Basel III norms-Is the Indian Banking Fraternity ready?

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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An Analysis of Impact of Budget 2012-13 on the Indian Aviation Sector

Authors:

SUBBA REDDY POLIMERA

VASUNDHRA SARASWAT 

TheIndian aviation sector is one of the fastest growing civil aviation industriesin the world. It has moved from an overly regulated industry to one that isopen, liberal and investment friendly. With entry of a lot of private players,higher household incomes, strong economic growth and favourable economicpolicies, the Indian Aviation Sector is treading on a path of high growthtrajectory. Domestic airlines have been allowed to fly overseas and strategic partnershipwith foreign carriers is being promoted while these foreign carriers in turnhave been interlining with domestic airlines to access secondary destinations.Greenfield and modernization project are developed with PPP model.  Private airlines account for more than 75%share of the domestic aerospace market.

Inrecent years, despite potential for huge growth, most of the airlines arerunning into losses. Major drivers for these losses are price of aviationturbine fuel which alone accounts for over 40% of operational costs, which isnearly more than double the international statistics of its counterparts and theother factor is interest paid towards its debt service. As per recent report byAviation regulator Directorate General of Civil Aviation (DGCA), IndigoAirlines is the only profit making airlines with an yearly profit of Rs 650crore.So in this situation current Budget 2012-13 has become a crucial point forthe future course of Indian Aviation Industry.

InBudget 2012-13, Mr.Pranab Mukharjee, the finance minister of India, hasdelivered several incentives to the ailing Aviation Industry.
Firstone is direct import of Aviation Turbine Fuel; this can reduce costs of fuelthereby increasing operating profit margin of Airlines. But the problem withthis is the storage of imported fuel, as the infrastructure for storage lieswith the State owned oil companies. In India Aviation turbine fuel accounts fornearly 40% of an Indian carrier's operating cost, compared to 20-25 per centglobally. With the direct import of fuel Airlines can save some money, therebyreducing some burden on them  

  Graph below gives how Power and Fuel costsare varying as part of Sales for Jet Airways

      

Due to thesewide fluctuations in fuel prices most of the Airlines are not able to maintainsustainable operations, leave alone them making any profits on the whole.

Secondone is permitting External Commercial Borrowings (ECB) for Working capitalrequirements for a period of one year, subject to a ceiling of $1billion. Thiswill help struggling airlines like Kingfisher airlines and Jet airways to raisemoney from overseas markets. The key to this step lies in the fact that thecost of debt in global markets is comparatively low. In domestic markets, Kingfisheris raising money at high interest rates. If we look at the 2011 annual reportof Kingfisher airlines, its capital structure and leverage figures of Debt areas follows,

• Rs.7,501 million of Loan from thebankers was converted into 7.5% Compulsorily Convertible Preference Shares.
• Rs.5,531 million of Loan from thebankers was converted into 8% Cumulative Redeemable Preference Sharesredeemable at par after 12 years.

Loans / Inter corporate deposits fromcertain business associates aggregating to Rs.7,093 million were converted into7,09,31,985 8% optionally convertible debentures of Rs.100/- each (“OCDs”)which are convertible into equity shares for until a period of 18 months fromtheir issue, after which they are redeemable.

Costof debt raised by Kingfisher in domestic market is more than 7%, where as inthe international market, capital can be raised at 5% or even below thandepending on the credibility of the company. In future by this form of raising capital, considerable savings can bemade by the Airlines.

Thethird one is active consideration allowing foreign airlines to participate inup to 49% equity of an airline company, operating scheduled and non scheduledservices. This will impact the overall growth of the sector by providing the muchrequired capital for Airlines.

Theabove mentioned three incentives provided by Government of India can give tremendousrelief to our Aviation Industry which is highly required at this juncture. 

Fourthone is tax concessions for part of aircraft and testing equipment for thirdparty Maintenance, Repair and Overhaul (MRO) of Civilian aircraft including full exemption from customs duty andcountervailing duty to aircraft spares, tyres and testing equipment. Indiais becoming the fastest growing market in the world for aircraft Maintenance,Repair and Overhaul services over the next decade tripling its worth to $1.5Billion, as airline companies buy more number of planes. According to globalconsultancy firm KPMG, over the next decade India is going to be the leader inthis space, which is currently split between North America and Western Europe,because of the higher economic growth rate that the country is going towitness. Till now due to customs duties and service tax for rendition ofservice local MRO industry has become less competitive compared to Globalpeers. With incentives offered in Budget, this Maintenance, Repair and Overhaulcan grow at rapid pace providing employment opportunities. This will alsobenefit low cost carriers which send their aircraft to Europe, Middle East orSouth East Asia for major maintenance.

Fifthone is Provision of increasing the service tax from 10 % to 12 % is going tomake airfare costlier. This can levy additional burden on consumer turning upfrom air travel. A reduce in small fragment of ticket sales, can have adverseaffect on ailing Aviation Industry.

Sixthone is the sop for Indian international travellers- proposal is made to raiseDuty free baggage allowance. This was last revisited in 2004. Duty free baggageallowance is from Rs. 25000 to Rs. 35000 for adults and for children up to 10years it ranged from Rs. 12,000 to Rs. 15,000. This can bring some cheers toInternational travellers who are burdened by increase in service tax of from10% to 12%. But for domestic travellers this very same Service tax burden isgoing to impact them adversely, which in turn affects the domestic carriers.

TheseIncentives given are intended for giving some respite to the Indian AviationIndustry. It didn’t specifically focus on some of the core issues which areailing the Industry. Some of these are-Ad valorem taxes of 20-29 per cent aremaking domestic airlines shell out nearly 52 per cent more for the fuel comparedto the average global price and High airport and handling charges in India,that are adversely affecting Indian airports' prospects of emerging asglobal/regional aviation hubs in gigantic proportions.

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