Effect of Basel III On Indian Banks

TABLE OF CONTENTS
Sr. No 1 2 3 4 5
Topic Executive Summary The Global Financial Crisis of 2008 Why Basel II Failed? Introduction to Basel III How is Basel III an improvement over Basel II Basel III in India
Page No 2 3 5 7 13
6 7 8 9 10 11 12 13 14
RBI guidelines for Basel III Study of 10 Banks in India with respect to Basel III guidelines Impact Of Basel III Ratios On Indian Banks Will Basel III affect profitability of Banks in India? Will Basel III hurt growth? Challenges in implementation of Basel III Should Basel III be implemented in India? Conclusion Bibliography
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EXECUTIVE SUMMARY
With the implementation date of Basel III norms by RBI being 1st April, 2013 a lot of challenges are in front of the Indian Banking sector in terms of raising capital, development of IT systems in the bank, managing the increased cost of capital. Through this study an attempt has been made to see how prepared are the banks in terms of capital. Also attempt has been made discern the effect of Basel III on profitability and growth in India. Finally we have tried to analyse the benefits of adopting Basel III v/s the cost incurred in order to adopt Basel III and conclude whether Indian banks should adopt Basel III norms.
THE GLOBAL FINANCIAL CRISIS OF 2008
The financial crisis of 20072008, also known as The Global Financial Crisis and 2008 Financial Crisis, is considered by many economists to be the worst financial crisis since the Great Depression of the 1930s. The crisis resulted in the threat of total collapse of large financial institutions, the bailout of banks by national governments, and downturns in stock markets around the world. The housing market also suffered, resulting in evictions, foreclosures and prolonged unemployment. The crisis saw, a series of bank and insurance company failures triggered a financial crisis that effectively halted global credit markets and required unprecedented government intervention. Fannie Mae (FNM) and Freddie Mac (FRE) were both taken over by the government. Lehman Brothers declared bankruptcy on September 14th after failing to find a buyer. Bank of America agreed to purchase Merrill Lynch (MER), and American International Group (AIG) was saved by an $85 billion capital injection by the federal government. Shortly after, on September 25th, J P Morgan Chase (JPM) agreed to purchase the assets of Washington Mutual (WM) in what was the biggest bank failure in history. In fact, by September 17, 2008, more public corporations had filed for bankruptcy in the U.S. than in all of 2007. These failures caused a crisis of confidence that made banks reluctant to lend money amongst themselves, or for that matter, to anyone. Over the years investment banks and other lending institutes provided credit through shadow banking system i.e. they obtained investors funds against various derivative securities like mortgage backed securities, asset backed commercial paper etc. Due to the collapse of housing market it became difficult to raise money against these instruments causing the US credit market to shrink by nearly one-third. This credit freeze brought the global financial system to the brink of collapse. The response of the Federal Reserve, the European Central Bank, and other central banks was immediate and dramatic. During the last quarter of 2008, these central banks purchased US$2.5 trillion of government debt and troubled private assets from banks. This was the
largest liquidity injection into the credit market, and the largest monetary policy action, in world history. The crisis caused loss of wealth of individuals, financial institutions and industries and brought on the US recession that began in December 2007 and lasted till June 2009. In order to prevent further collapse of US economy the Federal Government Bailout bill was implemented. As per the bill the Troubled Assets Relief Program (TARP) was enacted. The bill authorized $700 billion for this fund, which would be used to buy and hold troubled loanbased assets, many of which were tied to home prices in the slumping U.S. housing market. Through such efforts the US Government along with the Federal Reserve controlled the recession. But the crisis led to the failure of key businesses, decline in consumer wealth estimated in trillions of US dollars, and a downturn in economic activity which lead to the 20082012 global recession and contributed to the European sovereign-debt crisis.
WHY BASEL II FAILED?
Basel I considered only Credit Risk and Market Risk. When Basel II was developed it took into account Credit Risk, Market Risk and Operational Risk to account for the risks due to account for risk to banks due to operational factors like error of employees etc. The other major shift from Basel I to Basel II was in terms of capital regulation. While Basel I had a One-size-fits-all approach, Basel II introduced risk sensitive capital regulation. But this risk sensitivity made it procyclical. In good times, when banks were doing well, and the market was willing to invest capital in them, Basel II did not impose significant additional capital requirement on banks. On the other hand, in stressed times, when banks required additional capital and markets were wary of supplying that capital, Basel II required banks to bring in more of it. As was seen during the crisis, it was the failure to bring in capital when under pressure that forced major international banks into a vicious cycle of deleveraging, which hurtled global financial markets into seizure and economies around the world into recession. The other major drawback of Basel II was that although it introduced more risk sensitive capital regulation it did not correctly measure risk of complex derivative products which were coming up in the market. Also the market risk models proposed under Basel II demanded less capital against trading book exposures on the premisethat trading book exposures could be readily sold, and positions rapidly unwound. This gave a perverse incentive for banks to park banking book exposures in the trading book to optimise capital. The global financial crisis revealed that much of the toxic assets and their securitised derivatives, which were the epicentre of the crisis were parked in the trading book. Thus Basel II was unable to measure the risk effectively and therebyunable to suggest appropriate modelling frameworks for accurate measurement of that risk and thus Basel II could not correctly quantify the sufficient loss absorbing capital required for banks to mitigate that risk. The other drawback of Basel II was that it assumed its risk based capital requirement would automatically mitigate the risk of excessive leverage. But this assumption, turned out to be flawed as excessive leverage of banks was one I prime causes of the crisis.
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Also Basel II did not explicitly cover liquidity risk. This had particularly serious consequences as liquidity risk when left unaddressed, could cascade into a solvency risk. This proved to be the undoing of virtually every bank that came under stress during the crisis. Finally the last drawback of Basel II was that it only focussed on individual financial institutions and ignored the systemic risk arising from the interconnectedness across institutions. This interconnectedness among institutions caused the crisis to spread rapidly over the financial markets. Thus due to the above mentioned loopholes present in Basel II it was unable to prevent the 2008 financial crisis. Basel III tries to fix the gaps and lacunae in Basel II that came to light during the crisis; it also tries to incorporate other lessons learned during the crisis.
INTRODUCTION TO BASEL III

Basel III (or the Third Basel Accord) is a global, voluntary regulatory standard on bank capital adequacy, stress testing and market liquidity risk.It was agreed upon by the members of the Basel Committee on Banking Supervision in 201011, and was scheduled to be introduced from 2013 and to be implemented until 2019. Basel III was developed in response to the deficiencies in financial regulation revealed by the 2008 financial crisis. Basel III is supposed to strengthen banking system by improving quality of banks capital, banks liquidity and banks leverage.
Basel II
Basel II
Capital
Basel III
Capital
Liquidity
Basel III
Leverage
Systemic Risks & Interconectedness
Objectives of Basel III

According to BCBS the main two objectives of Basel III are: i. To strengthen global capital and liquidity regulations with goal of promoting more resilient banking sector ii. To improve banking sectors ability to withstand shocks arising from financial or economic stress, which would reduce risk of spillover of financial sector to real economy
Based on the above mentioned objectives the Basel IIIs recommendations are divided into three parts: i. Capital Includes quality and quantity of capital, risk weightage to assets, leverage ratio, capital conservation buffer, counter-cyclical buffer ii. Liquidity Short term & long term ratios iii. Other elements pertaining to overall stability of financial system
Proposal of Basel III

First, the quality, consistency, and transparency of the capital base will be raised. Tier 1 capital: the predominant form of Tier 1 capital must be common shares and retained earnings Tier 2 capital instruments will be harmonised Tier 3 capital will be eliminated
Second, the risk coverage of the capital framework will be strengthened. Promote more integrated management of market and counterparty credit risk Add the CVA (credit valuation adjustment)-risk due to deterioration in counterpartys credit rating Strengthen the capital requirements for counterparty credit exposures arising from banks derivatives, repo and securities financing transactions Raise the capital buffers backing these exposures Reduce procyclicality and Provide additional incentives to move OTC derivative contracts to central counterparties (probably clearing houses) Provide incentives to strengthen the risk management of counterparty credit exposures Raise counterparty credit risk management standards by including wrong-way risk
Third, a leverage ratio will be introduced as a supplementary measure to the Basel II riskbased framework, intended to achieve the following objectives: Put a floor under the build-up of leverage in the banking sector Introduce additional safeguards against model risk and measurement error by supplementing the risk based measure with a simpler measure that is based on gross exposures.
Fourth, a series of measures is introduced to promote the build-up of capital buffers in good times that can be drawn upon in periods of stress (Reducing procyclicality and promoting countercyclical buffers). Measures to address procyclicality: Dampen excess cyclicality of the minimum capital requirement; Promote more forward looking provisions; Conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and Achieve the broader macroprudential goal of protecting the banking sector from periods of excess credit growth. Requirement to use long term data horizons to estimate probabilities of default, downturn loss-given-default estimates, recommended in Basel II, to become mandatory Improved calibration of the risk functions, which convert loss estimates into regulatory capital requirements. Banks must conduct stress tests that include widening credit spreads in recessionary scenarios. Promoting stronger provisioning practices (forward looking provisioning) Advocating a change in the accounting standards towards an expected loss (EL) approach (usually, EL amount := LGD*PD*EAD) Fifth, a global minimum liquidity standard for internationally active banks is introduced that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio called the Net Stable Funding Ratio. (In January 2012, the oversight panel of the Basel Committee on Banking Supervision issued a statement saying that regulators will allow banks to dip below their required liquidity levels, the liquidity coverage ratio, during periods of stress. In January 2013 Global central bank chiefs watered down the liquidity measures in a bid to stave off another credit crunch The Committee also reviewed the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.
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Capital Requirements as per Basel III
Requirements Minimum Ratio of Total Capital To RWAs Minimum Ratio of Common Equity to RWAs Tier I capital to RWAs Core Tier I capital to RWAs Maximum Tier 2 Capital (within Total Capital) Capital Conservation Buffers to RWAs (CCB) Minimum Common Equity Tier 1 Capital + CCB Minimum Total Capital + CCB Leverage Ratio Countercyclical Buffer Minimum Liquidity Coverage Ratio Minimum Net Stable Funding Ratio Systemically important Financial Institutions Charge
Under Basel II 8% 2% 4% 2% 4% None 2% 8% None None None None None
Under Basel III 8% 4.50% to 7.00% 6.00% 5.00% 2% 2.50% 7% 10.5% 3.00% 0% to 2.50% TBD (2015) TBD (2018) TBD (2011)
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Timeline for Implementation of Basel III
Capital Requirements Date Milestone: Capital Requirement 2014 Minimum capital requirements: Start of the gradual phasing-in of the higher minimum capital requirements. Minimum capital requirements: Higher minimum capital requirements are fully implemented.
2015
2016 Conservation buffer: Start of the gradual phasing-in of the conservation buffer. 2019 Conservation buffer: The conservation buffer is fully implemented.
Leverage Ratio Date Milestone: Leverage Ratio 2011 Supervisory monitoring: Developing templates to track the leverage ratio and the underlying components. Parallel run I: The leverage ratio and its components will be tracked by supervisors but not disclosed and not mandatory. Parallel run II: The leverage ratio and its components will be tracked and disclosed but not mandatory. Final adjustments: Based on the results of the parallel run period, any final adjustments to the leverage ratio. Mandatory requirement: The leverage ratio will become a mandatory part of Basel III requirements.
2013
2015
2017
2018
Liquidity Requirements Date Milestone: Liquidity Requirements 2011 Observation period: Developing templates and supervisory monitoring of the liquidity ratios. Introduction of the LCR: Introduction of the Liquidity Coverage Ratio (LCR). Meet 60% of LCR obligations
2015
2018 Introduction of the NSFR: Introduction of the Net Stable Funding Ratio (NSFR).
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HOW IS BASEL III AN IMPROVEMENT OVER BASEL II

Basel III tries to fill the gaps present in Basel II. Basel III builds on the essence of Basel II its the link between the risk profiles and capital requirements of individual banks. In that sense, Basel III is an enhancement of Basel II. The enhancements of Basel III over Basel II come primarily in four areas: (i) (ii) (iii) (iv) Augmentation in the level and quality of capital; Introduction of liquidity standards; Modications in provisioning norms; Better and more comprehensive disclosures
Higher Capital Requirement & Liquidity Standards

Basel III requires higher and better quality capital. The minimum total capital remains unchanged at 8 per cent of risk weighted assets (RWA). However, Basel III introduces a capital conservation buffer of 2.5 per cent of RWA over and above the minimum capital requirement, raising the total capital requirement to 10.5 per cent against 8.0 per cent under Basel II. This buffer is intended to ensure that banks are able to absorb losses without breaching the minimum capital requirement, and are able to carry on business even in a downturn without deleveraging. This buffer is not part of the regulatory minimum; however, the level of the buffer will determine the dividend distributed to shareholders and the bonus paid to staff. There are also other prescriptions regarding the quality of capital within the minimum total so that capital is able to absorb losses, and calling upon taxpayers to bear the burden of bail out becomes absolutely the last resort. In addition to the capital conservation buffer, Basel III introduces another capital buffer the countercyclical capital buffer in the range of 0 2.5 per cent of RWA which could be imposed on banks during periods of excess credit growth. Also, there is a provision for a higher capital surcharge on systemically important banks.
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To mitigate the risk of banks building up excess leverage as happened under Basel II, Basel III institutes a leverage ratio as a backstop to the risk based capital requirement. The Basel Committee is contemplating a minimum Tier 1 leverage ratio of 3 per cent (33.3 times) which will eventually become a Pillar 1 requirement as of January 1, 2018. Also, Basel II failed to demand adequate loss absorbing capital to cover market risk. To remedy this, Basel III strengthens the counterparty credit risk framework in market risk instruments. This includes the use of stressed input parameters to determine the capital requirement for counterparty credit default risk. Besides, there is a new capital requirement known as CVA (credit valuation adjustment) risk capital charge for OTC derivatives to protect banks against the risk of decline in the credit quality of the counterparty. To mitigate liquidity risk, Basel III addresses both potential short-term liquidity stress and longer-term structural liquidity mismatches in banks balance sheets to cover short-term liquidity stress, banks will be required to maintain sufficient high-quality unencumbered liquid assets to withstand any stressed funding scenario over a 30-day horizon as measured by the liquidity coverage ratio (LCR). To mitigate liquidity mismatches in the longer term, banks will be mandated to maintain a net stable funding ratio (NSFR). The NSFR mandates a minimum amount of stable sources of funding relative to the liquidity pro le of the assets, as well as the potential for contingent liquidity needs arising from off-balance sheet commitments over a one-year horizon. In essence, the NSFR is aimed at encouraging banks to exploit stable sources of funding.
Liquidity Standards Ratio Liquidity Coverage Ratio (LCR) (to be introduced as on January 1,2015) Net Stable Funding Ratio (NSFR) (to be introduced as on January 1, 2018) Basel II Basel III Stock of high-quality liquid assets 100% Total net cash outflows over the next 30 calendar days Available amount of stable funding > 100% Required amount of stable funding
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Provisioning Norms
The Basel Committee supports the proposal for adoption of an expected loss based measure of provisioning which captures actual losses more transparently and is also less procyclical than the current incurred loss approach. The expected loss approach for provisioning will make nancial reporting more useful for all stakeholders, including regulators and supervisors.
Disclosure Requirements
The disclosures made by banks are important for market participants to make informed decisions. One of the lessons of the crisis is that the disclosures made by banks on their risky exposures and on regulatory capital were neither appropriate nor sufficiently transparent to afford any comparative analysis. To remedy this, Basel III requires banks to disclose all relevant details, including any regulatory adjustments, as regards the composition of the regulatory capital of the bank.
Thus through the above mentioned means Base II has tried to fill the lacunae present in Basel II and also incorporate the lessons learned during the crisis in the regulatory framework.
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BASEL III IN INDIA
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RBI GUIDELINES FOR BASEL III
Requirements Minimum Ratio of Total Capital To RWAs Minimum Ratio of Common Equity to RWAs Additional Tier 1 Capital Minimum Tier I capital to RWAs Maximum Tier 2 Capital (within Total Capital) Capital Conservation Buffer comprised of common equity to RWAs (CCB) Minimum Common Equity Tier 1 ratio plus capital conservation buffer to RWAs Minimum Total Capital + CCB
As per RBI 9% 5.50% 1.5% 7.00% 2%
2.50%
8.00% 11.5%
Capital Constituents
Elements of Common Equity Tier 1 Elements of Common Equity Tier 1 Capital Indian Banks The Common Equity component of Tier 1 capital will comprise the following: i. Common shares (paid-up equity capital) issued by the bank which meet the criteria for classification as common shares for regulatory purposes ii. iii. iv. v. vi. Stock surplus (share premium) resulting from the issue of common shares; Statutory reserves; Capital reserves representing surplus arising out of sale proceeds of assets; Other disclosed free reserves, if any; Balance in Profit & Loss Account at the end of the previous financial year;
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vii.
Banks may reckon the profits in current financial year for CRAR calculation on a quarterly basis provided the incremental provisions made for non-performing assets at the end of any of the four quarters of the previous financial year have not deviated more than 25% from the average of the four quarters. The amount which can be reckoned would be arrived at by using the following formula: ePt= {NPt 0.25*D*t} Where; Ept = Eligible profit up to the quartert of the current financial year; t varies from 1 to 4 NPt = Net profit up to the quartert D= average annual dividend paid during last three years
viii.
While calculating capital adequacy at the consolidated level, common shares issued by consolidated subsidiaries of the bank and held by third parties (i.e. minority interest) which meet the criteria for inclusion in Common Equity Tier 1 capital
Common Equity Tier 1 Capital Foreign Banks Branches Elements of Common Equity Tier 1 Capital Elements of Common Equity Tier 1 capital will remain the same and consist of the following: i. Interest-free funds from Head Office kept in a separate account in Indian books specifically for the purpose of meeting the capital adequacy norms; ii. iii. Statutory reserves kept in Indian books; Remittable surplus retained in Indian books which is not repatriable so long as the bank functions in India; iv. Interest-free funds remitted from abroad for the purpose of acquisition of property and held in a separate account in Indian books provided they are non-repatriable and have the ability to absorb losses regardless of their source;
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v.
Capital reserve representing surplus arising out of sale of assets in India held in a separate account and which is not eligible for repatriation so long as the bank functions in India; and
vi.
Less: Regulatory adjustments / deductions applied in the calculation of Common Equity Tier 1 capital
Elements of Additional Tier 1 Capital Elements of Additional Tier 1 Capital Indian Banks Elements of Additional Tier 1 capital will remain the same. Additional Tier 1 capital consists of the sum of the following elements: i. Perpetual Non-Cumulative Preference Shares (PNCPS), which comply with the regulatory requirements ii. Stock surplus (share premium) resulting from the issue of instruments included in Additional Tier 1 capital; iii. Debt capital instruments eligible for inclusion in Additional Tier 1 capital, which comply with the regulatory requirements iv. Any other type of instrument generally notified by the Reserve Bank from time to time for inclusion in Additional Tier 1 capital; v. While calculating capital adequacy at the consolidated level, Additional Tier 1 instruments issued by consolidated subsidiaries of the bank and held by third parties which meet the criteria for inclusion in Additional Tier 1 and vi. Less: Regulatory adjustments / deductions applied in the calculation of Additional Tier 1 capital
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Elements of Additional Tier 1 Capital Foreign Banks Branches i. Elements of Additional Tier 1 capital will remain the same as under existing guidelines. Various elements of Additional Tier 1 capital are as follows: ii. Head Office borrowings in foreign currency by foreign banks operating in India for inclusion in Additional Tier 1 capital which comply with the regulatory requirements iii. Any other item specifically allowed by the Reserve Bank from time to time for inclusion in Additional Tier 1 capital; and iv. Less: Regulatory adjustments / deductions applied in the calculation of Additional Tier 1 capital
Elements of Tier 2 Capital Elements of Tier 2 capital will largely remain the same under existing guidelines except that there will be no separate Tier 2 debt capital instruments in the form of Upper Tier 2 and subordinated debt. Instead, there will be a single set of criteria governing all Tier 2 debt capital instruments. Elements of Tier 2 Capital Indian Banks i. ii. iii. General Provisions and Loss Reserves Debt Capital Instruments issued by the banks Preference Share Capital Instruments [Perpetual Cumulative Preference Shares (PCPS) / Redeemable Non-Cumulative Preference Shares (RNCPS) / Redeemable Cumulative Preference Shares (RCPS)] issued by the banks; iv. Stock surplus (share premium) resulting from the issue of instruments included in Tier 2 capital; v. While calculating capital adequacy at the consolidated level, Tier 2 capital instruments issued by consolidated subsidiaries of the bank and held by third parties which meet the criteria for inclusion in Tier 2 capital vi. vii. viii. Revaluation reserves at a discount of 55% Any other type of instrument generally notified by the RBI Less: Regulatory adjustments / deductions applied in the calculation of Tier 2 capital
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Elements of Tier 2 Capital Foreign Banks Branches i. ii. iii. Elements of Tier 2 capital in case of foreign banks branches will be as under: General Provisions and Loss Reserves Head Office (HO) borrowings in foreign currency received as part of Tier 2 debt capital; iv. v. Revaluation reserves at a discount of 55%; and Less: Regulatory adjustments / deductions applied in the calculation of Tier 2 capital
Disclosure Requirements
In order to ensure adequate disclosure of details of the components of capital which aims at improving transparency of regulatory capital reporting as well as improving market discipline, banks are required to disclose the following: i. A full reconciliation of all regulatory capital elements back to the balance sheet in the audited financial statements; ii. Separate disclosure of all regulatory adjustments and the items not deducted from Common Equity Tier 1 iii. A description of all limits and minima, identifying the positive and negative elements of capital to which the limits and minima apply; iv. v. A description of the main features of capital instruments issued; and Banks which disclose ratios involving components of regulatory capital (e.g. Equity Tier 1, Core Tier 1 or Tangible Common Equity ratios) must accompany such disclosures with a comprehensive explanation of how these ratios are calculated. Banks are also required to make available on their websites the full terms and conditions of all instruments included in regulatory capital. The Basel Committee will issue more detailed Pillar 3 disclosure shortly, based on which appropriate disclosure norms under Pillar 3 will be issued by RBI. During the transition phase banks are required to disclose the specific components of capital, including capital instruments and regulatory adjustments which are benefiting from the transitional provisions.
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TRANSITIONAL ARRANGEMENT
In order to ensure smooth migration to Basel III without aggravating any near term stress, appropriate grandfathering and transitional arrangements have been made by the BCBS in terms of which national implementation of Basel III will begin on January 1, 2013 and will be fully phased-in on January 1, 2019.
Transitional Arrangements (% of RWAs) Minimum capital ratios Minimum Common Equity Tier 1 (CET1) Capital conservation buffer (CCB) Minimum CET1+ CCB Minimum Tier 1 capital Minimum Total Capital* Minimum Total Capital +CCB Phase-in of all deductions from CET1(in%)# 20 40 60 80 100 100 April1 2013 4.5 March 31, 2014 5 March 31, 2015 5.5 March 31 2016 5.5 March 31, 2017 5.5 March 31, 2018 5.5
4.5 6 9 9
5 6.5 9 9
0.625 6.125 7 9 9.625
1.25 6.75 7 9 10.25
1.875 7.375 7 9 10.875
2.5 8 7 9 11.5
*The difference between the minimum total capital requirement of 9% and the Tier 1 requirement can be met with Tier 2 and higher forms of capital; # The same transition approach will apply to deductions from Additional Tier 1 and Tier 2 capital
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RISK COVERAGE
Modifications have been made to Basel II framework in the area of capital charge for credit risk including counterparty credit risk, external credit assessments, credit risk mitigation and capital charge for market risk.
SUPERVISORY REVIEW AND EVALUATION PROCESS (PILLAR 2)
Basel III also contains certain modifications to guidance on Supervisory Review and Evaluation Process under Pillar 2 of Basel II framework. The modifications relate to use of external ratings for risk weighting of exposures and improvements in collateral management by banks in order to address the deficiencies observed in these areas during the financial crisis.
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CAPITAL CONSERVATION BUFFER
Objective The capital conservation buffer (CCB) is designed to ensure that banks build up capital buffers during normal times (i.e. outside periods of stress) which can be drawn down as losses are incurred during a stressed period. The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements. Outside the period of stress, banks should hold buffers of capital above the regulatory minimum. When buffers have been drawn down, one way banks should look to rebuild them is through reducing discretionary distributions of earnings. The capital conservation buffer can be drawn down only when a bank faces a systemic or idiosyncratic stress. A bank should not choose in normal times to operate in the buffer range simply to compete with other banks and win market share. The banks which draw down their capital conservation buffer during a stressed period should also have a definite plan to replenish the buffer as part of its Internal Capital Adequacy Assessment Process and strive to bring the buffer to the desired level within a time limit agreed to with Reserve Bank of India during the Supervisory Review and Evaluation Process. The framework of capital conservation buffer will strengthen the ability of banks to withstand adverse economic environment conditions, will help increase banking sector resilience both going into a downturn, and provide the mechanism for rebuilding capital during the early stages of economic recovery. Thus, by retaining a greater proportion of earnings during a downturn, banks will be able to help ensure that capital remains available to support the ongoing business operations / lending activities during the period of stress. Therefore, this framework is expected to help reduce pro-cyclicality.
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The Framework Banks are required to maintain a capital conservation buffer of 2.5%, comprised of Common Equity Tier 1 capital, above the regulatory minimum capital requirement of 9%. Banks should not distribute capital (i.e. pay dividends or bonuses in any form) in case capital level falls within this range. However, they will be able to conduct business as normal when their capital levels fall into the conservation range as they experience losses. Therefore, the constraints imposed are related to the distributions only and are not related to the operations of banks. The distribution constraints imposed on banks when their capital levels fall into the range increase as the banks capital levels approach the minimum requirements. The Table below shows the minimum capital conservation ratios a bank must meet at various levels of the Common Equity Tier 1 capital ratios.
Minimum capital conservation standards for individual bank Common Equity Tier 1 Ratio after including the current periods retained earnings 5.5% - 6.125% >6.125% - 6.75% >6.75% - 7.375% >7.375% - 8.0% >8.0% Minimum Capital Conservation Ratios (expressed as a %age of earnings) 100% 80% 60% 40% 0%
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LEVERAGE RATIO
Rationale and Objective One of the underlying features of the crisis was the build-up of excessive on- and off-balance sheet leverage in the banking system. In many cases, banks built up excessive leverage while still showing strong risk based capital ratios. During the most severe part of the crisis, the banking sector was forced by the market to reduce its leverage in a manner that amplified downward pressure on asset prices, further exacerbating the positive feedback loop between losses, declines in bank capital, and contraction in credit availability. Therefore, under Basel III, a simple, transparent, non-risk based leverage ratio has been introduced. The leverage ratio is calibrated to act as a credible supplementary measure to the risk based capital requirements. The leverage ratio is intended to achieve the following objectives: (a) Constrain the build-up of leverage in the banking sector, helping avoid destabilising deleveraging processes which can damage the broader financial system and the economy; and (b) Reinforce the risk based requirements with a simple, non-risk based backstop measure.
Definition and Calculation of the Leverage Ratio The provisions relating to leverage ratio contained in the Basel III document are intended to serve as the basis for testing the leverage ratio during the parallel run period. The Basel Committee will test a minimum Tier 1 leverage ratio of 3% during the parallel run period from 1 January 2013 to 1 January 2017. During the period of parallel run, banks should strive to maintain their existing level of leverage ratio but, in no case the leverage ratio should fall below 4.5%. A bank whose leverage ratio is below 4.5% may endeavour to bring it above 4.5% as early as possible. Final leverage ratio requirement would be prescribed by RBI after the parallel run taking into account the prescriptions given by the Basel Committee.
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The leverage ratio shall be maintained on a quarterly basis. The basis of calculation at the end of each quarter is the average of the month-end leverage ratio over the quarter based on the definitions of capital (the capital measure) and total exposure (the exposure measure)
Leverage Ratio (as percentage of risk weighted assets) Reserve Banks Prescriptions Basel III (as on April 1, 2019) Current (Basel II) Leverage Ratio (ratio to total assets) Basel III (as on March 31, 2018) 4.5
3.0
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G-SIBs & D-SIBs
Basel III seeks to mitigate this externality by identifying global systemically important banks (G-SIBs) and mandating them to maintain a higher level of capital dependent on their level of systemic importance. The list of G-SIBs is to be reviewed annually. Currently, no Indian bank appears in the list of GSIBs. Separately, the Basel Committee is working on establishing a minimum set of principles for domestic systemically important banks (D-SIBs), and also on the norms for prescribing higher loss absorbency (HLA) capital standards for them. Besides, it is also necessary to evolve a sound resolution mechanism for D-SIBs. The RBI has decided to await the guidance of Basel committee in the declaration of D-SIBs and the RBI Governor hopes that the Basel committee will prescribe higher solvency standards DSIBs. This would be like an additional cushion for the systemically important banks and would help them in periods of financial stress and try to mitigate their liquidity risk.
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STUDY OF 10 BANKS IN INDIA WITH RESPECT TO BASEL III GUIDELINES
For the study of Basel III on Indian banks, a few banks were analysed. The 10 banks that were analysed were selected on basis of their market capitalisation. Among the top 15 banks with respect to market capitalisation 10 banks were selected. All banks were analysed based on their 2011-2012 annual report data. The banks that were analysed are: Market Capitalisation (Rs. cr.) 1,56,115.33 1,48,267.45 1,31,427.17 65,760.51 50,337.36 27,631.19 22,799.97 19,166.40 18,350.17 17,416.11
Name HDFC Bank State Bank of India ICICI Bank Axis Bank Kotak Mahindra Punjab National Bank IndusInd Bank Canara Bank Bank of India Yes Bank
The current capital levels and various capital to risk weighted assets ratios were studied and the capital requirement as per Basel III were computed.
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HDFC Bank
Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 399664.6 280674.9 118989.7 365000 2418963.2 256752.25 102535.96 4693.38 294550.36 53092.77 2954.68 19402.72 1.77
Requirements Ratio of Total Capital To RWAs Ratio of Common Equity to RWAs Additional Tier 1 Capital Tier I capital to RWAs Tier 2 Capital (within Total Capital) Capital Conservation Buffer comprised of common equity to RWAs (CCB) Common Equity Tier 1 ratio plus capital conservation buffer to RWAs Total Capital + CCB
Current 16.52% 3.31% 11.60% 4.92% None
As per RBI Under Basel III 9% 5.50% 1.50% 7.00% 2% 2.50%
11.80% 16.52%
8.0000% 11.50%
Total Capital Requirement @ 9 % under Basel III Total Core Tier I Capital Requirement @ 5.5 % under Basel III
221126 52899.426
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State Bank of India

Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 1522560 1074110 448450 40016.16 15959487 969655.17 542735.87 6710.4 832801.6 360578.5 15080.88 0.91
Current 13.86% 0.67% 9.79% 4.07% None 10.46% 13.86%
As per RBI Under Basel III 9% 5.50% 1.50% 7.00% 2% 2.50% 8.0000% 11.50%
1003694.4 495402.005
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ICICI Bank
Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 738129.2 505182.8 232946.4 16000 3985857.8
362529.7 204376.37
11527.68 592500.89 89916.52 21842.5 1.47
Current 18.52% 3.09% 12.67% 5.84% None 12.96% 18.52%
397340 95935.479
32
Axis Bank
Current 13.66% 2.22% 9.45% 4.21% None 9.62% 13.66%
208540.3 75915.2845
33
Kotak Mahindra Bank

Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 83845.9 75339.2 8506.7 813.58 742792.9 37213.48 9297.01 3703.45 75755.94 9228.9 289.3 4049.65 1.86
Current 11.29% 2.33% 10.14% 1.78% None 10.64% 11.29%
74279.4 23582.3095
34
Punjab National Bank

Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 368525.9 270799.7 97726.2 0 3200662 350505.31 122703.99 3391.79 274778.94 68790.94 10645.89 1.17
Current 12.63% 1.29% 9.28% 3.35% None 10.57% 12.63%
Total Capital Requirement @ 9 % under Basel III Total Core Tier I Capital Requirement @ 5.5 % under Basel III 35
262694.4 93207.79
IndusInd Bank
Current 13.85% 2.97% 11.37% 2.48% None 12.56% 13.85%
35282.8 9913.4705
36
Canara Bank
Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 290080 218290 71790 0 2108750 345870.63 113874.74 4430 222469.56 59330 12257.02 0.92
Current Ratio of Total Capital To RWAs Ratio of Common Equity to RWAs Additional Tier 1 Capital Tier I capital to RWAs Tier 2 Capital (within Total Capital) Capital Conservation Buffer comprised of common equity to RWAs (CCB) Common Equity Tier 1 ratio plus capital conservation buffer to RWAs Total Capital + CCB 13.76% 3.60% 10.35% 3.41% None 10.56% 13.76%
189787.9 39964.23
37
Bank of India
Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 285084.9 205921.2 79163.7 0 2354660 288199.81
208779.84
5745.19 203872.65 52695.47 8433.28 0.73
Current 12.11% 2.84% 8.75% 3.36% None 8.99% 12.11%
240594.3 62632.36
38
Yes Bank
Current Capital (Rs mill) Total capital Basel II Tier-1 Capital Tier-2 Capital Debt Raised as Capital During the Year Total Risk Weighted Assets Cash & Balances with RBI Other Cash or cash equivalents Share Capital Total Reserves Statutory Reserve Capital Reserves General Reserves Return on assets % 93260.55 51512.73 41747.82 47482058 519826.33 23325.44 12529.97 3529.87 43236.49 2440 250 11150 1.47
Current 17.94% 0.68% 9.91% 8% None 10.59% 17.94%
51982.63 11220.57815
39
Analysis
It can be observed that in case of all the above 10 banks though the capital is sufficient in terms of quantity but in terms of quality the banks will have to build their capital. They will have to infuse Total Capital of Rs.2685322.13 million out of which Rs.960672.9327
million will have to be Core Tier 1 Capital / Common equity (i.e. Share Capital + Statutory Reserve+ Capital Reserve + Other Free Reserve) HDFC Bank, State Bank of India, ICICI Bank, Kotak Mahindra Bank, Axis Bank & Yes Bank have debt on their books which is classified as capital. Under Basel III loss absorbency
requirements have been levied on the non-equity regulatory capital (such as debt) will increase its cost. This will make issuing of debt as capital more expensive. Thus overall cost of capital will increase for banks. Also as mentioned above all banks have cash with RBI as well as other cash and cash equivalents in their assets. This coupled with SLR, I feel the banks will be in comfortable position to withstand liquidity stress. Also currently RBI has already employed sectoral lending guidelines to prevent overheating of any particular sector of the economy this mechanism can be continued to address the counter cyclical buffer. RBI has also introduced the conversion of Basel II to Basel III in a phased manner over 5yrs. This will give the above banks enough time to build up their capital to comply with Basel III norms. RBI has also issued capital requirements slightly higher than Basel III. This is because Indian banks have not yet migrated to advanced risk measurement approach and the additional capital will be like an extra cushion for the banks against stress. Other countries like Philippines, Singapore, China & South Africa also have set the capital requirements higher than Basel III to safeguard their banks. Along with the above measures RBI is also awaiting guidance on the list of D-SIBs in India. According to me banks like State Bank of India, Bank of Baroda having large assets under management and a wide network may be classified as D-SIBs. Through implementation of Basel III RBI has tried to strengthen the banking system in India.
40
IMPACT OF BASEL III RATIOS ON INDIAN BANKS
Capital Requirement
The average Tier 1 capital ratio of Indian banks is around 10 per cent with more than 85% of it comprising common equity. The regulatory adjustments will reduce the available equity capital only marginally. Hence the task of raising capital will not be so onerous for Indian Banks. As quoted by RBI Governor D. Subbarao in September Indian banks would require an additional capital of Rs.5 trillion to meet the new global banking norms. Of the total Rs.5 trillion, equity capital will be Rs.1.75 trillion, while Rs.3.25 trillion will have to come as the non-equity portion. This capital can be raised through markets and through Government (in PSBs) Also under Basel III, the trading book exposures, especially those having credit risk and resecuritisations exposures in both banking and trading book attract enhanced capital charges. The CVA for OTC derivatives will also attract additional capital. Since the trading book and OTC derivative portfolios of Indian banks are very small and they do not have any exposures to re-securitised instruments, impact of these changes in capital regulation on their balance sheets is insignificant.
Leverage Ratios
RBI already had Statuary Liquidity Ratio (SLR), as a regulatory mandate. The statutory liquidity portfolio of Indian banks is constituted only for moderate risk i.e. Market Risk and it is excluded from leverage ratio. The tier I capital of many Indian banks is comfortable (more than 8% as per Basel II regulation of Tier I capital) and their derivatives activities are not very large. So leverage ratio will not be a binding constraint for Indian Banks.
41
Countercyclical Buffer
A critical component of the Basel III package is a countercyclical capital buffer which mandates banks to build up a higher level of capital in good times that could be run down in times of economic contraction, consistent with safety and soundness considerations. This is conceptually neat, but is challenging in operational terms. The foremost challenge is identifying the inflexion point in an economic cycle which should trigger the release of the buffer. Both tightening too early or too late can be costly in macroeconomic terms. The identification of the inflexion point therefore needs to be based on objective and observable criteria. It also needs long series data on economic cycles. So, what we need is both a better database and more refined statistical skills in analysing economic cycles. The countercyclical capital buffer as prescribed in Basel III was initially based on the credit/GDP metric. This is not a good economic indicator from the Indian perspective. A study undertaken by the Reserve Bank showed that the credit to GDP ratio has not historically been a good indicator of build-up of systemic risk in our banking system. Furthermore, some economic sectors such as real estate, housing, micro finance and consumer credit is relatively new in India, and banks have only recently begun financing them in a big way. The risk build up in such sectors cannot accurately be captured by the aggregate credit to GDP ratio. The Reserve Bank has so far calibrated countercyclical policies at the sectoral level, and I believe we need to continue to use that approach. The Basel Committee also has now recognised that no single variable can fully capture the dynamics of the economic cycle. Appropriate calibration of the buffer requires country specific judgement backed by a broad range of other simple indicators used in financial stability assessments.
42
Liquidity Ratio
The major challenge for banks in implementing the liquidity standards is to develop the capability to collect the relevant data accurately and to formulate them for identifying the stress scenario with accuracy. However positive side for Indian banks, they have a substantial amount of liquid assets which will enable them to meet requirements of Basel III. In India, banks are statutorily required to hold minimum reserves of high-quality liquid assets. Currently, such reserves (statutory liquidity ratio SLR) are required to be maintained at a minimum of 24 per cent of net demand and time liabilities. Since these reserves are part of the minimum statutory requirement, the Reserve Bank faces a dilemma whether and how much of these reserves can be allowed to be reckoned towards the LCR. If these reserves are not reckoned towards the LCR and banks are to meet the entire LCR with additional liquid assets, the proportion of liquid assets in total assets of banks will increase substantially, thereby lowering their income significantly. Thus the Reserve Bank is examining to what extent the SLR requirements could be reckoned towards the liquidity requirement under Basel III.
D-SIBs
DSIBs are generally considered too big to fail banks as their failure might have a devastating cascading effect on the economy. Hence, any bank named as a D-SIB may have higher capital requirements increasing its cost of capital. But at the same times this increased capital will prove to be safeguard for it in times of stress and prevent it from facing a liquidity crisis.
43
WILL BASEL III AFFECT PROFITABILITY OF BANKS IN INDIA?
Basel III requires higher and better quality capital. The cost of this equity capital is high. It is also likely that the loss absorbency requirements on the non-equity regulatory capital will increase its cost. The average Return on Equity (RoE) of the Indian banking system for the last three years has been approximately 15%. Implementation of Basel III is expected to result in a decline in Indian banks RoE in the short-term. However, the expected benefits arising out of a more stable and stronger banking system will largely offset the negative impact of a lower RoE in the medium to long term. It is also fair to assume that investors will perceive the benefits of having less risky and more stable banks, and will therefore be willing to trade in higher returns for lower risks. Now the point in front of the banks will be to bear the increased cost of capital themselves or pass it to their depositors and borrowers. This trade-off needs to be assessed in the context of the relatively higher level of net interest margins (NIMs) of Indian banks, of approximately 3%. This higher NIM suggests that there is scope for banks to improve their efficiency, bring down the cost of intermediation and ensure that returns are not overly compromised even as the cost of capital may increase. Also shifting from Standard approach to Advanced approach in risk measurement may also help in improving profitability as total capital required would decrease. As accurate risk measurement for each asset would enable banks to set aside only the necessary capital rather than setting aside capital based on ratings. Thus even though the increased capital requirement will have some impact on profitability, the banks can reduce the effect on profitability by making their operations more efficient (reduce NIM margin and also by implementing better risk sensitive capital management process. Also though Basel III will affect profitability in the short term, in the long term due to the risk return profile; implementing Basel III will be viewed positively by investors
44
WILL BASEL III HURT GROWTH?
Major concern in implementing Basel III is that the higher capital requirements under Basel III will kick in at a time when credit demand in the economy will be on the rise. In a structurally transforming economy with rapid upward mobility, credit demand will expand faster than GDP for several reasons. i. First, India will shift increasingly from services to manufactures, and the credit intensity of manufacturing is higher per unit of GDP than that for services. ii. Second, we need to at least double our investment in infrastructure which will place enormous demands on credit. iii. Finally, financial inclusion, which both the Government and the Reserve Bank are driving, will bring millions of low income households into the formal financial system with almost all of them needing credit. This means is that higher capital requirements will be imposed on banks as per Basel III at a time when credit demand is going to expand rapidly. This may mitigate growth. But empirical research by BIS economists shows that even if Basel III may impose some costs in the short-term, it will secure medium to long term growth prospects. This helps to ease fears relating to growth.
45
CHALLENGES IN IMPLEMENTATION OF BASEL III
Indian banks have already meet the minimum capital requirements of Basel III by a comfortable margin at an aggregate level (if we do not consider quality of capital), but some individual banks may have to top up. Still capital adequacy today does not mean capital adequacy going forward. Currently, the bank credit GDP ratio in India is around 55%. For growth to accelerate, this ratio will have to go up as one of the necessary pre-conditions. Besides, as our economy goes through a structural transformation, the share of the industry sector will increase and the credit-GDP ratio will rise even further. This means is that Indian banks would have been required to raise additional capital even in the absence of Basel III. In estimating the net additional burden on account of Basel III, this factor needs to be considered. The size of the additional capital required to be raised by Indian banks depends on the assumptions made, and there are various estimates floating around. The Reserve Bank too has made some quick estimates based on the following two conservative assumptions covering the period to March 31, 2018: i. ii. Risk weighted assets of individual banks will increase by 20 per cent per annum; and Internal accruals will be of the order of 1% of risk weighted assets. Based on the above assumptions the Reserve Bank estimates an additional capital requirement of `5 trillion, of which non-equity capital will be of the order of `3.25 trillion while equity capital will be of the order of `1.75 trillion. This capital burden will be shared by the markets and Government as per its discretion (in case of PSBs). Depending on the amount of capital Government will infuse in the PSBs the market will have to provide in the range of `700 billion `1 trillion.
46
Additional* Common Equity Requirements of Indian Banks under Basel III (` billion Rs)
Sr. No.
Public Sector Banks
Private Sector Banks
Total
Additional Equity Capital Requirements under Basel III
1400-1500
200-250
1600-1750
Additional Equity Capital Requirements under Basel II
650-700
20-25
670-725
Net Equity Capital Requirements under Basel III {(1)-(2)} Of Additional Equity Capital
750-800
180-225
930-1025
Requirements under Basel III for Public Sector Banks (1) Government Share (if present shareholding pattern is maintained)
4.1
880-910
4.2
Government Share (if shareholding is brought down to 51 per cent) Market Share (if the Governments
660-690
4.3
shareholding pattern is maintained at present level)
520-590
* On top of internal accruals
47
Over the last five years, banks have revised equity capital to the tune of `520 billion through the primary markets. Raising an additional `700 billion `1 trillion over the next five years from the market should therefore not be an insurmountable problem. The extended period of full Basel III implementation spread over five years gives sufficient time to banks to plan the time-table of their capital rising over this period. The Government owns 70 per cent of the banking system. If the Government opts to maintain its shareholding at the current level, the burden of recapitalisation will be of the order of `900 billion; on the other hand, if it decides to reduce its shareholding in every bank to a minimum of 51 per cent, the burden reduces to under `700 billion. But providing equity capital of this size in the face of fiscal constraints poses significant challenges. So a tempting option in front of the Government would be to issue recapitalisation bonds against common equity infusion. But this will militate against fiscal transparency. Other alternative, would be for the Government reduce its shareholding in PSBs to below 51 per cent. If Government chooses this option then there is a possibility that the Government might amend the statute to protect its majority voting rights in the PSBs. Currently the macroeconomic climate is full of uncertainty. It has been observed that though in the past year the market rallied yet the rise was due to large cap stocks, the mid cap and small cap stocks did not see significant increase in price. Thus we can observe that currently equity investors have shown a bias towards strong large cap stocks. Thus this may prove to be a challenge for smaller banks that are in need of capital more urgently than the larger banks. Thus raising capital from the market is not as straightforward as it looks and banks which are not fundamentally strong may find it difficult to raise capital from the market. Also Basel III requires debt which is part of core capital to be convertible to equity in case the bank is under stress. This would make the debt instruments unappealing to investors at their current rates. But increasing the coupon rate would increase cost of capital for the banks. Another challenge is re-structuring the assets of some of the banks would be a tedious process, since most of the banks have poor asset quality leading to significant proportion of NPA. This also may lead to Mergers & Acquisitions leading to consolidation of banks.
48
Also Basel III implementation will also hurt the smaller banks that are likely to be hurt by the rise in weightage of inter-bank loans that will effectively price them out of the market. Thus, banks will have to re-structure themselves if they are to survive in the new environment. Basel III wishes to promote improved risk management and measurement and to give impetus to the use of internal rating system by the international banks. Hence, more and more banks may have to use internal models Basel III wishes to promote improved risk management and measurement and to give impetus to the use of internal rating system by the international banks. Hence, more and more banks may have to use internal models developed in house and their impact is uncertain. Most of these models require minimum historical bank data that is a tedious and high cost process, as most Indian banks do not have such a database. The technology infrastructure in terms of computerization is still in a nascent stage in most Indian banks. Computerization of branches, especially for those banks, which have their network spread out in far-flung areas, will be a daunting task. Penetration of information technology in banking has been successful in the urban areas, unlike in the rural areas where it is insignificant. Experts say that dearth of risk management expertise in the Asia Pacific region will serve as a hindrance in laying down guidelines for a basic framework for the new capital accord. An integrated risk management concept, which is the need of the hour to align market, credit and operational risk, will be difficult due to significant disconnect between business, risk managers and IT across the organizations in their existing set-up. Implementation of the Basel III will require huge investments in technology. According to estimates, Indian banks, especially those with a sizeable branch network, will need to spend well over $ 50-70 Million on this. Thus the major challenges in front of the banking system are fulfilling the capital requirements not just at the present but in the scenario of increasing credit growth. This challenge will be tougher for the smaller banks as compared to the larger banks. Also other than the capital the banks would have to invest in technology to be to enjoy the benefits of risk sensitive capital regulation.
49
SHOULD BASEL III BE IMPLEMENTED IN INDIA?
Implementation of Basel III will face certain challenges like need of investment in new IT and technology systems, the burden of raising additional capital and the costs of complying with the new liquidity standards their impact on banks profitability, and on the overall growth prospects of the economy. Hence, it becomes necessary to see whether its even necessary for banks to adopt Basel III. Some are of the view that India should adopt only a diluted version of Basel III, so as to balance the benefits against the putative costs. To buttress this view, it is argued that Basel III is designed as a corrective for advanced economy banks which had gone astray, often times taking advantage of regulatory gaps and regulatory looseness, and that Indian banks which remained sound through the crisis should not be burdened with the onerous obligations of Basel III. The Reserve Bank does not agree with this view. Its position is that India should transit to Basel III because of several reasons. By far the most important reason is that as India integrates with the rest of the world, as increasingly Indian banks go abroad and foreign banks come on to our shores, Indian banks cannot afford to have a regulatory deviation from global standards. Any deviation will hurt us both by way of perception and also in actual practice. The perception of a lower standard regulatory regime will put Indian banks at a disadvantage in global competition, especially because the implementation of Basel III is subject to a peer group review whose findings will be in the public domain. Deviation from Basel III will also hurt us in actual practice. As Basel III provides for improved risk management systems in banks, it is important that Indian banks have the cushion afforded by these risk management systems to withstand shocks from external systems, especially as they deepen their links with the global financial system going forward. Hence it is desirable for Indian banks to transition from Basel II to Basel III along with the global banking system.
50
CONCLUSION
Both internationally and in India bankers have expressed their concerns over the additional capital requirements under Basel III. It is feared that these additional capital requirements, leverage ratios would hurt profitability of the bank. But studies have shown that though the Basel III guidelines would impose short term costs on the banks in the long term it would strengthen the financial system and make the banks more resilient against stress. Also investors would appreciate the fact that though the returns have lowered the risk has also reduced. In India Basel III would make our banks compliant with global regulations, this would help the Indian banks who wish to expand overseas. Also through Basel III would strengthen the financial system. Capital requirements under Basel III may cause some smaller banks to merge with the larger banks leading to consolidation of banks. In the initial stages Basel III will require banks to incur expenditure on both capital as well as IT infrastructure for accurate risk measurement. But adoption of a more risk sensitive approach will increase the profitability of the banks in the long run. Also as the banks will be perceived to be more stable and thus less risky the cost of capital will also decrease in future. Now apart from raising capital the other challenges ahead of the banks are improving their operational efficiency to decrease their NIM margins. Also reducing their NPA levels in the current macroeconomic scenario will be a major challenge for the banks. RBI will start implementation of Basel III from 1st April, 2013, now it is upon the banks to efficiently restructure their operations so as to not only be Basel III compliant but enjoy healthy profits in the medium and long run.
51
BIBLIOGRAPHY
i. ii. iii. iv. v.
RBI website Ace Equity database Annual report of State Bank of India, Yes Bank and Punjab National Bank Wikipedia KPMG consultancy paper on implication of Basel III
52

Effect of Basel III On Indian Banks

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Effect of Basel III On Indian Banks

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TABLE OF CONTENTS

THE GLOBAL FINANCIAL CRISIS OF 2008

WHY BASEL II FAILED?

INTRODUCTION TO BASEL III

Systemic Risks & Interconectedness

Objectives of Basel III

Proposal of Basel III

Capital Requirements as per Basel III

Under Basel II 8% 2% 4% 2% 4% None 2% 8% None None None None None

Timeline for Implementation of Basel III

HOW IS BASEL III AN IMPROVEMENT OVER BASEL II

Higher Capital Requirement & Liquidity Standards

BASEL III IN INDIA

RBI GUIDELINES FOR BASEL III

As per RBI 9% 5.50% 1.5% 7.00% 2%

0.625 6.125 7 9 9.625

1.25 6.75 7 9 10.25

1.875 7.375 7 9 10.875

SUPERVISORY REVIEW AND EVALUATION PROCESS (PILLAR 2)

CAPITAL CONSERVATION BUFFER

G-SIBs & D-SIBs

STUDY OF 10 BANKS IN INDIA WITH RESPECT TO BASEL III GUIDELINES

Current 16.52% 3.31% 11.60% 4.92% None

As per RBI Under Basel III 9% 5.50% 1.50% 7.00% 2% 2.50%

State Bank of India

Current 13.86% 0.67% 9.79% 4.07% None 10.46% 13.86%

11527.68 592500.89 89916.52 21842.5 1.47

Current 18.52% 3.09% 12.67% 5.84% None 12.96% 18.52%

Current 13.66% 2.22% 9.45% 4.21% None 9.62% 13.66%

Kotak Mahindra Bank

Current 11.29% 2.33% 10.14% 1.78% None 10.64% 11.29%

Punjab National Bank

Current 12.63% 1.29% 9.28% 3.35% None 10.57% 12.63%

Current 13.85% 2.97% 11.37% 2.48% None 12.56% 13.85%

5745.19 203872.65 52695.47 8433.28 0.73

Current 12.11% 2.84% 8.75% 3.36% None 8.99% 12.11%

Current 17.94% 0.68% 9.91% 8% None 10.59% 17.94%

IMPACT OF BASEL III RATIOS ON INDIAN BANKS

WILL BASEL III AFFECT PROFITABILITY OF BANKS IN INDIA?

WILL BASEL III HURT GROWTH?

CHALLENGES IN IMPLEMENTATION OF BASEL III

Public Sector Banks

Private Sector Banks

Additional Equity Capital Requirements under Basel III

Additional Equity Capital Requirements under Basel II

shareholding pattern is maintained at present level)

* On top of internal accruals

SHOULD BASEL III BE IMPLEMENTED IN INDIA?

i. ii. iii. iv. v.

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