23/08/2012

BASEL- III GUIDELINES

Background :

➢ RBI released its final guidelines on 2nd May,2012 on the implementation of Basel – III capital regulation in India.

➢ These guidelines will be effective from 1st January,2013 in a phased manner & will be fully implemented by 31st March,2018.

➢ For the FY 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.

Purpose :

• Implementation of Basel III is essential for restoring confidence in the regulatory framework for banks and to ensure a safe & stable global banking system.

• Basel-III urges banks to raise the quality of Capital to absorb unexpected losses, to reduce the chance of another financial crisis.

Need arose due to :

• The U S sub-prime crisis has highlighted the linkages of the main types of risks, especially Credit, Market & Liquidity risks and since then the need for strengthening the capital regime has emerged prominently.

Important Points :

➢ Greater focus on “Common Equity” i.e. paid up capital, reserves, retained earnings etc. raising the minimum common equity requirements from the existing 2% of risk-weighted assets to 5.50% by 31st March,2018, and a capital conservation buffer of 2.50%, bring the total common equity requirements to 8% by 2018.

➢ The overall minimum Tier – I capital requirements, which includes common equity and other qualifying financial instruments (1.50%), will be 6% (without conservation buffer) by 2013 and 7% by 2015.

➢ The minimum total capital must be at least 9% of risk-weighted assets – however, what counts as core capital may impact the Indian banking Industry’s competitiveness significantly.

➢ Capital contingency planning under Basel - III’s “loss absorbency” requirement is an important international development.

➢ In a crisis, a bank will be allowed to let its Tier – I capital ratio drop temporarily to as low as 4.50%, but then the bank will not be permitted to declare dividends & paying bonuses, till the time it has rebuild the ratio to 7%.

➢ Basel – III emphasizes that bank’s liquid assets should be sufficient enough to cover the net cash outflow. For this, two liquidity standards / ratios are proposed :

i) Liquidity coverage ratio (LCR) – it’s the ratio of liquid assets to net cash outflow for short term (30 days) liquidity management, and

ii) Net stable funding ratio (NSFR) – it’s the ratio of available stable funds to required stable funds and it indicates the long term structural liquidity mismatches. Basically, it aims to

The regulator expects that LCR to be always more than 100%, implying that the banks have sufficient high quality liquid assets. Similarly, RBI wants the banks to have >100% NSFR and which is possible only if the banks a) limit over-reliance on wholesale funding during times of buoyant market liquidity and b) encourages better assessment of liquidity risk across all on & off balance sheet items.

➢ Basel – III also wants to ensure that bank’s leverage ratio (Tier-I capital divided by all on & off balance sheet items) should be at least greater than 3%. Unlike the debt-equity ratio, it’s just the reverse ratio that indicates bank’s solvency. It must be calculated as an average over the quarter. Bank level disclosure of leverage ratio is proposed to start from January 01,2015.

Implications on Indian Banking System :

RBI has recently assessed that Indian banks at the system level will not be much impacted by the proposed capital rule as our banks are already well capitalized ( System level CRAR is >14% (against prescribed minimum 9%), Tier-I 9.9% (6%) and Common Equity > 8% (2%).

However, because of higher growth and bank’s obligations to infrastructure sector and financial inclusion, this capital may be eroded and the requirement of additional capital buffer may go up in future.

RBI has assessed that leverage position of our Banks is moderate but it’s on the safer side as compared to the banks in western countries.