Are you willing to know the detailed information about Global Banking Regulation? Here is the article which provides you the detailed information about the Global Banking Regulation. Bank regulation is a form of government regulation which subjects banks to certain requirements, restrictions, and guidelines, designed to create market transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things.
The role of banks in global and National Economics is very important. The banking industry holds reliance on the entire economy and it is important for all the authorities to maintain control over the practices of banks. The most common objectives of banking regulations are:-
- Prudential Objectives: to reduce the level of risk to bank creditors i.e. to protect the depositors.
- Systemic risk reduction—to reduce the risk of failure of banks
- Avoid misuse of banks—to reduce the risk of banks being used for criminal purposes such as money laundering.
- To protect banking confidentiality.
- Credit allocation- to direct credit to favored sectors.
General Principles of Banking Regulation:-
It deals with the banking regulation which includes the minimum requirements, supervisory review and market discipline. Those are discussed below:-
Minimum Requirements:-
These are closely tied to the level of risk exposure for a certain sector of the bank. The most important requirements include the Capital Requirement and Reserve requirement.
Capital requirements:- It sets a framework on how banks must handle their capital in relation to their assets. The first international level capital requirements were introduced by the Basel Capital Accords in 1988. The current framework of Capital Requirements is called Basel III.
- Reserve Requirements:- These Reserve Requirements sets the minimum reserves each bank must hold to demand deposits and banknotes. Reserve requirements have also been used in the past to control the stock of banknotes. Required reserves have at times been gold coins, central bank banknotes (or) deposits and also foreign currency.
Supervisory Review:-
This includes licensing by the regulators, obtaining undertakings, giving directions, imposing penalties or revoking the bank's license.
Market Discipline:-
The Central bank requires the banks to publicly disclose financial and other information, and depositors and other creditors. The bank is thus made subject to market discipline.
Basel Committee on Banking Supervision:-
The Secretariat of Bureau of International Settlement is in which fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations, which are located in Basel, a city of Switzerland. The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities established in 1974 by the governors of the central banks of G-10. This committee provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It has 27 members including India and major economies of the world.
Basel-I:-
The Basel Committee on Banking Supervision had introduced a capital measurement system in 1988. It was called as Basel Capital accord or Basel-I. The focus of Basel-I was entirely on credit risk. It gave a structure of risk-weighted assets (RWA). RWA implies that the assets with different risk profiles are given different risk weights.
Basel-II:-
The Basel-II guidelines were published by BCBS in 2004. These guidelines refined the Basel-I norms on the base of three parameters as follows:
- Banks should maintain a minimum capital adequacy requirement of 8% of risk assets.
- Banks were needed to develop and use better risk management techniques in monitoring and managing all three types of risks.
- Mandatory disclosure of risk exposure.
Basel-III:-
The Basel-III guidelines was issued in 2010 as a response to the global financial crisis of 2008. The idea was to further strengthen the banking system. The Objective of these guidelines is to achieve a resilient banking system by focusing on four key banking parameters, such as Capital, Leverage, Funding, and Liquidity. The Ultimate aim is to:-
- Improve the Banking sectors ability to absorb shocks arising from financial and economic stress.
- Improve risk Management and governance.
- Strengthen banks transparency and Disclosures.
Capital Adequacy:-
It refers to the Stock of Financial Assets which is capable of generating income. The capital Adequacy Ration is like a thermometer of Banks health because it is the ratio of its capital to its risk. The Regulators check CAR to monitor the health of the Bank because a good CAR protects the depositors and maintains the faith and confidence in the Banking System.
Capital to Risk Assets Ratio:-
CRAR is a Standard metric to measure balance sheet strength of banks. BASEL I and BASEL II are global capital adequacy rules that prescribe a minimum amount of capital a bank has to hold given size of weighted assets. The old rules mandate banks to back to back every Rs. 100 of commercial loans with Rs. 9 of the capital irrespective of nature of these loans.
Tier-1 and Tier-2 Capital:-
The Basel accords define two tiers of the capital in the banks to provide a point of view to the regulators. The tier-I Capital is the core Capital while the Tier-II capital can be said to be the Subordinate Capitals. Tier 1 mainly includes permanent shareholders equity and disclosed reserves another surplus.
Three Pillars of Basel-III:-
Basel III has three mutually reinforcing pillars as follows:-
- Pillar 1:-Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs): Maintaining capital calculated through credit, market and operational r
- Pillar 2:-Supervisory Review Process: Regulating tools and frameworks for dealing with peripheral risks that banks face.
- Pillar 3:-Market Discipline: Increasing the disclosures that banks must provide to increase the transparency of banks
Common Equity:-
Currently, the bank’s capital comprises Tier 1 and Tier 2 capital. The restriction is that Tier 2 capital cannot be more than 100% of Tier 1 capital. Under Basel III, with an objective of improving the quality of capital, the Tier 1 capital will predominantly consist of Common Equity. Common EquityCommon Equity is the amount that all common shareholders have invested in a company. Most importantly, this includes the value of the common shares themselves.
- Although the minimum total capital requirement will remain at the current 8% level, under Basel-III, the capital adequacy requirement was raised to 10.50%.
- Basel-III norms prescribe minimum common equity of 4.5%.
Elements of Common Equity:-
The Seven Elements of Common Equity include the following:-
- Common shares (paid-up equity capital) issued by the bank which meets the criteria for classification as common shares for regulatory purposes.
- Stock surplus (share premium) resulting from the issue of common shares.
- Statutory reserves.
- Capital reserves representing surplus arising out of sale proceeds of assets.
- Other disclosed free reserves if any.
- Balance in Profit & Loss Account at the end of the previous financial year.
- Current year profits can be reckoned on a quarterly basis provided incremental NPA provision at the end of any of 4 quarters of the previous financial year have not deviated more than 25% from an average of the 4 quarters.
The Capital Conservation Buffer:-
The banks will require to hold a capital conservation buffer of 2.5%. The aim of asking to build conservation buffer is to ensure that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and Economic Stress.
Countercyclical Buffer:-
The countercyclical buffer has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times. The buffer will slow banking activity when it overheats and will encourage lending when times are tough i.e. in bad times. The buffer will range from 0% to 2.5%, consisting of common equity or other fully loss-absorbing capital.
Leverage Ratio:-
Basel III rules include a leverage ratio to serve as a safety net. A leverage ratio is a relative amount of capital to total assets (not risk-weight). This aims to put a cap on the swelling of leverage in the banking sector on a global basis. A 3% leverage ratio of Tier 1 will be tested before a mandatory leverage ratio is introduced in January 2018.
Liquidity Ratios:-
Under Basel III, a framework for liquidity risk management has to be created. A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced in 2015 and 2018, respectively.
