Basel III and Indian Banking
System
By Prof. (Dr.) Divya Gupta
IMIS, Bhubaneswar
Evolution of the Reform
• BCBS is a committee formed by BIS to look
into the adequacy of capital of banks with
international presence. And the most far
reaching of these initiatives was the laying
down of minimum capital standards in 1988,
known as Basel Capital accord.
Basel I, II and III
Basel I
•In effect since 1988
•Very simple in application
• India implemented in 1992
•“One-size-fits-all” approach
• Concentrated only on “credit
risk”
Basel II
•In effect since 2004
•More risk sensitive
• India Implemented in 2009
•Did not impose additional capital
requirement on banks
•Did not consider liquidity risk as
part of capital regulation.
Basel III
• In effect from 2013 to 2019
•Addresses perceived
shortcomings of Basel II
•Greatest impact on trading
book, bank liquidity and bank
leverage
• Will increase capital charges
materially and make certain
banking activities much more
capital intensive
Hierarchy of Financial Risks
Equity Risk
Market Risk
Financial
Risks
Interest Rate Risk
Currency Risk
Credit Risk
Commodity Risk
Operational
Risk
Transaction Risk
Portfolio
Concentration
Risk
Basel III
Objectives of Basel III
• To strengthen global capital and liquidity regulations with the goal of
promoting a more resilient banking sector.
• To improve the banking sector's ability to absorb shocks arising from
financial and economic stress
Type of Capital
• Tier I capital is capital that is available to absorb losses on a "goingconcern" basis, or capital that can be depleted without placing the bank
into insolvency, administration or liquidation.
• Tier II capital is capital that can absorb losses on a "gone-concern" basis or
capital that absorbs losses in insolvency prior to depositors losing any
money.
Key Principles
Capital Requirements
• Increase in capital
• Introduction of Capital conservation buffer
• Introduction of Counter-cyclical buffer
Key principles
Leverage Ratios
• The banks are expected to maintain a leverage
ratio in excess of 3% under Basel III.
Key Principles
Liquidity requirement
Basel III introduced two required liquidity ratios.
• "Liquidity Coverage Ratio" is supposed to
require a bank to hold sufficient high-quality
liquid assets to cover its total net cash outflows
over 30 days.
• “Net Stable Funding Ratio” is to require the
available amount of stable funding to exceed the
required amount of stable funding over a oneyear period of extended stress.
Basel III
Summary of Reforms:
• Increased overall capital requirement
• Narrower definition of qualifying regulatory
capital
• Increased capital charges for banking book
exposures
• Increased capital charges for trading book
exposures
• New leverage ratio
• Two new liquidity ratios
Challenges & Impact
• Additional CapitalMore capital -> less leverage to lend money and profitability -> Increase in
lending rates.
• Pressure on ROE- As the upper limit for the leverage ratio by Basel III has
been set at 3%, the value of the leverage multiplier will come down,
resulting in a reduction in the ROE.
• Pressure on yield on assets- On account of higher deployment of funds in
liquid assets that give comparatively lower returns, banks' yield on assets,
and thereby their profit margins, may be under pressure.
• Capital conservative buffer- There is a trade-off for banks between being
prudent and increasing profit.
• Implementing the countercyclical capital buffer- A critical component of
the Basel III package is implementation of countercyclical capital buffer
which mandates that banks build up a higher level of capital in good times.
Challenges & Impact
• Frequent regulatory reports - Cost will be high.
• Change in business mix- more focus on retail banking
which has a comparatively lower risk weight compared to
corporate banking.
• Improvement in systems and procedures- Refining the
rating model/data cleaning/ modernisation of systems
and procedures may help banks economise their riskweighted assets.
Initiatives
• Lowering of Government stake in public sector
banks.
• Non-equity regulatory capital instruments by
banks under the stringent Basel III framework
under which lenders can issue tier 2 capital with a
minimum original maturity of 5 years as against
10 years now.
• Reserve Bank of India (RBI) has added an extra
year to the transitional period for local banks to
meet Basel III capital requirements.
Initiatives
• The RBI proposal to create a holding company
for Public sector banks to which the equity of
state-owned banks can be transferred. This is
being seen as first step to effect much-needed
structural changes in the banking sector of the
country.
Thank You!!!