IMPACT OF BASEL & OTHER INDIAN COMMITTEES RECOMMENDATIONS ON INDIAN BANKING SYSTEM

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A PROJECT REPORT ON
IMPACT OF BASEL & OTHER INDIAN COMMITTEES
RECOMMENDATIONS ON INDIAN BANKING SYSTEM
In partial fulfillment of the Dissertation
In Semester - IV of the Master of Business Administration
Prepared by:
Aayush Kumar
Registration No: 13010121218
Under the Guidance of
Prof. Shivaprasad.G
Bangalore

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Master of Business Administration
Declaration
This is to declare that the report entitled “IMPACT OF BASEL & OTHER INDIAN
COMMITTEES RECOMMENDATIONS ON INDIAN BANKING SYSTEM” is prepared
for the partial fulfillment of the Dissertation course in Semester IV of the Master
of Business Administration by me under the guidance of Prof. Shivaprasad.G.
I confirm that this dissertation truly represents my work. This work is not a
replication of work done previously by any other person. I also confirm that the
contents of the report and the views contained therein have been discussed and
deliberated with the Faculty Guide.
Signature of the Student :
Name of the Student : AAYUSH KUMAR
Registration No : 13010121218

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Master of Business Administration
Certificate
This is to certify that Mr. Aayush Kumar Regn. No. 13010121218 has completed
the dissertation titled IMPACT OF BASEL & OTHER INDIAN COMMITTEES
RECOMMENDATIONS ON INDIAN BANKING SYSTEM under my guidance for the
partial fulfillment of the Dissertation course in Semester IV of the Master of
Business Administration
Signature of Faculty Guide:
Name of the Faculty Guide: Prof. SHIVAPRASAD. G

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CONTENTS
Chapter Page no.
Abstract
List of Tables
List of Charts
1. INTRODUCTION………………………………………………8-28
1.1 Statement of BASEL Norms
1.2 Introduction of Narasimham Committee
1.3 Introduction of Raghuram Rajan Committee
1.4 Introduction of Indian Banking System
2. RESEARCH METHODOLOGY……………………………...29-33
2.1 Need of the Study
2.2 Research Design and Survey Design
2.3 Data Analysis
2.4 Research Methodology
2.5 Research Design
2.6 Project Objectives
2.7 Expected Outcomes
3. DATA ANALYSIS……………………………………………...34-71
3.1 BASEL III

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3.2 Impact of BASEL III on Loan Spreads
3.3 Impact of BASEL III on Bank Capital
3.4 Narasimham Committee Recommendations and Action
3.5 Raghuram Rajan Committee Report Analysis
4. CONCLUSION & FINDINGS………………………………...72-84
4.1 BASEL III
4.2 Narasimham Committee
4.3 Raghuram Rajan Committee
5. REFERENCES…………………………………………………85-86

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LIST OF CHARTS/DIAGRAMS
SR NO PARTICULARS PG NO
1 Structure of Indian Banking 22
2 Core Banking Sector Indicators in India 24
3 Interest Rates in India 25
4 Capital to Risk Weighted Assets Ratio-Bank GroupWise 25
5 CRAR Levels of Indian Banking 35
6 CRAR Levels of Indian Banking 41
LIST OF TABLES
SR NO PARTICULARS PG NO
1 Comparison of Capital Requirement Standards 34
2 Deductions from Capital BASEL III guidelines Vs. Existing RBI
Norms
34-35
3 Sample Distribution by Category of Scheduled Commercial Banks
in India
38-39
4 Stylized Balance sheet and Income Statement of Scheduled
Commercial Banks
39
5 Levels of Capital Adequacy Ratios of Banks in selected Economies 40
6 Comparison of Capital Requirement Standards 41-42
7 Deductions from Capital BASEL III guidelines Vs. Existing RBI
Norms
42-43
8 Impact of Key Factors of Capital Standards on Equity 43-44
9 Possible Impact of Capital Standards on Indian Banks 44
10 BASEL III compliance – Required Minimum Capital 45
11 Comparison of Results for Estimations of Bank Loan Spread for
SCBs
71-72
12 Comparison of Results for Estimations of Bank Loan Spread for
SCBs
72
13 Increase in Bank Lending Spreads for a One Percentage Point
Increase in Bank Capital
72
14 Summary of Findings of Different Studies on Capital Requirement
of Indian Banks
73
15 Cost Benefit Analysis of BASEL III for Indian Banking 74

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ABSTRACT
The impacts of the global financial crisis coupled with domestic policy paralysis have dented
India’s growth prospects much more than what had been predicted. The implementation of
Basel III norms would considerably enhance the regulatory capital requirement of Indian
banks apart from subjecting them to rigorous regulatory monitoring. Undoubtedly, the
increased capital requirements would result in the increase in the cost to banks as well as to
borrowers. Given this context, this research project has adequately assessed the impact of the
new capital requirements introduced under the Basel III framework on bank lending rates
and loan growth and also estimated the extent of higher capital requirements for the Indian
banks.
This study has been successful in broadening and deepening the understanding of the
potential impact of Basel III framework along with other committee’s recommendations by
estimating the qualitative as well as quantitative impact of Basel III. This study observes that
new capital requirements under Basel III would have positive impact for Indian banks as they
raise the minimum core capital, introduce counter-cyclical measures, and enhance banks’
ability to conserve core capital in the event of stress through a conservation capital buffer. The
liquidity standard requirements would benefit the banks in managing the pressures on
liquidity in a stress scenario more effectively.
The study has estimated that the impact of Basel III on bank loan spreads would be 31 basis
points increase for every 1-percentage point increase in capital ratio and would go up to an
extent of 100 basis points for 6-percentage point increase in the capital ratio assuming that the
Risk weighted assets are unchanged. However, assuming the risk weighted assets to decline by
20 percent; the study finds that there would be 22 basis points increase for every 1-percentage
point increase in capital ratio and would go up to an extent of 68 basis points for 6-percentage
point increase in the capital ratio.
Estimating the additional capital requirements of Indian banks in the wake of Basel III
regime, this study estimates that with an assumed growth of RWAs at 10%, Indian banks
would require additional minimum tier-1 capital of INR 251106.57 Crores, and with RWAs
growth at 12% and 15%, the requirement is estimated to be respectively in the order of INR
336390.41 Crores and INR 474168.60 Crores.
It was one of the objectives of this study to make a cost-benefit analysis of the implementation
of Basel III in the Indian context. Accordingly, it is estimated that while the requirement of
additional minimum tier-1 capital would be INR 2,51,106 crores with RWAs assumed at 10%,
the probable prevention of loss-in-output due to a crisis (at a very conservative estimation)
would be in the range of INR 16,01,971 crores.

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1.1 INTRODUCTION OF BASEL NORMS:
The Basel Banking Accords are norms issued by the Basel Committee on Banking Supervision
(BCBS), formed under the auspices of the Bank of International Settlements (BIS), located in
Basel, Switzerland. The committee formulates guidelines and makes recommendations on best
practices in the banking industry. The Basel Accords, which govern capital adequacy norms of
the banking sector, aim to ensure financial stability and thereby increase risk absorbing
capability of the banks.
The first set of Basel Accords, known as Basel I, was issued in 1988, with primary focus on
credit risk. It laid the foundation of risk weighting of assets and set objective targets of capital to
be maintained. Basel II was issued in 2004 with the objective of being more comprehensive. It
aimed at increasing capital adequacy by imposing a buffer for a larger spectrum of risk. As time
has gone by, we have witnessed the Basel norms failing to restrict two major crisis during its
tenure, the South Asian Crisis in 1998 and Sub-prime Mortgage Crisis in 2007, which raises
questions about its effectiveness. As the banking world prepares to comply with Basel III, the
effectiveness of the Basel accord has come under the radar.
The Committee seeks to achieve its aims by setting minimum supervisory standards; by
improving the effectiveness of techniques for supervising international banking business; and by
exchanging information on national supervisory arrangements. And, to engage with the
challenges presented by diversified financial conglomerates, the Committee also works with
other standard-setting bodies, including those of the securities and insurance industries.
The Committee's decisions have no legal force. Rather, the Committee formulates supervisory
standards and guidelines and recommends statements of best practice in the expectation that
individual national authorities will implement them. In this way, the Committee encourages
convergence towards common standards and monitors their implementation, but without
attempting detailed harmonization of member countries' supervisory approaches.
At the outset, one important aim of the Committee's work was to close gaps in international
supervisory coverage so that (i) no foreign banking establishment would escape supervision; and
(ii) that supervision would be adequate and consistent across member jurisdictions. A first step in
this direction was the paper issued in 1975 that came to be known as the "Concordat", which set
out principles by which supervisory responsibility should be shared for banks' foreign branches,
subsidiaries and joint ventures between host and parent (or home) supervisory authorities. In
May 1983, the Concordat was revised and re-issued as Principles for the supervision of banks'
foreign establishments .
In October 1996, the Committee released a report on The supervision of cross-border banking,
drawn up by a joint working group that included supervisors from non-G10 jurisdictions and
offshore centres. The document presented proposals for overcoming the impediments to effective
consolidated supervision of the cross-border operations of international banks. Subsequently
endorsed by supervisors from 140 countries, the report helped to forge relationships between
supervisors in home and host countries.

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Basel – I
Basel I Accord attempts to create a cushion against credit risk. It comprises of four pillars,
namely
 Constituents of Capital: It prescribes the nature of capital that is eligible to be treated as
reserves.
 Risk Weighting: Risk Weighting created a comprehensive system to provide weights to
different categories of bank’s assets (on balance sheet as well as off balance sheet assets)
on the basis of relative riskiness.
 Target Standard Ratio: This acted as a unifying factor between the first two pillars. A
universal standard of 8% coverage of risk weighted assets by Tier I and II capital was set,
with at least 4% being covered by Tier I capital alone.
 Transitional & implementing arrangements: Phase wise implementation deadlines were
set wherein a target of 7.25% was to be achieved by the end of 1990 and 8% by the end
of 1992.
Capital adequacy soon became the main focus of the Committee's activities. In the early 1980s,
the onset of the Latin American debt crisis heightened the Committee's concerns that the capital
ratios of the main international banks were deteriorating at a time of growing international risks.
Backed by the G10 Governors, the Committee members resolved to halt the erosion of capital
standards in their banking systems and to work towards greater convergence in the measurement
of capital adequacy. This resulted in a broad consensus on a weighted approach to the
measurement of risk, both on and off banks' balance sheets.
There was a strong recognition within the Committee of the overriding need for a multinational
accord to strengthen the stability of the international banking system and to remove a source of
competitive inequality arising from differences in national capital requirements. Following
comments on a consultative paper published in December 1987, a capital measurement system
commonly referred to as the Basel Capital Accord (or the 1988 Accord) was approved by the
G10 Governors and released to banks in July 1988.
The Accord called for a minimum capital ratio of capital to risk-weighted assets of 8% to be
implemented by the end of 1992. Ultimately, this framework was introduced not only in member
countries but also in virtually all other countries with active international banks. In September
1993, a statement was issued confirming that all the banks in the G10 countries with material
international banking business were meeting the minimum requirements set out in the 1988
Accord.
The 1988 capital framework was always intended to evolve over time. In November 1991, it was
amended to give greater precision to the definition of general provisions or general loan-loss
reserves that could be included in the capital adequacy calculation. In April 1995, the Committee
issued an amendment to the Capital Accord, to take effect at end-1995, to recognize the effects

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of bilateral netting of banks' credit exposures in derivative products and to expand the matrix of
add-on factors. In April 1996, another document was issued explaining how Committee members
intended to recognize the effects of multilateral netting.
The Committee also refined the framework to address risks other than credit risk, which was the
focus of the 1988 Accord. In January 1996, following two consultative processes, the Committee
issued the so-called Market Risk Amendment to the Capital Accord to take effect at the end of
1997 at the latest.
This was designed to incorporate within the Accord a capital requirement for the market risks
arising from banks' exposures to foreign exchange, traded debt securities, equities, commodities
and options. An important aspect of this amendment is that banks are allowed to use internal
value-at-risk models as a basis for measuring their market risk capital requirements, subject to
strict quantitative and qualitative standards. Much of the preparatory work for the market risk
package was undertaken jointly with securities regulators.
Basel – II
Basel II retained the ‘pillar’ framework of Basel I, yet crucially expanded the scope and specifics
of Basel I. The 4 pillars were amended as follows:
 Minimum Capital Requirements, risks & target adequacy ratio: The primary mandate of
widening the scope of regulation was achieved by expanding the definition of banking
institutions to include them on a fully consolidated basis. Reserves requirement were
defined as follows:
Reserves = 8% * Risk-Weighted Assets + Operational Risk Reserves + Market Risk Reserves
 Regulator-Bank Interaction: This empowers regulators in supervision and dissolution of
banks, giving them liberty to set buffer capital requirement above the minimum capital
requirement as per pillar I.
 Banking Sector Discipline: It aims to induce discipline by mandating adequate
disclosures about capital and risk profile to the regulators and public.
The new framework was designed to improve the way regulatory capital requirements reflect
underlying risks and to better address the financial innovation that had occurred in recent years.
The changes aimed at rewarding and encouraging continued improvements in risk measurement
and control.
The framework's publication in June 2004 followed almost six years of intensive preparation.
During this period, the Basel Committee had consulted extensively with banking sector
representatives, supervisory agencies, and central banks and outside observers in an attempt to
develop significantly more risk-sensitive capital requirements.
Following the June 2004 release, which focused primarily on the banking book, the Committee
turned its attention to the trading book. In close cooperation with the International Organization
of Securities Commissions (IOSCO), the international body of securities regulators, the

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Committee published in July 2005 a consensus document governing the treatment of banks'
trading books under the new framework. For ease of reference, this new text was integrated with
the June 2004 text in a comprehensive document released in June 2006.
Both Committee member countries and several non-member countries agreed to adopt the new
rules, albeit on varying timescales. Thus, consistent implementation of the new framework
across borders has become a challenging task for the Committee. To encourage collaboration and
shared approaches, the Committee's Supervision and Implementation Group (SIG) serves as a
forum on implementation matters. The SIG discusses issues of mutual concern with supervisors
outside the Committee's membership through its contacts with regional associations. In January
2009, its mandate was broadened to concentrate on implementation of Basel Committee
guidance and standards more generally.
One challenge that supervisors worldwide faced under Basel II was the need to approve the use
of certain approaches to risk measurement in multiple jurisdictions. While this is not a new
concept for the supervisory community - the Market Risk Amendment of 1996 involved a similar
requirement - Basel II extended the scope of such approvals and demanded an even greater
degree of cooperation between home and host supervisors. To help address this issue, the
Committee issued guidance on information-sharing and supervisory cooperation and allocation
mechanisms in the context of Advanced Measurement Approaches in 2006 and 2007,
respectively.
Basel – III
There were several limitations of Basel II. It was recommended for G-10 counties, thus leaving
out the emerging economies. The scope of responsibilities for regulators in emerging economies
may be too much for them to handle. Central banks might not be stringent enough in regulating
private banks, thus letting them raise their risk exposure – defeating the entire purpose.
The essence of Basel III revolves around compliance regarding capital and liquidity. While good
quality of capital will ensure stable long term sustenance, compliance with liquidity covers will
increase ability to withstand short term economic and financial stress.
Liquidity Rules: The two standards of liquidity are:
 Liquidity Coverage Ratio (LCR): This is to safeguard banks against sustained financial
stress for 30 days period.
 Net Stable Funding Ratio (NSFR): The objective of long term stability of financial
liquidity risk profile is met by maintaining a ratio of amount available of stable funding
to required amount of stable funding at a minimum of 100%.
Capital Rules: Enhancement of risk coverage is achieved by introduction of Capital
Conservation Buffer and Countercyclical Buffer.

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 Capital Conservation Buffer: A buffer of 2.5% (entirely out of Tier I capital) above
minimum capital requirement to be maintained to ensure that banks accumulate buffers in
time of low financial stress. It discourages distribution of earnings as a signal of financial
strength in times of reduced buffers
 Countercyclical Buffer: This buffer can be enacted by national authorities when they
believe that the excess credit growth potentially implies a threat of financial distress.
 Leverage Ratio: This aims to avoid the overuse of on- and off-balance sheet leverage in
the banking sector, despite portraying healthy risk based capital ratios, a characteristic of
the 2007 financial crisis.
Even before Lehman Brothers collapsed in September 2008, the need for a fundamental
strengthening of the Basel II framework had become apparent. The banking sector had entered
the crisis with too much leverage and inadequate liquidity buffers. These defects were
accompanied by poor governance and risk management, as well as inappropriate incentive
structures. The combination of these factors was manifest in the mispricing of credit and
liquidity risk, and excess credit growth.
Responding to these risk factors, the Basel Committee issued Principles for sound liquidity risk
management and supervision in the same month that Lehman Brothers failed. In July 2009, the
Committee issued a further package of documents to strengthen the Basel II capital framework,
notably with regard to the treatment of certain complex securitization positions, off-balance sheet
vehicles and trading book exposures. These enhancements were part of a broader effort to
strengthen the regulation and supervision of internationally active banks, in the light of
weaknesses revealed by the financial market crisis.
In September 2010, the Group of Governors and Heads of Supervision announced higher global
minimum capital standards for commercial banks. This followed an agreement reached in July
regarding the overall design of the capital and liquidity reform package, now referred to as
"Basel III". In November 2010, the new capital and liquidity standards were endorsed at the G20
Leaders Summit in Seoul. The Basel Committee has worked in close collaboration with the
Financial Stability Board (FSB) given the FSB's role in coordinating the monitoring of
implementation of regulatory reforms. The Committee designed its programme to be consistent
with the FSB's Coordination Framework for Monitoring the Implementation of Financial
Reforms (CFIM) as agreed by the G20.
These tightened definitions of capital, significantly higher minimum ratios and the introduction
of a macro prudential overlay represent a fundamental overhaul for banking regulation. At the
same time, the Basel Committee, its governing body and the G20 Leaders have emphasized that
the reforms will be introduced in a way that does not impede the recovery of the real economy.
In addition, time is needed to translate the new internationally agreed standards into national
legislation. To reflect these concerns, a set of transitional arrangements for the new standards
was announced as early as September 2010, although national authorities are free to impose
higher standards and shorten transition periods where appropriate.

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The new, strengthened definition of capital will be phased in over five years: the requirements
were introduced in 2013 and will be fully implemented by the end of 2017. Capital instruments
that no longer qualify as non-common equity Tier 1 capital or Tier 2 capital will be phased out
over 10 years beginning 1 January 2013.
Turning to the minimum capital requirements, the higher minimums for common equity and Tier
1 capital are being phased in from 2013, and will become effective at the beginning of 2015. The
schedule will be as follows:
 The minimum common equity and Tier 1 requirements increased from 2% and 4% levels
to 3.5% and 4.5%, respectively, at the beginning of 2013.
 The minimum common equity and Tier 1 requirements will be 4% and 5.5%,
respectively, starting in 2014.
 The final requirements for common equity and Tier 1 capital will be 4.5% and 6%,
respectively, beginning in 2015.
The 2.5% capital conservation buffer, which will comprise common equity and is in addition to
the 4.5% minimum requirement, will be phased in progressively starting on 1 January 2016, and
will become fully effective by 1 January 2019.
The leverage ratio will also be phased in gradually. The test (the so-called "parallel run period")
began in 2013 and run until 2017, with a view to migrating to a Pillar 1 treatment on 1 January
2018 based on review and appropriate calibration.
The liquidity coverage ratio (LCR) will be phased in from 1 January 2015 and will require banks
to hold a buffer of high-quality liquid assets sufficient to deal with the cash outflows encountered
in an acute short-term stress scenario as specified by supervisors. To ensure that banks can
implement the LCR without disruption to their financing activities, the minimum LCR
requirement will begin at 60% in 2015, rising in equal annual steps of 10 percentage points to
reach 100% on 1 January 2019.
The other minimum liquidity standard introduced by Basel III is the net stable funding ratio. This
requirement, which will be introduced as a minimum standard by 1 January 2018, will address
funding mismatches and provide incentives for banks to use stable sources to fund their
activities.
Critical Review of BASEL III
The global financial meltdown in 2007-2009 bought to fore the limitations of the Basel II accord.
The norms failed to capture losses on off-balance sheet items leading to a decline in return on
equity, in spite of meeting capital adequacy ratios. The new Basel III accord intends to
proactively plug leakages from the previous norms.
For a country in crisis, it is estimated that, on an average, Basel III will impact by 4.9%, while
the estimates are substantially higher for non-crisis countries. Given the impact regulations on
capital adequacy can potentially have on a country, it is imperative for policy makers to

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recognize reasons for high elasticity and high cost of equity. Further, it is prudent for the central
bank of a country to consider the capital adequacy norms and requirement of additional capital as
an important tool to regulate monetary policy.
Australia: Australia was largely insulated from the 2007 crisis. Two measures saved Australia in
this regard – the preventive actions taken prior to 2008, and the extraordinary public sector
intervention 2008 onwards.
The key preventive actions in the period prior to 2008 are as follows:
 Well-managed Australian Authorized Deposit-taking Institutions (ADIs), which were
prudent to avoid taking on unsustainably risky assets;
 Preemptive Australian Prudential Regulation Authority (APRA) supervision, maintaining
an emphasis on capital adequacy and sound asset quality; and
 More stringent adoption of Basel II, which actually incorporated several propositions of
Basel III.
It is important to note that tough times could indeed arise as a consequence of economic
reversals in the Australian economy. In such a scenario, Australian ADIs would plausibly face a
far higher level of capital stress. Clearly, the Australian Basel II framework might prove to be
lacking. This is where the Basel III framework comes in – it incorporates a higher quality as well
as quantity of capital.
Brazil: Brazil is expected to implement Basel III norms by October 2013, and will follow the
international schedule as indicated by BCBS, with a few aspects to be implemented by 2012
itself. The requirement of additional capital to comply with Basel III norms is quite low in
Brazil, and hence, is unlikely to have a negative impact on economic growth. The grey line
indicates capital requirement of 11%. Except 3 banks, most of the banks comply with the
regulation. The capital adequacy shall be raised to 13% under Basel III norms, in which case, 9
banks shall have a shortfall, while 18 banks shall be uncomfortably close to the regulation.
However, banks shall have until 2019 to comply. Refer to Exhibit 4 for the timeline of phased
implementation of Basel III accord in Brazil.
United Kingdom: Across the EU, the Basel norms are implemented under the legal name of
Capital Requirements Directives (CRD). In UK, the responsibility of convergence to CRD is
equally shared between the Financial Services Authority (FSA) and the HM Treasury. Following
the 2008 financial turmoil gripping UK, the Prudential Regulation Authority (PRA) was formed
as a successor to Financial Services Authority (FSA), the banking regulator, in April 2013, as a
part of restructuring efforts for more effective supervision and governance. CRD IV, which
directs implementation of Basel III, has been approved by the EU parliament, with the
implementation to commence from January 2014. This creates an obligation to adopt the Basel
III norms on all the member countries including the United Kingdom.

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United States of America: Banking regulation is highly fragmented in U.S., because of the
existence of regulation at both the federal and state level. The U.S. has always been a laggard in
implementation of Basel norms. Multiple regulatory bodies have interest in the same issue.
All the banks in USA continue to follow the revised Basel I norms. Certain portions of advanced
approach of Basel II were implemented, which applies to the most complex banks. This led to
the Basel II norms being applicable for only large financial institutions, keeping the majority of
the banking community outside the purview.
The financial crisis of 2008 called for sweeping changes in banking supervision and regulation
standards in the country. Stringent capital requirements, severe credit analysis of securities rated
externally and enhancement of Pillar 2 (Supervisory and review process) and Pillar 3 (Disclose
and market discipline) were implemented.
Basel III shall be implemented in USA in a phased manner between January 1, 2013 and January
1, 2019. Implementation of Basel III norms in USA will require an additional Core Tier I Capital
to the extent of $700bn, and total Tier I capital of $870bn, with the gap in long term funding
estimated at $3.2trillion. These shortfalls are expected bring down Return on Equity of banks by
3%.
1.2 INTRODUCTION OF NARSIMHAM COMMITTEE:
From the 1991 India economic crisis to its status of third largest economy in the world by 2011,
India has grown significantly in terms of economic development. So has its banking sector.
During this period, recognizing the evolving needs of the sector, the Finance Ministry of
Government of India (GOI) set up various committees with the task of analyzing India's banking
sector and recommending legislation and regulations to make it more effective, competitive and
efficient. Two such expert Committees were set up under the chairmanship of M. Narasimham.
They submitted their recommendations in the 1990s in reports widely known as the Narasimham
Committee-I (1991) report and the Narasimham Committee-II (1998) Report. These
recommendations not only helped unleash the potential of banking in India, they are also
recognized as a factor towards minimizing the impact of global financial crisis starting in 2007.
Unlike the socialist-democratic era of the 1960s to 1980s, India is no longer insulated from the
global economy and yet its banks survived the 2008 financial crisis relatively unscathed, a feat
due in part to these Narasimham Committees.
During the decades of the 60s and the 70s, India nationalized most of its banks. This culminated
with the balance of payments crisis of the Indian economy where India had to airlift gold to
International Monetary Fund (IMF) to loan money to meet its financial obligations. This event
called into question the previous banking policies of India and triggered the era of economic
liberalization in India in 1991. Given that rigidities and weaknesses had made serious inroads
into the Indian banking system by the late 1980s, the Government of India (GOI), post-crisis,
took several steps to remodel the country's financial system. The banking sector, handling 80%
of the flow of money in the economy, needed serious reforms to make it internationally
reputable, accelerate the pace of reforms and develop it into a constructive usher of an efficient,
vibrant and competitive economy by adequately supporting the country's financial needs. In the

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light of these requirements, two expert Committees were set up in 1990s under the chairmanship
of M. Narasimham (an ex-RBI (Reserve Bank of India) governor) which are widely credited for
spearheading the financial sector reform in India. The first Narasimhan Committee (Committee
on the Financial System – CFS) was appointed by Manmohan Singh as India's Finance Minister
on 14 August 1991, and the second one (Committee on Banking Sector Reforms) was appointed
by P.Chidambaram as Finance Minister in December 1997. Subsequently, the first one widely
came to be known as the Narasimham Committee-I (1991) and the second one as Narasimham-II
Committee (1998). This article is about the recommendations of the Second Narasimham
Committee, the Committee on Banking Sector Reforms.
The purpose of the Narasimham-I Committee was to study all aspects relating to the structure,
organization, functions and procedures of the financial systems and to recommend improvements
in their efficiency and productivity. The Committee submitted its report to the Finance Minister
in November 1991 which was tabled in Parliament on 17 December 1991.
The Narasimham-II Committee was tasked with the progress review of the implementation of the
banking reforms since 1992 with the aim of further strengthening the financial institutions of
India. It focused on issues like size of banks and capital adequacy ratio among other things. M.
Narasimham, Chairman, submitted the report of the Committee on Banking Sector Reforms
(Committee-II) to the Finance Minister Yashwant Sinha in April 1998. The 1998 report of the
Committee to the GOI made the following major recommendations:
Autonomy in Banking - Greater autonomy was proposed for the public sector banks in order for
them to function with equivalent professionalism as their international counterparts. For this the
panel recommended that recruitment procedures, training and remuneration policies of public
sector banks be brought in line with the best-market-practices of professional bank management.
Secondly, the committee recommended GOI equity in nationalized banks be reduced to 33% for
increased autonomy. It also recommended the RBI relinquish its seats on the board of directors
of these banks. The committee further added that given that the government nominees to the
board of banks are often members of parliament, politicians, bureaucrats, etc., they often
interfere in the day-to-day operations of the bank in the form of the behest-lending. As such the
committee recommended a review of functions of banks boards with a view to make them
responsible for enhancing shareholder value through formulation of corporate strategy and
reduction of government equity. To implement this, criteria for autonomous status was identified
by March 1999 (among other implementation measures) and 17 banks were considered eligible
for autonomy. But some recommendations like reduction in Government's equity to 33%, the
issue of greater professionalism and independence of the board of directors of public sector
banks is still awaiting Government follow-through and implementation.
Reform in the role of RBI - First, the committee recommended that the RBI withdraw from the
91-day treasury bills market and that interbank call money and term money markets be restricted
to banks and primary dealers. Second, the Committee proposed a segregation of the roles of RBI
as a regulator of banks and owner of bank. It observed that "The Reserve Bank as a regulator of
the monetary system should not be the owner of a bank in view of a possible conflict of interest".
As such, it highlighted that RBI's role of effective supervision was not adequate and wanted it to
divest its holdings in banks and financial institutions. Pursuant to the recommendations, the RBI

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introduced a Liquidity Adjustment Facility (LAF) operated through repo and reverse repos to set
a corridor for money market interest rates. To begin with, in April 1999, an Interim Liquidity
Adjustment Facility (ILAF) was introduced pending further up gradation in technology and
legal/procedural changes to facilitate electronic transfer. As for the second recommendation, the
RBI decided to transfer its respective shareholdings of public banks like State Bank of India
(SBI), National Housing Bank (NHB) and National Bank for Agriculture and Rural
Development (NABARD) to GOI. Subsequently, in 2007–08, GOI decided to acquire entire
stake of RBI in SBI, NHB and NABARD. Of these, the terms of sale for SBI were finalized in
2007–08 themselves.
Stronger banking system - The Committee recommended for merger of large Indian banks to
make them strong enough for supporting international trade. It recommended a three tier banking
structure in India through establishment of three large banks with international presence, eight to
ten national banks and a large number of regional and local banks. This proposal had been
severely criticized by the RBI employees union. The Committee recommended the use of
mergers to build the size and strength of operations for each bank. However, it cautioned that
large banks should merge only with banks of equivalent size and not with weaker banks, which
should be closed down if unable to revitalize themselves. Given the large percentage of non-
performing assets for weaker banks, some as high as 20% of their total assets, the concept of
"narrow banking" was proposed to assist in their rehabilitation. There were a string of mergers in
banks of India during the late 90s and early 2000s, encouraged strongly by the Government of
India GOI in line with the Committee's recommendations. However, the recommended degree of
consolidation is still awaiting sufficient government impetus.
Non-performing assets - Non-performing assets had been the single largest cause of irritation of
the banking sector of India. Earlier the Narasimham Committee-I had broadly concluded that the
main reason for the reduced profitability of the commercial banks in India was the priority sector
lending. The committee had highlighted that 'priority sector lending' was leading to the buildup
of non-performing assets of the banks and thus it recommended it to be phased out.
Subsequently, the Narasimham Committee-II also highlighted the need for 'zero' non-performing
assets for all Indian banks with International presence. The 1998 report further blamed poor
credit decisions, behest-lending and cyclical economic factors among other reasons for the
buildup of the non-performing assets of these banks to uncomfortably high levels. The
Committee recommended creation of Asset Reconstruction Funds or Asset Reconstruction
Companies to take over the bad debts of banks, allowing them to start on a clean-slate. The
option of recapitalization through budgetary provisions was ruled out. Overall the committee
wanted a proper system to identify and classify NPAs, NPAs to be brought down to 3% by 2002
and for an independent loan review mechanism for improved management of loan portfolios.
The committee's recommendations let to introduction of a new legislation which was
subsequently implemented as the Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 and came into force with effect from 21 June 2002.
Capital adequacy and tightening of provisioning norms - To improve the inherent strength of
the Indian banking system the committee recommended that the Government should raise the
prescribed capital adequacy norms. This would also improve their risk taking ability; The
committee targeted raising the capital adequacy ratio to 9% by 2000 and 10% by 2002 and have

19
penal provisions for banks that fail to meet these requirements. For asset classification, the
Committee recommended a mandatory 1% in case of standard assets and for the accrual of
interest income to be done every 90 days instead of 180 days. To implement these
recommendations, the RBI in Oct 1998, initiated the second phase of financial sector reforms by
raising the banks' capital adequacy ratio by 1% and tightening the prudential norms for
provisioning and asset classification in a phased manner on the lines of the Narasimham
Committee-II report. The RBI targeted to bring the capital adequacy ratio to 9% by March 2001.
The mid-term Review of the Monetary and Credit Policy of RBI announced another series of
reforms, in line with the recommendations with the Committee, in October 1999.
Entry of foreign bank - The committee suggested that the foreign banks seeking to set up
business in India should have a minimum start-up capital of $25 million as against the existing
requirement of $10 million. It said that foreign banks can be allowed to set up subsidiaries and
joint ventures that should be treated on a par with private banks.
Critical Review of Narsimham Committee
There were protests by employee unions of banks in India against the report. The Union of RBI
employees made a strong protest against the Narasimham II Report. There were other plans by
the United Forum of Bank Unions (UFBU), representing about 1.3 million bank employees in
India, to meet in Delhi and to work out a plan of action in the wake of the Narasimham
Committee report on banking reforms. The committee was also criticized in some quarters as
"anti-poor". According to some, the committees failed to recommend measures for faster
alleviation of poverty in India by generating new employment. This caused some suffering to
small borrowers (both individuals and businesses in tiny, micro and small sectors).
In 1998, RBI Governor Bimal Jalan informed the banks that the RBI had a three to four-year
perspective on the implementation of the Committee's recommendations. Based on the other
recommendations of the committee, the concept of a universal bank was discussed by the RBI
and finally ICICI bank became the first universal bank of India. The RBI published an "Actions
Taken on the Recommendations" report on 31 October 2001 on its own website. Most of the
recommendations of the Committee have been acted upon (as discussed above) although some
major recommendations are still awaiting action from the Government of India.
Initially, the recommendations were well received in all quarters, including the Planning
Commission of India leading to successful implementation of most of its recommendations.
Then it turned out that during the 2008 economic crisis of major economies worldwide,
performance of Indian banking sector was far better than their international counterparts. This
was also credited to the successful implementation of the recommendations of the Narasimham
Committee-II with particular reference to the capital adequacy norms and the recapitalization of
the public sector banks. The impact of the two committees has been so significant that elite
politicians and financial sectors professionals have been discussing these reports for more than a
decade since their first submission applauding their positive contribution.

20
1.3 INTRODUCTION OF RAGHURAM RAJAN COMMITTEE REPORT:
India’s financial system holds one of the keys, if not the key, to the country’s future growth
trajectory. The financial system’s ability to efficiently intermediate domestic and foreign capital
into productive investment and to provide financial services to a vast majority of households will
influence economic as well as social stability.
While India’s financial institutions and regulatory structures have been developing gradually, the
time has come to push forward the next generation of financial reforms. The needs of a growing
and increasingly complex market-oriented economy, and its rising integration with global trade
and finance, call out for deeper, more efficient and well-regulated financial markets.
Notwithstanding concerns about its depth and efficiency, the financial system seems to have
enabled rapid growth and relatively moderate inflation. Arguably, it must be getting something
right. Why fix what ain’t broke? There are three main reasons. First, the financial system is
actually not working well in terms of providing adequate services to the majority of Indians,
meeting the large-scale and sophisticated needs of large Indian corporate, or penetrating deeply
enough to meet the needs of small and medium-sized enterprises. All of this will inevitably
become a barrier to high growth. Second, the financial sector—if unleashed but with proper
regulation--has the potential to generate millions of much-needed jobs and, more important, have
an enormous multiplier effect on economic growth and the inclusiveness of the financial system.
Third, in these uncertain times, financial stability is more important than ever to keep growth
from being derailed by shocks hitting the system, especially from abroad.
Even if one accepts all of this, why now? After all, the world’s deepest and most sophisticated
financial market seems to be imploding, and taking down many foreign financial institutions
with it. Perhaps it is time for India to batten down the hatches, insulate itself from global finance,
and not venture into sophisticated but apparently risky products. This is the wrong lesson to draw
from the U.S. sub-prime mess.
The right lesson is that markets and institutions do succumb occasionally to excesses, which is
why regulators have to be vigilant, constantly striking the right balance between attenuating risk-
taking and inhibiting growth. Similarly, the right lesson to be drawn from the Asian crisis is not
that foreign capital or financial markets are inherently destabilizing, but that weak legal
frameworks and toothless regulation, especially if coupled with public corruption and weak
corporate governance, can spell trouble. Financial sector reforms that lead to well-functioning
competitive markets can reduce these vulnerabilities. Indeed, the U.S. equity, government debt,
and corporate debt markets remain resilient, despite being close to the epicenter of the crisis.
But a robust financial system is not much good if most people don’t have access to it. Financial
inclusion, which means providing not just basic banking but also instruments to insure against
adverse events, is a key priority in India. The absence of access to formal banking services,
which affects more than one-third of poor households, leaves them vulnerable to informal
intermediaries such as moneylenders. Government-imposed priority-sector lending requirements
and interest rate ceilings for small loans have ended up restricting rather than improving broad
access to institutional finance. Banks have no incentive to expand lending if the price of small
loans is fixed by fiat. Consequently, nearly half of the loans taken by those in the bottom quarter

21
of the income distribution are from informal lenders at an interest rate above 36 percent a year,
well above the mandated lending rate. The solution is not more intervention but more
competition between formal and informal financial institutions and fewer strictures on the
former.
With so many difficult challenges, what is the way to proceed? One point to keep in mind is that
many of the reforms are intertwined. For instance, it makes sense to level the playing field
between banks and nonbank financial corporation’s by easing the requirement that the former
finance priority sectors and the government. But making these changes while the government
continues to have huge financing needs and without having a more uniform and nimble
regulatory regime could be dangerous.
The connections, which stretch beyond just financial reforms to broader macroeconomic
reforms, can in fact have a positive effect by reinforcing the effects of individual actions. For
instance, the process of removing restrictions on capital flows could serve as an adjunct to other
reforms if handled adroitly. Allowing foreign investors to participate more freely in corporate
and government debt markets could increase liquidity in those markets, provide financing for
infrastructure investment, and reduce public debt financing through banks.
India’s rich and complex political process being what it is, focusing solely on the big picture
could bog down progress. A hundred small steps, many of them less controversial but still
requiring some resolve on the part of policymakers, could get the process of reforms going and
build up momentum for the bigger challenges that lie ahead. For instance, converting trade
receivable claims to electronic format and creating a structure to allow them to be sold as
commercial paper could greatly boost the credit available to small and medium enterprises.
1.4 INDIAN BANKING SYSTEM:
For decades, banks in India have played an important role in shaping the financial system and
thereby contributing for economic development. This vital role of the banks in India continues
even today albeit the trends in banking delivery has undergone a sea change with the
advancement in usage of information technology as well as design and delivery of customer
service oriented products. Although there has been an extensive mention of existence of banking
in India even during the days of Rig Veda, the comparable banking understandable in terms of
modern banking can be traced to British rule in India during which agency houses carried on the
banking business. The first bank in India – The Hindustan Bank was established in 1779 and
later the General Bank of India was started in 1786. Three more banks namely, the Bank of
Bengal (1809), the Bank of Bombay (1840), and the Bank of Madras (1843) were formed and
were popularly known as “Presidency Banks”. Later in 1920, all the three presidency banks were
amalgamated to form the Imperial Bank of India on 27 January 1921.
The passing of the Reserve Bank of India Act in 1934 and the consequent formation of Reserve
Bank of India (RBI) in 1935 heralded a new era in the Indian banking evolution. Again, with the
passing of the State Bank of India Act in 1955, the undertaking of the Imperial Bank of India
was taken over by State Bank of India (SBI).

22
The Swadeshi movement gave a new dimension to the evolution of banking in India by giving a
fillip to the formation of joint stock banking companies like; The Punjab National Bank Ltd.,
Bank of India Ltd., Canara Bank Ltd., Indian Bank Ltd., the Bank of Baroda Ltd., the Central
Bank of India Ltd., etc. By 1941, there were around 41 Indian banking companies.
Post-Independence period in Indian banking witnessed the emergence of Reserve Bank of India
as India’s central banking authority after it was nationalized and taken over completely by the
Government of India. In 1949, the Banking Regulation Act was enacted which empowered the
Reserve Bank of India (RBI) “to regulate, control, and inspect the banks in India”. Further, the
Indian government decided to nationalize the banks as they failed to heed to the government
directions in enhancing credit to the priority sectors as directed by the government.
Consequently, 14 largest commercial banks nationalized on July 19, 1969. Further, a second
dose of nationalization of 6 more commercial banks followed in 1980. Nationalization of banks
witnessed a rapid expansion of bank branch network in India. Again in 1976, under the Regional
Rural Banks Act, several Regional Rural Banks (RRBs) were set up.
Structure of Indian Banking
India opened up its banking sector in 1991-92 as a part of globalization of Indian economy. The
financial sector reforms initiated by the government could bring in tectonic changes in the
structure and functioning of the commercial banks. Indian Banking structure is broadly made up of
Scheduled and unscheduled banks. Scheduled banks contribute to more than 95 percent of the
banking in India. Scheduled commercial banks include 26 public sector banks (State Bank of India
and its five associates, 19 nationalized banks and IDBI Bank Ltd.), 7 new private sector banks, 14
old private sector banks and 36 foreign banks. The number of SCBs increased to 83 in 2010-11
from 81 in 2009-10. The structure of Indian banking sector is presented in the figure

23
Source: Dr. Swamy “Basel III: Implication on Indian Banking”
As mentioned earlier, RRBs are also scheduled commercial banks with a specific focus and
agenda unlike the commercial banks whose operations are unlimited. RRBs are sponsored by
commercial banks along with the Central Government and the concerned State Governments. As
at the end of March 2011, there were, 82 RRBs functioning in the country (reduced from 196 in
early 2000s on account of restructuring and amalgamation of existing RRBs to improve their
financial soundness). By the end of March 2011, while the assets of RRBs stood at INR 2,15,359
crores (a growth of 17% over the previous year), the deposits were at a level of INR 1,66,232
crores (a 14.6% growth over the previous year). Further, while the advances of RRBs stood at
INR 94,715 crores (a 19.7% growth over previous year), the investments were to the tune of INR
55,280 crores (a growth of 16.9% over the previous year) by the end of March 2011.
There were 97410 cooperatives in the country as at the end of March 2011 amongst which the
Urban Cooperative Banks (UCBs) were 1645 and rural cooperatives were 95765. Amongst the
UCBs only 53 were scheduled and the remaining 1592 were unscheduled ones. In addition,
amongst the rural cooperatives, long-term cooperatives constituted 717 and the short-term
cooperatives were 95048. While the cooperative banks have a long history of their own, due to
various reasons such as; Lack of recognition of cooperatives as economic institutions, structural
diversity across states, design issues, board and management interface and accountability and

24
politicization of cooperatives and control/interference by government, etc., they have been
constrained in attaining their expected performance.
Development Banks are generally termed as all India financial institutions. As at end-March
2011, there were five financial institutions (FIs) under the regulation of the Reserve Bank viz.,
EXIM Bank, NABARD, NHB, SIDBI and IIBI. Of these, four FIs (EXIM Bank, NABARD,
NHB and SIDBI) are under full-fledged regulation and supervision of the Reserve Bank of India.
Operations and Performances of Indian Banking
The Indian banking sector regarded as edifice of the Indian financial sector, though weathered
the stressful consequences of the global financial instability largely, had to traverse through a
challenging macro-economic environment during the post-crisis period. Shadowed by the
financial crisis, the global financial sector was generally turbulent mainly because of the
European sovereign debt crisis, and sluggish growth recovery in the Euro zone as also in the US.
According to RBI (RBI 2011, p 59), the Indian banking sector performed better in 2010-11 over
the previous year despite the challenging operational environment.
The business of SCBs recorded higher growth in 2010- 11 as compared with their performance
during the last few years. Credit deployment has grown at 22.9 per cent and deposits have grown
at 18.3 per cent in 2010- 11 over the previous year. Consequently, the outstanding credit-deposit
ratio of SCBs has increased to 76.5 per cent in 2010-11 as against 73.6 per cent in the previous
year. While the assets of the SCBs stood at INR 71, 83,522 crores, the deposits were to the tune
of INR 56, 16,432 crores and advances outstanding were INR 42, 98,704 crores. Further
investments of SCBs stood at INR 19, 16,053 crores. Indian financial sector’s resilience lies in
the fact that around 70% of it is domestically owned. In addition, about 74% of the assets of the
Indian banking sector are held by the public sector banks. The relatively feeble presence of
foreign banks helped the sector minimize its exposure to the global toxic assets and thereby had a
minimal impact of the devastative global financial crisis. The off-balance sheet exposures of the
Indian banking sector, which declined during the crisis years 2008-09, 2009-10, have witnessed a
growth of 31 per cent in 2010-11. More than 75% of off-balance sheet exposures in 2010-11
constituted forward exchange contracts. Further, the share of foreign banks constituted more than
66% of off-balance sheet exposures during 2010- 11.
Despite the growing pressures on margins owing to higher interest rate environment, the return
on assets (ROA) of SCBs improved to 1.10 per cent in 2010-11 from 1.05 per cent in 2009-10.
The capital to risk weighted assets ratio under both Basel I and II frameworks stood at 13.0 per
cent and 14.2 per cent, respectively in 2010-11 as against the required minimum of 9 per cent.
The gross Non-Performing Assets (NPAs) to gross advances ratio declined to 2.25 per cent in
2010-11 from 2.39 per cent in 2009-10, displaying improvement in asset quality of the banking
sector. Although there was some advancement in the penetration of banking services in 2010-11
over the previous year, the extent of financial exclusion continued to be swaging.
Banking sector being an integral part of the economy in ensuring the efficient transmission of the
funds, it has a close relationship with the other macro-economic factors that play a vital part in
the economic development. Despite the downward movement of some of the economic

25
indicators like the imports and exports, the bank credit has continued to show rising trend in
view of the strong domestic demand led growth.
Financial Soundness in Indian Banking
Banking sector is by far the most central part of the financial system in most of the emerging
economies and is, therefore, also the main source of risk for financial stability. Undoubtedly,
financial soundness of banks has a significant sway on the stability of the financial system as a
whole as the banking system constitutes more than 75% of the financial markets in India. The
Indian banking system endured the onslaught of the global financial crisis and a factor that
bolstered the normal functioning of the banking system even in the face of one of the largest
global financial crisis was its robust capital adequacy. Further, the core banking sector indicators
for India like; Capital Adequacy Ratio (CAR), Capital Adequacy Ratio–Tier-1, Gross Non-
Performing Assets (GNPAs) to total loans, Net Non- Performing Assets (NNPAs) to total loans
and Return on Equity (ROE) have experienced downward pressure during the recent recession
period.. On the contrary, liquid assets to total assets ratio has moved upwards indicating the
tendency of the banks to hold cash during the times of recession instead of investing in loans or
investment products.
Core Banking Sector Indicators in India
Interest Rates (Benchmark prime lending rate), Money market rate and the discount rates) which
have significant impact on the lending activity showed downward movement in the Indian
banking scenario

26
Interest Rates in India
Under Basel II, Capital to Risk-weighted Assets Ratio (CRAR) of Indian banks as at end-March
2009 was at 14.0 per cent, far above the stipulated level of 9 percent (Figure-5.6). This suggests
that Indian banks have successfully managed to meet the increased capital requirement under the
amended framework.
Capital to Risk Weighted Assets Ratio–Bank Group-wise (As at end-March)

27
Prudential Regulation in Indian Banking
Prudential regulation mostly characterizes the adoption of best practices as stipulated by Basel
Accord. However, in devising the regulatory framework for banks, RBI has always kept in focus
the financial stability objective. Some of the counter-cyclical regulatory measures that are now
attracting attention worldwide were already in place in India even before the looming of the
crisis
In terms of capital requirements, even though, as per Basel norms the minimum capital adequacy
ratio (CAR) for banks is 8%, the Indian banks are asked by RBI to maintain the ratio at 9%.
Further, the banks are also stipulated to ensure a minimum Tier I capital ratio of 6 % from April
1, 2010. The current average CAR for the SCBs in India is over 13% while the Tier I capital
ratio is about nine percent. Further, Tier I capital is stated as the one that does not include items
such as intangible assets and deferred tax assets that are now sought to be deducted
internationally.
In the terms of liquidity buffers, Indian banks are found to have substantial holding of liquid
assets as they are required to maintain cash reserve ratio (CRR) which is currently 4.75% and
statutory liquidity ratio (SLR) currently 24% - both ratios as a proportion to their ‘net liabilities’.
As such, in case of maintenance of excess of SLR requirements is always available as a source of
liquidity buffer. Moreover, in order to mitigate liquidity risks at short end, RBI had already
issued detailed Asset-Liability Management (ALM) guidelines encompassing liquidity risk
measurement, reporting framework and prudential limits.
In terms of managing the leverage by banks, RBI has been keeping a watch through the
prudential focus on credit-deposit ratio (CD ratio or CDR) and SLR. Moreover, a prudent focus
on CDR encourages the banks to raise deposits for funding credit flow thus minimizing the use
of purchased funds. Further, as the requirement for SLR is to hold unencumbered securities,
banks cannot leverage the minimum SLR portfolio to take on more assets. Accordingly, the
focus on credit deposit ratio and the SLR prescription have both served to limit the degree of
leverage in the Indian banking system.
Securitization of assets by Indian banks has been regulated by RBI under its guidelines issued in
February 2006. Accordingly, the banks (originators) are prohibited from booking profits upfront
at the time of securitization and also the release of credit enhancement during the life of the
credit-enhanced transaction is disallowed. In view of the same, banks were not having any
incentives to resort to unbridled securitization as observed in “originate-to-distribute57” and
“acquire and arbitrage”58 models of securitization as found in many other countries.
In order to contain the short-term liquidity crisis, RBI recognized the possible impact of
excessive inter- connectedness within the banking system, and has stipulated a restriction on
inter-bank liabilities (IBL) to twice the bank’s net worth. In addition, a higher limit up to 3 times
the net worth is allowed only for those banks whose CAR is at least 25% more than the
minimum of 9%. With a view to recognize the impact that restructuring of credit and slower
growth of credit could have on the credit quality of the banks and also considering the necessity

28
to build up provisions when the bank’s earnings are good, RBI has, in December 2009 advised
the banks to maintain a provision coverage ratio of not below 70% by September 2010.

29
CHAPTER 2
RESEARCH
METHODOLOGY

30
2.1 NEED OF THE STUDY:
The topic undertaken for the dissertation is “Impact of BASEL and Other Indian Committees
Recommendation on Indian Banking System”. The purpose behind opting this topic is immense
potential of the Indian banking sector. Half of the population still lives in the villages, which
needs to be included in the financial system for the inclusive growth of the economy and reduce
the NPAs.
In order to improve the banking sector, various committees have been formed such as
Narasimham committee, Raghuram Rajan committee etc for Indian banks. Similarly BASEL
committee had been formed in order to improve the banking sector worldwide by G10 countries.
As it is the era of globalization and liberalization, most of the economies have been linked with
each other. Anything happened in one country has cascading effect on the other countries’
economy. The effect was recently observed in the 2008 market crash and defaulting of various
European countries on their debt obligation (PIGS countries). Any crash or boom has one thing
in common and that plays a key role in order to make it happen. It is the money flow mechanism
of the countries’ banking sector liquidity. A fragile banking industry could not sustain the growth
of the economy for a longer period of time. This can be clearly proved by 2008 crisis, which
leads to the fall of many banking giants which were too large to fall.
2.2 RESEARCH DESIGN AND SURVEY DESIGN:
Research approach would be based on the quantitative & qualitative section. Here, the data and
information gathered would be in moreover in the form of text, comments or numeric value. We
have to screen all the collected data and information and scratch out the required information out
of that. Here, we have to rely on the information, comments or data released/provided by the
designated authorities related to the RBI. The data would be gathered and distributed in form of
text and numeric only and put at the required stages.
Accordingly considered research approaches is essential, as it permits researcher to draw more
conversant information about the selected research design; this information afterward permits the
researcher to acclimatize the research design and furnish for limitations (Easterby- Smith et al
2002) cited by Saunders (2007).
2.3 DATA ANALYSIS:
The Data would be analyzed from the texts, numeric information provided by the experts and
samples. This information would be segregated as per the requirement and the concrete
information will be distributed according to the required heads.
(A)Secondary Data – The data would be collected from the earlier Journals, and data
collected from the designated authorities
The data would be moreover in the form of numeric value of text information, so that has to be
converted into presentable or graphical form as per the requirement of the project.

31
2.4 RESEARCH METHODOLOGY:
(A) Historical research
It creates explanations & sometimes attempted explanations, of conditions, situations and events
that have occurred in near past. For Example, Any research that documents the evolution of
teacher training program since the turn of century, with the focus of defining the historical
origins of the content and processes of current programs (Postlethwaite, 2005)
Here, in this study, this methodology may solve the problem because, the study on Impact of
BASEL and other Indian Committees Recommendations on Indian Banking System.
(B) Descriptive research
It provides information about conditions, situations and events that occur in the current. For
example, a survey of the physical conditions of school building in order to establish a descriptive
profile of the facilities that exist in a typical school. (Postlethwaite, 2005)
This is a very elaborative and correct kind of research method, where we not only rely on the
past trends and studies but also can observe the current studies and current concepts. The study
on study on Impact of BASEL and other Indian Committees Recommendations on Indian
Banking System
(C) Correlation research
It involves the search for relationship between variables through the use of various measures of
statistical association. For example, an investigation of the relationship between teachers’
satisfaction with their job and various factors describing the provision and quality of teacher
housing, salaries, leave entitlements, and the availability of class room supplies. (Postlethwaite,
2005)
Correlation research method makes relationship between two variables. And our study does not
satisfy this methodology because we are studying on only study on Impact of BASEL and other
Indian Committees Recommendations on Indian Banking System. The sector selected is only
RBI Guidelines, i.e., if there would be comparison between two industries then it could be used.
(D) Causal research
It aims to suggest casual linkages between variables by observing existing phenomena and then
searching back through available data in order to try to identify plausible casual relationships.
For example, a study of factors related to student ‘drop out’ from secondary school using data
obtained from school records over the past decade. (Postlethwaite, 2005)
Our study regarding “Impact of BASEL and other Indian Committees Recommendations on
Indian Banking System” does not satisfy this kind of research methodology because, this study is
completely depended on the factual data and theories, and casual method simply solves the
problems which have been already almost solved. It means, this method is suitable when you
already know the results but you simply need any fact to support that.

32
(E) Experimental research
It is used in settings where variables defining one or more “causes” can be manipulated in a
systematic fashion in order to discern “effects’ on other variables. For Example, an investigation
of the effectiveness of two new textbooks using random assignment of teachers and students of
three groups – two groups for each of the new textbooks, and one group as a ‘control’ group to
use the existing textbook. (Postlethwaite, 2005)
Experimental research methodology is suitable where we are completely studying any field or
study which is altogether virgin and has not been touched earlier. And the researcher has to make
various experiments to come out on one result. Here, we are studying a field where, we are
moreover relied on the persons and information which is already existed in this field.
(F) Case study research
It generally refers to two distinct research approaches. The first consist of and in depth of a
particular student, classroom or school with the aim of producing a nuanced description of
pervading cultural setting that affects education, and an account of the interactions that take
place between students and other relevant persons. For example, an in-depth exploration of the
patterns of friendship between students in a single class, the second approach to case study
research involves the application of quantitative research methods to non-probability samples-
which provide results that are not necessarily designed to generalizable to wider populations. For
example, a survey of the reading achievements of the students in one rural region of a particular
country (Postlethwaite, 2005)
Case study research more over focus on the past data and past information, where we study a
case, which is almost similar to our current problem or study so, as such we are not dealing with
such kind of study or case, we are collecting desecrated information from different places and
gathering at one common place to come out on one judgment.
(G) Ethnographic research
It usually consists of a description of events that occur within the life of a group – with particular
reference to the interaction of individuals in the context of socio cultural norms, rituals and
beliefs shared by the group. The researcher generally participates in some part of the normal life
of the group and uses what he or she learns from his participation to understand the interactions
between group members. For example, a detailed account of the daily tasks and interactions
encountered by a school principal using observations gathered by a researcher who is placed in
the position of “Principal’s Assistant’ in order to become fully involved in the daily life of the
school. (Postlethwaite, 2005)
This type of method suffices the kind the research which is not based on data and facts but on the
social and cultural behavior of the people, for example to understand the customers purchasing
behavior etc. So, our study does not suit this method.
(H) Research and development research
It differs from the above types of research in that, rather than bringing new information to light,
it focuses on the interaction between research and the production and evaluation of a new
product. This type of research can be ‘formative’. For example, an investigation of teachers’

33
reactions to the various drafts and redrafts of a new mathematics teaching kit, with the
information gathered at each stage being used to improve each stage of the drafting process.
Alternatively, it can be used summative. For example, a comparison of the mathematics
achievements of student exposed to anew mathematics teaching kit in comparison with students
exposed to the established mathematics curriculum. (Postlethwaite, 2005)
Well, this kind of method itself defines that it is not suitable for our study, which we are doing
on “Impact of BASEL and other Indian Committees Recommendations on Indian Banking
System”.
So, finally, from all the above mentioned research methodology, we reached on the point that,
the current study “Impact of BASEL and other Indian Committees Recommendations on Indian
Banking System” satisfy the Descriptive research method. Because, here we are suppose to deal
with the information and data which is based on the past facts and figures and at the same
moment current judgment and studies.
2.5 RESEARCH DESIGN:
Phase I- Exploratory work
Exploratory information has been collected from the interviews (mentioned in various journals)
of the various senior officials related BASEL & Other committee recommendations in RBI
Journals.
Phase II- Descriptive research
Descriptive study is done from the various journals, websites & from the books of the authors,
who have specifically written about the BASEL & Other committee's recommendations.
Research Type: Descriptive.
2.6 PROJECT OBJECTIVE:
 Research on the recommendation of BASEL committees.
 Research on the recommendation of Indian banking committees such as Narasimham
committee, Raghuram Rajan committee etc.
 Before and after the implementation of these recommendation in the banking industry.
 Analysis of the bank’s balance sheet for the improvements after the recommendation.
2.7 EXPECTED OUTCOME:
 Better understanding of the banking industry regulation.
 Banking structure in India.
 Regulatory structure of the banks in Indian and global.
 Impact of the committee’s recommendation on Indian banking sector.
 Various risks faced by the banks.
 Day to day capital requirements by the banks for their smooth operation

35
3.1 BASEL III:
Basel III guidelines attempt to enhance the ability of banks to withstand periods of economic and
financial stress by prescribing more stringent capital and liquidity requirements for them. The
new Basel III capital requirement would be a positive impact for banks as it raises the minimum
core capital stipulation, introduces counter-cyclical measures, and enhances banks’ ability to
conserve core capital in the event of stress through a conservation capital buffer. The prescribed
liquidity requirements, on the other hand, would bring in uniformity in the liquidity standards
followed by the banks globally. This liquidity standard requirement, would benefit the Indian
banks manage pressure on liquidity in a stress scenario more effectively. Although implementing
Basel III will only be an evolutionary step, the impact of Basel III on the banking sector cannot
be underestimated, as it will drive significant challenges that need to be understood and
addressed. Working out the most cost-effective model for implementation of Basel III will be a
critical issue for Indian banking.
Impact on Financial System - Basel III framework implementation would lead to reduced risk of
systemic banking crises as the enhanced capital and liquidity buffers together lead to better
management of probable risks emanating due to counterparty defaults and or liquidity stress
circumstances. Further, in view of the stricter norms on Inter-bank liability limits, there would be
reduction of the interdependence of the banks and thereby reduced interconnectivity among the
banks would save the banks from contagion risk during the times of crises.
Undoubtedly, Basel III implementation would strengthen the Indian banking sector’s ability to
absorb shocks arising from financial and economic stress, whatever the source be, and
consequently reduce the risk of spillovers from the financial sector to the real economy.
On Weaker Banks- Further, there would be a drastic impact on the weaker banks leading to their
crowding out. As is well established, as conditions deteriorate and the regulatory position gets
even more intensive, the weaker banks would definitely find it very challenging to raise the
required capital and funding. In turn, this would affect their business models apart from tilting
the banking businesses in favor of large financial institutions and thereby tilting the competition.
Increase Supervisory Vigil - Banking operations might experience a reduced pace as there
would be an increased supervisory vigil on the activities of the banks in terms of ensuring the
capital standards, liquidity ratios – LCR and NSFR and others.
Reorganization of Institutions - The increased focus of the regulatory authorities on the
organizational structure and capital structure ability of the financial firms (mainly banks) would
lead the banks to reorganize their legal identity by resorting to mergers & acquisitions and
disposals of portfolios, entities, or parts of entities wherever possible.
International Arbitrage - In case of inconsistent implementation of Basel III framework among
different countries would lead to international arbitrage thereby resulting in disruption of global
financial stability.

36
Capital standards for India - Indian banks need to look for quality capital and also have to
preserve the core capital as well as use it more efficiently in the backdrop of Basel III
implementation. Indian banks look comfortably placed; they will have to phase out those
instruments from their capital that are disallowed under Basel III.
Comparison of Capital Requirement Standards
Minimum Capital Ratios Basel
III of
BCBs
Basel III
of RBI
Existing
RBI
norms
PSBs
Current
Position
Private
Banks
Current
Position
Minimum Common Equity Tier 1
(CET1)
4.5% 5.5% 3.6% 7.3% 11.2%
Capital Conservation Buffer
(CCB)
2.5% 2.5% - - -
Minimum CET1 + CCB 7% 8% 3.5% 7.3% 11.2%
Minimum Tier 1 Capital 7% 7% 3.6% 7.3% 11.2%
Minimum Total Capital Including
Buffer
8% 9% 6% 8.1% 11.5%
Minimum Total Capital + CCB 10.5% 11.5% 9.0% 12.1% 15.9%
Additional Counter Cyclical
Buffer in the form of Common
Equity Capital
0-
2.5%
0-2.5% NA NA NA
Source: RBI Guidelines
Deductions from Capital – Basel III guidelines Vs. Existing RBI norms
Particulars BASEL III of RBI Existing RBI Norms Impact
Limit on deductions Deductions would be
made if deductibles
exceed the 15% of
core capital at an
aggregate level, or
10% at the individual
item level.
All deductibles to be
deducted
Positive
Deductions from Tier
I or Tier II
All deductions from
core capital
50% of the deductions
from Tier I and
remaining 50% from
Tier II capital
(excepting DTAs and
intangibles where
100% deduction is
made from Tier I
capital
Negative
Treatment of
significant
Aggregated total
equity investment in
For investments upto:
(a) 30%:
Negative

37
investments in
common shares of
unconsolidated
financial
entities
entities where banks
own more than 10%
of shares • (a) Less
than 10% of banks’
common equity – 250
risk
weight (b) More than
10 % will
be deducted from
common
equity
125% risk weight or
risk weight as
warranted by external
rating
(b) 30-50%: 50%
deduction from Tier I
capital and 50% from
Tier II capital
Out of 10.50%, total equity, the capital (equity + reserves) requirement is hiked from the existing
2% to 7%. However, tier II capital that is hybrid capital (fund raising through mostly debt
instruments) dumped from 4% to 2%. Further, with the stipulation of “countercyclical buffer” of
up to 2.5%, the total CAR requirement would raise upto 13%.
Though Indian banks are undoubtedly well capitalized, and maintaining a higher equity capital
ratio than stipulated under Basel III guidelines, they are indeed required to strengthen their
common equity after the relevant deductions. Investor preference would require the banks to
ensure that all the banks would have to maintain an equity capital ratio of higher than 7% by
2013.
CRAR Levels of Indian Banking
Source: Developed by author based on data from RBI Publications
In view of the predicted favorable economic growth over the next three years, it would enable
the banks to shore up their capital bases through issuance of equity. However, a few of the below

38
average performing banks may be necessitated to raise additional equity capital to maintain the
required 7%.
3.2 IMPACT OF BASEL III ON LOAN SPREADS:
The purpose of this section is to map the capital and liquidity requirements as per Basel III to
bank lending spreads. This estimation supposes that the return on equity (ROE) and the cost of
debt are unaffected, with no change in other sources of income and on the same line of thought it
is further assumed that there is no reduction in operating expenses. Such a mapping endows
researchers with a useful instrument to analyze the impact of regulatory changes on the cost of
credit and the real economy. A raise in the interest rate charged on bank loans is believed to
reduce loan demand, all else equal, leading to a drop in investment and output.
This methodology has been employed in the BCBS’s assessment of the long-term economic
impact of the proposed regulatory changes on output (BCBS, 2010, King, 2010). Further, the
benefit of these estimates of changes in bank lending spreads could be found in the using them as
inputs into dynamic stochastic general equilibrium models that have been augmented to include a
micro-founded banking sector such as Goodfriend and McCallum (2007), or as a proxy for
increased financial frictions in macroeconomic models that lack a financial sector. Similar to the
studies by Repullo and Suarez (2004) and Ruthenberg and Landskroner (2008) for Basel II
framework, this mapping exercise attempts to illustrate the potential loan pricing implications for
the banks under the Basel III proposals.
A representative bank is designed to map the changes in the bank’s capital structure and to
understand how the composition of assets has an effect on the different components of net
income using the standard accounting relationships. Even though banks can adjust to the
regulatory reforms in several ways, this study supposes that they seek to pass on any additional
costs by raising the cost of loans to end-customers. It is believed that by computing the change in
net income and shareholder’s equity associated with the regulatory changes, we can compute the
increase in lending spreads required to achieve a given return on equity (ROE).
Of course, this approach is not without limitations. This approach does not formally model the
choices faced by the banks, nor does it offers estimates based on an optimization in a general
equilibrium setting. On other hand, as a substitute, it offers a starting point for understanding the
behavioral response of banks to a regulatory change in a most acceptable practical setting. It
enables and the researchers and the policy makers in determining the impact given a country’s
institutional setting, its banking sector and the elasticity of loan demand.
Though this approach can suggest the potential magnitude of the change in lending spreads,
deciding whether banks would be able to pass on these costs to borrowers is beyond the scope of
this study. Further, this approach focuses on the ‘steady state’ and does not consider the
transition period to the higher regulatory requirements. In the steady state, the supply of bank
credit is considered as exogenous and credit rationing is ignored. It is further implied that banks
price their loans to meet the marginal cost of loan production.

39
As this approach is understandably illustrative and general in nature and could be used to
estimate the impact on lending spreads from a change in bank’s capital structure, assets
composition, risk weighted assets and the corporate tax paid by these banks. Also, as this
approach does not rely much on the availability of very large datasets (which are obviously the
requirement in effective use of statistical methods); it is acceptable particularly for practitioners
for easy comprehension. Another advantage of this approach is that it explains how a given
change can alter the bank’s profitability and indicates to different possible behavioral responses
to the regulations including the unintended consequences. Further, this approach being a bottom-
up, micro-founded one, it offers a useful complement to top-down, structural models where the
modeling of the financial sector is necessarily parsimonious. Although this approach is founded
on several assumptions, all the assumptions are apparent, realistic, and simple and can be
modified to check the sensitivity of the results.
This approach focuses on only two elements of Basel III proposals viz., the first relating to
raising the minimum capital requirement and the second relating to enhanced liquidity
requirement. Firstly, though the previous Basel accords (Basel I and II) specified capital
adequacy rules for minimum capital adequacy ratios, however, they could not absorb the losses
during the recent crisis. In this backdrop, Basel III stipulates higher levels of tangible common
equity. In order to achieve this, banks need to increase their common equity with high- quality
capital. Although this can be achieved by deleveraging banks’ balance sheets by offloading
assets in the near term, but it does not change the fact that the relative share of common equity
and liabilities need to change.
Secondly, as per the Basel III framework, banks are required to meet two new liquidity standard
requirements viz., liquidity coverage ratio (LCR) and net stable funding ratio (NSFR). The LCR
is employed to identify the amount of unencumbered, high quality, liquid assets that can be made
use of to offset cash outflows. Basically, LCR aims to ensure that banks have adequate funding
liquidity to survive at least one month of a situation of stressed funding. As the related data
(requires details on a bank’s expected cash outflows over a one-month period) is not available
for researchers, it cannot be calibrated. The aim of NSFR is to address maturity mismatches
between assets and liabilities. NSFR establishes a minimum adequate amount of stable funding
based on the liquidity characteristics of a bank’s assets over a one-year horizon. This approach
estimates the cost to meet the NSFR. This approach mostly follows the footsteps of King (2010)
in estimating the impact of capital and liquidity requirements on the lending spreads.
This section of the study does not focus on measurement of credit risk, but on the relationships
between a bank’s capital structure, asset composition and their impact on bank’s profitability.
This greater level of detail is vital for understanding as to how the banks respond to the Basel III
regulatory reforms. Both theorists and researchers are quite concerned in understanding these
relationships, albeit they may be too complex to model parsimoniously. By offering greater
detail on the significance of different sources of capital, the present study also contributes to a
growing literature on bank capital structure choices and their impact on lending.
Elliott (2010) is one of the recent studies that has analyzed the loan pricing implications of the
proposed higher capital requirements under Basel III. By providing an accounting-based
analysis, Elliott (2010) has estimated how much the interest rate charged on loans would increase
if banks are required to hold more equity. However, in the stylized model of Elliot, banks hold

40
only loans funded by equity, deposits and wholesale funding and the interest rate on loan is
priced in order to meet a targeted ROE after covering for the cost of liabilities and other fixed
expenses (such as administrative costs and expected loan losses). Using the Federal Deposit
Insurance Corporation (FDIC) data for aggregate United States (US) banking system, Elliott has
calculated that if the ratio of common equity required for a given loan is raised by 2% with no
other changes, banks would need to raise lending spreads by 39 basis points (bps) to maintain the
target ROE of 15%. Further, if the ROE is allowed to fall to 14.5%, lending spread would have
raise only by 9 bps. Elliott summarizes that through a combination of actions the US banking
system would be able to adjust to higher capital requirements and ensure that they would not
have a strong effect on the pricing or availability of bank loans. The merit of the Elliott’s method
is in its simplicity as well as the intuition it provides on pricing of loans and the alternatives
available to banks to adjust to higher capital levels.
The approach of this section of the study is influenced largely by Elliott as well as King’s
approaches. By actual usage of the balance sheet data to compute the regulatory impact, it takes
into account the composition of the assets and liabilities as well the very important distinction
between the assets and risk weighted assets. Further, it models the cost meet the NSFR
unambiguously, elucidating the sensitivity of this computation to the inputs. This study makes an
attempt to compare two steady states, namely, one with and other one without the regulatory
requirements. Firstly, I consider the impact of higher capital requirements in isolation, and then
the cost to meet the NSFR is computed assuming the higher capital requirements have already
been met. Lastly, by considering the potential synergies between the two regulatory
enhancements, it models the capital and liquidity requirements together.
Lending Spreads - A more popular definition for the lending spread is that it is the difference
between the interest rate charged on loans and the rate paid on deposits (Repullo and Suarez,
2004). Goodfriend and McCallum (2007) determine the lending spread as the difference between
the uncollateralized lending rate and the interbank rate. Further, the rate charged by banks on
loans varies on several factors like; terms of the loan, the characteristics of the borrower, the
collateral provided and other costs associated with the loan.
Constructing a representative bank’s financial statements - Stylized balance sheet and income
statement data for scheduled commercial banks in India has been collected from Capitaline Plus
database, respective websites of the banks under study, RBI database, and Basel II Pillar III
disclosures of respective banks from their websites. The data employed for analysis is for the
period from 2002 to 2011 as the Capitaline Plus database provides complete datasets only for a
ten-year period IDBI Bank Ltd. in spite of its dual nature, it is also included amongst the public
sector banks. Public sector banks category also includes the State Bank of India and its associate
banks. Private sector banks also include the foreign banks operating in India. Scheduled
commercial banks (SCBs) include both the public and private sector banks.

41
Sample Distribution by Category of Scheduled Commercial Banks in India
Year Public Sector Banks Private Sector Banks SCBs
2002 30 87 117
2003 30 94 124
2004 30 93 123
2005 30 97 127
2006 30 88 118
2007 30 86 116
2008 30 83 113
2009 29 69 98
2010 29 87 116
2011 28 85 113
2014 27 68 95
The number of banks varies by year due to the merger, closure, or entry of a new foreign bank in
the year. Capitaline Plus database does not report RWAs directly in its datasets. Instead the
quantity of RWAs is collected from the more authenticate source; i.e. the Basel II Pillar III
disclosures of respective banks from their websites. Since the Capitaline Plus database presents
the data for category of banks, there was no problem of the outliers and the requirement of
winsorization of capital adequacy ratios to reduce the impact of outliers. Based on the data
described, a representative bank balance sheet and income statement is constructed for each
category of banks by taking the weighted average values for each component of the balance
sheet and the income statement for banks in each category of study. The weights are based on
total assets of the category of the banks.
Stylized Balance sheet and Income Statement of Scheduled Commercial Bank
BALANCE SHEET AVERAGE INCOME STATEMENT AVERAGE
Cash & Balances with RBI 5.59 Interest Income 6.21
Interbank Claims 4.09 Interest Expended 3.97
Investment & Securities 31.48 A. Net Interest Income 2.24
Loans & Advances 53.23 B. Other Income 1.28
Fixed Assets 0.99 C. Total Revenue (A+B) 3.52
Other Assets 4.63 D. Personnel Expenses 0.95
TOTAL ASSETS 100.00 E. Other Administrative Exp 1.37
Deposits by Customer (Retail 75.65 F. Operating Expenses (D+E) 2.32

42
& Corporate)
Interbank Funding Borrowings 9.16 G. Operating Profit (C-F) 1.20
Other Liabilities & Provisions 8.06 H. Tax Provisions 0.36
TOTAL LIABILITIES 92.88 I. Net Income (G-H) 0.84
Capital 1.05
Reserves Total 6.06
Equity Share Warrants 0.00
Equity Application Money 0.00 Return on Equity (ROE %) 0.15
Total Capital 7.12 Leverage Multiple 6.60
TOTAL LIAB & CAPITAL 100.00
Risk Weighted Asset / Total
Asset
65.77 Average Effective Tax Rate
(%)
33.00%
Loans & advances represent about more than half of the typical banks assets, followed by
investments & securities (31.48%), cash and balances with RBI (5.59%), other assets (4.63%)
and interbank claims (4.09%). These assets are funded mainly by deposits (75.65%), bank
borrowings or interbank funding (9.6%). Shareholder’s equity is to the extent of 7.12%. RWAs
constitute around 65.77% total assets on average. This ratio is significant when calculating the cost of
meeting the higher capital requirement. Table-7.2.2 also shows the consolidated income statement for
the representative bank. In terms of the composition of net income, net interest income is 2.24% with
non-interest income also important at 1.28%. Total operating expenses constitute 2.32% of total
assets. Personnel expenses represent around 41% of total operating expenses. Net income (or
ROA) is 0.8%, implying that the average ROE is around 15%. The average historical corporate tax
rate is accepted at 33%.
3.3 IMPACT OF BASEL III ON BANK CAPITAL:
Post crisis, on the global there have been sincere efforts towards improving the capital adequacy
of the banks. Capital adequacy levels across banks in most advanced economies were on a rise
between 2008 and 2010. For instance, by 2010, in the US, UK, Germany, and Japan, Capital to
Assets Ratio (CAR) was found to be above 15 per cent. The ratio showed a further increase for
US and German banks in the first quarter of 2011. However, among the major emerging
economies, the level of capital adequacy exhibited a moderate decline between 2009 and 2010,
with the exceptions of China, India, and Mexico. How- ever, Chinese banks experience a modest
decline in their capital positions by March 2011.
Levels of Capital Adequacy Ratios of Banks in Select Economies
Countries 2007 2008 2009 2010 2011 2014
Advanced Economies
France 10.2 10.5 12.4 12.3 …. 12.7
Germany 12.9 13.6 14.8 16.1 16.6 17.3
Greece 11.2 9.4 11.7 11.4 12.3 12.6
Italy 10.4 10.8 12.1 12.3 …. 12.7
Japan 12.3 12.4 15.8 16.7 …. ….
Portugal 10.4 9.4 10.5 10.2 10.5 10.7
Spain 11.4 11.3 12.2 11.8 …. 12.5

43
United Kingdom 12.6 12.9 14.8 15.9 …. 17.1
Unites States 12.8 12.8 14.3 15.3 15.5 ….
Emerging & Developing Economies
Brazil 18.7 18.2 18.9 17.6 18.2 …..
China 8.4 12 11.4 12.2 11.8 …
India 12.3 13 13.2 13.6 …. 14.1
Malaysia 14.4 15.5 18.2 17.5 16.4 16.2
Mexico 15.9 15.3 16.5 16.9 16.5 16.1
Russia 15.5 16.8 20.9 18.1 17.2 17.9
Source:Dr.Swamy“BaselIII:ImplicationonIndianBanking” & http://data.worldbank.org/indicator/FB.BNK.CAPA.ZS
Notwithstanding the progress in CAR, soundness of global banks remained a concern because of
a slow process of deleveraging and increasing levels of NPAs. There has been asymmetry in the
decline in banking sector leverage across countries after the crisis. The percentage of total capital
(and reserves) to total assets has been taken as an indicator of leverage in the banking system.
However, deleveraging has not gained any significant momentum in the banking systems of
other advanced European economies, viz., France, Germany, Portugal, Greece, and Spain,
treating 2008 as the reference point. Further, there was a general weakening of the asset quality
of top global banks. Further, according to RBI, financial soundness of the banking sector is a
sine qua non for the financial system’s stability in a bank-dominated country like India. In the
Indian context, the CAR, however, has weakened in 2010-11 over the previous year mostly due
to a decline in Tier II CAR ratio. Amongst the bank groups, foreign banks have registered the
highest CAR, followed by private sector banks and PSBs in 2010-11. Under Basel II also, the
CAR of SCBs remained well above the required minimum in 2010-11. This implies that, in the
short to medium term, SCBs are not constrained by capital in extending credit.
CRAR Levels of Indian Banking

44
According to RBI (RBI 2011), Indian banks can comfortably cope with the proposed Basel III
framework, as they may not face huge difficulty in adjusting to the new capital rules in terms of
both quantum and quality. Quick estimates of RBI (based on the data furnished by banks in their
off-site returns) observe that the CAR of Indian banks under Basel III will be 11.7 per cent (as on
June 30, 2010) as compared with the required CAR under proposed Basel III at 10.5 per cent.
Capital Requirement Standards in Indian Context
Indian banks need to look for quality capital and also have to preserve the core capital as well as
use it more efficiently in the backdrop of Basel III implementation. Out of 10.50%, total equity,
the capital (equity + reserves) requirement has been hiked from the existing 2% to 7%. However,
Tier II capital that is hybrid capital (fund raising through mostly debt instruments) dumped from
4% to 2%. Further, with the stipulation of “counter-cyclical buffer” of up to 2.5%, the total CAR
requirement would raise upto 13%.
Comparison of Capital Requirement Standards
Minimum Capital Ratios Basel
III of
BCBs
Basel III
of RBI
Existing
RBI
norms
PSBs
Current
Position
Private
Banks
Current
Position
Minimum Common Equity Tier 1
(CET1)
4.5% 5.5% 3.6% 7.3% 11.2%
Capital Conservation Buffer
(CCB)
2.5% 2.5% - - -
Minimum CET1 + CCB 7% 8% 3.5% 7.3% 11.2%
Minimum Tier 1 Capital 7% 7% 3.6% 7.3% 11.2%
Minimum Total Capital Including
Buffer
8% 9% 6% 8.1% 11.5%
Minimum Total Capital + CCB 10.5% 11.5% 9.0% 12.1% 15.9%
Additional Counter Cyclical
Buffer in the form of Common
Equity Capital
0-
2.5%
0-2.5% NA NA NA
Indian banks look comfortably placed. They will have to phase out those instruments from their
capital that are disallowed under Basel III.
Deductions from Capital – Basel III guidelines Vs. Existing RBI norms
Particulars BASEL III of RBI Existing RBI Norms Impact
Limit on deductions Deductions would be
made if deductibles
exceed the 15% of
core capital at an
aggregate level, or
10% at the individual
item level.
All deductibles to be
deducted
Positive

IMPACT OF BASEL & OTHER INDIAN COMMITTEES RECOMMENDATIONS ON INDIAN BANKING SYSTEM

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