Basel Committee on Banking Supervision

The Basel Committee on Banking Supervision (BCBS) is an international body that sets global standards for the regulation and supervision of banks. Established in 1974 by the central bank governors of the Group of Ten (G10) countries, the Committee’s primary objective is to strengthen the regulation, supervision, and risk management of the global banking sector to promote financial stability. The BCBS formulates broad supervisory standards and guidelines known as the Basel Accords, which serve as the foundation for banking regulations worldwide, including in India.

Historical Background

The creation of the Basel Committee was a response to the collapse of Bankhaus Herstatt, a German bank that failed in June 1974 due to significant foreign exchange losses. Its failure exposed the lack of coordination among national regulators in handling international banking crises. Recognising the need for cooperation and uniform standards, the Bank for International Settlements (BIS) in Basel, Switzerland, facilitated the formation of a standing committee of banking supervisors—the Basel Committee on Banking Supervision.
Since its establishment, the BCBS has played a crucial role in framing internationally accepted regulatory frameworks that aim to ensure that banks maintain sufficient capital to absorb losses and manage risks effectively.

Composition and Structure

• The BCBS is hosted and supported by the Bank for International Settlements (BIS) in Basel, Switzerland.
• It consists of representatives from central banks and supervisory authorities of 45 member jurisdictions, including major economies such as the United States, the United Kingdom, India, Japan, China, and members of the European Union.
• The Reserve Bank of India (RBI) represents India on the Committee.
• Decisions of the BCBS are made by consensus among members, reflecting international cooperation rather than legal compulsion.

The BCBS does not possess formal supranational authority; its standards are non-binding. However, its recommendations are widely adopted by national regulators, giving them near-universal application.

Objectives of the BCBS

The main goals of the Basel Committee are:

• To enhance the quality of banking supervision globally.
• To promote financial stability by improving risk management and capital adequacy.
• To foster cooperation among banking supervisors in different countries.
• To develop internationally harmonised standards for bank regulation and oversight.
• To ensure that banks maintain sufficient capital buffers to withstand economic shocks.

Core Principles of Banking Supervision

In 1997, the BCBS introduced the Core Principles for Effective Banking Supervision, later revised in 2012. These principles provide a comprehensive framework for sound supervisory practices and are widely recognised as the global benchmark for effective banking regulation. They emphasise:

• Licensing and ownership control of banks.
• Adequate capital and liquidity management.
• Risk identification, measurement, and mitigation.
• Governance and internal control mechanisms.
• Effective cross-border supervisory cooperation.

The Basel Accords: Evolution of Global Banking Standards

The BCBS has developed three major sets of regulatory frameworks known as the Basel Accords—Basel I, Basel II, and Basel III. Each successive framework reflects the evolving understanding of banking risks and the lessons learned from financial crises.
1. Basel I (1988): The Capital Adequacy Framework

• Introduced the concept of minimum capital requirements for banks to cover credit risk.
• Recommended that banks maintain a Capital to Risk-Weighted Assets Ratio (CRAR) of 8%.
• Focused primarily on credit risk, dividing assets into five categories with different risk weights (0%, 10%, 20%, 50%, 100%).
• Provided a simple and standardised approach but lacked depth in addressing market and operational risks.

2. Basel II (2004): Risk Sensitivity and Three Pillar Framework

• Designed to make the capital framework more risk-sensitive and comprehensive.
• Introduced three key pillars:
  • Pillar 1 – Minimum Capital Requirements: Covered credit, market, and operational risks.
  • Pillar 2 – Supervisory Review Process: Encouraged regulators to assess banks’ internal risk management processes.
  • Pillar 3 – Market Discipline: Mandated transparency through disclosure of key financial information to enhance market confidence.
• Allowed banks to use internal rating-based (IRB) approaches to calculate risk weights, subject to regulatory approval.
• Promoted a more sophisticated understanding of risk but was criticised for being complex and dependent on credit ratings.

3. Basel III (2010–2017): Post-Financial Crisis Reforms

• Introduced in response to the Global Financial Crisis of 2008, which exposed weaknesses in bank capital and liquidity management.
• Strengthened the capital framework by:
  • Raising the minimum capital requirement to 10.5% (including a capital conservation buffer).
  • Introducing Common Equity Tier 1 (CET1) as the highest quality capital.
  • Establishing new liquidity standards, including the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).
  • Introducing the leverage ratio to limit excessive borrowing.
  • Creating additional capital requirements for systemically important banks (SIBs).
• Basel III aimed to make banks more resilient to financial shocks by strengthening both capital quality and liquidity discipline.

Basel IV (Ongoing Reforms)

Though not officially termed “Basel IV”, the latest round of reforms (finalised in 2017 and to be implemented by 2028) seeks to further refine risk calculations and enhance the comparability of banks’ capital ratios. These reforms focus on:

• Revising the standardised approach for credit and operational risks.
• Placing limits on the use of internal models by banks.
• Enhancing the output floor, ensuring that risk-weighted assets calculated using internal models cannot fall below a certain percentage of those under the standardised approach.

Implementation in India

India has been a committed adopter of the Basel frameworks under the supervision of the Reserve Bank of India (RBI).

• Basel I norms were implemented in India in 1992.
• Basel II was phased in from 2008.
• Basel III implementation began in 2013, with full compliance targeted by March 2023.

The RBI monitors capital adequacy, liquidity, and leverage ratios for all scheduled commercial banks, ensuring that they maintain resilience against market shocks. Indian banks are required to maintain a Capital to Risk-Weighted Assets Ratio (CRAR) of at least 9%, higher than the global Basel III minimum of 8%, reflecting the RBI’s conservative regulatory approach.

Significance of the BCBS

The Basel Committee has had a profound impact on global financial stability and bank regulation:

• Established a common international framework for capital adequacy.
• Strengthened the soundness and stability of the global banking system.
• Promoted transparency and accountability in banking practices.
• Enhanced supervisory cooperation across borders.
• Helped prevent contagion effects during financial crises by enforcing robust capital and liquidity requirements.

Criticisms and Challenges

Despite its achievements, the Basel framework has faced several criticisms:

• Complexity: The risk-weighted asset approach is often seen as overly complicated and dependent on quantitative models.
• One-size-fits-all approach: The same standards may not suit banks in developing economies with different market structures.
• Procyclicality: Capital requirements may amplify credit cycles by restricting lending during downturns.
• Implementation disparities: Differences in enforcement across jurisdictions can lead to regulatory arbitrage.