Increasing complexity of the financial system and the risk of various financial products were a matter of concern for central bankers for a long time. It is the central banks who have the responsibility to regulate and supervise banks to ensure their stability. Efficient supervision and regulation need in-depth understanding of the risk profile of each financial product offered by banks.
But since 2000, central banks came to know that modern financial products like derivatives contain unmeasurable level of risks. Similarly, banks have risk taking mentality which is dangerous for their stability. Higher level of globalization, integration and advanced financial products – all necessitate an equal upgradation of regulatory norms.
In the context of these developments, central bankers have made collaborative arrangements to develop and establish superior regulatory norms over risk thirsty banks. The major one among them is the Basel Committee on Banking Supervision (BCBS). The Secretariat of BCBS is provided by the Bank for International Settlements (BIS) and it supports the work of the Committee.
What is BCBS?
The Basel Committee on Banking Supervision (BCBS) is the primary global standard-setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mission is to strengthen the regulation, supervision and practices of banks worldwide with the objective of enhancing financial stability (BIS).
The objective of BCBS is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee sets minimum standards for the regulation and supervision of banks and other modes to realize its objectives.
The Committee is comprised of 28 jurisdictions including the European Union. India is also a member of BCBS. Countries are represented on the Committee by their central banks. The Committee's decisions have no legal force; rather it sets regulatory standards for members to follow.
The BCBS has its origin in the financial market turmoil that followed the breakdown of the Bretton Woods system in 1973. After the appearance of too much complexity in financial markets across the world since early 2000 and especially after the financial crisis of 2007, the Basel norms are now becoming the basic standard for supervising banks by central banks.
What is Basel Capital standards?
Basle capital standards or Basel norms are the most important effort of the BCBS to regulate the banking system of individual countries. These norms have been upgraded from Basel I, to Basle II and to Basel III. The central philosophy of Basel norm is that additional capital injected into banks by its shareholders will compel it to take less risks and at the same time to overcome any crisis on its own. The logic behind this thinking is that when your business (banking) is at risk, your money (capital) will be at risk.
Hence, Basel capital standards requires banks to keep additional capital to face different risks – liquidity risks, market risk, credit risks, cyclical risks etc.
Basel III norms are comprehensive set of reform measures, developed by the BCBS to strengthen the regulation, supervision and risk management of the banking sector. It is an improvement over the previous norm -Basel II. An important feature of Basel III is that it aims to increase the capital requirement to make financial institutions healthy. Similarly, it introduces robust liquidity ratios and leverage ratios to make financial institution safer. Basel III recommends liquidity ratio which is an improvement over the previous Basel II.