Basel II (Simplified)

Basel I and Basel II are two important rules of Basel Accords which has been made by committee on banking supervision. In these rules, main stress has been given on the strengthening of bank's capital. Now, we are discussing the three main rules of Basel II

1. Minimum capital standards rule

According to basel II, it is the duty of bank to fix minimum capital standards according to its assets and risk level. Now, for applying this first rule, every bank will be interested to calculate minimum capital. But, bank can find that its capital is based on minimum standard. It will tell its capital adequacy ratio. Capital adequacy ratio is


= capital fund/ risk weighted assets of bank X 100.

Capital Fund ={ Tier I  = Paid up capital + Disclosed Reserves + Non redeemable and non cumulative Preference Share capital + Disclosed Reserves }+ { Tier II = Provisions + Revolution Reserves + Undisclosed Reserves + Hybrid Instruments + Subordinate Debt }

CAR on Tier 1 basis must be 6% out of total CAR 9%

Risk Weighted Assets =

Bank's main assets are given loan to customers. So, its risk weight will be under following rules

a) Cash in the hand of bank = 0% Risk weight
b) Balance in Other bank = 20 % risk weight
c) Educational Loans - 75 % risk weight 
d) Retail Loans ( Maximum given loan is Rs. 5 Crores) = 75% risk weight
e) House loan ( Maximum given loan is Rs. 50 Lakh ) = 50% risk weight
f) House loan ( more than Rs. 50 Lakh ) = 75% risk weight
g) Personal Loan = 125% risk weight

As per Basel II rule, it must be 8%. As per RBI rule, it must be 9%. If this CAR is less than rule of thumb, then bank should increase its capital.

2. Supervisory review Rule 

Under this rule, every country who is member of committee on banking supervision, will have an authority who will check rule one. It is the duty of supervisory review authority to check minimum capital of each bank.

3. Market Discipline  Rule

Under this rule, market will also play important role to check the minimum capital of bank. In market, we can include interested parties of bank. These interested parties may be the customers of bank, shareholders of bank and govt.