1. Basel III

2. Overview…
 What is the Basel III framework relating to....
 Definitions of the three pillars and relationship among the
three
 Significant methods of measurement of each one of them
 Challenges in implementation of these norms
 Indian scenario

3. What is "Basel III"
A global regulatory standard on
 bank capital adequacy
 stress testing and
 market liquidity risk
With a set of reform measures to
improve
 Regulation
 supervision and
 risk management

4. Reasons for formulation of Basel
III
(failure of basel II)

5.  Reducing profitability of small banks and threat of
takeover
 Lack of comprehensive approach to address risks
 Self-regulation in area of asset securitization
 Lack of safety
 Inability to strengthen the stability of financial
system
 Failure to achieve large capital reductions

6. Aim
 To minimize the probability of recurrence of crises
to greater extent
 To improve the banking sector's ability to absorb
shocks arising from financial and economic
stress.
 To improve risk management and governance
 To strengthen banks' transparency and
disclosures.

7. Target
 Bank-level, or micro prudential, regulation, which
will help raise the resilience of individual banking
institutions to periods of stress.
 Macro prudential, system wide risks that can build
up across the banking sector as well as the
procyclical amplification of these risks over time.

9. Micro- prudential elements
To minimize the risk contained with individual
institutions
The elements are:
 Definition of capital
 Enhancing risk coverage of capital
 leverage ratio
 International liquidity framework

10. Macro- prudential elements
 To take care of the issues relating to the systemic
risk
The elements are:
 Leverage ratio
 Capital conservation buffer
 Countercyclical capital buffer
 Addressing the procyclicality of provisioning
requirements

11. Cont’d
 Addressing interconnectedness
 Addressing the too- big to- fail problems
 Addressing reliance on external credit rating
agencies.

12. Definition of the three pillars

13. Pillar 1- Minimum Capital
Requirements
• calculate required capital
• Required capital based on
 Market risk
 Credit risk
 Operational risk
• Used to monitor funding concentration

14. Pillar 2- Supervisory Review
Process
 Bank should have strong internal process
 Adequacy of capital based on risk evaluation

15. Pillar 3 – Enhanced Disclosure
 Provide market discipline
 Intends to provide information about banks
exposure to risk

17. The relationship among the three
 Second pillar – supervisory review process to
ensure the first pillar
- intended to ensure that the banks have
adequate capital
 Third pillar – compliments first and second pillar
- a discipline followed by the bank such as
disclosing capital structure, tier-i and tier-ii capital
and approaches to assess the capital adequacy
i.e. assessment of the first pillar.
 Model of commercial banks interpret first pillar as
a closure threshold rather than bank’s asset
allocation

18. Significant Methods of
Measurement

19. The pillar is divided in three types of risk for which
capital should be held.
 Credit Risk
 Operational risk
 Market risk

20. Credit Risk…
 Credit risk is the risk that those who owe you
money will not pay you back.
 Historically credit risk is the larger risk banks run.
BIS II proposes three approaches by which a bank
may calculate its required capital for credit risk.
 Standardized approach
 Internal rating based (IRB) advanced
 Internal rating based (IRB) foundation

21. Operational Risk…
 Operational risk is defined as the risk of loss
resulting from inadequate or failed internal
processes, people and systems or from external
events.
Comparable to credit risk, BIS II proposes three
methods for measuring operational risk.
 Basic indicator approach
 Standardized approach
 Advanced measurement approach (AMA)

22. Market Risk…
 Market risk is the risk of losses due to changes in
the market price of an asset.
 Market risk will only have to be calculated for
assets in the trading book.
 Foreign exchange rate risk and commodities risk
are part of the market risk.
Two methods may be used:
 Standardized measurement method
 Internal models approach

23. Challenges in implementation of
basel 3 norms

24. • The new and stricter regulations of the basel3
like higher capital requirements, the new liquidity
standard, the increased risk coverage, the new
leverage ratio or a combination of the different
requirements will be difficult to adopt by the banks
• Banks have to take a number of actions to meet
the various new regulatory ratios, restoring of data
,
• Banks must be able to calculate and report the
new ratios. Which requires the huge
implementation effort.

25. Challenges of basel3
implementation:
Banks usually have 3 types of challenges
1. Functional challenges
2. Technical challenges
3. Organizational challenges

26. Functional challenges
•Developing specifications for the new regulatory
requirements, such as the mapping of positions (assets
and liabilities) to the new liquidity and funding
categories in the LCR and NSFR calculations.
•the specification of the new requirements for trading
book positions and within the CCR framework (e.g.
CVA) as well as adjustments of the limit systems with
regard to the new capital and liquidity ratios.
•Crucial is the integration of new regulatory
requirements into existing capital and risk management
as some measures to improve new ratios (e.g. liquidity
ratios) might have a negative effect on existing figures.

27. Technical challenges
•The technical challenges includes the availability of
data, data completeness, and data quality and data
consistency to calculate the new ratios.
• The financial reporting system with regard to the new
ratios and the creation of effective interfaces with the
existing risk management systems.

28. Operational challenges
• The operational challenges includes stricter capital
definition lowers banks’ available capital. At the same
time the risk weighted assets (RWA) for
securitizations, trading book positions and certain
counterparty credit risk exposures are significantly
increased.
• The stricter capital requirements, the introduction of
the LCR and NSFR will force banks to rethink their
liquidity position, and potentially require banks to
increase their stock of high-quality liquid assets and to
use more stable sources of funding.

29. •Basel III also introduces a non-risk based
leverage ratio of 3 percent. Group1 banks are
failed in maintaining the this leverage ratio
•The banks will experience increased pressure on
their Return on Equity (RoE) due to increased
capital and liquidity costs, which along with
increased RWAs will put pressure on margins
across all segments

30. Indian Scenario

31. Capital…
 Indian banks need to raise Rs 1.5 lakh crore to
Rs 1.75 lakh crore as capital to meet the BASEL-
III requirements.
 Can PSU banks mobilize this sort of capital?
- Probably NO, The alternate to the
government is either to reduce shareholding
below 50% or slowdown PSU growth
 Can private banks raise this sort of money?
- They probably can, because Rs 500 billion
was raised in last 5 years

32. Problems for PSUs
 Capital adequacy ratio
- has been stipulated at 9%, unchanged from
what the regulator requires in India
currently, banks here will need to raise more
money than under the current Basel II norms
because several capital instruments cannot be
included under the new definition.
Ex: Perpetual Bond
 Maintaining an 8% tier I capital ratio
 More additions to non-performing assets
 Unamortized expenditure on pension liabilities

33. The Indian economy is also expected to grow at
an annual growth rate of 8-9% for next 10 years
or so. This would undoubtedly necessitate a
considerable growth in bank capital.

34. Issues relating to SLR and LCR
….
 India, banks are statutorily required to hold
minimum reserves of high-quality liquid assets at
24% of net demand and time liabilities.
 The proportion of liquid assets in total assets of
banks will increase substantially, if the SLR
reserves are not reckoned towards the LCR
(Liquidity coverage ratio) and banks are to meet
the entire LCR with additional liquid
assets, thereby lowering their income
significantly.
 RBI is examining to what extent the SLR
requirements could be reckoned towards the
liquidity requirement under Basel III.

35. Profitability ….
 Retail banks will be affected least, though
institutions with very low capital ratios may find
themselves under significant pressure.
 Corporate banks will be affected primarily in
specialized lending and trade finance.
 Investment banks will find several core
businesses profoundly affected, particularly
trading and securitization businesses.
 Balance sheet restructuring and business-model
adjustments could potentially mitigate up to 40
percent of Basel III’s RoE impact, on an average.
 Government banks may have to sacrifice growth

36. Cont’d…
 The impact of credit requirements on the
profitability of banks would depend upon sensitivity
of lending rates to capital structure of banks and
sensitivity of the credit growth to the lending rates.
 When banks with low core Tier I shore up their
capital to around 9% required, their return on
equity (RoE) could drop by 1-4%.
 Basel III will force banks to plough back a larger
chunk of their profit into the balance sheet.
 Banks might have to rationalize dividend policies
so that more profit could be retained and used as
capital, indicating a lower dividend for the
government.

37. Benefits of Implementation…
 Demonstrate that the banking system is
recovering well from the global financial crisis of
2008 and has been developing the resilience to
future shocks.
 Contribute to a bank’s competitiveness by
delivering better management insight into the
business, allowing it to take advantage of future
opportunities.
 Strengthen the financial system of both
developing and developed countries by
addressing the weaknesses in the measurement
of risk under Basel II framework revealed during

38. Cont’d…
 Delivers a much safer financial system with
reduced probability of banking crises at affordable
costs. The impact of costs is minimized through
long phase-in.
 It is expected that as the proportion of equity in
the capital structure of banks rises, it would
reduce the incremental costs of raising further
equity as well as non-common equity capital.

39. The Reserve Bank’s approach has been to
adopt Basel III capital and liquidity guidelines
with more conservatism and at a quicker
pace. The impact of these rules is not going to
be onerous and there will be considerable
advantage in adopting Basel III by our banks.