The role of banks in global and national economies is very important. The banking industry holds reliance of the entire economy and it is important for 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
The general principles that deal with the banking regulation include Minimum requirements, supervisory review and market discipline. They have been discussed below:
Certain minimum requirements are imposed on banks, which are closely tied to the level of risk exposure for a certain sector of the bank. The most important minimum requirements include the Capital Requirements and Reserve Requirements.
- Capital Requirements:The capital requirement 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: The reserve requirement 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 and/or bank deposits. Required reserves have at times been gold coin, central bank banknotes or deposits, and foreign currency.
This includes licensing by the regulator, obtaining undertakings, giving directions, imposing penalties or revoking the bank’s license.
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 (BIS); which fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations; are located in Basel, a city in 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.
Box: The 27 countries are Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. Out of them 12 are permanent members.
The Basel Committee on Banking Supervision (BCBS) had introduced a capital measurement system in 1988. It was called 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. For example, personal loans would carry higher loans in comparison to loans that are backed by assets. The Basel-I fixed minimum capital requirement at 8% of risk weighted assets (RWA). India adopted Basel 1 guidelines in 1999.
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 the three types of risks