Basel III Norms

What are the Basel-III norms?

These are rules written by the Bank of International Settlement’s Committee on Banking Supervision (BCBS) whose mandate is to define the reform agenda for the global banking community as a whole. The new rule prescribes how to assess risks, and how much capital to set aside for banks in keeping with their risk profile.

What are the changes which have been made to the way in which capital is defined?

Going by the new rules, the predominant component of capital is common equity and retained earnings. The 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. These rules aim to improve the quantity and quality of the capital.

What do these new rules say?

While the key capital ratio has been raised to 7% of risky assets, according to the new norms, Tier-I capital that includes common equity and perpetual preferred stock will be raised from 2-4.5% starting in phases from January 2013 to be completed by January 2015. In addition, banks will have to set aside another 2.5% as a contingency for future stress. Banks that fail to meet the buffer would be unable to pay dividends, though they will not be forced to raise cash.

How different is the approach now?

The new norms are based on renewed focus of central bankers on macro-prudential stability. The global financial crisis following the crisis in the US sub-prime market has prompted this change in approach. The previous set of guidelines, popularly known as Basel II focused on macro-prudential regulation. In other words, global regulators are now focusing on financial stability of the system as a whole rather than micro regulation of any individual bank.

How will these norms impact Indian banks?

According to RBI governor D Subbarao, Indian banks are not likely to be 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%. As such, RBI does not expect our banking system to be significantly stretched in meeting the proposed new capital rules, both in terms of the overall capital requirement and the quality of capital. There may be some negative impact arising from shifting some deductions from Tier-I and Tier-II capital to common equity.