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Transcript
00:00:00Hello, my dear friends.
00:00:02Today, I am starting the Banking Awareness course of StudyIQ.
00:00:06Banking Awareness course is a bit difficult and conceptual.
00:00:10But the beauty of it is that it is conceptual.
00:00:13When you understand it, you will understand news, financial awareness,
00:00:19how banks work, etc.
00:00:22And today's topic is Basel Norms.
00:00:25I have started with the toughest and most challenging topic.
00:00:29I know that in Banking Awareness Static,
00:00:32this is a topic that scares you a little,
00:00:35distracts you a little,
00:00:37but will not do it again.
00:00:39So we will do its analysis in detail,
00:00:42we will break it down,
00:00:43we will understand it in a very granular way,
00:00:45what are Basel Norms.
00:00:47There will be conceptual clarity in this.
00:00:49And whenever I finish 3 or 4 lectures,
00:00:52I will bring a video in which we will practice MCQs.
00:00:55So this course will not only have theory,
00:00:58I will also make you do MCQs.
00:01:00So let's start the first topic today,
00:01:02Static Banking Awareness, lecture no. 1, Basel Norms.
00:01:05Let's start.
00:01:08First of all, it is important for you to know
00:01:10how a bank works.
00:01:12Until you understand how a bank works,
00:01:15it will be difficult to understand Basel and other complex things.
00:01:19So let's start with the basics.
00:01:21How does a bank work?
00:01:23You will also have a bank account.
00:01:26This is a bank.
00:01:29And when a bank opens,
00:01:33there are some promoters,
00:01:35i.e. those who start a bank.
00:01:37Suppose I open a bank tomorrow.
00:01:39So to open a bank,
00:01:41suppose I need 500 crores.
00:01:43So I put 500 crores in it.
00:01:46Now when I have put 500 crores,
00:01:48then I will start spending it.
00:01:50First I will hire a building.
00:01:52You keep imagining in your mind,
00:01:55you also have to open a bank.
00:01:57You have 500 crores.
00:01:58This 500 crores is called capital.
00:02:02Or you can also call it equity.
00:02:04This is your own money,
00:02:06your own money of the bank.
00:02:08So I started the bank with 500 crores.
00:02:11I will advertise it,
00:02:12I will advertise it on TV,
00:02:14that this is a bank,
00:02:15it is very trustworthy.
00:02:17I will hire a brand ambassador.
00:02:19My effort will be to win people's trust.
00:02:23This will be my first effort.
00:02:25And why?
00:02:27Because I have very little money.
00:02:29How much money does a person have?
00:02:31Some 100 crores, 200 crores, 300 crores, 400 crores,
00:02:33500 crores, maximum 1000 crores.
00:02:35But once you win people's trust,
00:02:37then people will start depositing money in that bank.
00:02:41That is,
00:02:43the whole game is of deposits.
00:02:45Because our money is very less,
00:02:48500 crores.
00:02:49But if I see a big bank,
00:02:51then 500,000 crores, 200,000 crores,
00:02:54they give so much loan.
00:02:56So people will start depositing money.
00:02:58People can open a current account in it.
00:03:00People can open a savings account in it.
00:03:02People can do FD in it.
00:03:04People can invest gold in it.
00:03:08There are many ways
00:03:10people will deposit in the bank.
00:03:13Okay?
00:03:14Now the corpus I have has become very big.
00:03:17So I will talk in numbers.
00:03:19In this whole video,
00:03:21I will talk in numbers.
00:03:23I opened a bank with 500 crores,
00:03:25which is my capital.
00:03:27And let's suppose that
00:03:29people have deposited
00:03:315500 crores in total.
00:03:335500 crores.
00:03:35That means I now have
00:03:376000 crores in the total bank.
00:03:40Assuming that I don't have
00:03:42any other type of asset.
00:03:44Assuming that.
00:03:45Or there is no other source of income.
00:03:47500 crores is my own capital.
00:03:49And 5500 crores is the deposit.
00:03:51Now how do I earn?
00:03:53How will I earn money?
00:03:55I will tell the depositor
00:03:57that I will give you
00:03:595% interest on this.
00:04:01I will give 5% interest.
00:04:03And when I get this deposit,
00:04:05I will give him a loan.
00:04:07And I will give that loan
00:04:09at 10%, 12%, 11%.
00:04:12And the difference in between
00:04:14will be my earnings.
00:04:16This is how a bank works.
00:04:18That is, a bank works
00:04:20like a financial intermediary.
00:04:22It is like a piggy bank.
00:04:24You take from people on this side
00:04:26and give a loan on this side.
00:04:28You take a deposit from people
00:04:30and give a loan here.
00:04:32This is the job of a bank.
00:04:34To work like a financial intermediary.
00:04:36This is very important.
00:04:38That is, banks are
00:04:40between people.
00:04:42One person is giving a loan
00:04:44to another person.
00:04:46But the bank is in the middle.
00:04:48Banks manage the flow of money
00:04:50between people and businesses.
00:04:52People deposit money in banks
00:04:54because they consider them
00:04:56to be secure places
00:04:58where they can deposit money.
00:05:00The bank then gives this money
00:05:02to people as a loan.
00:05:04How does the bank earn money?
00:05:06How does the bank make money?
00:05:08It gives loans to people
00:05:10at a higher rate.
00:05:12Instead of that,
00:05:14it promises people
00:05:16that if they deposit,
00:05:18it will give them 5%.
00:05:20The difference in the middle
00:05:22is earned by the bank.
00:05:24It is very simple.
00:05:26Let's move ahead.
00:05:28Now,
00:05:30are things so simple?
00:05:32No, they are not.
00:05:34First, let's see what is credit risk?
00:05:36Credit risk is,
00:05:38till now, it was very simple
00:05:40to take 5% from here,
00:05:42give 10% from there,
00:05:44and earn in between.
00:05:46But what happens is,
00:05:48when we give 10%,
00:05:50some loans default.
00:05:54Loans default.
00:05:56What does this mean?
00:05:58Defaulting a loan means
00:06:00that the money went,
00:06:02but did not come back.
00:06:04It may be that the principal
00:06:06did not come back,
00:06:08so this loan will become
00:06:10a bad loan or
00:06:12a non-performing asset.
00:06:16When these loans
00:06:18start defaulting,
00:06:20what is the loss to the bank?
00:06:22The loss is that the money
00:06:24in the bank decreases.
00:06:26Till now,
00:06:28the bank was giving loans
00:06:30with 10% interest,
00:06:32so the bank was earning.
00:06:34Now, suppose the interest did not come
00:06:36till now,
00:06:38the interest in the bank
00:06:40will start decreasing.
00:06:42And when the interest
00:06:44starts decreasing,
00:06:46this is the credit risk.
00:06:48What is the reason for credit risk?
00:06:50When a borrower does not
00:06:52return the money,
00:06:54the bank faces a risk
00:06:56called credit risk.
00:06:58Credit risk is important
00:07:00because when Basel Norm 1 came,
00:07:02which I will tell you later,
00:07:04they were on credit risk.
00:07:06Basel Norm 1 believed
00:07:08that only credit risk
00:07:10is a risk in the bank.
00:07:12There is no other risk.
00:07:14So, credit risk is
00:07:16actually a risk,
00:07:18but Basel Norm 1 said
00:07:20that credit risk is
00:07:22a risk.
00:07:24So, when a possibility
00:07:26arises that the borrower
00:07:28fails to
00:07:30repay the loan,
00:07:32right?
00:07:34And what does the bank
00:07:36do to reduce credit risk?
00:07:38To reduce credit risk,
00:07:40the bank checks the
00:07:42credibility,
00:07:44background,
00:07:46credit history,
00:07:48Sabil score, etc.
00:07:52Now, let's come to a
00:07:54very good question
00:07:56where everything starts.
00:07:58Does a bank
00:08:00give a 100% deposit
00:08:02in a loan?
00:08:04Suppose people
00:08:06deposited, let's say,
00:08:08any random number, 5000 crores.
00:08:10Can this entire
00:08:125000 crores be given
00:08:14from 5% to 10%?
00:08:16Is it possible?
00:08:18We will try to
00:08:20explore the answer
00:08:22to this question in this video.
00:08:24See, a bank
00:08:26has a different depositor's money,
00:08:28right?
00:08:30But it has its own money,
00:08:32which we call equity or capital.
00:08:34I told you about the case
00:08:36where I started a bank with 500 crores.
00:08:38So, this 500 crores is
00:08:40my equity or capital.
00:08:42Suppose,
00:08:44there is a loan
00:08:46that I give,
00:08:48and it doesn't come back.
00:08:50Okay?
00:08:52There is a risk.
00:08:54All loans are not like this,
00:08:56but if I give a loan
00:08:58which has a risk
00:09:00and it doesn't come back,
00:09:02who will pay for it?
00:09:04Will the depositor pay?
00:09:06Obviously not.
00:09:08Depositors can take their money back whenever they want.
00:09:10A bank should always
00:09:12be in a position
00:09:14that the money taken from the depositor
00:09:16should be able to pay it back.
00:09:18Did you understand?
00:09:20If there is a loss,
00:09:22the bank will be able to pay it back
00:09:24with its equity or capital,
00:09:26which is 500 crores.
00:09:28So,
00:09:30a bank has to
00:09:32keep its own money
00:09:34and this money
00:09:36is called equity or capital.
00:09:38You can also think
00:09:40that suppose
00:09:42there is a trustworthy person,
00:09:44he will take a deposit from people
00:09:46and give it back.
00:09:48The bank will not keep its own money.
00:09:50It is also possible.
00:09:52Suppose there is a goodwill in the market.
00:09:54When the bank opens, people will say
00:09:56that the goodwill is good,
00:09:58we will deposit the money
00:10:00and it will start giving.
00:10:02In that case,
00:10:04if the bank goes down,
00:10:06nothing will go out of its pocket.
00:10:08Let me give you an example.
00:10:12Take a case
00:10:14where
00:10:16500 crores is equity or capital,
00:10:18i.e. I started the bank.
00:10:20People deposited
00:10:225500 crores in my bank.
00:10:26Now,
00:10:28imagine
00:10:30if the bank goes down,
00:10:34what is my loss?
00:10:36My loss is 500 crores.
00:10:38But what is the loss
00:10:40of the public?
00:10:42The loss is 5500 crores.
00:10:44Let's say
00:10:46this is 6000 crores.
00:10:48Imagine
00:10:50and I
00:10:52earned 10% profit on it.
00:10:56Let's say
00:10:58I earned 600 crores
00:11:00after repaying all the depositors.
00:11:02I earned
00:11:04600 crores on 500 crores.
00:11:06You can imagine
00:11:08that I got more than 100% return.
00:11:12It means that
00:11:14when the bank has a profit,
00:11:16it goes to the owner.
00:11:18But when there is a loss,
00:11:20it goes to the public.
00:11:22I have given you an example
00:11:24where the public's money was only 10%.
00:11:26Generally,
00:11:28the bank's capital
00:11:30is very less
00:11:32and the public deposits
00:11:34lakhs of crores in the bank.
00:11:362 lakh crores, 3 lakh crores,
00:11:384 lakh crores, 5 lakh crores.
00:11:40So,
00:11:42this ratio is skewed
00:11:44in favor of the bank.
00:11:46If the bank loses money,
00:11:48the public will lose more
00:11:50and if the bank earns profit,
00:11:52the profit will be more.
00:11:54Why will the bank's profit be more?
00:11:56Because the depositors
00:11:58have to give only 5%.
00:12:00And the loan
00:12:02will give 10%.
00:12:04So, the 5% in between
00:12:06is generated by the bank
00:12:08from the public's money
00:12:10where the public's money is not invested.
00:12:12In banking,
00:12:14you earn money
00:12:16from someone else's money.
00:12:18You invest very little of your money.
00:12:20But,
00:12:22this ratio is skewed
00:12:24and the banking system is like this.
00:12:26But can we do something
00:12:28so that the bank does not go bankrupt
00:12:30and the public's money is not wasted?
00:12:32For that,
00:12:34we need Basel norms.
00:12:36And I will tell you
00:12:382-3 more things.
00:12:40The bank gave a loan
00:12:42and the loan did not come back.
00:12:44That means,
00:12:46there is a twin balance sheet problem.
00:12:48Non-performing assets are increasing.
00:12:50That means, the money the bank has
00:12:52to give the loan is decreasing.
00:12:54So, there is a problem in the balance sheet.
00:12:56Non-performing assets are increasing.
00:12:58In such a situation,
00:13:00suppose a depositor comes
00:13:02and asks for his money from the bank.
00:13:04Once the bank
00:13:06refuses to give it,
00:13:08there is a rumor
00:13:10that the bank is not giving the money
00:13:12to the depositor.
00:13:14I will give you a small example.
00:13:16There is a bank
00:13:18who took money
00:13:20from the people.
00:13:22Now, the people
00:13:26deposited the money.
00:13:28Now, the bank
00:13:30started giving loans.
00:13:32Many people defaulted the loans.
00:13:34The bank
00:13:36was short of money.
00:13:38In such a situation,
00:13:40a depositor comes
00:13:42and asks the bank
00:13:44to return the money.
00:13:46The bank says that
00:13:48it does not have the money
00:13:50because all the people
00:13:52are stuck in the loan.
00:13:54If the depositor
00:13:56does not get the money,
00:13:58he will go and tell 10 people.
00:14:00The reputation of the bank
00:14:02will be ruined.
00:14:04There will be a chain reaction.
00:14:06As a result,
00:14:08thousands and lakhs of people
00:14:10will come to the bank
00:14:12and say that
00:14:14they want their money back.
00:14:18Due to loss of reputation,
00:14:20withdrawal requests
00:14:22increase and
00:14:24start flooding.
00:14:26Therefore, the bank
00:14:28will have to provide
00:14:30some capital.
00:14:32Even if the loan defaults,
00:14:34the capital will
00:14:36belong to the bank.
00:14:38Any doubt?
00:14:40If a bank
00:14:42does not have Diwali,
00:14:44if the bank does not have
00:14:46enough money,
00:14:48if the bank defaults,
00:14:50then there is no risk of
00:14:52insolvency.
00:14:54There is no bad name of the bank.
00:14:56There is no loss of reputation.
00:14:58People's withdrawal
00:15:00requests should not increase.
00:15:02For this, the bank has to be
00:15:04well capitalized.
00:15:06The money that the bank has
00:15:08should be there.
00:15:10Suppose the bank gave a loan
00:15:12of Rs. 100 crores.
00:15:14Now, the loan of Rs. 100 crores
00:15:16has a risk of 20%.
00:15:18We will see
00:15:20how the risk is calculated later.
00:15:22Suppose there is a risk of 20%.
00:15:24There is a 20% chance that
00:15:26the money will not come back.
00:15:2820% of Rs. 100 crores means
00:15:30Rs. 20 crores are your
00:15:32risk-weighted assets.
00:15:34The total is Rs. 100 crores,
00:15:36but there is a 20% chance.
00:15:3820% risk means Rs. 20 crores.
00:15:40I am telling you that
00:15:429% of Rs. 20 crores
00:15:44has to be kept by the bank.
00:15:46How much is this?
00:15:48This is Rs. 1.8 crores.
00:15:509% because
00:15:529% is the capital adequacy ratio.
00:15:54So, Rs. 1.8 crores
00:15:56has to be kept
00:15:58by the bank.
00:16:04So,
00:16:06our entire purpose
00:16:08is that
00:16:10there should always be money in the bank.
00:16:12The bank should not be beaten.
00:16:14The bank should not be insolvent.
00:16:16Is it clear so far?
00:16:18Let's move ahead.
00:16:20Now, we have understood
00:16:22why the bank has to keep capital.
00:16:24If there is a loss,
00:16:26the bank should pay the loss.
00:16:28The bank should run smoothly.
00:16:30But how much capital
00:16:32should a bank keep?
00:16:34How much capital must a bank keep?
00:16:36Secondly,
00:16:38one bank
00:16:40works with many other banks.
00:16:42If there is a bank
00:16:44which is not well-capitalized,
00:16:46it is a threat to other banks as well.
00:16:48As we saw in 2008,
00:16:50Lehman Brothers,
00:16:52which is a financial institution,
00:16:54was defaulted.
00:16:56And Lehman Brothers
00:16:58had a lot of banks' money.
00:17:00So, those banks were also
00:17:02defaulted.
00:17:04There was a recession.
00:17:06Why? Because Lehman Brothers
00:17:08was defaulted.
00:17:10There are many such examples.
00:17:12For example,
00:17:14a bank works with businessmen.
00:17:16There are many big importers and exporters
00:17:18who do business
00:17:20with a bank.
00:17:22If that bank defaults overnight,
00:17:24their business will be affected.
00:17:26Their money will be lost.
00:17:28That means,
00:17:30the risk of doing business
00:17:32with that bank.
00:17:34Today, we are talking about a globalized world.
00:17:36Everything is connected in a globalized world.
00:17:38Right?
00:17:40In such a world, import and export
00:17:42are not affected.
00:17:44When a bank goes bankrupt,
00:17:46not only people's money dies,
00:17:48but also the bank itself.
00:17:50There are many institutions
00:17:52working with that bank.
00:17:54There can be many schools, for example.
00:17:56Many other institutions
00:17:58or non-banking financial companies
00:18:00may be working.
00:18:02Their money also dies.
00:18:04So, our ease of doing business
00:18:06decreases and the risk of doing business
00:18:08increases.
00:18:10So, other institutions
00:18:12should also know that
00:18:14the bank has sufficient capital.
00:18:16Do you have any doubt?
00:18:18So, for this,
00:18:20we need to make some laws,
00:18:22make some norms,
00:18:24make some rules.
00:18:26So, we need to have
00:18:28mutual understanding between countries.
00:18:30We need to have some norms,
00:18:32some laws,
00:18:34which all countries should follow.
00:18:36And,
00:18:38from here,
00:18:40things started to develop.
00:18:42Countries started to meet
00:18:44to make some laws.
00:18:46Right?
00:18:48So, from there,
00:18:50our process started.
00:18:52We started to feel the need
00:18:54of an international body
00:18:56to strengthen regulations,
00:18:58to supervise banks,
00:19:00to strengthen practices
00:19:02of banks
00:19:04all over the world.
00:19:06And,
00:19:08the purpose of this is
00:19:10to increase financial stability.
00:19:12So,
00:19:14there should be someone
00:19:16to tell the bank
00:19:18how to identify risk,
00:19:20how to save yourself from risk,
00:19:22and how to save yourself
00:19:24from Diwali.
00:19:26Okay.
00:19:28Now, let me ask you a question.
00:19:30What will the bank prefer?
00:19:32To have more capital
00:19:34or less capital?
00:19:36Mind it, when I say capital,
00:19:38I mean the bank's own money.
00:19:40So, what will the bank prefer?
00:19:42To have less or more money?
00:19:44Let's understand this.
00:19:46Let's understand this with an example.
00:19:48Okay.
00:19:50Let's say,
00:19:52a person opened a bank
00:19:54with 1000 crores.
00:19:56I am that person.
00:19:58So, I put 1000 crores.
00:20:00I call this equity or capital.
00:20:02Then,
00:20:04I gained people's trust.
00:20:06So, people deposited
00:20:08lakhs of money.
00:20:10Total, 9000 crores.
00:20:12So, how much money did the bank have?
00:20:1410,000 crores.
00:20:16Now,
00:20:18the bank started giving it
00:20:2010% interest.
00:20:22So, what is the bank's earning?
00:20:24Assuming there is no non-performing asset.
00:20:26Okay.
00:20:28So, the bank's earning is
00:20:301000 crores.
00:20:3210% of 10,000 crores.
00:20:34The bank earned 1000 crores.
00:20:36But, 1000 crores is the
00:20:38total return of the bank.
00:20:4010% of 10,000 crores.
00:20:42But, the depositors
00:20:44will have to give it to the public.
00:20:46So, the public deposited
00:20:489000 crores.
00:20:50So, they were promised 5% interest
00:20:52by the bank.
00:20:54So, they have to return
00:20:565% of 9000 crores i.e. 450 crores
00:20:58to the public.
00:21:00The depositors
00:21:02were given 450 crores.
00:21:04So, if you subtract 450 crores
00:21:06from 1000 crores,
00:21:08the profit of the bank is
00:21:10550 crores.
00:21:12Everything is simple, right?
00:21:14The bank earned 550 crores.
00:21:16So, what is the bank's
00:21:18return on equity and return on investment?
00:21:20These are two different things.
00:21:22One is ROE i.e. return on equity.
00:21:24The other is ROI i.e. return on investment.
00:21:26What is the difference between the two?
00:21:28See,
00:21:30the bank earned 550 crores.
00:21:32How much did the bank invest?
00:21:34What was the equity of the bank?
00:21:36Only 1000 crores.
00:21:38So, the profit is 550 crores.
00:21:40How much did the bank earn?
00:21:421000 crores.
00:21:44So, multiply it by 100 i.e. 55%.
00:21:46What is the return of the bank
00:21:48on its equity i.e. capital?
00:21:5055%.
00:21:52What was the total investment
00:21:54of the bank?
00:21:561000 crores for the bank and
00:21:589000 crores for the public i.e. 10000 crores.
00:22:00What is the return on investment?
00:22:0210%.
00:22:04Let me repeat.
00:22:06What was the total investment
00:22:08of the bank?
00:22:1010000 crores for the bank
00:22:12and 9000 crores for the public i.e. 10000 crores.
00:22:14What was the earning of the bank?
00:22:1610% i.e. 1000 crores.
00:22:18What was the return on investment?
00:22:201000 x 10000 x 100
00:22:22i.e. 10%.
00:22:24So,
00:22:26the return on investment is only 10%.
00:22:28But the return on equity is 55%.
00:22:30That's why I said
00:22:32banking is a very profitable business.
00:22:34Think of a business
00:22:36in which
00:22:38you invested 1000 crores
00:22:40and in one year
00:22:42you earned 550 crores.
00:22:44How many such businesses are there?
00:22:46You are getting 55% return in a year.
00:22:48Why?
00:22:50Because you earned from other people's money.
00:22:52And the financial institutions
00:22:54are
00:22:56interested in the return on equity.
00:22:58Because that's their profit.
00:23:00They don't care about the public.
00:23:02If I am investing 1000 crores in a business,
00:23:04I want to get the maximum return.
00:23:06I am getting 55% here
00:23:08and I want to get 70%, 80%, 90%.
00:23:10Okay?
00:23:12Now, let's look at another scenario
00:23:14in which the bank
00:23:16invested less money.
00:23:18I asked you an important question.
00:23:20What will the bank prefer?
00:23:22Investing more money
00:23:24or investing less money?
00:23:32We saw the return on equity.
00:23:34The bank got 55%.
00:23:36Now, imagine
00:23:38that the bank
00:23:40invested only 100 crores.
00:23:42Now, I started a bank
00:23:44investing only 100 crores.
00:23:46I won the public's trust.
00:23:48I advertised a lot.
00:23:50I told the public that I will give 5% interest.
00:23:529900 crores.
00:23:54100 crores is mine.
00:23:569900 crores is the public's.
00:23:58Total is 10,000 crores.
00:24:00In the previous case,
00:24:02I had 10,000 crores.
00:24:04This time also 10,000 crores.
00:24:06But there is a difference.
00:24:08Last time, 500 crores was mine.
00:24:10And 9,000 crores was the public's.
00:24:12This time, I have only 100 crores.
00:24:14And 9900 crores is the public's.
00:24:16Total is 10,000 crores.
00:24:18Now, I did the same thing.
00:24:20I gave a loan at 10%.
00:24:24I promised 5% to the public.
00:24:26Now, I will take out my profit.
00:24:30The return is 10,000 crores.
00:24:32So, 10% is my earning.
00:24:341,000 crores.
00:24:36Now, I have to return it to the public.
00:24:38How much did the public invest?
00:24:40This time, the public invested
00:24:429900 crores.
00:24:44I have to return 5% of 9900 crores to the public.
00:24:46And this is 495 crores.
00:24:48So, how much is my profit?
00:24:50Out of 1,000 crores,
00:24:52I will subtract 495 crores.
00:24:54And this is 505 crores.
00:24:56So, how much is my
00:24:58return on equity?
00:25:00How much money did I invest?
00:25:02In the denominator,
00:25:04only 100 crores.
00:25:06How much profit did I earn?
00:25:08505 crores into 100.
00:25:10So, I got
00:25:12505% returns.
00:25:14Think about it.
00:25:16It means that
00:25:20the public should invest
00:25:22as much as possible.
00:25:24That is the profit.
00:25:26I should invest as less as possible.
00:25:28Did you get the answer to my question?
00:25:30Return on equity
00:25:32will increase in which case?
00:25:34When I invest less
00:25:36and the public invests more.
00:25:38Because I am earning from the public's money.
00:25:40There is no need to trap my money.
00:25:42So, what will a bank prefer?
00:25:44That it invests less capital
00:25:46and the public
00:25:48invests more.
00:25:50In both the cases,
00:25:5210,000 crores were
00:25:54invested.
00:25:56In one case,
00:25:58my money was 1,000 crores
00:26:00and in the other, it was only 100 crores.
00:26:02But what I got in return,
00:26:04in one case,
00:26:06I got only 55% returns
00:26:08and in the other, I got 505% returns.
00:26:10Clear?
00:26:12But in this case,
00:26:14why should I invest 100 crores?
00:26:16I have a belief
00:26:18that I should collect money from the public
00:26:20and earn from it.
00:26:22Think about my return.
00:26:24It is nothing.
00:26:26Do we want this to happen?
00:26:28Do we want that if the bank drowns,
00:26:30all the money will go to the public?
00:26:32No.
00:26:34We need some
00:26:36rules and regulations.
00:26:40So, these things started happening in the world.
00:26:46What happens if a bank
00:26:48invests more capital?
00:26:50Its return on equity
00:26:52reduces, which it does not want.
00:26:54But there is an advantage to this.
00:26:56The chances of bankruptcy
00:26:58reduce. Why?
00:27:00Because if there is a loss,
00:27:02if the loan defaults,
00:27:04then it gets
00:27:06provisioned.
00:27:08If the bank invests more capital,
00:27:10the risk of bankruptcy reduces.
00:27:12And if it reduces,
00:27:14all the money will go to the public.
00:27:16So, what do we have to make sure?
00:27:18The bank should be well capitalized.
00:27:20We have to safeguard
00:27:22the interests of the consumer.
00:27:26So, now I will start
00:27:28Basel Nouns.
00:27:30So, when these things started happening in the world,
00:27:32this was the time
00:27:34of 1970s,
00:27:36there were some banks
00:27:38that were hit during that time.
00:27:40There is a big bank in Germany that
00:27:42defaulted.
00:27:44Then these countries met
00:27:46and decided
00:27:48to make some laws.
00:27:50There is a committee
00:27:52named Basel Committee on Banking
00:27:54Supervision,
00:27:56BCBS.
00:27:58When this committee was formed,
00:28:00you can call it only Basel Committee.
00:28:02So, what is Basel?
00:28:04Basel is a city
00:28:06in Switzerland.
00:28:08It is a very famous city.
00:28:10You must have heard the name of a tennis player,
00:28:12Roger Federer. He also comes from Basel.
00:28:14So, the city of Switzerland,
00:28:16Basel,
00:28:18is the headquarter of this committee.
00:28:20Because there is a bank called
00:28:22Bank of International Settlements,
00:28:24BIS.
00:28:26So, the headquarter of Bank of International Settlements
00:28:28is in Basel.
00:28:30And this committee
00:28:32operates from the headquarter of Bank of International Settlements.
00:28:34So, Basel Committee
00:28:36on Banking Supervision,
00:28:38was formed by
00:28:40the central bank governors
00:28:42of G10 countries.
00:28:44G10 countries
00:28:46started together
00:28:48to take an initiative
00:28:50to make laws to prevent banks from being hit.
00:28:52We will make rules and regulations.
00:28:54We will make best practices.
00:28:56So, the central bank governors
00:28:58of G10 countries met
00:29:00and formed a committee named
00:29:02Basel Committee.
00:29:04When this committee was formed,
00:29:06its name was Committee on Banking Regulation and Supervisory Practice.
00:29:08But later its name became
00:29:10Basel Committee on Banking Supervision.
00:29:12And,
00:29:14I told you that there was a German bank
00:29:16which was hit.
00:29:18It was Bankhaus Herstadt.
00:29:20It was a big bank of West Germany.
00:29:22It was hit.
00:29:24Because of this,
00:29:26there was turmoil in international currency
00:29:28markets.
00:29:30Now,
00:29:32the first question is
00:29:34where is the headquarter of
00:29:36Basel Committee on Banking Supervision?
00:29:38Its headquarter is in Basel itself.
00:29:40It is the headquarter of
00:29:42Bank for International Settlements.
00:29:44Why was this committee formed?
00:29:46To improve the quality of banking supervision.
00:29:48To keep an eye on banks.
00:29:50To regulate them.
00:29:52To ensure their financial stability.
00:29:54Not only this,
00:29:56but also to tell the countries
00:29:58what are the best practices.
00:30:00So that their banking system
00:30:02remains robust.
00:30:04Because,
00:30:06if one country's banking system gets damaged,
00:30:08it is a globalized world.
00:30:10So, others also get damaged.
00:30:12So,
00:30:14this committee had its first meeting
00:30:16in February 1975.
00:30:18And,
00:30:20it meets every 2-3 years.
00:30:22This is the headquarter.
00:30:24This is a very famous building in Basel.
00:30:26This is the headquarter of
00:30:28Bank for International Settlements.
00:30:30This is the headquarter of
00:30:32Basel Committee on Banking Supervision.
00:30:34When was Bank for International Settlements formed?
00:30:36It was formed in 1930.
00:30:38There is a long story behind this.
00:30:40It is out of the scope of this video.
00:30:42But, let me give you an idea.
00:30:44After the World War,
00:30:46the Treaty of Versailles was formed.
00:30:48It declared Germany guilty of war.
00:30:50It called Germany an aggressor.
00:30:52Many sanctions were imposed on Germany.
00:30:54To help Germany,
00:30:56to give money to Germany,
00:30:58a commission was formed.
00:31:00A Young Committee was formed.
00:31:02At the behest of the Young Committee,
00:31:04a Bank for International Settlements was formed.
00:31:06Its purpose was to work
00:31:08as a trustee of the German government.
00:31:10So, when Bank for International Settlements
00:31:12was formed,
00:31:14its purpose was that
00:31:16after the World War,
00:31:18when the Treaty of Versailles was signed,
00:31:20the sanctions imposed on Germany,
00:31:22the damages to Germany,
00:31:24it should help Germany.
00:31:26So,
00:31:28Bank for International Settlements was formed
00:31:30at the behest of the Young Committee.
00:31:32It was formed in 1930.
00:31:34The headquarter of this bank is in Basel,
00:31:36Switzerland.
00:31:38It has two representative offices.
00:31:40One in Hong Kong and one in Mexico.
00:31:42It has two representative offices.
00:31:44The Hong Kong office represents
00:31:46Asia and the Pacific.
00:31:48The American office
00:31:50represents Mexico.
00:31:52Mexico is in North America.
00:31:56Bank for International Settlements
00:31:58has a Financial Stability Institute,
00:32:00FSI,
00:32:02which was created in 1998.
00:32:04Its purpose is that
00:32:06the central banks
00:32:08and supervisors,
00:32:10like RBI in India,
00:32:12Reserve Bank of India,
00:32:14which is the supervisor of all banks,
00:32:16help them.
00:32:18So, the Financial Stability Institute
00:32:20is also under Bank for International Settlements.
00:32:22It was created in 1998.
00:32:24Its headquarter is also there.
00:32:26Now, let's start with Basel 1.
00:32:28So far,
00:32:30all the stories are clear to you.
00:32:32So far, I have seen how the bank works,
00:32:34what is the credit risk,
00:32:36how money is earned
00:32:38in the banking system,
00:32:40and how to protect
00:32:42the bank.
00:32:44Now, you have a basic understanding.
00:32:46Now,
00:32:48when the Basel Committee for Banking Supervision
00:32:50made the first law,
00:32:52the first rule and regulation,
00:32:54when I say law,
00:32:56it doesn't mean that it is legally binding.
00:32:58Keep this in mind.
00:33:00It is not legally binding
00:33:02on any member.
00:33:04Like India is also a member
00:33:06of Bank for International Settlements.
00:33:08Yes, India is a member of BIS.
00:33:10India is also a member
00:33:12of Bank for International Settlements.
00:33:14But,
00:33:16it is not legally binding on India.
00:33:20They just said,
00:33:22we will tell you the best things.
00:33:24If you like it,
00:33:26then follow it.
00:33:28If you don't like it, then don't follow it.
00:33:30Who did they say this to?
00:33:32They said to RBI.
00:33:34Did RBI like it or not?
00:33:36They liked it.
00:33:38That's why we want to apply
00:33:40Basel 3 norms on all banks.
00:33:42They liked it.
00:33:44And then RBI
00:33:46applied all the rules and regulations
00:33:48on the banks.
00:33:50RBI said,
00:33:52these are the best practices.
00:33:54If I say,
00:33:569% capital adequacy ratio has to be maintained,
00:33:58then it has to be done.
00:34:00That means,
00:34:02Basel Committee instructed RBI
00:34:04and said, it is voluntary.
00:34:06It is your wish.
00:34:08RBI agreed.
00:34:10And then RBI asked all the banks
00:34:12to apply this.
00:34:14And if you don't apply,
00:34:16then you will lose your banking license.
00:34:18Or there will be many other
00:34:20actions like prompt corrective action.
00:34:22That means,
00:34:24banks have to apply this.
00:34:26Which actions?
00:34:28We are in 2022.
00:34:30So, we have to apply Basel 3.
00:34:32There were many shortcomings.
00:34:34Let's start with Basel 1.
00:34:38Basel 1 laws
00:34:40were introduced in 1988.
00:34:42And India
00:34:44adopted Basel 1 norms
00:34:46in 1999.
00:34:48These are direct MCQ questions.
00:34:50We will practice these
00:34:52when we cover 3-4 topics.
00:34:54After that, there will be a video
00:34:56in which we will cover MCQs.
00:34:58Then we will practice these.
00:35:00Basel norm 1
00:35:02only focuses on
00:35:04credit risk.
00:35:06It says
00:35:08that if a bank gets hit,
00:35:10then only because of one thing.
00:35:12And that is credit risk.
00:35:14That means,
00:35:16the bank gave a loan
00:35:18and it didn't come back.
00:35:20Only because of this,
00:35:22the bank will get hit.
00:35:24There is no other reason to get hit.
00:35:26Let me ask you a question.
00:35:28Suppose,
00:35:30a bank's server gets hacked,
00:35:32i.e., cyber security.
00:35:34Can the bank get hit because of cyber security?
00:35:36Of course, it can.
00:35:40All the data of the bank
00:35:42has been crashed.
00:35:44It can get hit.
00:35:46Can a corrupt manager
00:35:48get hit because of cyber security?
00:35:50If he gives a loan
00:35:52to a person like Vijay Mallya,
00:35:54doesn't he deserve the loan?
00:35:56Can the bank get hit because of him?
00:35:58Of course, it can.
00:36:00So, is credit risk
00:36:02the only risk?
00:36:04No.
00:36:06But Basel 1 said yes.
00:36:08So, when Basel 1
00:36:10came, Basel 1 rules,
00:36:12we call them Accord.
00:36:14Accord means
00:36:16agreement.
00:36:18Basel norms.
00:36:20Norms means rules
00:36:22that follow everyone.
00:36:24So, when Basel 1 Accord
00:36:26means agreement
00:36:28between countries,
00:36:30Basel 1 came in 1988
00:36:32and India adopted it
00:36:34in 1999.
00:36:36So,
00:36:38Basel norms
00:36:40only focus on credit risk.
00:36:42Okay?
00:36:44We have seen credit risk.
00:36:46If the bank gets a loss
00:36:48because the borrower doesn't
00:36:50repay the loan,
00:36:52then it is a credit risk.
00:36:54So, they only focus on credit risk.
00:36:56Risk-weighted assets,
00:36:58RWA,
00:37:00are the
00:37:02assets of the bank
00:37:04that we weigh
00:37:06according to the risk.
00:37:08What does it mean?
00:37:10See, all loans
00:37:12are not equally risky.
00:37:14Okay?
00:37:16Some loans are less risky
00:37:18and some are more risky.
00:37:20For example,
00:37:22home loan.
00:37:24Is home loan more risky
00:37:26or car loan?
00:37:28Is home loan more risky
00:37:30or car loan?
00:37:34Home loan means
00:37:36if someone wants to build a house
00:37:38but he has taken a loan
00:37:40and has no money to build a house.
00:37:42Home loan.
00:37:44What is home loan?
00:37:46If there is a default
00:37:48in the home loan,
00:37:50if the person can't repay
00:37:52the loan tomorrow,
00:37:54can the bank repay the loan tomorrow?
00:37:56Yes, it can.
00:38:00In fact,
00:38:02until your EMI is not completed,
00:38:04you don't get the land papers.
00:38:06Both you and the bank
00:38:08are its owners.
00:38:10But what is the problem
00:38:12with car loan?
00:38:14You bought a car.
00:38:16You are enjoying driving the car.
00:38:18You couldn't repay
00:38:20the car loan.
00:38:22You bought a 5-year-old car.
00:38:24After 6 months, you told the bank
00:38:26that you don't have money.
00:38:28The bank will auction the car.
00:38:30But what is the problem?
00:38:32The problem is
00:38:34that the car is a depreciating asset.
00:38:38Today, you bought a car for Rs. 40 lakh.
00:38:40After a year, its value will be Rs. 20 lakh.
00:38:42Generally,
00:38:44the price of a house increases with time.
00:38:46Even if it remains the same,
00:38:48there is no loss to the bank.
00:38:50So, car loan is more risky.
00:38:52In fact,
00:38:54you don't have to pay
00:38:56any collateral
00:38:58for personal loans.
00:39:00For example,
00:39:02if you want to take an educational loan
00:39:04from a college,
00:39:06do you have to pay any collateral?
00:39:08No.
00:39:10It depends on the college's reputation
00:39:12or tie-up with the college.
00:39:14If your credit history is good,
00:39:16your reputation is good,
00:39:18your bank account is good.
00:39:20So, personal loans are risky.
00:39:22But not all personal loans
00:39:24are equally risky.
00:39:26Some loans are more risky,
00:39:28some are less risky.
00:39:30Some loans are 10%,
00:39:32some are 20%,
00:39:34some are 30%,
00:39:36some are 100%.
00:39:38That means,
00:39:40the risk of every loan is different.
00:39:42So, I have to calculate the average.
00:39:44I have to calculate the risk.
00:39:46To calculate the average,
00:39:48what is the weighted average?
00:39:50One is the normal average.
00:39:52Suppose I ask you to calculate
00:39:54the average of 1, 2, and 3.
00:39:56So, you add 1, 2, and 3
00:39:58and subtract 3.
00:40:00The average is 2.
00:40:02That is the normal average.
00:40:04But what is the weighted average?
00:40:06We multiply it by its weightage.
00:40:08So, we calculate
00:40:10the risk-weighted asset.
00:40:12Risk-weighted asset.
00:40:14With numbers.
00:40:16For example,
00:40:18there are some assets
00:40:20which are bagged by collateral.
00:40:22They carry lesser risk
00:40:24as compared to personal loans
00:40:26which have no collateral.
00:40:28Suppose you take a loan
00:40:30of 1 crore from the bank.
00:40:32In return, you mortgaged your land.
00:40:34You mortgaged your land.
00:40:36That means, you mortgaged collateral.
00:40:38So, the risk on that loan is less.
00:40:40In future, even if you default,
00:40:42the bank will sell your land
00:40:44and take your money back.
00:40:46It will put a surface on you.
00:40:48And loans like personal loans
00:40:50which have no collateral
00:40:52are more risky.
00:40:54So,
00:40:56I gave an example.
00:40:58That's why
00:41:00every loan is not that risky.
00:41:02Some are less risky.
00:41:04Some are more risky.
00:41:06That's why we use the concept
00:41:08of risk-weighted asset.
00:41:10The biggest beauty
00:41:12of Basel 1 is that
00:41:14it teaches us
00:41:16how to calculate risk-weighted assets.
00:41:18So,
00:41:20there are
00:41:22many pillars of Basel 1.
00:41:24Only one.
00:41:26What is it?
00:41:28Minimum capital requirement.
00:41:30I told you in the beginning of this video
00:41:32that
00:41:34tell a bank
00:41:36how much money
00:41:38you want to keep.
00:41:40The bank will want
00:41:42minimum capital requirement.
00:41:44If you keep this much,
00:41:46you won't be insolvent.
00:41:50So, minimum capital requirement
00:41:52is only one pillar of Basel 1.
00:41:54That's it. Keep this much capital
00:41:56and you won't be insolvent.
00:41:58And there is only one type of risk.
00:42:00Credit risk. There is no other risk.
00:42:02What does Basel 1 teach us?
00:42:04Basel 1 teaches us
00:42:06how to calculate
00:42:08risk-weighted assets
00:42:10and on that basis,
00:42:12how much minimum capital requirement
00:42:14we should keep.
00:42:16Or vice versa,
00:42:18how much minimum capital requirement
00:42:20we should keep.
00:42:22You can interpret it in any way.
00:42:24So, according to Basel norm,
00:42:26minimum capital requirement
00:42:28should be 8%.
00:42:308% capital adequacy ratio
00:42:32should be there.
00:42:34Let's understand this with numbers.
00:42:36Basel 1 says
00:42:38that there is only one type of risk.
00:42:40Credit risk.
00:42:42And there is only one pillar
00:42:44and that is minimum capital requirement.
00:42:46Pillar means
00:42:48on which this whole thought is based.
00:42:50Pillar.
00:42:52If you keep minimum capital requirement,
00:42:54the bank won't be insolvent.
00:42:56Is this true? Let's see.
00:42:58Basel norm 1.
00:43:00Let me write here.
00:43:02What did norm 1 do?
00:43:04It divided
00:43:06the asset class
00:43:08of the loan
00:43:10into 4 parts.
00:43:14S, B, R, O.
00:43:18S are those which have no risk.
00:43:20Is there any loan
00:43:22which has no risk?
00:43:24It will come back.
00:43:26Suppose a bank is giving
00:43:28a loan to the government.
00:43:30What did Basel 1 say?
00:43:32Those loans which are
00:43:34sovereign debt.
00:43:36Sovereign means government.
00:43:38Sovereign debt
00:43:40to OECD countries
00:43:42and their central bank.
00:43:44OECD is an organization
00:43:46for Economic Cooperation and Development
00:43:48which is based in Paris.
00:43:50If you
00:43:52are giving loan
00:43:54to member countries
00:43:56of OECD,
00:43:58then there is no risk.
00:44:00There is 0% risk.
00:44:04If you
00:44:06are giving loan
00:44:08to other banks and public sector institutions
00:44:10in OECD countries,
00:44:12then there is
00:44:1420% risk.
00:44:16If you are giving loan
00:44:18to other banks
00:44:20or public sector institutions,
00:44:22then there is 20% risk.
00:44:24If you are giving
00:44:26home loan or housing loan,
00:44:28then there is 50% risk.
00:44:30And on other loans,
00:44:32there is 100% risk.
00:44:34So, Basel norms
00:44:36divided all the loans
00:44:38into 4 parts.
00:44:40Okay?
00:44:42And defined their risk.
00:44:440%, 20%,
00:44:4650%, and 100%.
00:44:48These were
00:44:50called SBRO.
00:44:52Now, this classification
00:44:54helps us
00:44:56a bank.
00:44:58This classification helps a bank
00:45:00to find out
00:45:02how much money I have to keep.
00:45:04How?
00:45:06Let's see.
00:45:08Suppose there is a bank ABC.
00:45:10Okay?
00:45:12It has given a loan
00:45:14of Rs. 1000 crores.
00:45:16It gave Rs. 200 crores to RBI.
00:45:18It gave Rs. 200 crores
00:45:20to ONGC.
00:45:22ONGC is a government company.
00:45:24It is a public sector
00:45:26undertaking.
00:45:28It gave a loan of Rs. 200 crores
00:45:30for a secured home loan.
00:45:32It is secured.
00:45:34And it gave a loan of Rs. 400 crores
00:45:36for a personal loan.
00:45:38It gave a loan for a car
00:45:40or something else.
00:45:42There are many types of personal loans.
00:45:44So, it divided it into 4 parts.
00:45:46If a bank has to give
00:45:48a loan of Rs. 1000 crores,
00:45:50it divided it into 4 parts.
00:45:52Now, the Rs. 200 crores
00:45:54given to RBI, how much risk is there?
00:45:56Zero.
00:45:58Now, I am calculating
00:46:00risk-weighted assets.
00:46:02Total assets are Rs. 1000 crores.
00:46:04It gave a loan of Rs. 1000 crores.
00:46:06Out of these,
00:46:08how much is the risk?
00:46:10Risk-weighted assets.
00:46:12So,
00:46:14RBI, Rs. 200 crores.
00:46:16There is no risk in this.
00:46:18ONGC.
00:46:22Public sector institutions
00:46:24in OECD country, 20%.
00:46:26So, there is a risk of 20%.
00:46:28That means,
00:46:3020% of Rs. 200 crores
00:46:32is such that
00:46:34it can sink.
00:46:36I am not saying that it will sink.
00:46:38There is a risk.
00:46:40There is a risk of 20%.
00:46:42That means,
00:46:4420% of Rs. 200 crores is Rs. 40 crores.
00:46:46In the previous case,
00:46:48in RBI, Rs. 0 crores.
00:46:50In this, 20% means Rs. 40 crores.
00:46:52In this Rs. 200 crores,
00:46:54this is a secured loan.
00:46:56And in this,
00:46:58any loan secured
00:47:00by residential property.
00:47:02That means, any such loan
00:47:04which is secured by
00:47:06residential property,
00:47:08has a risk of 50%.
00:47:10So, for this Rs. 200 crores,
00:47:12I have to provide a provision of Rs. 100 crores.
00:47:14And for Rs. 400 crores,
00:47:16I have to provide a provision of Rs. 400 crores.
00:47:18This is a risk.
00:47:20This is a risk-weighted asset.
00:47:22Now, tell me one thing.
00:47:24What is my total
00:47:26risk-weighted asset?
00:47:28In RBI, it is Rs. 0 crores.
00:47:30In ONGC, it is Rs. 40 crores.
00:47:32In secured loan,
00:47:34it is Rs. 100 crores.
00:47:36And in personal loan,
00:47:38it is Rs. 400 crores.
00:47:40So, this is Rs. 540 crores.
00:47:44Rs. 540 crores.
00:47:46That means,
00:47:48a bank gave a loan of Rs. 1000 crores.
00:47:50In that,
00:47:52there are risk-weighted
00:47:54assets of Rs. 540 crores.
00:47:56We have calculated this.
00:47:58We have applied this formula.
00:48:00We have multiplied the risk
00:48:02in it by that.
00:48:04And Rs. 540 crores.
00:48:06This is a risk-weighted asset, Rs. 540 crores.
00:48:08Now, tell me one thing.
00:48:10If a bank
00:48:12gave a loan of Rs. 1000 crores,
00:48:14in which there are
00:48:16risk-weighted assets of Rs. 540 crores,
00:48:18then the capital adequacy ratio,
00:48:20that is,
00:48:22how much equity or capital
00:48:24a bank has to keep,
00:48:26is 8%.
00:48:28Basel 1 says 8%.
00:48:30And that 8%
00:48:32is 8% of Rs. 540 crores,
00:48:34that is, Rs. 43.2 crores.
00:48:36So, this
00:48:38Rs. 43.2 crores
00:48:40has to be kept
00:48:42separately
00:48:44in the bank.
00:48:46You cannot touch it at all.
00:48:48You cannot use it at all.
00:48:50And where will this Rs. 43.2 crores come from?
00:48:52It will come half from
00:48:54T1 capital and half from T2 capital.
00:48:56Okay?
00:48:58According to Basel 1,
00:49:00Rs. 43.2 crores,
00:49:02that is, if a bank gives a loan
00:49:04of Rs. 1000 crores,
00:49:06then it will have to keep
00:49:08Rs. 43.2 crores
00:49:10separately
00:49:12according to this risk profile,
00:49:14which I told you,
00:49:16in which some gave it to RBI
00:49:18and some gave it to ONGC.
00:49:20It will have to keep Rs. 43.2 crores
00:49:22separately,
00:49:24half from T1 capital
00:49:26and half from T2 capital.
00:49:28Only then it can give a loan of Rs. 1000 crores
00:49:30on that risk profile.
00:49:32Did India accept Basel 1?
00:49:34I won't say that,
00:49:36but we are still a developing country.
00:49:38And when our people's money will be lost,
00:49:40think about it,
00:49:42you know,
00:49:44there are many repercussions of it.
00:49:46People's trust in the banking system
00:49:48will be lost.
00:49:50So, we will have to be more careful.
00:49:52So, Reserve Bank of India said
00:49:54that we will not keep 8%,
00:49:56but we will keep 1% more,
00:49:589%.
00:50:00The more the capital adequacy ratio,
00:50:02if the bank is safe,
00:50:04we are safe in India,
00:50:06and it should be.
00:50:08We saw in the recession in 2008,
00:50:10we were very bind,
00:50:12other countries were struggling.
00:50:14So, in our country,
00:50:16the capital adequacy ratio is 9%.
00:50:18Basel 1 said
00:50:20that it should be 8%.
00:50:22One more thing,
00:50:24this 8% will come
00:50:264% from T1 capital
00:50:28and the rest will come from T2 capital.
00:50:30This is also very important.
00:50:32That this 8%
00:50:34is not only linear,
00:50:36in this 8%,
00:50:384% will come from T1 capital
00:50:40and the rest 4% will come from T2 capital.
00:50:42So, banks
00:50:44have to keep 8%
00:50:46of their risk-weighted assets.
00:50:48In India, 9%.
00:50:50But I will talk in general, not about India.
00:50:528% of their risk-weighted assets
00:50:54have to be kept separately.
00:50:56In which 4% will come from T1 capital
00:50:58and 4% will come from T2 capital.
00:51:02Now, look here.
00:51:04This is RBI's
00:51:06latest PCA framework.
00:51:08The latest
00:51:10Prompt Corrective Action Framework.
00:51:12If you
00:51:14don't maintain this
00:51:16capital adequacy ratio,
00:51:18then RBI
00:51:20will take action
00:51:22against you.
00:51:24RBI said
00:51:26Keep 9% of your risk-weighted assets.
00:51:28Provision it.
00:51:30Okay?
00:51:32So, for example,
00:51:34there are many risk thresholds.
00:51:36Risk threshold 1, 2, 3.
00:51:38If
00:51:40CRAR falls below
00:51:42one level, then action will be taken.
00:51:44If CRAR falls
00:51:46below one level, then action will be taken.
00:51:48We will discuss this
00:51:50in detail in PCA.
00:51:52But if you
00:51:54don't maintain the capital adequacy ratio,
00:51:56then action will be taken.
00:52:00Let's go.
00:52:02If I want to
00:52:04sum up Basel 1
00:52:06in one line,
00:52:08then what will I say?
00:52:12My T1 and T2
00:52:14divided by
00:52:16risk-weighted assets
00:52:18should be more than 8%.
00:52:20We
00:52:22define
00:52:24capital adequacy ratio
00:52:26as
00:52:28capital
00:52:30divided by
00:52:32risk-weighted assets.
00:52:34capital
00:52:36divided by
00:52:38risk-weighted assets.
00:52:40So, how to
00:52:42calculate risk-weighted assets?
00:52:44I told you how to calculate RWA.
00:52:46Multiply all the risks
00:52:48and loans
00:52:50to get
00:52:52risk-weighted assets.
00:52:54Multiply all the
00:52:56requirements.
00:52:58Capital adequacy ratio is 8%.
00:53:00Multiply risk-weighted assets.
00:53:02This is your capital.
00:53:04But this capital
00:53:06should be equally distributed in T1 and T2.
00:53:08Let's come to the next concept.
00:53:10T1 capital
00:53:12and T2 capital.
00:53:14Which capital
00:53:16keeps a bank more secure?
00:53:18T1 or T2?
00:53:20There are two things.
00:53:22Here you can see
00:53:24that the understanding
00:53:26has changed.
00:53:28From Basel 1 to Basel 2 to Basel 3.
00:53:30We are still studying Basel 1.
00:53:32Basel 1
00:53:34said that
00:53:36T1 and T2 are both important.
00:53:40T1 capital is
00:53:42the core capital of the bank.
00:53:44Okay?
00:53:46The core capital of the bank
00:53:48is called tier 1 capital
00:53:50or core capital.
00:53:52And T2 capital is
00:53:54supplementary capital.
00:53:56So, tier 1 capital
00:53:58is the primary funding source
00:54:00of the bank.
00:54:02In tier 1 capital,
00:54:04there are shareholders' equity
00:54:06and disclosed reserves.
00:54:08Shareholders' equity means
00:54:10the equity or capital
00:54:12of the bank's promoter.
00:54:14And disclosed reserves.
00:54:16Disclosed means that whatever
00:54:18the bank has disclosed,
00:54:20it is in tier 1 capital.
00:54:22For example, if the bank says
00:54:24that it has 5 kg gold,
00:54:26it will be considered
00:54:28as disclosed reserves.
00:54:30So, all the disclosed
00:54:32or declared reserves of the bank
00:54:34are in tier 1 capital.
00:54:36And this is the primary funding source
00:54:38of the bank.
00:54:40The core capital of the bank
00:54:42is tier 1 capital.
00:54:44Retained earnings are also included.
00:54:46Retained earnings means
00:54:48that a bank opens
00:54:50and earns a profit of Rs. 1000 crores
00:54:52after a year.
00:54:54The bank's profit
00:54:56means the final profit
00:54:58after giving to the depositors.
00:55:00Rs. 1000 crores.
00:55:02This Rs. 1000 crores can be taken
00:55:04by the owners of the bank
00:55:06who started the bank.
00:55:08But they say,
00:55:10So, retained earnings
00:55:12means the bank's
00:55:14earnings which they did not
00:55:16take home but returned to the bank.
00:55:18So, it becomes the core capital of the bank.
00:55:20So, retained earnings are also included.
00:55:22It is the most
00:55:24reliable and liquid.
00:55:26Okay?
00:55:28These are highly liquid assets.
00:55:30So, the highest capacity
00:55:32in tier 1 capital is
00:55:34to absorb losses.
00:55:36If the bank starts losing money,
00:55:38then tier 1 capital
00:55:40is useful.
00:55:42The highest capacity in tier 1 capital
00:55:44is to bear losses.
00:55:46For example,
00:55:48I gave a loan of Rs. 20 crores
00:55:50which had 100% risk.
00:55:52As we saw, Basel 1 says
00:55:54there are 4 types of risk.
00:55:56Let's suppose it was 100% risk.
00:55:58He took Rs. 20 crores
00:56:00and ran away.
00:56:02He did not return it.
00:56:04So, Rs. 20 crores
00:56:06is the loss of the bank.
00:56:08So, where will it come from?
00:56:10It will come from
00:56:12the capital adequacy
00:56:14I have kept.
00:56:16So, whose money is capital adequacy?
00:56:18It is the money of the promoter.
00:56:20It will come from there.
00:56:22And which capital is the
00:56:24money of the promoter?
00:56:26It is shareholder's equity.
00:56:28It is written here,
00:56:30shareholder's equity.
00:56:32It is tier 1 capital.
00:56:34Tier 1 capital
00:56:36absorbs losses first.
00:56:40Suppose a bank has a loss of Rs. 10 crores.
00:56:42Will the bank sell its land
00:56:44for that money?
00:56:46No.
00:56:48Land is sold only when
00:56:50the bank is hit.
00:56:52But that is also important.
00:56:54If the bank is hit,
00:56:56give the money back to the depositors.
00:56:58For that, we call T2 capital
00:57:00as supplementary capital.
00:57:02What does it include?
00:57:04Let's see what it includes.
00:57:06It includes revaluation reserve.
00:57:08Revaluation reserve means,
00:57:10suppose the building in which the bank is,
00:57:12when the bank was opened 50 years ago,
00:57:14its value was Rs. 10 crores.
00:57:16Today, its value is Rs. 100 crores.
00:57:18So, it is being revalued.
00:57:20So, those are the revaluation reserves.
00:57:22Hybrid capital instruments.
00:57:24Subordinated term debt.
00:57:26What does subordinated term debt mean?
00:57:28Suppose
00:57:30the bank issues a bond.
00:57:36People issue bonds
00:57:38to raise money.
00:57:40The bank issues
00:57:42two types of bonds.
00:57:44One with
00:57:467% interest
00:57:48and the other with 12%.
00:57:50So,
00:57:52where will people invest?
00:57:54They will invest in the bank
00:57:56but there is a condition.
00:57:58The condition is,
00:58:00if I get beaten up tomorrow,
00:58:02that is,
00:58:04if I default tomorrow,
00:58:06then
00:58:08first, when I will
00:58:10auction my assets,
00:58:12I will return the money to those
00:58:14who have 7% interest.
00:58:18Why will a person
00:58:20accept subordination
00:58:22when he is getting some benefit?
00:58:26Because
00:58:28if the money is defaulted,
00:58:30then it will be covered
00:58:32with tier 2 capital,
00:58:34which is supplementary capital.
00:58:36It is not the main capital.
00:58:38But then he is getting more interest.
00:58:40So,
00:58:42subordinated term debt
00:58:44generally gives more returns to the bank.
00:58:46But
00:58:48it will be filled with tier 2 capital
00:58:50if the bank is defaulted.
00:58:52So, there are many types of bonds.
00:58:54There are different types of interest on them.
00:58:56There is a bond.
00:58:58The bank issued a bond.
00:59:00You take this bond from me.
00:59:02Invest in it.
00:59:04You will get a fixed return every year.
00:59:06So, subordinated term debt,
00:59:08general loan loss reserves,
00:59:10and undisclosed reserves,
00:59:12all these come in tier 2 capital.
00:59:14This is very important for your MCQs.
00:59:16And tier 2 capital is not
00:59:18as reliable as tier 1.
00:59:20Why?
00:59:22Because it is difficult to calculate
00:59:24accurately and
00:59:26to liquidate it.
00:59:28There is a bank.
00:59:30It has
00:59:32some investments
00:59:34in government securities.
00:59:36Or let's say,
00:59:38the bank has invested in start-ups.
00:59:40Is it easy to withdraw the money?
00:59:42No.
00:59:44Will the bank ask the start-up
00:59:46to return the money?
00:59:48How?
00:59:50Will the bank ask the start-up
00:59:52to return the money?
00:59:54If I invest in a company,
00:59:56I sign a contract
00:59:58to invest for 3 years or 2 years.
01:00:00This is tier 2 capital.
01:00:02It is not easy to withdraw it.
01:00:04It is not easy to calculate it.
01:00:06It is not easy to liquidate it.
01:00:08It is not easy to convert it into real money.
01:00:10Let's say,
01:00:12there is a bank.
01:00:14It has invested 50 crores in studyIQ.
01:00:16I have given 50% of the money to the bank.
01:00:18Let's say,
01:00:20after a week, the bank comes to me
01:00:22and asks me to return the 50% of the money.
01:00:24I am not giving it.
01:00:26I have to grow the company with that money.
01:00:28I have to return it after 2 years.
01:00:30We had discussed about 2 years or 3 years.
01:00:32If the bank
01:00:34has invested in government securities,
01:00:36it is not easy to
01:00:38liquidate the money.
01:00:40It is tier 2 capital.
01:00:42It is not reliable.
01:00:44Let's say, there is a bank's land.
01:00:46Who knows
01:00:48the value of the land?
01:00:50We have to evaluate it.
01:00:52We have to sell it.
01:00:54So,
01:00:56tier 2 capital is not
01:00:58liquid and
01:01:00reliable.
01:01:02But tier 1 capital
01:01:04is the core capital.
01:01:06Any doubt?
01:01:08So, tier 1 and tier 2 capital are clear.
01:01:10Tier 1 capital
01:01:12is 4%.
01:01:14Tier 2 capital is 4%.
01:01:16This is what Basel 1 said.
01:01:188%
01:01:20has to be divided in half.
01:01:22Now, you will say,
01:01:24Sir, if tier 1 capital
01:01:26is more important to save the bank
01:01:28from drowning,
01:01:30and tier 2 capital is less important,
01:01:32then why are both 4%?
01:01:34Why is tier 1 not 6%?
01:01:36Why is tier 2 not 2%?
01:01:38Even if it is 6% and 2%, still 8%?
01:01:40This is also a flaw in Basel 1 norm.
01:01:42Think about it.
01:01:44Why did Basel 2
01:01:46come in Basel 1 norm?
01:01:48If Basel 1 was so good,
01:01:50Basel 2 would have remained as Basel 1.
01:01:52Why did Basel 2 come?
01:01:54There are many flaws in it.
01:01:56I will tell you the flaws.
01:01:58Now, let's study
01:02:00the pros and cons of Basel 1 norm.
01:02:02Pros and cons mean
01:02:04benefit and
01:02:06loss.
01:02:08Let's see the benefit first.
01:02:10The benefit is that it is very simple.
01:02:12There are no hard calculations.
01:02:14It is a very simple
01:02:16framework.
01:02:18Easy to calculate.
01:02:20It gave a very good framework.
01:02:22At least it tried.
01:02:24When these rules came for the first time,
01:02:26they told the world
01:02:28how to calculate
01:02:30a risk.
01:02:32There was no method till now.
01:02:34And they
01:02:36calculated the capital adequacy ratio
01:02:38and minimum
01:02:40capital requirements.
01:02:42They told the world all these things.
01:02:44These are the benefits.
01:02:46But what is the
01:02:48loss?
01:02:50The loss is that
01:02:52it is very oversimplified.
01:02:54It is too simple.
01:02:56It is called simplistic.
01:02:58What is the difference
01:03:00between simple and simplistic?
01:03:02Simple means good.
01:03:04Simplistic means
01:03:06oversimplified.
01:03:08For example,
01:03:10it talks about only one type of risk.
01:03:12Credit risk.
01:03:14But as I told you,
01:03:16there are many types of risk.
01:03:18Cyber security risk.
01:03:20Operational risk. Market risk.
01:03:22In 2008,
01:03:24when all these banks
01:03:26were defaulted.
01:03:28Many banks were defaulted.
01:03:30What was that?
01:03:32Suppose,
01:03:34when there was a war
01:03:36between Ukraine and Russia,
01:03:38all the banks' shares
01:03:40were 20-15% down.
01:03:42Was it the fault of the banks?
01:03:44No.
01:03:46The impact of the market
01:03:48is also on the banks.
01:03:50But
01:03:52Basel 1 does not say so.
01:03:54According to Basel 1,
01:03:56banks will be troubled
01:03:58only when the lender
01:04:00does not return the loan.
01:04:02It only talks about credit risk.
01:04:04It does not talk about
01:04:06operational risk, market risk.
01:04:08This is the biggest drawback
01:04:10in Basel 1.
01:04:12Then, it only tells
01:04:144 risk weightages.
01:04:160, 20, 50, 100.
01:04:18And there are no categories in them.
01:04:20For example,
01:04:22Suppose,
01:04:24I talk about
01:04:26corporate loan.
01:04:28Corporate loan.
01:04:30What does Basel 1 say?
01:04:32Corporate loan means
01:04:34there is 100% risk in it.
01:04:36But,
01:04:38is there 100% risk
01:04:40in all corporate companies?
01:04:42Suppose,
01:04:44you are giving a loan to Tata.
01:04:46You are giving a loan to Tata.
01:04:48And you are giving a loan
01:04:50to a new startup.
01:04:52Is the risk of both the companies
01:04:54the same?
01:04:56No.
01:04:58That is why it is very simple.
01:05:00There is not as much risk
01:05:02in giving a loan to Tata
01:05:04as there is in giving a loan
01:05:06to a new startup.
01:05:08But, in Basel 1,
01:05:10there is 100% risk in both.
01:05:12100% risk in corporate loan
01:05:14and 100% risk in all the types
01:05:16of other loans.
01:05:18There is a difference in both.
01:05:20In fact,
01:05:22banks have to take this call.
01:05:24Because, MSMEs
01:05:26or small businesses
01:05:28or new industries
01:05:30may give more interest
01:05:32to the banks.
01:05:34Because,
01:05:36there are thousands of banks
01:05:38giving loans to Tata.
01:05:40Tata can take a loan from anyone.
01:05:42But, this small company
01:05:44will not get a loan easily.
01:05:46What is the problem of MSMEs?
01:05:48They do not get loans.
01:05:50MSMEs do not get
01:05:52loans easily.
01:05:54This is the problem.
01:05:56So,
01:05:58Tata vs New Startup
01:06:00Basel 1 has 100% risk in both.
01:06:02But, this is not true.
01:06:04That is,
01:06:06the risk within a category
01:06:08is different.
01:06:10This is what it ignores.
01:06:12There are many banks
01:06:14that give loans to new startups
01:06:16because they want more profit.
01:06:18Because, the new startup
01:06:20will be ready to take a loan.
01:06:22Because, he is not getting a loan.
01:06:24And when he is not getting a loan,
01:06:26he will be ready for more interest.
01:06:28So, the bank can take a call
01:06:30that I will give loans to startups.
01:06:32So, it ignores all this.
01:06:34This is very simplistic.
01:06:36And, there is only one pillar of this.
01:06:38Minimum Capital Requirement.
01:06:40Okay?
01:06:42Second thing,
01:06:44it does not identify
01:06:46other types of risks.
01:06:48It does not identify
01:06:50macroeconomic risks.
01:06:52For example,
01:06:54in a country,
01:06:56for example, in Myanmar,
01:06:58you know the situation
01:07:00of banks in Myanmar.
01:07:02But, is there any fault of banks?
01:07:04No.
01:07:06So, it does not consider
01:07:08macroeconomic scenarios.
01:07:10Okay?
01:07:12There are some things
01:07:14that are against profitability.
01:07:16For example,
01:07:18Basel 1 says,
01:07:20you give a loan to the government
01:07:22because there is 0% risk.
01:07:24But, the risk is less.
01:07:26It is zero.
01:07:28But, the government will not give you
01:07:30that much interest.
01:07:32The government will give you
01:07:344% interest or 5%.
01:07:36But, the private
01:07:38or corporate,
01:07:40even if they have 100%,
01:07:42the corporate will give you more interest.
01:07:44But,
01:07:46it does not teach banks
01:07:48to take risks.
01:07:50It is against profitability.
01:07:52Even if you
01:07:54try to save the bank,
01:07:56you will not be able to
01:07:58make a profit.
01:08:00So, it is against
01:08:02profitability.
01:08:06And, as I said,
01:08:08corporate loans can be different.
01:08:10New vs Established.
01:08:12So, this is just to explain
01:08:14the shortcomings of Basel 1.
01:08:18So,
01:08:20let me give you
01:08:22some more examples
01:08:24of shortcomings of Basel 1.
01:08:26The riskiness
01:08:28depends on
01:08:30many factors.
01:08:34For example,
01:08:36if you are giving a personal loan
01:08:38to someone,
01:08:40a person A and a person B.
01:08:42According to Basel,
01:08:44there is a 100% risk.
01:08:46But, the person A
01:08:48and B,
01:08:50if you look at their credit history,
01:08:52A has already taken 4 loans
01:08:54and repaid all of them on time.
01:08:56He has a good civil score.
01:08:58His income is also good.
01:09:00The dependent people
01:09:02are also less.
01:09:04His disposable income is also good.
01:09:06So, the chance of
01:09:08the loan coming back
01:09:10is more.
01:09:12And, the person B
01:09:14has a bad credit history.
01:09:16He might have defaulted a few loans.
01:09:18So,
01:09:20there is not much risk in both.
01:09:22So, these things are not considered.
01:09:24Okay?
01:09:26So,
01:09:28let me give you an example of a home loan.
01:09:30Now, all home loans
01:09:32are not equally risky.
01:09:34For example,
01:09:36I took a loan from a bank
01:09:38and I built a house
01:09:40in a place where
01:09:42there is a lot of growth.
01:09:44Where the price of land is increasing rapidly.
01:09:46So, the bank will say
01:09:48that I will give him a loan easily.
01:09:50Because,
01:09:52even if there is a default,
01:09:54I will earn a profit
01:09:56in the price of land.
01:09:58Collateral is secured.
01:10:00But,
01:10:02I built a house in such a place
01:10:04where
01:10:06there is no scope.
01:10:08That is,
01:10:10there can be a lot of sub-categories
01:10:12of risk in a loan.
01:10:14Basel I
01:10:16ignores them.
01:10:18Here,
01:10:20there are two more things
01:10:22that he ignores.
01:10:24One is securitization
01:10:26and the other is
01:10:28regulatory arbitrage.
01:10:30Now, what is all this?
01:10:32These are probably
01:10:34things above your level,
01:10:36but let me tell you.
01:10:38Securitization happens when
01:10:40you convert a loan
01:10:42into marketable securities.
01:10:44That is called securitization.
01:10:46For example,
01:10:48a bank gave
01:10:50a loan of 1000 crores
01:10:52and divided that 1000 crores
01:10:54into 5 parts.
01:10:56Let's assume that
01:10:58a bank gave a loan of 1000 crores
01:11:00and only gave
01:11:02a personal loan
01:11:04in which there is 100% risk.
01:11:06But they also divided
01:11:08that 1000 crores into 5 parts.
01:11:10These categories
01:11:12are made by the bank itself.
01:11:14Let's assume A, B, C, D, E.
01:11:16A is those whose
01:11:18credit history is very good.
01:11:20Okay?
01:11:22B is those
01:11:24who are less good than them.
01:11:26C is those who are less than them.
01:11:28Then,
01:11:30these 3 categories
01:11:32A, B, and C,
01:11:34because they have
01:11:36less risk
01:11:38and D and E have
01:11:40more risk,
01:11:42what did the bank do?
01:11:44They converted
01:11:46their loan
01:11:48into a bond.
01:11:50What did the bank do?
01:11:52Let's suppose it is 1000 crores.
01:11:54Let's assume that
01:11:56in these 5 categories,
01:11:58there is a loan of 200 crores.
01:12:00The chances of coming back
01:12:02from A are the highest.
01:12:04Their credit history is the best.
01:12:06Everything is good.
01:12:08So, this bond is
01:12:10the highest quality bond.
01:12:12The bank said,
01:12:14I am converting my asset
01:12:16into a bond.
01:12:18So, when you convert your asset
01:12:20into marketable securities,
01:12:22it is called securitization.
01:12:24The bank said to the public,
01:12:26this loan of 200 crores,
01:12:28you should invest in this.
01:12:30And because
01:12:32the chances of coming back
01:12:34are very high,
01:12:36this is a high quality bond.
01:12:38But I will give you
01:12:40less interest because
01:12:42the chances of coming back
01:12:44are very high.
01:12:46The bank converted
01:12:48the E category into a bond.
01:12:50This is the lowest quality bond.
01:12:52The bank said,
01:12:54I will give you 11% interest.
01:12:56So, the public will invest
01:12:58according to their risk appetite.
01:13:00But Basel 1 does not
01:13:02talk about this.
01:13:04Securitization is a very good
01:13:06method of the bank in which
01:13:08they convert the assets into
01:13:10marketable securities.
01:13:12But according to Basel 1,
01:13:14you cannot do this because
01:13:16there is no category of A, B, C, D.
01:13:18And the second is
01:13:20Regulatory Arbitrage.
01:13:22Now, what is Regulatory Arbitrage?
01:13:24Now, understand this carefully.
01:13:26Regulatory Arbitrage is
01:13:28that in the same category,
01:13:30I am applying two different laws.
01:13:32For example,
01:13:34in A, B, and C, the risk is less.
01:13:36In A, it is very less.
01:13:38So, in return,
01:13:40will the bank
01:13:42want to keep capital adequacy?
01:13:44There is almost 100%
01:13:46surety in this.
01:13:48There is almost 100% surety
01:13:50that the money will come back
01:13:52from category A.
01:13:54So, the bank
01:13:56can take all these complex calls.
01:13:58The bank
01:14:00can reduce
01:14:02its risk
01:14:04without keeping
01:14:06extra capital.
01:14:08If they
01:14:10make subcategories in the same category.
01:14:12Regulatory Arbitrage
01:14:14means when banks
01:14:16structure their activities
01:14:18in such a way that
01:14:20regulation or any law
01:14:22reduces its impact
01:14:24without affecting
01:14:26the risk.
01:14:28So, all these things
01:14:30are not possible in Basel 1.
01:14:32Securitization,
01:14:34Regulatory Arbitrage, etc. are not possible.
01:14:36Today, every bank does this.
01:14:38Every bank checks
01:14:40your credit history,
01:14:42banking history, income,
01:14:44everything.
01:14:46So, Basel 1 is over.
01:14:48We adopted Basel 1.
01:14:50But,
01:14:52with time,
01:14:54we felt the need
01:14:56to update
01:14:58and upgrade them.
01:15:00And then
01:15:02Basel Norms 2 came.
01:15:06Basel Norms 2.
01:15:08It was introduced in 2004.
01:15:10India also adopted it.
01:15:12And
01:15:14this is the updated version
01:15:16of Basel 1.
01:15:18These guidelines
01:15:20are on three pillars.
01:15:22By the way,
01:15:24how many pillars were there in Basel 1?
01:15:26Only one.
01:15:28Minimum Capital Requirement.
01:15:30But,
01:15:32there are two more pillars here.
01:15:34They are Supervisory Review
01:15:36and Market Discipline and Disclosure.
01:15:38Let's study
01:15:40these pillars first.
01:15:42Minimum Capital Requirement
01:15:44was 8%
01:15:46in Basel 1.
01:15:484% in tier 1
01:15:50and 4% in tier 2.
01:15:528% was simple.
01:15:544% in tier 1
01:15:56and 4% in tier 2.
01:15:58This was in Basel 1.
01:16:00Basel 2 said
01:16:02to keep 8%.
01:16:04Capital Requirement is 8%.
01:16:06There is no change in it.
01:16:08But,
01:16:104% in tier 1
01:16:12is same as Basel 1.
01:16:14But,
01:16:162% in this 4%
01:16:18should be
01:16:20CET1 Capital.
01:16:22Here, you are hearing a new term.
01:16:24CET1 Capital is nothing.
01:16:26It is Shareholder's Equity.
01:16:28Let me take you back to
01:16:30T1 and T2 Capital.
01:16:32There are many things
01:16:34in T1 Capital.
01:16:36Among them,
01:16:38Shareholder's Equity
01:16:40is the most important.
01:16:42Shareholder's Equity,
01:16:44Capital, Promoter's Capital.
01:16:46The person who started
01:16:48the bank,
01:16:50his own money.
01:16:52You can also call it
01:16:54Paid-Up Capital.
01:16:56There are some technical differences.
01:16:58I will clear them with time.
01:17:00The money invested
01:17:02while starting the bank.
01:17:04Promoter's Capital.
01:17:06So,
01:17:10in tier 1 also,
01:17:12the 4%
01:17:14capital that will be there,
01:17:162% of that
01:17:18will be Common Equity Capital
01:17:20or Shareholder's Capital.
01:17:22This is added in small things.
01:17:24Because again,
01:17:26Promoter's money is very important.
01:17:28To save a bank.
01:17:30To save a bank.
01:17:32The whole game is in
01:17:34Capital Adequacy Ratio.
01:17:36So,
01:17:38Basel 1 said 8%.
01:17:40Basel 2 also said 8%.
01:17:42Basel 1 said
01:17:444 tier 1 capital out of 8
01:17:46and 4 tier 2 capital.
01:17:48Basel 2 also said the same.
01:17:504 tier 1 and 4 tier 2.
01:17:52The only difference is
01:17:54the 4% of tier 1
01:17:56also has 2%
01:17:58of Common Equity
01:18:00or CET Capital.
01:18:02You can also call it as Shareholder's Capital.
01:18:04Or you can also call it as
01:18:06Paid-Up Capital.
01:18:08It should be 2%.
01:18:10Then, what is Supervisory Review?
01:18:12Which was not there
01:18:14in Basel 1.
01:18:16This is in 3 pillars of Basel 2.
01:18:18MCQ is the favorite MCQ
01:18:20in the exam.
01:18:22How many pillars
01:18:24are there in Basel 2?
01:18:26There are 3 pillars.
01:18:28Minimum Capital Requirement
01:18:30and Supervisory Review
01:18:32and Market Discipline and Disclosure.
01:18:34Supervisory Review means
01:18:36a framework
01:18:38which can handle
01:18:40many types of risks.
01:18:42Like Liquidity Risk.
01:18:44So,
01:18:46there should be a supervisor.
01:18:48And that is RBI.
01:18:50In India.
01:18:52RBI also saves a bank
01:18:54from liquidity risk.
01:18:56Now, if
01:18:58our country's banks have less money,
01:19:00then what does RBI do?
01:19:02To push liquidity,
01:19:04it reduces the repo rate.
01:19:06So that banks can take
01:19:08cheaper loans.
01:19:10It is saving banks from
01:19:12liquidity risk.
01:19:14So, RBI
01:19:16is a supervisor.
01:19:18So, Supervisory Review
01:19:20is also a pillar.
01:19:22If we want to save a bank,
01:19:24then Minimum Capital Requirement
01:19:26is not enough.
01:19:28Supervisory Review is also necessary.
01:19:30This is added in Basel 2.
01:19:32And Market Discipline and Disclosure.
01:19:34All the banks
01:19:36should keep publishing their reports
01:19:38from time to time.
01:19:40So that the market knows
01:19:42how much water the bank is in.
01:19:44Whether they are well capitalized or not.
01:19:46Whether they have Buffer Capital or not.
01:19:48How much non-performing assets
01:19:50they have.
01:19:52That's why every bank in India
01:19:54publishes its quarterly report.
01:19:56It publishes its report every 3 months.
01:19:58In which it tells everything.
01:20:00It publishes its annual report separately.
01:20:02It publishes its 6-monthly report separately.
01:20:04It publishes its 6-monthly report separately.
01:20:06It publishes its monthly report separately.
01:20:08There are some banks.
01:20:10I am telling you according to different criteria.
01:20:12For example, SBI
01:20:14publishes its quarterly report separately.
01:20:16So, what is the benefit of this?
01:20:18This gives all the information
01:20:20about that bank to the public.
01:20:22And more importantly,
01:20:24to the RBI as well.
01:20:26And all the other financial institutions
01:20:28that are working with that bank
01:20:30and are dependent on that bank.
01:20:32They also get it.
01:20:34Clear?
01:20:36So, Market Discipline and Disclosure.
01:20:38From time to time,
01:20:40the participants,
01:20:42the banks,
01:20:44disclose all the information
01:20:46about that bank.
01:20:48So, Basel 2 said
01:20:50that in a year,
01:20:52at least once in two years.
01:20:54Okay?
01:20:56But quarterly, half yearly,
01:20:58all kinds of reports are disclosed
01:21:00by the banks.
01:21:02So, this is Market Discipline and Disclosure.
01:21:04This is the third pillar of Basel 2.
01:21:08Now, if I ask you
01:21:10about risk.
01:21:12So, Basel 1 talked about
01:21:14credit risk.
01:21:16But Basel 2 talks about
01:21:18three types of risk.
01:21:20Broadly,
01:21:22there are three types of risk.
01:21:241. Credit risk.
01:21:26But apart from that,
01:21:282. Market risk.
01:21:303. Operational risk.
01:21:32What is Operational risk?
01:21:34It is the risk
01:21:36caused by the individual's mistake.
01:21:40Suppose your manager
01:21:42commits a fraud.
01:21:44Internal fraud, external fraud.
01:21:46Cyber security risk.
01:21:48Your cyber security team is not good.
01:21:50Hacking has happened.
01:21:52So, in a way,
01:21:54it will be believed that
01:21:56the bank's cyber security team was not good.
01:21:583rd party risk.
01:22:00The bank gave the job of
01:22:02making its software to a third party.
01:22:04That third party leaked all the data
01:22:06and the bank's app was also damaged.
01:22:08All the data was also lost.
01:22:12This is Operational risk.
01:22:14The operations of the bank
01:22:16every day,
01:22:18are buffered by
01:22:20Operational risk.
01:22:24They are told about Operational risk.
01:22:26We have to buffer it.
01:22:28Buffering means reducing something.
01:22:30Reducing the effect of something.
01:22:32So,
01:22:34Operational risk,
01:22:36business disruption, system failure,
01:22:38all these are Operational risk.
01:22:40Then there is market risk.
01:22:42I told you about market risk.
01:22:44If the whole market is bad,
01:22:46suppose a war breaks out,
01:22:48or if the market falls,
01:22:50then the shares of the bank will also fall.
01:22:52The overall market
01:22:54also affects the bank.
01:22:56So,
01:22:58the bank may face losses
01:23:00due to movement in market prices.
01:23:02Default risk,
01:23:04interest rate risk, credit spread risk,
01:23:06equity risk, foreign exchange risk,
01:23:08market risk.
01:23:10Suppose tomorrow,
01:23:12due to some reason,
01:23:14the dollar price becomes
01:23:16stronger than the rupee,
01:23:18then the bank will also be affected.
01:23:20So, that is market risk.
01:23:22Okay?
01:23:24So, Basel 1 only talked about
01:23:26credit risk, but Basel 2
01:23:28also talks about market risk
01:23:30and operational risk.
01:23:34In Basel 2,
01:23:36a very good innovation was done
01:23:38that in this,
01:23:40many types of
01:23:42credit rating assets were discussed
01:23:44so that we can
01:23:46calculate their risk weight.
01:23:48For example, in Basel 1,
01:23:50it was divided into 4 parts.
01:23:520% risk in 1,
01:23:5420% risk in 1,
01:23:5650% risk in 1, and 100% risk in 1.
01:23:58But this is not the case in Basel 2.
01:24:00In Basel 2,
01:24:02we can give them many types of ratings.
01:24:04For example,
01:24:06AAA
01:24:08and AA
01:24:10minus,
01:24:12we have given 100%.
01:24:14There is a very wide range in this.
01:24:16For example,
01:24:18let's say,
01:24:20personal loan or corporate loan.
01:24:22So, if Basel 1,
01:24:24the table above is according to Basel 1,
01:24:26then in any category,
01:24:28there is 100% risk in all.
01:24:30The risk weight is 100% in all.
01:24:32But,
01:24:34what does Basel 2 do?
01:24:36It gives me a very wide range.
01:24:38I can also divide
01:24:40corporate loans
01:24:42in many categories.
01:24:44For example,
01:24:46AAA and AA.
01:24:48The more you go towards A and above,
01:24:50the lower the risk will be.
01:24:52If you go towards
01:24:54CD and below,
01:24:56the risk will increase.
01:24:58For example,
01:25:00A and A-.
01:25:02This means,
01:25:04it gives credit rating to loans.
01:25:08And in today's time,
01:25:10these credit ratings are given by
01:25:12credit rating agencies.
01:25:14For example, Moody's,
01:25:16Standard and Poor,
01:25:18Fitch.
01:25:22So, it gives many types of ratings.
01:25:24For example,
01:25:26if there is a plus to a minus category,
01:25:28then there is a risk of 50%.
01:25:32If there is a plus to a minus category,
01:25:34then there is a risk of 100%.
01:25:36If there is a plus to a minus category,
01:25:38then there is a risk of 150%.
01:25:44So, there is a wide range in this.
01:25:48In one loan,
01:25:50there is a wide range in terms of
01:25:52credit rating.
01:25:54This is a big innovation
01:25:56of Basel 2.
01:25:58According to the credit rating,
01:26:00it allots the risk weightage.
01:26:02The better your credit rating is,
01:26:04the lower the risk will be.
01:26:10And,
01:26:12what is the minimum capital requirement
01:26:14in Basel 2?
01:26:16I have told you.
01:26:188%.
01:26:204% in tier 1 and 4% in tier 2.
01:26:22Okay?
01:26:24But,
01:26:262% of that 4% in tier 1
01:26:28will be CET1.
01:26:30Which means,
01:26:32Shareholder's Equity.
01:26:34Or Common Equity.
01:26:362%.
01:26:38This is for your MCQs.
01:26:42Now, let's talk about
01:26:44the shortcomings in Basel 2.
01:26:46See,
01:26:48when did Basel 2 come in 2004?
01:26:50Now,
01:26:52many countries did not even start
01:26:54applying it properly.
01:26:56The recession of 2007-2008 came.
01:27:00Now,
01:27:02it is clear that
01:27:04Basel 2 is not enough.
01:27:06If Basel 2 was enough,
01:27:08so many countries
01:27:10applied Basel 2 till 2008.
01:27:12But,
01:27:14was it able to stop the recession?
01:27:16Was it able to stop the banking system
01:27:18from collapsing?
01:27:20So,
01:27:22what was the shortcoming of Basel 2?
01:27:24It was
01:27:26what is written here.
01:27:28For example,
01:27:30Basel 2 underestimated
01:27:32the risks in the system.
01:27:34The risks of current
01:27:36banking practices.
01:27:38And,
01:27:40the financial system was
01:27:42undercapitalized.
01:27:44More capital was needed.
01:27:46More controls were needed.
01:27:48This was understood later.
01:27:50What he said
01:27:52was not enough.
01:27:54The banking system
01:27:56was undercapitalized.
01:27:58The capital he suggested
01:28:00was 8%
01:28:02and then 4%,
01:28:04and then 2%.
01:28:06That was not enough.
01:28:08Banks
01:28:10find it difficult to predict
01:28:12rare but large events.
01:28:14For example,
01:28:16the recession
01:28:18was a very rare case
01:28:20in 2008.
01:28:22Such events
01:28:24occur once in 50 years
01:28:26and once in 25 years.
01:28:28They are rare but large.
01:28:30Basel 2 was unable to predict them.
01:28:34Market disclosure,
01:28:36as it was said that
01:28:38banks give their annual reports
01:28:40every 3 months,
01:28:42every year,
01:28:44was not checked properly.
01:28:46Investors
01:28:48were unable to analyze
01:28:50market disclosures properly.
01:28:52And,
01:28:54due to this,
01:28:56they were unable to get
01:28:58proper warnings.
01:29:00The banks that issued
01:29:02their reports
01:29:04in the market
01:29:06were not able to
01:29:08read them properly.
01:29:10They were unable
01:29:12to give proper warning signals.
01:29:16And,
01:29:18external credit rating agencies
01:29:20may not understand the risk
01:29:22associated with the firm's operation.
01:29:24As I told you,
01:29:26in Basel 2,
01:29:28credit rating agencies
01:29:30started giving various ratings.
01:29:34So,
01:29:36credit rating agencies
01:29:38used to give ratings
01:29:40which the banks
01:29:42were unable to understand.
01:29:44So,
01:29:46they had to go deep
01:29:48into the bank
01:29:50to understand
01:29:52the bank's operation,
01:29:54supply chain,
01:29:56and employees.
01:29:58Credit rating agencies
01:30:00were unable to understand
01:30:02the operational risk
01:30:04of the bank.
01:30:06So,
01:30:08this was the
01:30:10recession of 2008.
01:30:14Now, let's talk about Basel 3.
01:30:18In Basel 3,
01:30:20the financial crisis of 2008,
01:30:22the Basel Committee
01:30:24of Banking Supervision
01:30:26released the Basel 3
01:30:28guideline in 2010.
01:30:30What was the difference?
01:30:34Minimum capital requirement
01:30:36was 8%.
01:30:38I am not talking about India.
01:30:40We will see the 9% in India later.
01:30:42Basel 1 was also 8%.
01:30:44Basel 2 was also 8%.
01:30:46Basel 3 was also 8%.
01:30:48There was a slight difference.
01:30:52In Basel 2, it was 8%.
01:30:54In Tier 1 and Tier 2, it was 4.
01:30:56In Tier 1, it was 2% out of 4.
01:30:58Let's see what happened here.
01:31:00Here,
01:31:02as I told you,
01:31:04Tier 1 capital is the real capital.
01:31:06So, Basel 3 said
01:31:08that
01:31:10keep only 8%.
01:31:12But,
01:31:14divide that 8%
01:31:16in Tier 1 and Tier 2.
01:31:18As Tier 1 is more important,
01:31:20Tier 1 should be more.
01:31:22Not 4-4,
01:31:24but 6-2.
01:31:26Now, you have to
01:31:28keep Tier 1 as 6%
01:31:30and Tier 2 as 2%.
01:31:32Okay?
01:31:34Not only this,
01:31:36Tier 1's 6
01:31:38will have
01:31:404.5%
01:31:42CET1 capital.
01:31:44Because shareholder's equity
01:31:46is more important.
01:31:48In Tier 1 also,
01:31:50shareholder's equity
01:31:52is more important.
01:31:56It means
01:31:58when we go from Basel 1
01:32:00to Basel 3,
01:32:02we are giving more importance
01:32:04to Tier 1 capital.
01:32:06Let me tell you a big difference
01:32:08between Tier 1 and Tier 2.
01:32:10Tier 1 is core capital
01:32:12and Tier 2 is supplementary capital.
01:32:14If in a bank,
01:32:16Tier 2 capital is more,
01:32:20it means
01:32:22after beating the bank,
01:32:24we want to save
01:32:26the depositors.
01:32:28We want to save them.
01:32:30Listen to this carefully.
01:32:32There are only two people in a bank.
01:32:34One is a shareholder,
01:32:36promoter, owner,
01:32:38and the other is a depositor.
01:32:40If we want more
01:32:42Tier 2 capital,
01:32:44it means
01:32:46if the bank is beaten,
01:32:48my depositors should be safe.
01:32:50It is a highly
01:32:52conservative thought.
01:32:54Think about
01:32:56why should the bank be beaten?
01:32:58Why should the bank
01:33:00fail?
01:33:02The earlier thought was
01:33:04very conservative.
01:33:06If the bank fails,
01:33:08the depositors
01:33:10should be protected.
01:33:12Keep Tier 2 capital as much as Tier 1.
01:33:14But not anymore.
01:33:16Now they say
01:33:18that if Tier 1 capital is real capital,
01:33:20is the core capital,
01:33:22is what protects the bank,
01:33:24is what protects the bank,
01:33:26then keep Tier 1 capital more.
01:33:28Why do you let the bank fail?
01:33:30So the thought changed.
01:33:32That's why in Basel 3,
01:33:34Tier 1 capital should be more.
01:33:36And in Tier 1 capital,
01:33:38what is there?
01:33:40Shareholder's equity.
01:33:42CET1 capital.
01:33:44It should be more.
01:33:46So,
01:33:48this is a big difference
01:33:50between Basel 2 and Basel 3.
01:33:52In Basel 2,
01:33:548%, 4%,
01:33:56and 4% in Tier 1,
01:33:582% CET1 capital.
01:34:00And in Basel 3,
01:34:028%,
01:34:04but 6%
01:34:06Tier 1 and 2% Tier 2.
01:34:08And in this 6%,
01:34:104.5%
01:34:12CET1 capital.
01:34:14Clear?
01:34:16And in India, because we say 9%,
01:34:18in India,
01:34:20RBI keeps 1% more
01:34:22because we want to be more safe.
01:34:24So, how much is Tier 1?
01:34:267%. Instead of 6, it is 7.
01:34:28And Tier 2 is 2%
01:34:30in India.
01:34:32But out of these 7,
01:34:345.5% should be CET1 capital
01:34:36or shareholder's equity.
01:34:38This is with respect to India.
01:34:40So, whoever comes to MCQ,
01:34:42they will come with respect to India.
01:34:44The direct question is,
01:34:46according to Basel 3 norms,
01:34:48how much should be
01:34:50Tier 1 capital?
01:34:52It should be 7%.
01:34:54Then we will ask,
01:34:56according to Basel 3 norms,
01:34:58how much should be
01:35:00CET1 capital?
01:35:02It should be 5.5% in India.
01:35:04Out of these 7,
01:35:065.5% should be CET1 capital.
01:35:08Clear? Basel 3.
01:35:10Apart from this,
01:35:12only
01:35:149% will not work.
01:35:16I am talking about India.
01:35:18So, RBI said,
01:35:20keep a little more.
01:35:22How much should we keep?
01:35:24Two types of buffer.
01:35:26Buffer means keep a little more money.
01:35:28One is capital conservation buffer
01:35:30and the other is
01:35:32counter-cyclical buffer.
01:35:34What is capital conservation buffer?
01:35:38Your risk-weighted assets,
01:35:40you are keeping 9% of them
01:35:42in the form of capital adequacy ratio.
01:35:44That is fine.
01:35:46But you should keep 2.5% more.
01:35:502.5% more.
01:35:52So, this is
01:35:54capital conservation buffer.
01:35:56That means,
01:35:58India has 11.5% capital requirement.
01:36:009% is
01:36:02capital adequacy ratio
01:36:04and 2.5% is capital conservation buffer.
01:36:06One more thing.
01:36:08Where will 2.5%
01:36:10come from?
01:36:12Will it come from T1 capital
01:36:14or T2?
01:36:16It will come from T1
01:36:18and from T1 also,
01:36:20it will come from shareholder equity
01:36:22i.e. from CET1.
01:36:24So, it will only come from CET1 capital.
01:36:26India's banks are
01:36:28very safeguarded.
01:36:30So, 9%
01:36:32will have to be kept.
01:36:342.5% more will have to be kept.
01:36:36And that 2.5% will be
01:36:38promoter equity i.e. CET1 capital.
01:36:40So, in a way,
01:36:42India has 11.5% capital requirement.
01:36:449% is capital adequacy ratio
01:36:46and 2.5% is
01:36:48capital conservation buffer.
01:36:502.5% more will have to be kept
01:36:52for risk-weighted assets.
01:36:54Okay?
01:36:56And not only this,
01:36:58from time to time,
01:37:00this RBI will tell you
01:37:02anything between 0 to 2.5%.
01:37:04If there are some periods
01:37:06where credit growth is very high,
01:37:08there are some periods
01:37:10when banks give a lot of loans.
01:37:12Like Diwali, Christmas,
01:37:14which is the season of festivals,
01:37:16banks give a lot of loans.
01:37:18So, in periods of
01:37:20high credit growth,
01:37:22some or the other
01:37:24counter-cyclical buffer
01:37:26will have to be kept.
01:37:28But this will only have to be kept
01:37:30in the period of high credit growth.
01:37:32Anything can happen between 0 to 2.5%.
01:37:34Sometimes RBI will say
01:37:36that credit growth is very high.
01:37:38Keep 1% more than 11.5%.
01:37:40Now, how much will you keep?
01:37:42RBI will tell you from time to time.
01:37:44So, the counter-cyclical buffer
01:37:46can be anything between 0 to 2.5%.
01:37:48Okay?
01:37:50So, this Basel III
01:37:52is in India.
01:37:54This thing is in Basel III.
01:37:56Apart from this, Basel III
01:37:58has brought three more ratios.
01:38:00So, in that,
01:38:02there is a leverage ratio.
01:38:04The concept of leverage ratio
01:38:06is only in Basel III.
01:38:08What should be the leverage ratio
01:38:10in India? According to RBI's
01:38:12latest guidelines,
01:38:144% in domestic systemically
01:38:16important banks
01:38:18and 3.5% in other banks.
01:38:20What is the leverage ratio?
01:38:22The leverage ratio is
01:38:24the tier 1 capital of the bank
01:38:26divided by
01:38:28the total assets of the bank
01:38:30into 100.
01:38:32This leverage ratio
01:38:34is the
01:38:36tier 1 capital
01:38:38as a percentage
01:38:40of the
01:38:42bank's exposure.
01:38:44This is called leverage ratio.
01:38:46And this should be 4%
01:38:48for domestic systemically important banks
01:38:50and 3.5% for other banks.
01:38:52In India, only three banks got
01:38:54DSIB status. HDFC Bank,
01:38:56ICICI Bank and
01:38:58State Bank of India.
01:39:00These banks' assets are more than
01:39:022% of the GDP of India.
01:39:04That's why they are called DSIB Bank.
01:39:06They can't fail.
01:39:08If they fail,
01:39:10it will affect our entire
01:39:12domestic economy.
01:39:14Our economy can crash.
01:39:16It will have a negative effect.
01:39:18It will affect our trades.
01:39:20HDFC, ICICI and SBI
01:39:22are domestic systemically important banks.
01:39:24Okay?
01:39:26Keep this in mind.
01:39:28This is leverage ratio.
01:39:30And 3.5%
01:39:32is for other banks.
01:39:34In other banks,
01:39:36Punjab National Bank and other banks.
01:39:38Except these three banks.
01:39:40How do we define leverage ratio?
01:39:42Under Basel 3 norms,
01:39:44tier 1 capital as a percentage
01:39:46of the bank's exposure.
01:39:48If the leverage ratio is high,
01:39:50then the profitability
01:39:52of the bank can be low.
01:39:54But we don't care about
01:39:56that.
01:39:58We want tier 1 capital from the bank.
01:40:00So that it is not insolvent.
01:40:02Okay?
01:40:04If there are more capital reserves,
01:40:06especially tier 1,
01:40:08then the bank can easily survive
01:40:10the financial crisis.
01:40:12And here you can see,
01:40:14if the bank doesn't maintain leverage ratio,
01:40:16these are the latest guidelines of RBI.
01:40:18Then also,
01:40:20prompt corrective action will be required.
01:40:22Against them,
01:40:24the Reserve Bank can take
01:40:26prompt corrective action.
01:40:28Any doubt?
01:40:30These are the different criteria.
01:40:32We will discuss these in detail in PCA.
01:40:34Apart from this,
01:40:36Basel 3 talks about two more ratios.
01:40:38One is liquidity coverage ratio.
01:40:42What is liquidity coverage ratio?
01:40:44A bank
01:40:48can calculate
01:40:50in the next 30 days,
01:40:52in the next month,
01:40:54how much money
01:40:56it will have to give.
01:40:58That is,
01:41:00the money that has to be given,
01:41:02is called net outgo.
01:41:04If ever there is a stressed condition,
01:41:06the economy is down,
01:41:08if there is any stressed condition,
01:41:10then the bank
01:41:12can see it first.
01:41:14Suppose there is a bank,
01:41:16it has a stressed condition.
01:41:18The bank is not different from the economy.
01:41:20Suppose there is a bank,
01:41:22it has a stressed condition.
01:41:24The bank can see it first.
01:41:26Suppose there is a shortage of money.
01:41:28The bank can calculate it first.
01:41:30In the next 30 days,
01:41:32how much money depositors can come to take.
01:41:34Or how much is the other outgo.
01:41:36The bank can keep it.
01:41:38Highly liquid.
01:41:40That is liquid coverage ratio.
01:41:42Ideally, it should be 100%.
01:41:44Suppose there is a bank.
01:41:46The time of the bank is a bit bad.
01:41:48The time of the bank is a bit bad.
01:41:50The bank can see that
01:41:52in the next one month,
01:41:54people can come to ask for
01:41:56150-200 crores.
01:41:58So, they can do their provisioning first.
01:42:00They can keep 150-200 crores with them.
01:42:02These highly liquid assets,
01:42:04which are called
01:42:06high quality liquid assets.
01:42:08Because people have to give it immediately.
01:42:10High quality liquid assets,
01:42:12like gold,
01:42:14can be monetized immediately.
01:42:16Like cash.
01:42:18All this.
01:42:20So, the liquid coverage ratio
01:42:22should be 100%.
01:42:24That means, in the next 30 days,
01:42:26the bank is very resilient.
01:42:28If the bank sees
01:42:30how much money
01:42:32has to be given in the next 30 days.
01:42:34And already
01:42:36has done 100% provisioning.
01:42:38It shows that the bank is very resilient.
01:42:40At least for one month.
01:42:42That means,
01:42:44a bank shows medium term resiliency.
01:42:46Liquidity coverage ratio.
01:42:50And there is another ratio,
01:42:52which is called net stable fund rate.
01:42:54This should also be 100%.
01:42:56But this shows medium term resiliency.
01:43:00In an ideal scenario, this should also be 100%.
01:43:02This means,
01:43:04net stable fund rate means,
01:43:06in the medium term,
01:43:08like we take 1 year.
01:43:10How much money has to be given
01:43:12in the next 30 days.
01:43:14It should be provisioned.
01:43:16So,
01:43:18banks need to have
01:43:20a stable funding profile.
01:43:22And
01:43:24they should be able to fund
01:43:26their activities.
01:43:28And they should be able to
01:43:30provide money to people.
01:43:32So, they need to have
01:43:34a minimum NSFR requirement of 100%.
01:43:36For the next 1 year horizon.
01:43:38This much money
01:43:40should be provisioned.
01:43:42Liquidity coverage ratio shows
01:43:44short term resilience of a bank.
01:43:46And NSFR shows
01:43:48medium term resilience of a bank.
01:43:50This concept
01:43:52was also brought by Basel 3.
01:43:54Now, if I want to
01:43:56show the difference
01:43:58between Basel 2
01:44:00and Basel 3
01:44:02in one slide.
01:44:04It is very easy.
01:44:06Let's start from the bottom.
01:44:08Basel 2 didn't talk about
01:44:10NSFR.
01:44:12Basel 3 did.
01:44:16Basel 2 didn't talk about
01:44:18leverage ratio.
01:44:20Tier 1 to total
01:44:22exposure of a bank ratio.
01:44:24But Basel 3 did.
01:44:26In India, 4% for DSIB
01:44:28and 3.5% for other banks.
01:44:32It didn't talk about
01:44:34counter-cyclical buffer.
01:44:36RBI will tell you
01:44:38in between 0 to 2.5.
01:44:40Basel 2 didn't talk about
01:44:42minimum liquidity coverage ratio.
01:44:44Basel 3 did.
01:44:46It shows short term
01:44:48resilience.
01:44:50Then, Basel 2 didn't talk about
01:44:52capital conservation buffer.
01:44:54Which is 2.5% more.
01:44:56It came in Basel 3.
01:44:58Capital conservation buffer.
01:45:02In India, it is
01:45:049 plus 2.5.
01:45:06In Basel 3, it is 9%
01:45:08capital adequacy and 2.5%
01:45:10capital conservation buffer.
01:45:12But,
01:45:14in general,
01:45:16RBI didn't talk about it.
01:45:18Capital adequacy ratio.
01:45:20Let's talk about
01:45:22capital requirement.
01:45:24In Basel 2,
01:45:26it was 8%.
01:45:28In Basel 3,
01:45:30it was 11.5%.
01:45:32But, in India,
01:45:34it is 9 plus 2.5.
01:45:36In India, it is 8 plus 2.5.
01:45:38Capital requirement.
01:45:40Because,
01:45:42capital adequacy ratio was same in both.
01:45:448-8.
01:45:46In Basel 3,
01:45:48it didn't change.
01:45:50In Basel 1, it was 8.
01:45:52In Basel 2, it was 8.
01:45:54Yes, it changed in 8.
01:45:56Did you understand?
01:45:58Capital requirement is different.
01:46:00Capital requirement means total.
01:46:02Here, we talk about
01:46:049% capital adequacy ratio
01:46:06and 2.5%
01:46:08capital conservation buffer.
01:46:10In Globalized,
01:46:12it is 8%
01:46:14capital adequacy ratio
01:46:16and 2.5%
01:46:18capital conservation buffer.
01:46:20Total capital requirement
01:46:22should be 10.5% of risk-weighted assets.
01:46:24According to Basel 3.
01:46:26In India, it is 11.5%.
01:46:28In Basel 2, it is 8.
01:46:32In Tier 1 Capital,
01:46:34it was 4%.
01:46:36In Basel 2,
01:46:38it is 8%.
01:46:40In Basel 2,
01:46:42it is 4%.
01:46:44In Basel 3,
01:46:46it is 6.2%.
01:46:48Because, Tier 1 is more important.
01:46:50So, it is 6%.
01:46:52In CET,
01:46:54it is
01:46:56CET1 Capital.
01:46:58In Tier 1,
01:47:00how much shareholder equity is there?
01:47:02In Basel 2,
01:47:04it is 4%.
01:47:06In Basel 2, it is 2%.
01:47:08CET1 Capital.
01:47:10But, in Basel 3,
01:47:12it is 6.2%.
01:47:14In Basel 3, it is 6.2%.
01:47:16In Basel 3, it is 4.5%.
01:47:20CET1 Capital.
01:47:22In India,
01:47:24it is 5.5%.
01:47:26In India,
01:47:28it is 5.5%.
01:47:305.5%.
01:47:32Okay?
01:47:34In CET1 Capital,
01:47:36it is 2%.
01:47:38So, these are the differences
01:47:40between Basel 2 and Basel 3.
01:47:42So, I hope,
01:47:44you understood this video.
01:47:46I tried to give you
01:47:48a conceptual explanation.
01:47:50Basel 1, Basel 2, Basel 3,
01:47:52CET1 Capital, Tier 2 Capital,
01:47:54Leverage Ratio, Liquidity Coverage Ratio,
01:47:56NSFR, we studied a lot of things in this video.
01:47:58Where did we start?
01:48:00How does a bank work?
01:48:02From there to here,
01:48:04we studied it in detail.
01:48:06If you have any doubts,
01:48:08you can email me at
01:48:10gaurabatstudyiq.com
01:48:12I will arrange
01:48:14a doubt class
01:48:16for all our students.
01:48:18Once you complete 4-5 chapters,
01:48:20there will be a common doubt class.
01:48:22If you have any doubts,
01:48:24you can ask me.
01:48:26So, this was the first video
01:48:28on Banking Awareness Static.
01:48:30As I told you,
01:48:32Static Banking Awareness
01:48:34is not easy for anyone.
01:48:36Not even for me.
01:48:38Obviously, there are some concepts
01:48:40which I know very naturally.
01:48:42But to explain them,
01:48:44you have to make a story.
01:48:46There should be an example
01:48:48So, everything I say in the video
01:48:50is not necessarily politically correct.
01:48:52But yes,
01:48:54it is factually correct.
01:48:56So, it is important for your MCQs too.
01:48:58Revise it again and again.
01:49:00You will get the PDF
01:49:02and also the quiz.
01:49:04So, enjoy this course.
01:49:06Thank you.

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