Thursday, May 3, 2012


I have tried my level best to make my readers understand that RBI is not going to play the old tunes of boosting the stock market. Whenever there has been a rate cut we have hoped that RBI is doing the action to boost the market and Indian industrial growth. But every time it did just to adjust its Banks portfolio’s. Well it seems that RBI rates cuts will only help Indian banks to comply the new norms of Basel III. The objective of this article is to present the balance and the affects of the Basel III norms which are being implemented by RBI. I depicted both pros and cons of the new norms and its overall affects on the Indian economy. Before start I would like to make one personal comment from my heart that after going through the norms I find Indian economic growth might be capped for some time. The norms of RBI are tough than the international norms of Basel III.

After 31st March 2010 Indian banks will have to adhere to the Basel II norms. India had adopted Basel I guidelines in 1999. Later on in February 2005 gain , the RBI had issued draft guidelines for implementing a New Capital Adequacy Framework, in line with Basel II.

The deadline for implementing Basel II, originally set for March 31, 2007, was extended. Foreign banks in India and Indian banks operating abroad will have to adhere to the guidelines by March 31, 2009.

Now its time for Basel III. Basel III norms, which will be effective from January 2013 in a phased manner and fully implemented by March 2018.Well the time frame might sound lengthy enough to adopt the norms but its very hard to swallow and chew too. So let us dig what is this Basel III al about and how it will affect the Indian Banking sector.
What is Basel III?
Basel III is the third of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. Basel III is asset of guidelines agreed upon by the Basel Committee on Banking Supervision in 2010-11. The Basel committee was formed in 1974 by a group of central bank governors from 10 countries, and has now expanded to include members from nearly 30 countries, including India. The purpose of Basel III is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Basel III strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. For instance, the change in the calculation of loan risk in Basel II which some consider a causal factor in the credit bubble prior to the 2007-8 collapse: in Basel II one of the principal factors of financial risk management was out-sourced to companies that were not subject to supervision: credit rating agencies. Ratings of creditworthiness and of bonds, financial bundles and various other financial instruments were conducted without supervision by official agencies, leading to AAA ratings on mortgage-backed securities, credit default swaps and other instruments that proved in practice to be extremely bad credit risks. In Basel III a more formal scenario analysis is applied (three official scenarios from regulators, with ratings agencies and firms urged to apply more extreme ones)

Basel III uses a "three pillars" concept – (1) minimum capital requirements (addressing risk), (2) supervisory review and (3) market discipline – to promote greater stability in the financial system.

Lets digg out how all the three above pillars will bring changes in the Indian banking segment.

The first concept deals with minimum capital requirements under Basel III followed with analysis.

• According to the guidelines, which will be effective from January 1, 2013, banks will have to maintain their total capital ratio at 9%, higher than the minimum recommended requirement of 8% under the Basel III norms. Capital ratio is the percentage of a bank’s capital to its risk-weighted assets.The risk consists of interest rate risk in the banking book, foreign exchange risk, liquidity risk, business cycle risk, reputation risk, strategic risk.

• The norms also require banks to maintain Tier I capital at 7% of risk weighted assets. Tier I capital, or core capital, includes a bank’s equity capital and disclosed reserves.

• In other words it can be described as the minimum amount of capital a Bank should maintain to cover its various business risks. This might affect the credit growth of banks since in first place Indian Banks are basically born skeptical which also acts as a boon in times of crisis. Banks will have to increase their margins for providing loans and moreover may reduce the rate of percentage of sanctions they make in usual conditions.

• Basel III also introduces additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth.

• Tier I capital consists of common stock, retained earnings and some forms of preferred stock, besides instruments with characteristics of both equity and debt. Basel III norms force banks to eliminate most of these calculations and arrive at a pure equity-based calculation of tier I capital—an issue that is hotly debated by global banks.

• The Indian regulator has been more stringent. For Indian banks, common equity should be at least 5.5% of the asset base, whereas the international norm suggests 4.5%.

• Minimum Common Equity Tier 1 capital of 5.5 per cent of RWAs, banks are also required to maintain a capital conservation buffer (CCB) of 2.5 per cent of RWAs in the form of Common Equity Tier 1 capital,

• Under Basel II, Indian banks need to maintain tier I capital of 6%, which rises to 7% under Basel III. Under Basel III, several instruments, including some that have the characteristics of debt, cannot be included for arriving at tier I capital.

The other pillar of Basell III is supervisory review & enhanced disclosure norms.

Banks have been given the power by which they will not only maintain the minimum capital requirements but will also be able to have a process by which they can assess their capital adequacy themselves. This process, and its assessment by the supervisory authority, is central to the second pillar of the Basel II Accord.

This also ensures that banks will be able to make arrangements to ensure that they hold enough capital to cover all their risks. The prime responsibility will lie on the PSU banks to compile with the norms.

• This review process will provide benefits when another financial crisis will hit in the future. We should not forget that when the US banks were getting sold out the Indian Banking segments stood still as if nothing has happened. That’s why we can go off to sleep when our prime wealth is being safely preserved in the Indian banks. It works in this frame work shown below.

• The last but the most important one of Basel III is market discipline.

• The recent financial crisis in US and the bailouts of the Century old Banks have raised the voice of market discipline. This is one of the most important pillar of any financial process.

• Market Discipline in banking and financial sector is highly required in coming days as more globalization will expand. Market discipline as per Basel II focuses on:

• To achieve increased transparency through expanded disclosure requirements for banks.

• This will make sure that the banks are well positioned to handle the complex business process.

• This will bring transparency in the process followed with adequate updating to the banking regulators on the involved process of the various banks in dealing complex products.

Well the above regulatory aspects seems to protect the Indian Banking system from any fragile collapse but the real tough game will be to adopt with the capital requirements to cushion up the Banking system. According to the above capital adequacy its is being found that Banks in India may need at least $30 billion (around Rs. 1.6 trillion today) as capital over the next six years to comply with the norms. Well this funding seems to be difficult to maintain since Indian economy needs Banking support to develop industrial growth. In order to maintain these requirements Indian PSU banks might go for stringent loans and funding disbursement.

Moreover its is well predicted now that whatever rate cut will come from the womb of RBI will only help banks to comply the norms rather than providing funds for Indian economic growth. This Basel III might create a reverse impact on the Indian economic growth at present times. Private Banks are well capitalized in terms of the Basel III norms. I fear personally that will this norms will bring slowdown in Indian economic growth. The real problem will begin with PSU banks of India. Under the new norms Indian banks will be very stringent in disbursement of loans and will be very hard on the foul players who cheat the banking system. Under the new norms for every 1% increase in gross NPAs (non-performing assets), the banking system would require additional capital of Rs 25,000 crore. Hence one can understand clearly that how hard banks will go over the foul players on loan defaulters.This will reduce the NPA of the banks but also many sectors of indian eocnomy will be affected where  NPA are galopping like Power sector is among the top of the list.

In my previous articles I have told clearly that RBI actions are no longer focused towards boosting loan restructure and refinancing activities. RBI actions are well tuned keeping the global uncertainty outlook which is stretched over the next decade. Europe and U.S economic turbulence has forced RBI to take steps and measures which might seem as destructive for Indian economy but later on in the long run its will prove to be beneficial for Indian economic growth.One must not forget that all our savings are parked with the Banks. If Indian banks play like US and European banks where corporate restructuring of debt portfolio is being carried out then all our savings will be wiped out. Hence we don’t want any such type of play being adopted by Indian banks. But every time when RBI reduced the interest rates we wanted corporate structuring which will lead to economic boost of India. Well do you want economic boost at the cost of the foul plays of the Indian corporate. Choices are always yours.

So over all it can be concluded that with the advent of Basel III, banks with a risk appetite, i.e. high risk - high return lending strategy or lending without proper appraisal merely to generate additional business will find the going tough. Moreover Indian economy is going to face some tough times way ahead due to compilation of these norms which is spread over the years. I fear personally that will this norms will bring slowdown in Indian economic growth. We believe that such business models, which take disproportionately high risks, will not survive. The business models, which should survive, will be where risks are within acceptance levels for the banks backed by adequate returns.The game of NPA is about to get over for indian banks.


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