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The Bank for International Settlements (BIS):

Features:

It is an international organization of central banks which promotes international monetary


and financial cooperation and serves as a bank for central banks.
It coordinates regulations pertaining to financial services.
It promotes international financial stability.
It is not accountable to any national government.
It provides banking services only to central banks helping with management of foreign
currency reserves of the central banks. It also provides emergency financial assistance to
the central banks.
It is based in Basel, Switzerland, and was established under Hague agreements of 1930.
The BIS has 57 members.

Role / Objectives:

Central banks set monetary goals and intervene through the use of their financial resources in the
form of reserves and regulatory powers to achieve the monetary targets they set. The objectives
of the BIS is to make monetary policy more predictable and transparent among its member
central banks. While monetary is determined by each country individually, it is subject to
scrutiny of international institutions, speculators and analysts and their reactions have an impact
on the foreign exchange rates of the currency which is an important aspect of any monetary
policy. Two aspects of monetary policy which directly reflect the health and stability of the
financial system have been targeted by the BIS: to regulate capital adequacy of banks and make
reserves requirements transparent. The overall objective is to strengthen the International
Financial Architecture with specific focus on International Banking Supervision.

The primary objective of the BIS is to set capital adequacy requirements because from an
international point of view, speculative lending based on inadequate underlying capital and
inconsistent risk assessment strategies result in economic crises.
To make banking operations safer for customers and reduce risk of technical insolvency, banks
are required to set aside a proportion of their deposits as reserve. Reserve policy is more
difficult to standardize because it depends on domestic conditions prevailing in each nation.

Towards achieving these goals the BIS provides a common platform for dialogue on supervisory
issues to the concerned Central Banks, a research and statistical database to the participants and
conducts seminars / workshops on the subject of financial stability.

History:

The BIS was formed in 1930. The bank was originally intended to facilitate money transfers
arising from settling obligations under the Versailles treaty. Post World War II there were
allegations that the BIS had acted inappropriately during World War II. As a result, at the
Bretton Woods Conference in July, 1944, there was demand for liquidation of the BIS. However,
this was never undertaken. The decision to liquidate the BIS was officially reversed in 1948.

The BIS was originally owned by both governments and private individuals, but in recent years
the BIS has bought back all shares held by private investors, and is now wholly owned by tis
member central banks.

Since 2004, the BIS submits its accounts in terms of Special Drawing Rights (SDRs). As of
march 31, 2007, the bank had total assets of USD 409.15 billion (SDR / USD 1.5100) which is
included 150 tons of fine gold.

Banking Supervision:

Banking can be described as an activity involving accepting of deposits and giving loans on
interest. The interest rate differential between the two activities provides the buffer to adjust loan
defaults, if any. However the activities of a bank in totality include investments, trading in
commodities, foreign currencies, etc. Al such operations are subject to risks in terms of rate
changes. Operational deficiencies may also result in losses. Thus banks are exposed to credit risk
represented by possibility of loan default, market risk represented by change in asset prices and
operational risk represented by shortcomings in functional efficiency.
If the earnings and the realizable value of assets are inadequate to meet the obligations of a bank,
then there has to be a cushion to absorb the losses. This cushion is in the form of capital. Capital
adequacy therefore means sufficiency of capital to meet possible losses.

The contribution of the BIS in the area of Risk Management is provided by the committee on
Banking Supervision which undertakes its activities through four sub-committees, each of which
covers specific areas of Risk Management. They are:

The Standards Implementation Group (SIG) was originally established to share information and
promote consistency in implementation of the risk management norms. Currently the SIG has
two subgroups that share information and discuss specific issues related to implementation of
norms.

The Validation Subgroup explores issues related to the validation of systems used to generate the
ratings and parameters that serve as inputs into the internal ratings-based approaches to credit
risk.

The Operational Risk Subgroup addresses issues related mainly to banks implementation of
advanced measurement approaches for operational risk.

The Policy Development Group (PDG) helps to identify and review supervisory issues to
promote a sound banking system.

The Accounting Task Force (ATF)helps to ensure international accounting and auditing
standards and practices promote sound risk management at financial institutions, support market
discipline through transparency, and reinforce the safety and soundness of the banking system.
To fulfill this objective the task force develops prudential reporting systems and takes an active
interest in the development of international accounting and auditing standards.

The Basel Consultative Group (BCG)provides a common forum for supervisor and regulators for
incorporating new ideas and amendments to the existing regulations. It also initiates dialogue
with prospective members for further globalizing the standardizing process.
Recent Developments:

The BIS provides the Basel Committee on Banking Supervision which has played a central role
in establishing the Basel Capital Accords of 1988 and 2004.

The Basel Committee on Banking Supervision provides a forum for international cooperation on
banking supervisory matters. Its objective is to enhance understanding of important supervisory
issues and improve the quality of banking supervision worldwide. This is achieved by
exchanging information on national supervisory issues, approaches and techniques, with a view
to promoting common understanding. The Committee uses this common understanding to
develop guidelines and supervisory standards in areas where they are considered desirable. In
this regard, the Committee is known for its international standards on Capital Adequacy;
Effective Banking Supervision; and the Agreement on cross-border banking supervision.

Basel I:

This accord represents the set of international banking regulations put forth by the Basel
Committee on Bank Supervision, in 1988, which set out the minimum capital
requirements of financial institutions with the goal of minimizing credit risk.
Banks operating internationally were required to maintain a minimum amount (8%) of
capital based on a percentage of risk- weighted assets.
It focused mainly on credit risk by creating an asset classification system. This
classification system grouped a banks assets into five risk categories for which specific
risk weights were assigned.
Each bank was required to maintain capital (Tier 1 and Tier 2) equal to at least 8% of its
risk-weighted assets. For example, if a bank has risk-weighted assets of INR 1000
million, it was required to maintain capital of at least INR 80 million.

Basel II:

This accord represents an integration of Basel I capital standards with national regulations, by
setting the minimum capital requirements for financial institutions globally with the objective of
ensuring institutional liquidity / solvency.
The Basel II Framework demands more comprehensive measures and minimum standards for
capital adequacy and national supervisory authorities are currently in the process of
implementing the same in their respective jurisdictions.

The new guidelines provide a closer alignment between regulatory capital requirements and the
assessment of the underlying risk faced by banks. The process requires identification and
quantification of risk on an on-going basis so as to improve the ability to manage those risks.

This accord became effective from June 2004. On 4 July 2006, the Committee issued a
comprehensive version of Basel II Framework. Additional proposals were approved in the
meeting held on 8-9 December 2009. The overall objective is to strengthen global capital and
liquidity regulations and promote a more resilient banking system which will facilitate better
balance between financial innovation and sustainable growth.

The Committees proposals cover the following key areas:

Raising the quality, consistency and transparency of the capital base. This will ensure that
the banking system is in a better position to absorb losses on both a going concern and a
gone concern basis.
To strengthen the capital requirements for counterparty credit risk exposures arising from
derivatives, repos and securities financing activities.
To promote further convergence in the measurement, management and supervision of
operational risk.
Introducing a leverage ratio as a supplementary measure to help contain the build-up of
excessive leverage in the banking system.
Introducing a series of measures to promote the build-up of capital buffers in good times
that can be drawn upon in periods of stress. It will provide a more stable banking system,
which will help reduce, rather than amplify, economic and financial shocks.
Introducing a global minimum liquidity standard for internationally active banks and a
common monitoring mechanism for identifying and analyzing liquidity risk trends at both
the bank and system level.
The objective of Basel II accord is to establish risk and capital management processes designed
to ensure that a bank holds capital reserves appropriate to the risk the bank is exposed to in terms
of their lending and investment practices. Effectively, these rules ensure that the amount of
capital the bank needs to hold is proportional to its risk exposure so as to safeguard its solvency
and overall economic stability.

Basel II adopts a three pillar approach to risk management.

Pillar 1deals with holding minimum capital requirements as stipulated for credit risk, market risk
and operational risk. It stipulates the following for assigning capital to meet credit risk:

1. Standardized approach use of external credit rating standards


2. Internal Rating Based (IRB) Approach use of internal risk assessment systems
3. Advanced IRB Approach use of advanced estimation techniques

Pillar 2 deals with the supervisory review process to be followed by the central bank. It deals
with review of risk management procedures with respect to banking risks:

1. Credit risk (stress testing, defining default and credit concentration risk)
2. Market risk (interest rate risk, asset rate risk)
3. Operational risk (treatment of securitization, derivatives, process efficiencies, etc.)
4. All the other risks a bank may face, such as systemic risk, concentration risk, strategic
risk, liquidity risk and legal risk, etc. which are collectively described as residual risk.

Capital adequacy alone may not be sufficient to prevent bank failures. Therefore the underlying
objective is to ensure that deficiencies are identified and effective action is taken to reduce risk
or restore capital, on a continuous basis. The important principles involved in Pillar II:

Principle 1: Banks should develop a process for assessing the overall capital adequacy.

Principle 2: Supervisors (Central Banks) should review and evaluate the internal capital
adequacy assessment systems developed by individual banks.

Principle 3: Supervisors should encourage banks to operate above the minimum regulatory
capital adequacy ratios.
Principle 4: Supervisors should intervene to prevent capital from falling below the minimum
levels required to support the assessed risk.

Pillar 3deals with the need for market discipline and disclosures required there under. Disclosure
requirement are stipulated for the banks which risk market participants to assess the information
on capital, risk exposures, risk assessment processes and capital adequacy of the banks. Such
disclosures are more important in the case of the banks, which rely on internal methodologies for
assessing capital requirements.

Implementation of Basel II in India by RBI:

The introduction of the LPG model in India has dramatically increased the volume,
sophistication and complexities of transaction being handled by the banking system in India.
This has increased the need for stronger balance sheets providing the capacity to take on the
higher risks associated with complex international transactions. The Reserve Bank of India has
implemented the risk-based supervision guidelines provided under Basel II Pillar 2 on 31stMarch
2009. Procedures are being developed for internal credit risk assessment and operational risks.
Internal inspections of banks in India are also turned more towards risk-based audit.

As a member of the world trade organization (WTO), India is required to ensure that its banking
system is at par with global standards in terms of financial health, safety and transparency, by
implementing the Basel II Norms. This assumes greater importance due to Indias dependence on
foreign capital flows for sustained economic progress.

In terms of the Basel II Norms, banks should maintain a minimum capital adequacy requirement
of 8% of risk assets. For Indian banks, the Reserve Bank of India has mandated maintaining of
9% minimum capital adequacy requirement. This is described as Capital Adequacy Ratio (CAR)
or Capital to Risk Weighted Assets Ratio (CRAR).

Comparison between Basel I and Basel II Norms:

No BASEL I NORMS BASEL II NORMS

01. Introduced in 1988. Introduced in 2004.


These norms covered assessment of
These norms covered assessment of
02. credit, market, operational and residual
only credit risk.
risks.
They involved a wider approach
They involved one size fits all
providing for standardized external
03. approach with fixed risk weights for
rating methods as well as internally
five asset classes.
developed risk assessment processes.
A more flexible approach with focus on
A more rigid approach with focus only
04. liquidity and solvency on an on-going
on provisioning for risk.
basis.
These norms did not cover financial These norms have a more
05. innovations such as securitization, comprehensive approach and provide for
derivatives, etc. a changing environment.
Provision for a leverage ratio to avoid
06. No protection against over-trading.
excess leveraging.
Stringent disclosure norms to ensure
07. Disclosure norms less comprehensive.
greater discipline.

Limitation of Basel II

1. Dependence on credit rating agencies.


2. Inadequate and insufficient disclosure
3. Operational risk is not quantified.

Basel III

Basel III is a set of international banking regulations, developed by the bank for international
settlements, with a view to promote stability in the international finance system. The objective of
Basel III is to reduce the possibility of banks destabilizing the economy by taking on excess risk.

Basel III proposes new capital, leverage and liquidity standards to strengthen the regulation,
supervision and risk management elements of the banking sector. The capital adequacy standard
and new capital buffers will require banks to hold more capital and higher quality of capital as
compared to the current Basel II rules. The new liquidity ratios ensure that adequate funds are
available in case of crisis.

Banks must hold more capital against their assets. The minimum amount of equity, as a
percentage of assets, will increase from 2% to 4.5%. An additional 2.5% buffer has to be
maintained which the total equity requirement is 7%. This buffer can be used during times of
financial stress but such banks will be prevented from paying dividend and otherwise deploying
capital. Banks are required to fulfill these requirements by 2019.

Greater stability will enable banks to raise debt at a lower cost as they will be perceived as less
risky. Invested will assign a higher P/E multiple to shares of such banks which will reduce cost
of raising capital through public issues.

Basel III Objectives:

Banks-levels or micro prudential regulation which will help to increase the ability of
individual banking institution to manage stress.
System level, macro prudential regulations, which will govern the approach of the
regulation and the entire banking sector towards risk management.

The framework of Basel III was accept in September 2009 and concrete proposals were
finalize in December 2009. These proposals have been endorsed by the G20 leaders.

Basel III Approach:

The new norms are Basel on renewed focus of central bankers on macro-prudential stability. The
global financial meltdown following the crises in the US sub-prime market has prompted this
change in approach. The previous guidelines, knows as Basel II norms, focused on macro-
prudential regulation. Global regulation are now focusing on financial stability of the system as a
whole including micro regulation of individual banks.
Impact on Indian Banks:

The RBI does not expect the Indian banking system to face any difficulty in meeting the
proposed new capital rules, both in term of the overall capital requirement and quality of capital
because as of 30 June 2010.the the Indian banking sector had already achieved the required
capital adequacy levels.

Advantages

A. Lower economic cost:


Banks are highly leveraged institution and function as the center of the credit
intermediation process. A destabilized banking system affects the availability of credit
and liquidity to the economy and leads to loss in economic output.
B. Reduced frequency of crisis:
The costs of banking crisis are extremely high and so is their frequency. Since 1985,
there have been than 30 major banking crises in Basel committee-member countries. The
common elements in all these cases have been:
Excess liquidity chasing high returns
Inadequate credit assessment
Inadequate understanding risk assessment
Inadequate risk evaluation, and
Excess leveraging of capital resources
C. Sustainable long term growth:
The objective of Basel III reform is to reduce the probability and intensity of future
crisis. This involves costs arising from higher regulatory capital and liquidity
requirements and more intensive supervision. Increasing the stability of the banking and
financial system involve a trade-off, in which these costs are more than offset by the
long-term gain in the form of sustainable growth.

Disadvantages

Banks would be required to put in place automated reporting systems to meet the
reporting requirements.
Banks will be required to consolidate and maintain a centralized risk data warehouse.
Customized risk measurement and liquidity requirement ratios for different variables will
have to be developed.

Conclusion

This regulation will result in a safer financial system, with slightly lower economic growth. They
should result in safer and stable markets for both debt stock market investors.

BASEL II BASEL III


PILLAR I Minimum Capital requirements. Enhanced Capital and Liquidity
requirements.
PILLAR II Supervisory Review Process. Enhanced supervisory review process.
Micro-level Risk Management and
Capital Planning norms.
PILLAR Disclosures and market discipline. Enhanced risk disclosures and market
III discipline.
Background

The European Central Bank (ECB) is the central bank for the euro and administers monetary
policy of the Eurozone, which consists of 18 EU member states and is one of the largest currency
areas in the world. It is one of the world's most important central banks and is one of the seven
institutions of the European Union (EU) listed in the Treaty on European Union (TEU). The
capital stock of the bank is owned by the central banks of all 28 EU member states. The Treaty
of Amsterdam established the bank in 1998, and it is headquartered in Frankfurt, Germany. As of
2011 the President of the ECB is Mario Draghi, former governor of the Bank of Italy. The bank
occupied the Eurotower while new headquarters were being built. The owners and shareholders
of the European Central Bank are the central banks of the 28 member states of the EU.

The primary objective of the European Central Bank, as mandated in Article 2 of the Statute of
the ECB, is to maintain price stability within the Eurozone. The basic tasks, as defined in Article
3 of the Statute, are to define and implement the monetary policy for the Eurozone, to conduct
foreign exchange operations, to take care of the foreign reserves of the European System of
Central Banks and operation of the financial market infrastructure under the TARGET2
payments system and the technical platform (currently being developed) for settlement of
securities in Europe (TARGET2 Securities). The ECB has, under Article 16 of its Statute, the
exclusive right to authorise the issuance of euro banknotes. Member states can issue euro coins,
but the amount must be authorised by the ECB beforehand (upon the introduction of the euro, the
ECB also had exclusive right to issue coins).

ROLE OF ECB

The ECB has the mandate to administer the monetary policy of the 17 EU member countries who
have adopted the common currency EURO. These nations are collectively called EUROZONE.
Objective

Euro banknotes

The primary objective of the European Central Bank, as laid down in Article 127(1) of the
Treaty on the Functioning of the European Union, is to maintain price stability within the
Eurozone. The Governing Council in October 1998 defined price stability as inflation of around
2%, a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro
area of below 2% and added that price stability was to be maintained over the medium term.
(Harmonised Index of Consumer Prices) Unlike for example the United States Federal Reserve
Bank, the ECB has only one primary objective but this objective has never been defined in
statutory law, and the HICP target can be termed ad-hoc.

The Governing Council confirmed this definition in May 2003 following a thorough evaluation
of the ECB's monetary policy strategy. On that occasion, the Governing Council clarified that in
the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the
medium term. All lending to credit institutions must be collateralised as required by Article 18
of the Statute of the ESCB. The Governing Council clarification has little force in law.

Without prejudice to the objective of price stability, the Treaty also states that "the ESCB shall
support the general economic policies in the Union with a view to contributing to the
achievement of the objectives of the Union".

Organization

The ECB has three decision-making bodies, that take all the decisions with the objective of
fulfilling the ECB's mandate:

the Executive Board,


the Governing Council, and
the General Council.