Basel Norms: Risk Management and Capital Adequacy

Study Notes

Focus on identifying, assessing, and mitigating risks associated with banking activities
Banks must identify and manage three types of risk:
- Credit risk: risk of borrower default
- Market risk: risk of losses due to changes in market conditions
- Operational risk: risk of losses due to inadequate systems, processes, or people

Banks must maintain a minimum level of capital to absorb potential losses
Two types of capital:
- Tier 1 capital: common equity and disclosed reserves
- Tier 2 capital: supplementary capital, including undisclosed reserves and revaluation reserves
Capital requirements:
- Minimum capital requirement: 8% of risk-weighted assets
- Core capital requirement: 4% of risk-weighted assets

Banks must maintain sufficient liquidity to meet short-term obligations
Liquidity ratios:
- Liquidity coverage ratio (LCR): minimum 100% of net cash outflows over 30 days
- Net stable funding ratio (NSFR): minimum 100% of required stable funding over one year

Regulatory bodies monitor and supervise banks to ensure compliance with Basel norms
Supervisory review process:
- Risk assessment: identifying and assessing risks
- Capital planning: evaluating capital adequacy
- Supervisory action: taking corrective action when necessary

Basel norms aim to promote financial stability and prevent banking crises
Key objectives:
- Strengthening bank resilience
- Improving risk management practices
- Enhancing transparency and disclosure
- Promoting a level playing field for banks internationally

Risk management involves identifying, assessing, and mitigating risks associated with banking activities
Three types of risk to be managed:
- Credit risk: arises from borrower default, affects loan portfolios
- Market risk: arises from changes in market conditions, affects trading activities
- Operational risk: arises from inadequate systems, processes, or people, affects entire banking operations

Banks must maintain a minimum level of capital to absorb potential losses
Tier 1 capital: common equity and disclosed reserves, considered highest quality capital
Tier 2 capital: supplementary capital, including undisclosed reserves and revaluation reserves, considered lower quality capital
Capital requirements:
- Minimum capital requirement: 8% of risk-weighted assets, ensures banks can absorb potential losses
- Core capital requirement: 4% of risk-weighted assets, ensures banks have sufficient high-quality capital

Banks must maintain sufficient liquidity to meet short-term obligations
Liquidity ratios:
- Liquidity coverage ratio (LCR): ensures banks have sufficient high-quality liquid assets to meet net cash outflows over 30 days
- Net stable funding ratio (NSFR): ensures banks have sufficient stable funding to meet requirements over one year
LCR and NSFR aim to ensure banks can withstand short-term liquidity shocks and maintain long-term funding stability

Regulatory bodies monitor and supervise banks to ensure compliance with Basel norms
Supervisory review process:
- Risk assessment: identifies and assesses risks, evaluates risk management practices
- Capital planning: evaluates capital adequacy, ensures banks have sufficient capital to absorb potential losses
- Supervisory action: takes corrective action when necessary, ensures banks address identified risks and capital deficiencies

Basel norms aim to promote financial stability and prevent banking crises
Key objectives:
- Strengthening bank resilience: ensuring banks can absorb potential losses
- Improving risk management practices: ensuring banks identify, assess, and mitigate risks
- Enhancing transparency and disclosure: ensuring banks provide accurate and timely information
- Promoting a level playing field: ensuring banks internationally operate under similar regulatory requirements