Basel II is a set of international banking regulations put forth by the Basel Committee on Bank Supervision, which leveled the international regulation field with uniform rules and guidelines.
Basel II provides guidelines for the calculation of minimum regulatory capital ratios and confirms the definition of regulatory capital and an 8% minimum coefficient for regulatory capital over risk-weighted assets. Basel II divides the eligible regulatory capital of a bank into three tiers.
The
higher the tier, the less subordinated securities a bank is allowed to include
in it. Each tier must be of a certain minimum percentage of the total
regulatory capital and is used as a numerator in the calculation of regulatory
capital ratios.
The
major guidelines regarding capital management are as pointed out below:
1. Tier-1
Core Capital:
a)
Paid up capital
b)
Non-repayable share premium account
c)
Statutory reserve
d)
General reserve
e)
Retained earnings
f)
Minority interest in subsidiaries
g)
Non-cumulative irredeemable preference shares
h) Dividend equalization account
2.
Tier-2 Supplementary Capital:
a)
General provision
b)
Revaluation reserves - Fixed assets
c)
All other preference shares
d) Subordinated debt
3.
Tier-3 Additional Supplementary
Short-term subordinated debt that an original maturity of 2 to 5 years.
4.
Foreign banks operating:
a)
Tier-1 consists - Funds from head office - Remittable profit retained - Other
items approved by BB
b) Tier-2 consists- General provision borrowing from head office in foreign currency Revaluation of securities - Other items approved by BB.
5. Conditions of maintaining capital:
a)
Tier-2 will be limited to 100% of amount of Tier-1
b)
50% of revaluation reserves for fixed assets & securities eligible for
Tier-2
c)
10% of revaluation reserves for equity instruments eligible for Tier-2
d)
Subordinated debt should limited up to 30% of the amount of Tier-1
e) Limitation of Tier 3: 28.5% market risk needs to support by Tier-1. Market Risk support from Tier-3 should up to 250% of Tier-1
The Basel III accord is a set of financial reforms that was developed by the Basel Committee on Banking Supervision (BCBS), with the aim of strengthening regulation, supervision, and risk management within the banking industry.
Key
Principles of Basel III
1. Minimum Capital Requirements: The Basel III accord raised the
minimum capital requirements for banks from 2% in Basel II to 4.5% of common
equity, as a percentage of the bank's risk-weighted assets. There is also an
additional 2.5% buffer capital requirement that brings the total minimum
requirement to 7%. Banks can use the buffer when faced with financial stress,
but doing so can lead to even more financial constraints when paying dividends.
As of 2015, the Tier 1 capital requirement increased from 4% in Basel II to 6% in Basel III. The 6% includes 4.5% of Common Equity Tier 1 and an extra 1.5% of additional Tier 1 capital. The requirements were to be implemented starting in 2013, but the implementation date has been postponed several times, and banks now have until January 1, 2022, to implement the changes.
2. Leverage Ratio: Basel III introduced a non-risk-based leverage
ratio to serve as a backstop to the risk-based capital requirements. Banks are
required to hold a leverage ratio over 3%. The non-risk-based leverage ratio is
calculated by dividing Tier 1 capital by the average total consolidated assets
of a bank.
To conform to the
requirement, Central Bank fixed the leverage ratio at 5% for insured bank
holding companies, and at 6% for Systematically Important Financial
Institutions (SIFI).
3. Liquidity Requirements: Basel III introduced the usage of two liquidity
ratios the Liquidity Coverage Ratio and the Net Stable Funding Ratio. The
Liquidity Coverage Ratio requires banks to hold sufficient highly liquid assets
that can withstand a 30-day stressed funding scenario as specified by the
supervisors. The Liquidity Coverage Ratio mandate was introduced in 2015 at
only 60% of its stated requirements and is expected to increase by 10% each
year till 2019 when it takes full effect.
On the other hand, the
Net Stable Funding Ratio (NSFR) requires banks to maintain stable funding above
the required amount of stable funding for a period of one year of extended
stress. The NSFR was designed to address liquidity mismatches and will start
becoming operational in 2018.