim of Basel committee is to strengthen the soundness and stability of banking system globally. In July 1988 the Basel committee on banking supervision  came up with global capital adequacy rule and released the formulated guidelines on capital measures and capital standards The first guidelines issued by Basel Committee are known as 1st accord of Basel or BaseI I accord. .  RBI has accepted the Basel I accord and implemented the same with effect from 1992. In terms of Basel Accord 1, the capitals of Banks are divided into two categories. The first part is core equity capital of the bank, which is classified as Tier I capital. The second part of the capital is supplementary bank capital that includes items such as revaluation reserve. The supplementary capital of bank is called Tier II capital.

The second round of formulated guidelines on capital measures and capital standards by Basel Committee came into existence in June 2006 (The detailed guideline issued during 2007). This accord is known as Basel II accord.

Three Pillars of Basel II accord: 

First Pillar of Basel II deals with maintenance of regulatory Capital calculated on three major risks the bankers are facing viz. Credit risk, Operation risk and Market risk.

Second Pillar of Basel II deals with the regulatory answer to the first pillar, which enables the banks to review their risk management systems.

Third Pillar aspires to balance the minimum capital requirement and decision-making. The market participants are enabled to gauge the capital adequacy of a Bank with the help of set of mandatory disclosures prescribed in third pillar.

Revised deadline for implementation of Basel III

The Reserve Bank of India (RBI) RBI vides its notification no. RBI/2013-14/538
DBOD.No.BP.BC.102/21.06.201/2013-14 dated March 27, 2014, has deferred the deadline for full implementation of Basel III norms to March 2019 instead of as on March 31, 2018.  The revised deadline for full implementation of Basel III in India is closer to the internationally agreed date of January 1, 2019. Of late, industry-wide concerns have been expressed about the potential stresses on the asset quality and consequential impact on the performance / profitability of the banks. The Commercial banks in India were scrambling to raise thousands of crores of Rupees in the form of hybrid capital in FY15 to be complaint of capital requirement norms, prescribed under Basel III accord. This necessitated RBI to provide some lead time for banks to raise capital within the internationally agreed timeline for full implementation of the Basel III Capital Regulations. The extension of deadline by one year has delivered major respite to banks by removing immediate pressure on them to raise thousands of crores rupees of hybrid capital at a short period. The rescheduled transitional arrangements along with other modifications are as under.

Related articles:

  1. What is Basel Accords : First,second and third?
  2. Basel III : Capital treatment of Banks’ Balance Sheet item
  3. Credit Rating Agencies in India

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