Author :Chetan chauhan,IIM Indore
Basel III released in December, 2010 is the third in the seriesof Basel Accords. These accords deal with risk management aspectsfor the banking sector. It is the global regulatory standard agreed uponby the members of the Basel Committee on Banking Supervision on bankcapital adequacy, stress testing and market liquidity ratio to improve theability of banks to withstand periods of economic and financial stress.
Majorfeatures of Basel III-:
1. Better capital quality-: It will enhancethe loss absorbing capacity of the bank making them stronger to withstandperiods of stress.
2. Capital conservation buffer-: Thisallows the bank to hold a capital conservation buffer of 2.5% to ensure banksmaintain a cushion of capital to absorb losses during periods of financial andeconomic stress.
3. Countercyclical buffer-: This has been introduced to increase capitalrequirements in good times and decrease the same in bad times. The buffer willslow banking activity when it overheats and will encourage lending when timesare tough. The buffer will range from 0% to 2.5%, consisting of common equity.
4.Minimum commonequity and Tier 1 capital requirements-: The minimum requirement under commonequity has been raised from 2% to 4.5% of total risk weighted assets. Theoverall Tier 1 capital requirement will also increase from the current minimumof 4% to 6%.
5. LeverageRatio-: Financial crisis of 2008 indicated that the value of many assets fellquicker than assumed from historical experience. So leverage ratio has beenintroduced to serve as a safety net. This aims to put a cap on swelling ofleverage in the banking sector.
6. Liquidity Ratios-: Under Basel III,a framework for liquidity risk management will be created.A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR)are to be introduced in 2015 and 2018, respectively.
7.SystematicallyImportant Financial Institutions-: Afinancial institution whose eventual failure (default) may pose systemic risksto the world economy. According to the Basel 3 framework, SIFIs may be subjectto enhanced capital requirements.
How Basel III wouldaffect banks:
1.As per this banks would have to set aside a higher percentage of their capital to meet these norms. This would reduce the amount of money they can lend.
2.New Basel norms wouldmoderate the return on equity of public and private banks. It has been foundthat every additional 1% increase in core equity capital would reduce thereturn on equity by a minimum of 1.5%.
3. It is expected thatprivate sector banks being well capitalized can make smooth transition whereasPSBs[1]would need capital infusion from the government.
4. According to RBIIndian banks have to maintain a capital ratio of 9%, higher than the minimumrecommended requirement of 8% under the Basel III norms.
5. Under the newguidelines investments by banks in subsidiaries, securitization exposures andother charges to capital would be deducted from core equity. This means thatbanks have to constantly raise equity to meet these charges.
6. Banks would berequired to raise equity capital in the range of $45-55bn over the next 6 yearsand of these PSBs would be required to raise $15-20bn from the capital marketsassuming that GOI maintains the their current stake in them.
Comparison ofCapital Requirements under Basel II and Basel III
Requirements | Under Basel II | Under Basel III |
Minimum Ratio of Total Capital To RWAs[2] | 8% | 10.50% |
Minimum Ratio of Common Equity to RWAs | 2% | 4.50% to 7.00% |
Tier I capital to RWAs | 4% | 6.00% |
Core Tier I capital to RWAs | 2% | 5.00% |
Capital Conservation Buffers to RWAs | None | 2.50% |
Leverage Ratio | None | 3.00% |
Countercyclical Buffer | None | 0% to 2.50% |
Minimum Liquidity Coverage Ratio | None | TBD[3] (2015) |
Minimum Net Stable Funding Ratio | None | TBD (2018) |
Systemically important Financial Institutions Charge | None | TBD (2011) |
[1] PSBs refer to Indian Public Sector Banks
[2] RWAs stands for Risk weighted Assets
[3] TBD stands for To be disclosed
BIS proposed BASEL III minimum capital requirements for banks (%) as per RBI (Source:RBI)
The new capitaladequacy norms of Basel III do not impact Indian banks significantly. As the aggregate capital to risk weightedassets ratio of the Indian banking system stood at 13.4 percent in which theTier I capital constituted 9.3 percent. The new capital rule does not affectthe Indian banks much in terms of overall capital requirement and the qualityof capital. However, Banks in Public and Private sector will raise Rs 6 lakhCrore in external capital over 9 years to comply with Basel III norms,according to credit rating agency ICRA, International Credit Rating Agency.Most of the Indian banks have improved on their capital adequacy ratio in linewith the Basel II norms. The financial health of Indian banking system hasimproved significantly in terms of capital adequacy ratio (CAR) during thethird quarter of the fiscal 2009-10. In comparison to the mandated limit of 9per cent CRAR posed by the Basel II, the average capital adequacy ratio ofcommercial banks went up to 13 per cent in FY 10 from 12 per cent in theprevious year as shown in the table given below:
Capital Adequacy Ratio of PSBs inIndia under Basel II:
Capital Adequacy Ratio of Privatesector banks in India under Basel II:
Challenges with the Indian BankingIndustry:
1. Additional capital requirement wouldpose a big challenge for the Indian banking fraternity.
2. As many Indian banks have poor assetquality so restructuring the assets of these banks would be a tedious processand would require a lot of capital.
3. Technology Infrastructure in the form ofcomputerization is still in a very nascent stage in many Indian banks who havetheir network spread out in far flung remote areas, so integrated riskmanagement to align market, credit and operational risk is a big challenge dueto significant disconnect between risk managers, business and IT across theorganizations in the existing setup.
Conclusion:
Thus from the aboveanalysis I can say that Indian banking fraternity is ready for the Basel IIInorms as per RBI:
1. Provided banks get the additionalsources of capital in the form of dilution of GOI’s stake in them and bringingit down to 51%.
2. RBI can also consider selling holdingsin public enterprises, slashing subsidies and using the proceeds to infusecapital in Indian PSBs.
India has played a keyrole in developing Basel III safeguards so Indian banks must implement Basel IIIwith a view to improve their business processes as well as their regulatoryprocesses to reap further rewards as compared to those banks that see Basel IIIcompliance as an end in itself. This way Basel III regulation may work as a bigachievement for the Indian Banking sector which will inculcate safe bankinghabits in the banking fraternity.
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