Friends let me keep this very simple this article gives only the basic idea related to BASEL NORMS.
STRICTLY SPEAKING this article does not deal into extreme details such as exact numbers of Tier 1 and Tier 2, credit valuation adjustment or Net Stable Funding Ratio.
WARNING- THE PROVIDED INFORMATION IS TECHNICALLY INCORRECT. IT IS JUST FOR UNDERSTANDING THE WORKING MECHANISM....
If a Bank loans 1 crore rupee to a company with “B” Credit Rating, it must keep capital worth 20 lakhs aside for crisis and out of that 20 lakhs, Rs. 15 lakhs must in form of Tier 1 Capital and 5 lakhs can be in form of Tier 2.
Tier 1
Easily liquid. For example
Already existing complex Monetary policies of Central Banks in each country (example RBI’s CRR, SLR, Repo etc.) make it difficult to uniformly implement BASEL norms.
STRICTLY SPEAKING this article does not deal into extreme details such as exact numbers of Tier 1 and Tier 2, credit valuation adjustment or Net Stable Funding Ratio.
Why Do we Need BASEL norms?
consider a hypothetical case of punjab national bank...
- PNB gave Rs.2000 as loan to some airline company.
- PNB gave loan of Rs.5000 crores to Telecom players and their license is cancelled ( as in case of 2G)
- What if those telecom players run away without paying back the loan and airline goes broke?
- Someone spread rumors that PNB itself is going to
collapse
(as it happened in ICICI, Ahmedabad in 2003 in real-life). - Lakhs of middleclass account holders will run to the nearest PNB branch to take out their deposited money .
- Overnight entire banking sector will collapse.
- It provides detailed guidelines about how much money should a bank keep aside, to deal with such financial crisis.
- Even if loan-takers run away without paying, Bank should have money to give back to deposit holders.
- More risk the bank takes, more money it has to keep aside in reserve to counter the risk.
How basel protects the deposited amount?
WARNING- THE PROVIDED INFORMATION IS TECHNICALLY INCORRECT. IT IS JUST FOR UNDERSTANDING THE WORKING MECHANISM....
If a Bank loans 1 crore rupee to a company with “B” Credit Rating, it must keep capital worth 20 lakhs aside for crisis and out of that 20 lakhs, Rs. 15 lakhs must in form of Tier 1 Capital and 5 lakhs can be in form of Tier 2.
Tier 1
Easily liquid. For example
- currency notes and coins in the bank value
- Stocks held by Bank, can be easily sold off in share-market.
- Not easily Liquid, for example the building or land owned by the bank.
Already existing complex Monetary policies of Central Banks in each country (example RBI’s CRR, SLR, Repo etc.) make it difficult to uniformly implement BASEL norms.
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