Basel iii and its impact on banking system in india
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Basel iii and its impact on banking system in india
- 1. BASEL III AND ITS IMPACT ON THE INDIAN BANKING SECTOR Presented by:- Sameer Patil (111) Jonathan Perriera (113) 1 Anis Madraswala (115) Sanskruta Halepaeti (117) Durvesh Katkade (119)
- 2. FLOW OF THE PRESENTATION PART I: BASEL I PARTII BASEL II PART III BASEL III CASE STUDY 2
- 3. WHY CAPITAL REQUIREMENT? While bank’s assets (loans & investments) are risky and prone to losses, its liability (deposits) are certain. Assets = External Liabilities + Capital. Liabilities (deposits) to be honoured. Hence reduction in capital. When capital is wiped out – Bank fails. Bank failures - mainly by losses in assets – default by borrowers (Credit Risk), losses of investment in different securities (Market Risk) and frauds, system and process failures (Operational Risk)
- 4. BASEL COMMITTEE Committee—a group of eleven nations Liquidation of Cologne-based Bank Herstatt To achieve this goal G-10 countries agreed in Basel, Switzerland to form a quarterly committee Comprising of each country’s central bank and lead bank supervisory authority 4
- 5. BASEL 1 Set up an international 'minimum' amount of capital that banks should hold. ‘minimum’ amount of capital—minimum risk-based capital adequacy The set of agreement- mainly focuses on risks to banks the financial system To ensure that financial institutions have enough capital on account to meet obligations absorb unexpected losses. Focused on credit risk. 5 Supervision should be adequate.
- 6. THE ACCORD Divided into 4 pillars: 1. The Constituents of Capital 2. Risk Weighting 3. A Target Standard Ratio 4. Transitional and Implementing Agreements 6
- 7. PITFALLS Limited differentiation of credit risk Static measure of default risk No recognition of term-structure of credit risk Simplified calculation of potential future counterparty risk Lack of recognition of portfolio diversification effects Falsification of balance sheets 7
- 8. SHIFT FROM BASEL I TO BASEL II 8
- 9. BASEL II NORMS Basel II was intended : – to create an international standard for banking regulators – to maintain sufficient consistency of regulations. – protect the international financial system Addition of operational risk in the existing norms Defined new calculations of credit risk Ensuring that capital allocation is more risk sensitive
- 10. OBJECTIVES OF BASEL II 1. Better Evaluation of Risks 2. Better Allocation of resources 3. Supervisors should review each bank’s own risk assessment and capital strategies. 4. Improved Risk management 5. To strengthen international banking systems. 10
- 12. FAILURE OF BASEL II Banks defined their own risk metrics and derivative investments Depends on good underlying data Most of the institutional cogs in the credit crisis aren’t covered No independent standard. Wrong assumptions in case of mortgage-related risk calculations. Inadequate level of capital required by the new discipline
- 13. BASEL III ACCORD The G20 endorsed the new ‘Basel 3’ capital and liquidity requirements. Extension of Basel II with critical additions, such as a leverage ratio, a macro prudential overview and the liquidity framework. Basel III accord provides a substantial strengthening of capital requirements. Basel III will place greater emphasis on loss-absorbency capacity on a going concern basis The proposed changes are to be phased from 2013 to 2015 The creation of a conservation buffer could be set up by banks during the period January 2016 to 2019. 13
- 14. BASEL III-OBJECTIVES Special emphasis on the Capital Adequacy Ratio Capital Adequacy Ratio is calculated as – CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted Assets Reducing risk spillover to the real economy Comprehensive set of reform measures to strengthen the banking sector. Strengthens banks transparency and disclosures. Improve the banking sectors ability to absorb shocks arising from financial and economic stress. 14
- 15. MAJOR FEATURES OF BASEL III Revised Minimum Equity & Tier 1 Capital Requirements Better Capital Quality Backstop Leverage Ratio Short term and long term liquidity funding Inclusion of Leverage Ratio & Liquidity Ratios Rigorous credit risk management Counter Cyclical Buffer Capital conservation Buffer
- 16. PILLARS Minimum Regulatory Capital Requirement based on Risk weighted assets Maintaining capital ( Credit, market and Operational Risk) Supervisory Review Process • Regulatory Tools and Frameworks to deal with risks. Market Discipline. • Transparency of Banks 16
- 17. RATIOS Leverage Ratio ≥ 3% Liquidity Coverage Ratio = Stock of high quality liquid assets ≥ 100% Net cash outflows over a 30-day period Net Stable Funding Ratio (NSFR) = Available amount of stable funding ≥ 100% Required amount of stable funding 17
- 18. COMPARISON OF CAPITAL REQUIREMENTS UNDER BASEL II AND BASEL III : Requirements Under Basel II Under Basel III Minimum Ratio of Total 8% 11.50% Capital To RWAs Minimum Ratio of Common 2% 4.50% to 7.00% Equity to RWAs Tier I capital to RWAs 4% 6.00% Core Tier I capital to RWAs 2% 5.00% Capital Conservation Buffers None 2.50% to RWAs Leverage Ratio None 3.00% Countercyclical Buffer None 0% to 2.50% Minimum Liquidity Coverage None TBD (2015) Ratio Minimum Net Stable Funding None TBD (2018) Ratio
- 19. IMPACT ON INDIAN BANKING SYSTEM Profitability Capital acquisition Liquidity Needs Limits on lending Bank consolidation Pressure on Yield on Assets Pressure on Return on Equity: Stability in the Banking system 19
- 20. IMPACT ON PUBLIC SECTOR Public sector banks- needs Rs.1 trillion over 10-5 years Some public sector banks are likely to fall short of the revised core capital adequacy requirement. Government to recapitalize an estimated Rs 900 billion or be ready to reduce their equity stake in banks below 50%. Increase in the requirement of capital will affect the ROE of the Public banks. 20
- 21. POTENTIAL RESPONSES BY BANKS Operational responses RWA optimization, Stricter credit approval processes Tactical responses Risk-sensitive pricing, Shift to longer-term funding Reduction of securitization exposures Strategic responses - Sale of business unit, Change of holding structure 21
- 22. CHALLENGES OF BASEL 3 22
- 23. CONCLUSION One shoe doesn’t fit all. Monetary policies of Central Banks in each country (example RBI’s CRR, SLR, Repo etc.) make it difficult to uniformly implement BASEL norms Exercising controls on the capital, liquidity and leveraging of banks will ensure that they have the ability to withstand crises. 23
- 24. 24
Notas del editor
- Liquidation of Cologne-based Bank Herstatt, decided to form a cooperative council to harmonize banking standards and regulations within and between all member statesGoal- “…extend regulatory coverage, promote adequate banking supervision, and ensure that no foreign banking establishment can escape supervision”
- The set of agreement- mainly focuses on risks to banks the financial system……….are called BASEL ACCORD.
- The capital requirement as suggested by the proposed Basel IIIguidelines would necessitate Indian banks1 raising Rs. 600000 crore inexternal capital over next nine years, besides lowering their leveragingcapacity. It is the public sector banks that would require most of thiscapital, given that they dominate the Indian banking sector. Further, ahigher level of core capital could dilute the return on equity for banks.Nevertheless, Indian banks may still find it easier to make the transitionto a stricter capital requirement regime than some of their internationalcounterparts since the regulatory norms on capital adequacy in India arealready more stringent, and also because most Indian banks havehistorically maintained their core and overall capital well in excess of theregulatory minimum.As for the liquidity requirement, the liquidity coverage ratio as suggestedunder the proposed Basel III guidelines does not allow for anymismatches while also introducing a uniform liquidity definition.Comparable current regulatory norms prescribed by the Reserve Bank ofIndia (RBI), on the other hand, permit some mismatches, within the outerlimit of 28 days.1 Except foreign banksICRA CommentSeptember 2010
- However, some public sector banks are likely to fall short of the revised core capital adequacy requirement and would therefore depend on government support to augment their core capital. The additional equity capital requirements in the public sector banks, mainly due to Basel III norms in the next five years, work out to around Rs 1,400-1,500 billion. 2. With the Indian market growth story still intact, the banks will have scope for growth in assets. But increase in asset base will mean the government will have to recapitalize public sector banks with an estimated Rs 900 billion or be ready to reduce their equity stake in banks below 50% for them to comply with Basel III norms of 4.5% common equity. The Indian Government stated policy on stake dilution has been to maintain the majority stake in public sector entities. With the subsidy bill of the government snow-balling and social schemes like the MGNREGA escalating the Fiscal Deficit, it has left hardly any funds for recapitalization of the public sector banks.Basel III Compliance: Challenges for PSBs in India09 Nov, 2012 09:57 Basel III norms are supposed to be implemented in India starting next year in 2013 and will be completed by 2018. In the aftermath of the financial crisis of 2008-09, the Basel Committee on Banking Supervision in 2010-11 came up with the new stringent capital adequacy requirement along with the new counter-cyclical capital buffers. The stringent capital requirement for Basel III stipulates that banks will have to hold 6% of the Risk Weighted Assets as Tier I capital with 4.5% of this being Common Equity up from 2% in Basel II norms. Private Banks in India may be able to get other players onboard but for Public Sector Banks this will be a major challenge.With the Indian market growth story still intact, the banks will have scope for growth in assets. But increase in asset base will mean the government will have to recapitalize public sector banks with an estimated Rs 900 billion or be ready to reduce their equity stake in banks below 50% for them to comply with Basel III norms of 4.5% common equity. The Indian Government stated policy on stake dilution has been to maintain the majority stake in public sector entities. With the subsidy bill of the government snow-balling and social schemes like the MGNREGA escalating the Fiscal Deficit, it has left hardly any funds for recapitalization of the public sector banks. So what is the way out of this impending logjam?Possible SolutionsThere are a couple of possible solutions to this problem of compliance to Basel III norms for Public Sector Banks. The first would be to introduce the concept of golden share for Indian banks as Margaret Thatcher the then Prime Minister of Britain did it in the 1980’s for privatizing public sector entities. As a concept golden share means, reducing the stake in a company below 50% but retaining the majority voting rights. It basically delinks voting rights from ownership. So, as a solution the government can take up golden share to retail the voting rights but bring in funds from private players and reduce their stake below 50% in public sector banks.An alternative to this is to create a banking sector holding company in which the Government will hold the majority stake, and the holding company in turn will hold majority stake in public sector banks. This was briefly outlined by the Finance Minister of India in his Union budget speech in March 2012. The Government can raise capital for the banking holding company through various means including a public offering. The modalities of the same are not clear as of now and will have to be closely watched for this to be a success. If implemented successfully this could be the biggest structural change in the Indian banking sector since nationalization in 1969 and 1980.Looking AheadThe way in which the Government and public sector banks in India are able to cope with this puzzle will largely shape the banking industry in India in the next five years. As the Banks in India and across the world move to Basel III compliance, the demand for Out of the Box Banking solutions for regulatory reporting and aligning their operations to meet the stringent Basel III norms will grow manifold.And the players that are ahead of the curve will be able to capture the market!3. , financial ratios would be hurt and the public sector banks will not be able to expand their loan book due to unavailability of capital.
- The impact of Basel III on banks callsfor concentrated and reasoned actions.Apart from just attaining compliancewith the new regulations, banks –especially those with high internalstandards and demands – will gobeyond compliance and take measuresto restore profitability. Banks willassess their lines of business, levels ofrisk profiles and capital endowmentsas well as their funding strategiesto take the right steps towardscompliance and increased profitability.Numerous actions with differentduration and range are available toachieve these objectives.Operational ResponsesBasel III creates incentives for banksto improve their operating processes– not only to meet requirements butto increase efficiency and lower costs.Banks have already begun to examineareas such as:• RWA optimization, including modelrefinement, process improvement,enhancement of data quality, andframework alignment• Reducing credit exposure andpotential credit losses throughstricter credit approval processesand, potentially, through lowerlimits, especially in regard to bankexposures• Improving liquidity risk managementprocesses including stress testingand development of contingencyfunding plans• Fostering closer integration of riskand finance functions• Integrating all subsidiaries throughconsistent, group-wide risk andcapital management standardsTactical ResponsesBesides the rather short-termoperational responses banks have anumber of more far-reaching tacticalactions they can take to respond,especially to profitability concerns. Wesee the focus of tactical responses onthe areas of pricing, funding and assetrestructuring. While tactical responsesby definition do not address longtermstrategic issues, they may beextremely helpful in relieving pressureon profitability.Among tactical responses available tobanks are:• Adjusting lending rates, dependingon competition within the specificsegments and each segment’sstrategic importance for the bank• Reflecting higher capital andliquidity costs through more risksensitivepricing and performancemeasurement• Shifting to higher-value clients withregard to profitability• Shifting to less risky segments in theportfolio, with fewer securitizations,lower trading book exposures andreduced activities in areas such asderivatives, repos and securitiesfinancing• Increasing the level of high-qualityliquid assets• Changing the mix of funding andliquidity reserves to longer-termFigure 3: Potential responses to Basel III changes• Processes• Methods• DataExamples of operationalresponses• RWA optimization• Stricter credit approvalprocessesOperational responses Tactical responses• Pricing• Funding• Asset restructuringExamples of tacticalresponses• Risk-sensitive pricing• Shift to longer-term funding• Reduction of securitizationexposuresStrategic responses• Business model• Group organization• EquityExamples of strategicresponses• Sale of business unit• Change of holding structure8funding, for instance by replacinginterbank funding with longer-termdebt and increasing the maturity ofdeposits• Reducing total exposure, both onand-off-balance-sheet, with regardto risk and profitabilityStrategic ResponsesIn reviewing their strategic responsesto Basel III and to the dangers ofreduced profitability, banks have theopportunity to effect major changesthroughout all areas of the institution.These include fairly straightforwardinitiatives – such as retaining earningsto increase Tier 1 Capital – but alsoencompass a broad range of farreachingpossibilities including:• Issuing new capital in light of thenew eligibility criteria and phase-inarrangements• Changing liquidity risk and fundingstrategy• Taking a more active approach tobalance sheet management• Engaging in more active clientmanagement, for instance byadjusting client segmentation anddevoting more or fewer resourcesto clients at specific levels of size orprofitability• Undertaking strategic costreductions, including rationalizationof branch structures, productrationalization or implementation ofa shared services model• Changing the business model,which may entail selling highriskbusiness units, entering newproduct segments or businesses, oroutsourcing or off-shoring non-corefunctions• Changing the group structure, forexample by selling off minorityinterests in financial institutionsNo matter what actions banks take toreach compliance with Basel III and torestore profitability, all actions shouldbe harmonized to create an efficientapproach and achieve the best possibleresults.Accenture believes that, in thefinal analysis, even the most wellcapitalizedand managed banks willexperience lower profitability in thepost-Basel III environment despite therange of possible responses.
- Key challengesIndian banks on average have Tier 1 capital ratios of around 7.5% to 8%, which prima facie meet the proposed Basel III requirementsBUT: beware of definitional changesTransition to Basel III may not impact earnings much, but the upside potential associated with higher leveraging would decline. Further, as the countercyclical buffer has to be set periodically by the RBI, this could introduce an element of variation in lending rates and/or the ROE of banksImplementation of the liquidity coverage ratio (LCR) from 2015 may necessitate banks to maintain additional liquidity; also some assumptions on the rollover rates and the required liquidity for committed lines may be more stringent. However, considering the period of one month and the fact that most Indian banks have upgraded their technology platforms, the transition to LCR may not be a very difficult oneWhile the proposal to make deductions “only if such deductibles exceed 15% of core capital” would provide some relief to Indian banks , the stricter definition of “significant interest” and the suggested 100% deduction from the core capital (instead of 50% from Tier I and 50% from Tier II) could have a negative impact on the core capital of some banks.