BackGround for Basel III

BackGround for Basel III :

In a separate article I have already discussed the details of the Basel III accord as released by Basel Committee on Banking Supervision.   In this article we will be dealing with the broad guidelines as issued by RBI for implementation of Basel 3 Accord.   We are aware that originally Basel Committee was formed in 1974 by a group of central bank governors from 10 countries.   Earlier guidelines were known as Basel I and Basel II accords.  Later on the committee was expanded to include members from nearly 30 countries , including India.   Inspite of implementation of Basel I and II guidelines, the financial world saw the worst crisis in early 2008 and whole financial markets tumbled.    One of the major debacles was the fall of Lehman Brothers.   One of the interesting comments on the Balance Sheet of Lehman Brothers  read : “Whatever was on the left-hand side (liabilities) was not right and whatever was on the right-hand side (assets) was not left.” Thus, it became necessary to re-visit Basel II and plug the loopholes and make Basel norms more stringent and wider in scope.    

BCBS, through Basel III, put forward norms aimed at strengthening both sides of balance sheets of banks viz. (a) enhancing the quantum of common equity; (b) improving the quality of capital base (c) creation of capital buffers to absorb shocks; (d) improving liquidity of assets  (e) optimising the leverage through Leverage Ratio  (f) creating more space for banking supervision by regulators under Pillar II and (g) bringing further transparency and market discipline under Pillar III.    Thus, Basel  III norms were released by BCBS and individual central banks were asked to implement these in a phased manner.   RBI (India's central bank) too issued draft guidelines in the initial stage and then came up with the final guidelines.

Over View f the RBI Guidelines for Implementation of Basel III guidelines:

The final guidelines have been issued by Reserve Bank of India for implementation of Basel 3 guidelines on 2nd May, 2012.   Full detailed guidelines can be downloaded from RBI website, by clicking on the following link : Implementation of Base III Guidelines.     Major features of these guidelines are :

(a) These guidelines would become effective from January 1, 2013 in a phased manner.   This means that as at the close of business on January 1, 2013, banks must be able to declare or disclose capital ratios computed under the amended guidelinesThe Basel III capital ratios will be fully implemented as on March 31, 2018

(b) The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods and higher during the later years. Banks needs to keep this in view while Capital Planning;

(c) Guidelines on operational aspects of implementation of the Countercyclical Capital Buffer. Guidance to banks on this will be issued in due course as RBI is still working on these.   Moreover, some  other proposals viz. ‘Definition of Capital Disclosure Requirements’, ‘Capitalisation of Bank Exposures to Central Counterparties’ etc., are also engaging the attention of the Basel Committee at present.  Therefore, the final proposals of the Basel

Committee on these aspects will be considered for implementation, to the extent applicable, in future.

(d) For the financial year ending March 31, 2013, banks will have to disclose the capital ratios computed under the existing guidelines (Basel II) on capital adequacy as well as those computed under the Basel III capital adequacy framework.

(e) The guidelines require banks to maintain a Minimum Total Capital (MTC) of 9% against 8% (international) prescribed by the Basel Committee of Total Risk Weighted assets.  This has been decided  by Indian regulator as a matter of prudence.   Thus, it requirement in this regard remained at the same level.  However, banks will need to raise more money than under Basel II as several items are excluded under the new definition. 

(f) of the above, Common Equity Tier 1 (CET 1) capital must be at least 5.5% of RWAs;

(g) In addition to the Minimum Common Equity Tier 1 capital of 5.5% of RWAs, (international standards require these to be only at 4.5%)  banks are also required to maintain a Capital Conservation Buffer (CCB) of 2.5% of RWAs in the form of Common Equity Tier 1 capital.    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.  In case suchbuffers have been drawn down, the banks have to rebuild them through reduced discretionary distribution of earnings.  This could include reducing dividend payments, share buybacks and staff bonus.

(h) Indian banks under Basel II are required to maintain Tier 1 capital of 6%, which has been raised to 7% under Basel III.  Moreover, certain instruments, including some with the characteristics of debts, will not be now included for arriving at Tier 1 capital;

(i) The new norms do not allow banks to use the consolidated capital of any insurance or non financial subsidiaries for calculating capital adequacy.

(j) Leverage Ratio :   Under the new set of guidelines, RBI has set the leverage ratio at 4.5% (3% under Basel III).   Leverage ratio has been introduced in Basel 3 to regulate banks which have huge trading book and off balance sheet derivative positions.  However, In India,  most of banks do not have large derivative activities  so as to arrange enhanced cover for counterparty credit risk. Hence, the pressure on banks should be minimal on this count.

(k) Liquidity norms:   The Liquidity Coverage Ratio (LCR) under Basel III requires banks to hold enough unencumbered liquid assets to cover expected net outflows during a 30-day stress period. In India, the burden from LCR stipulation will depend on how much of CRR and SLR can be offset against LCR.     Under present guidelines, Indian banks already follow the norms set by RBI for  the statutory liquidity ratio (SLR) –  and cash reserve ratio (CRR), which are liquidity buffers.   The SLR is mainly government securities while the CRR is mainly cash. Thus, for this aspect also Indian banks are better placed over many of their overseas counterparts.

(l)   Countercyclical Buffer: Economic activity moves in cycles and banking system is inherently pro-cyclic. During upswings, carried away by the boom, banks end up in excessive lending and unchecked risk build-up, which carry the seeds of a disastrous downturn. The regulation to create additional capital buffers to lend further would act as a break on unbridled bank-lending.  The detailed guidelines for these are likely to be issued by RBI only at a later stage.

On the day of release of these guidelines, analysts felt that India may need at least $30 billion (i.e. around Rs 1.6 trillion) to $40 billion as capital over the next six years to comply with the new norms.   It was also felt that this would impose a heavy financial burden on the government, as it will need to infuse capital in case it wanst to continue its hold on these PS Banks.   RBI Deputy Governor, Mr Anand Sinha viewed that the implementation of Basel II may have a negative impact on India's growth story.   In FY 2012-13, Government of India is expected to provide Rs 15888 crores to recapitalize the banks. as to maintain capital adequacy of 8% under old Basel II norms.

Some Major Developments after 2nd May 2012 (i.e. the date when RBI issued Basel III guidelines) :

(A) On 30th October 2012, RBI in its  Second Quarter Review of Monetary Policy 2012-13  has declared as follows :

(i) "Basel III Disclosure Requirements on Regulatory Capital Composition

87. ....... The Basel Committee on Banking Supervision (BCBS) has finalised proposals on disclosure requirements in respect of the composition of regulatory capital, aimed at improving transparency of regulatory capital reporting as well as market discipline. As these disclosures have to be given effect by national authorities by June 30, 2013, it has been decided:

to issue draft guidelines on composition of capital disclosure requirements by end-December 2012.

(ii) Banks’ Exposures to Central Counterparties (CCP)

88. The BCBS has also issued an interim framework for determining capital requirements for bank exposures to CCPs. This framework is being introduced as an amendment to the existing Basel II capital adequacy framework and is intended to create incentives to increase the use of CCPs. These standards will come into effect on January 1, 2013. Accordingly, it has been decided:

to issue draft guidelines on capital requirements for bank exposures to central counterparties, based on the interim framework of the BCBS, by mid-November 2012.
 

(iii) Core Principles for Effective Banking Supervision

89. The Basel Committee has issued a revised version of the Core Principles in September 2012 to reflect the lessons learned during the recent global financial crisis. In this context, it is proposed:
to carry out a self-assessment of the existing regulatory and supervisory practices based on the revised Core Principles and to initiate steps to further strengthen the regulatory and supervisory mechanism.