Last updated on September 27th, 2023 at 10:45 am
What is Basel 2 Norms? What are the 3 pillars of Basel 2?
Hello, dear friends, as earlier I explained to you BASEL 1 NORMS if you didn’t read it. Kindly go through it where I have explained how Bank makes money and then what is Credit Risk and all. If you didn’t read that article, Kindly brush up on it and then read the Basel 2 Norms and importance in the Banking Sectors.
Here I am going to teach you about Basel 2 Norms, what are the 3 pillars of these Norms?, the Advantages and Disadvantages, risk factors, and much more. It will boost your knowledge in Banking Awareness. What are the RBI Guidelines under Basel 2 Norms? And the more important part,
If you are preparing for any competitive exams, what is the strategy to prepare for the Competitive exam, it would help you in your preparation. you can also read this article. So, without further ado, let’s read the article…
Basel 2 Norms
In 2004, the Basel 2 norms were proposed. These were the updated version norms of the Basel 1 accord. These norms stand with the 3 pillars. First Pillar talks about the minimum capital requirements, the second pillar talks about the supervisory review, and the third pillar talks about market discipline & disclosure.
Below, I have explained all of the 3 pillars of Basel 2 Norms.
Minimum Capital Requirements
The minimum capital requirement is as same as Basel 1 which is 8%. From the 8%, there should be at least 4% from Tier-one capital(T1) of the bank’s reserved capital, and out of 4% of the Tier 1 capital, 2% should be shareholder’s equity or common equity (CET1 Capital)
Tier 2 of the Basel 2 Norms provides 4%
To cut the residual risk like systemic risk, pension risk, concentration risk, strategic risk reputational risk, liquidity risk, and legal risk, the Basel 2 accords provide a framework of supervisory review to the bank.
Market Discipline & Disclosure
It will allow the market participants to disclose relevant market information like quarterly results, annual results, and other relevant information at a particular time. According to these Norms, the disclosure of the information should be at least once in two years.
Types of Risk
In these Norms, there is having 3 types of risks.
1) Credit Risk
Which is similar to the Basel 1 Norms
2) Market Risk
This type of risk occurred when the movements of the market are not so good, fluctuation is seen in the market price and there is no stability in the market. This is called market risk. These types of risks are credit spread risk, default risk, foreign exchange risk, commodities risk, equity risk, interest rate risk, etc.
3) Operational Risk
These types of risk are generally happened due to the errors made by the individual. The risks such as Third-Party Risks, Cybersecurity Risks, Internal Fraud, External Fraud, etc.
Disadvantages of Basel 2 Norms
1) In these norms neglected the risks involved in the current banking practices.
2) It bypasses the requirements of capital in the financial sectors.
3) The banks are unable to estimate rare but large incidents.
4) External Credit rating agencies may not understand the internal operational risk of the firm.
5) Investors do not understand the information which is publicly shared by the companies, could not help them to assess whether it is doing good or bad, and are also unable to raise a red alert.
These Norms come with Operational Risk, Market Risk, and Credit Risk which were not covered in the Basel 2 Norms.
These norms failed because they didn’t create any solution for the third-party risk, cyber-related risk, default risk, etc.
These Norms were introduced in 2004 by the Basel Committee on Banking Supervision (BCBS).