Why in the news?
The US Federal Reserve recently announced stricter bank capital requirements known as the “Basel III endgame” proposal.
What is Bank Capital?
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What are Basel Norms?
- Basel, Switzerland, hosts the Bureau of International Settlement (BIS), fostering collaboration among central banks to establish global banking standards.
- The Basel Committee on Banking Supervision (BCBS), established in 1974 formulates broad supervisory guidelines known as the Basel framework.
- Its purpose is to ensure banks maintain adequate capital to meet obligations and absorb losses.
- India has adopted Basel standards to align its banking practices with global norms.
| Description | |
| Basel I |
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| Basel II |
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| Basel III |
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| *Basel IV
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Proposed Changes under Basel III Endgame
- Expansion of Scope: The proposal aims to extend the strictest risk-based capital approach to more banks, lowering the asset threshold from $700 billion to $100 billion. This would encompass around 37 large banks in the U.S.
- Standardized Measure for Capital Requirements: Regulators propose curtailing banks’ use of internal models to calculate capital requirements for loans, advocating for a standardized measure for all banks to ensure uniform risk assessment.
- Increased Capital for Trading and Operational Risks: The proposal mandates higher capital reserves for risks linked to trading activities and operational challenges, requiring banks to utilize standard models for risk assessment instead of internal ones.
- Changes to Capital Calculations for Portfolios: Banks with assets exceeding $100 billion must reflect gains and losses in portfolios categorized as “available for sale” in their capital calculations, aiming for a more precise depiction of a bank’s risk exposure.
Challenges created by the new Norms
- Operational Risks: A substantial portion of the proposed capital increment targets banks’ operational risks, encompassing potential losses arising from internal processes, people, systems, or external events.
- Non-Traditional Banking Activities: Entities engaged in trading, market-making, wealth management, and investment banking, will face more pronounced capital requirements due to altered risk assessment and operational risk calculations.
- Industry-specific Concerns: Additionally, specific industries, like renewable energy, anticipate repercussions, fearing that increased capital requirements could undermine the effectiveness of tax incentives for projects targeting climate change.
Arguments in Favor of Increasing Capital
- Financial Stability: Proponents argue that heightened capital requirements are imperative for safeguarding financial stability, averting bank failures, and minimizing the need for government bailouts.
- Prudent Banking Practices: They contend that current standards inadequately address bank risks and that increased capital incentivizes prudent banking practices.
- Resilient Banking System: Economists suggests that the social costs of higher capital requirements are minimal compared to the benefits of a more resilient financial system.
PYQ:2015: ‘Basel III Accord’ or simply ‘Basel III’, often seen in the news, seeks to: (a) Develop national strategies for the conservation and sustainable use of biological diversity (b) Improve banking sector’s ability to deal with financial and economic stress and improve risk management (c) Reduce the greenhouse gas emissions but places a heavier burden on developed countries (d) Transfer technology from developed countries to poor countries to enable them to replace the use of chlorofluorocarbons in refrigeration with harmless chemicals
Practice MCQ:What is the primary objective of “Basel III Endgame” in the banking sector? (a) To encourage speculative investments by banks to boost short-term profits. (b) To ensure the stability of the global financial system by strengthening the regulation, supervision, and risk management practices of banks. (c) To encourage banks to invest more in less-risky assets to stimulate economic growth. (d) To limit the role of central banks in regulating commercial banks and promote market-driven banking practices. |
