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Money

Basel-III Norms – Highlights

Atul Kumar Thakur
Dec 2011

Aim

Following the recent financial meltdown, the leaders of the group of G-20 economies asked the Basel Committee on Banking Supervision (BCBS) to reach the new rules needed to prevent another financial crisis in future. The aim was to mitigate the greed ridden financial crisis instead of blocking the real factors behind it.

What banks will have to do?

Real impression of Basel-III norms could be sensed out with the statement of Hant Wellink, Head of Basel Committee on Banking Supervision - “Partly banks will have to retain profit for years which they cannot use to pay shareholders or bonuses. For another part, this will vary from bank to bank; they will have to get it from the capital market. I think it will make a new crisis less likely. Chances are much smaller, we have made calculations on this but we can't rule it out completely”. The statement reflects the genuine apprehension ahead in financial market; hence life after the Basel-III norms wouldn't remain indifferent from regulatory considerations.

Bird's eye view of Basel III norms – selected features

Basel-III norms, with its underlying proposition of insulating banks from adverse shocks by adequately enhancing the amount of its own capital holding compared to overall deposits and other borrowing can be regarded as an improved and standard set of rules over the existing Basel-II norms. The new rule comprehensively entails how to assess risks and capital management. A consensus was reached with focus on prevention of any further International Credit Crisis with provisioning more than triple of top quality capital as reserve for addressing any meltdown sort of occurrences.

Predominant component of capital is common equity and retained earnings – new rules restrict inclusion of items such as deferred tax assets, mortgage-servicing rights and investments in financial institutions to no more than 15% of the common equity component. The new norms are centered around the renewed focus of central bankers on macro-prudential stability. The global financial meltdown following the crisis in U.S sub-prime market has shaped the entire propositions.

Basel II vs. Basel III

Earlier guidelines, popularly known as Basel-II was focused on macro prudential regulation, those features being carried out in Basel-III norms as well with added advanced support. That systemizes the changed motives of regulators now – they have sharp concentration on financial stability of the system in totality instead of micro regulation of any individual bank. Under the Basel-III norms, Key Capital Ratio has been raised to 7% of risky assets - Tier-I capital that includes common equity and perpetual preferred stock will be raised from 2 to 4.5% starting in phases from January 2013 to be accomplished by January 2015. Moreover, banks will have to set aside another 2.5% as a contingency for future stress, taking the overall capital ratio or Capital Conservation Buffer to 7%. Banks that would fail to comply after the stipulated timeline would be unable to pay dividends, though they will not be forced to raise cash.

A further countercyclical buffer in average of 0%-2.5% of common equity is to be imposed depending on specific circumstances of an economy to protect the banking sector from periods of excess aggregate credit growth. A liquidity buffer, much like our Statutory Liquidity Ratio (SLR) is to be made mandatory by January 2018 to check the risk based measures and higher capital norms for systemically important bank.

On paper, Basel-III will triple the quantum of capital, banks will need to maintain but whether it will make the banking sector risk-proof is doubtful. Thus, regulation would decide whether Basel-III norms is light touch set of rules or indeed an effective panacea for hassle free and ethical functioning of banking system.

Impact on Indian Banks

RBI Governor, D. Subbarao is stoutly confident that Indian banks are not likely to be adversely impacted by the new capital rules. At the end of June 30, 2010; the aggregate capital to risk – weighted assets ratio of the Indian banking system stood at 13.4% of which Tier-I capital constituted 9.3%. It wouldn't leave any pressure on Indian banks in near future though there may be some negative impact arising from shifting some deductions from Tier-I and Tier-II capital to common equity. Despite strong fundamentals, RBI should ensure even more capital than essentially stipulated under the Basel-III norms; besides stress must be given on long term capital inflow rather on risky short term investments. Apart from innovative credit policies, RBI should also stringently ensure the well capitalized subsidiary structure for foreign banks and financial institutions operating in India.

Young Committee that recommended for the establishment of Bank of International Settlements (BIS) in1930 had enough sense for volatility in international financial market and greeds of bankers. Actual effects of even the best designed rules are of no value if not backed by competent, proactive and fearless supervision. Strengthening the global banking system should be and must be the aim of every new financial law but it's equally imperative to stop the adverse lobbying that makes regulation nothing more than a print order. We can safely assume this from recently enacted Dodd Frank Act (Wall Street and Consumer Protection Act) in U.S.A which is losing its effects under the stern pressure from affluent lobbyists. Regulation couldn't have any parallel while enforcing a law; our regulatory strength has recently tested during the world wide financial meltdown.

Indian banking relatively emerged unscratched compared to their western counterparts. Attention is needed from developed world for compliance of rules envisaged under the Basel-III. Co-operation at international level would be the real bone of contention for an ambitious rule like Basel-III. Meanwhile let's watch the movements around the financial circle!

Atul Thakur can be reached at atul_mdb@rediffmail.com

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