Effect of Basel III on Indian Banking

BASEL III

Regulators from around the world met on September 12,2010 in Basel, to reach an agreement on new banking rules aimed at preventing another financial crisis. The Committee has agreed on new norms for banks' capital adequacy standards (Basel III). Negotiators want to hammer out most of the details so they can deliver a package that the leaders of the Group of 20 largest industrialised nations can bless at a summit in South Korea in November.

On September 12, the Committee agreed on package of reforms that will increase the minimum common equity requirement from 2 per cent to 4.5 per cent. In addition, banks will be required to hold a capital conservation buffer of 2.5 per cent to withstand future periods of stress, bringing the total common equity requirements to 7 per cent.

These capital requirements are supplemented by a non-risk-based leverage ratio (a minimum Tier 1 leverage ratio of 3 per cent during the parallel run period) that will serve as a backdrop to the risk-based measures described above. It is not clear how the new accord will address the fundamental problems with the risk-weighting approach. The weighting system continues to suffer from the assumption of portfolio invariance, or linear weighting that facilitates additivity in the model.

The impact of the new norms (Basel III) on the Indian banking system is expected to be marginal. Most of the Indian banks complied (as on March 31, 2010) with Tier 1 capital ratio of 6 per cent, which banks have to achieve in 2015 (based on Basel III). Also, the RBI rules do not allow holding hybrid capital as part of Tier 1 capital; as a result, Indian banks will go through less pain than their counterparts in western economies.

Liquidity guidelines

However, there will be areas where the Banks may have to review its liquidity guidelines. For instance, after an observation period beginning in 2011, the liquidity coverage ratio (LCR) will be introduced on 2015. The revised net stable funding ratio (NSFR) will move to a minimum standard by 2018.

The Committee will put in place rigorous reporting processes to monitor the ratios during the transition period and will continue to review the implications of these standards for financial markets, credit and economic growth. The implications of these ratios on a bank's growth process need to be studied.