Basel norms & impact on indian banking system nisha
Basel Norms & Impact on
Indian Banking System
-Nisha Kapadia (22)
To study the impact of Basel III on Indian
Banking System (PSU)
To analyze Basel Norms in Indian
To study Basel Norms
• Purpose of banking supervision is
to ensure that banks operate in a safe and sound manner.
to ensure that banks "hold capital and reserves sufficient to support the
risks that arise in their business".
sound practices for banks' risk management
• Why Capital Requirement?
While bank’s assets (loans & Investments) are risky and prone to losses,
its liability (deposits) are certain.
Assets = External Liabilities + Capital
Liabilities (deposits) are to be honoured. Hence, reduction
In Capital. When Capital is wiped out – Bank Fails.
What is CAR?
• Default by Borrowers
• Interest Rate Risk
• Foreign Exchange
• Commodity Pricing
• Fraud, system and
• Capital Adequacy provides
regulators with a means of
establishing whether banks and
other financial institutions have
sufficient capital to keep them
out of difficulties. Regulators use
a Capital Adequacy Ratio (CAR) to
• CAR = Bank’s Capital
Risk Weighted Assets
• Basel Committee on Banking Supervision [BCBS] was
established by the central-bank governors of the G10
countries in 1974. (Current network - 26 Countries)
• Meets at the Bank for International Settlements in Basel,
• Its objective was to enhance understanding of key
supervisory issues and improve the quality of banking
• Formulates broad supervisory standards and guidelines
• First major result was the 1988 Capital Accord
• In 1997, developed a set of "Core Principles for Effective
Banking Supervision", which provides a comprehensive
blueprint for an effective supervisory system.
• Created in 1988, Basel I Capital Accord had general purpose:
To strengthen the stability of International Banking System
To set up a fair and consistent international banking system in order to
decrease competitive inequality among international banks.
• Focused on Credit Risk
• Set up an international ‘minimum’ amount of capital that
bank should hold
Tier I (Core Capital): Tier I capital includes stock issues (or share holder
equity) and declared reserves, such as loan loss reserves set aside to
cushion future losses or for smoothing out income variation.
Tier II (Supplementary Capital): Tier II Capital includes all other capital
such as gains on investment assets, long term debt with maturity
greater than 5 years and hidden reserves. However, short-term are not
Basel – I Norms
Basel – I (Contd.)
• Limited differentiation of credit
• Strategic Measure of default risk
• No recognition of term-structure
of credit risk
• Simplified calculation of potential
future counterparty risk
• Lack of recognition of portfolio
Pitfall of Basel - I
• According to Basel I, the total
capital should represent at least
8% of the bank’s credit risk.
• Basel II was intended:
To create an international standard for banking
To maintain sufficient consistency of regulations
To protect the international financial system
To reduce scope of regulatory arbitrage
• Defined new calculation of credit Risk
• Addition of operation risk in the existing norms
• Ensuring that capital allocation is more risk sensitive
Basel – II Norms (2004)
Requirement Extended Credit Risk
Pitfall of Basel II
• Too much regulatory compliance
• Banks defined their own risk metrics and derivative
• Depends on good underlying data requirement
• Complex to understand & implement and hence demand for
• Most of the institutional cogs in credit crisis aren’t covered
• Basic assumption was pre-cyclical process which fails to
consider capital requirement changes with inflation/ deflation
• Heavily Rely on external credit rating agencies
Basel – III Norms (2010)
• The G-20 endorsed the new ‘Basel 3’ capital
and liquidity requirement as remedy to overcome
financial crisis of 2008-2009.
• The new accord aims to:
Have special emphasis on Capital Adequacy Ratio
Improve banking sectors ability to absorb shocks
arising from financial and economic stress
Strengthen banks transparency and disclosures
• The accord provides a substantial strengthening of capital
• Places greater emphasis on loss-absorbency capacity on a
going concern basis
Basel III Framework
• Major Features of Basel III
Revised Minimum Equity &
Tier I Capital Requirements
Better Capital Quality
Capital Conservation Buffer
• Ratio under consideration
CAR = (Tier 1 Capital + Tier 2 Capital)
Risk Weighted Assets
Capital Requirements Under Basel II Under Basel III
Minimum Ratio of Total Capital To RWAs 8.00% 10.50%
Minimum Ratio of Common Equity to RWAs 2.00% 4.50% to 7.00%
Tier I capital to RWAs 4.00% 6.00%
Core Tier I capital to RWAs 2.00% 5.00%
Capital Conservation Buffers to RWAs None 2.50%
Leverage Ratio None 3.00%
Countercyclical Buffer None 0% to 2.50%
Minimum Liquidity Coverage Ratio None From 2015
Minimum Net Stable Funding Ratio None From 2018
Systemically important Financial Institutions Charge None From 2011
Comparison of Capital
Requirement under Basel II & III
Basel III- India Consideration
Regulatory Capital - Basel III Global
(As % to RWAs)
(As % to RWAs)
(i) Minimum common equity Tier I ratio 4.5 5.5
(ii) Capital conservation buffer (comprised of common equity) 2.5 2.5
(iii) Minimum common equity Tier I ratio plus capital
conservation buffer [(i)+ (ii)]
(iv) Additional Tier I capital 1.5 1.5
(v) Minimum Tier I capital Ratio [(i)+(iv)] 6.0 7.0
(vi) Tier 2 capital 2.0 2.0
(vii) Minimum Total Capital ratio (MTC) [(v)+(vi) 8.0 9.0
(viii) Minimum total capital ratio plus capital conservation
Impact on Indian Banking System
• Reduced Systematic Risk and absorb economic-finance stress
• Challenge for Weaker Banks to survive
• Increased Supervisory Vigil
• Reorganisation of Institutions with more mergers &
• Chances of increased International Arbitrage
• Bank Capital – Increased NPA, reduced Tier II CAR Ratio
• Increased Tier I capital requirement
Current Phase – Indian Banking
Minimum capital Ratios Basel III
Min. Common Equity Tier 1 4.5% 5.5% 3.6% 7.3% 11.2%
Capital Conservation Buffer 2.5% 2.5% - - -
Minimum CET 1 + CCB 7.0% 8.0% 3.6% 7.3% 11.2%
Minimum Tier 1 Capital 7.0% 7.0% 3.6% 7.3% 11.2%
Min. Total Capital Including buffer 8.0% 9.0% 6.0% 8.1% 11.5%
Min. Total Capital + CCB * 10.5% 11.5% 9.0% 12.1% 15.9%
Additional counter-cyclical buffer
in form of common equity capital
0-2.5% 0-2.5% NA NA NA
•- Data as on June 30 2010.
- Private Banks & Foreign banks maintained high Capital Ratio as compared to Public Sector Banks in India.
Capital & NPA Levels in Sample PSBs
Canara BankBank of India
Punjab National BankBank of BarodaState Bank of India
Latest Developments in Sample
SBI has raised Rs. 8,032 Cr. by way of QIP and Govt. Stake
reduced from 62.9 % to 58.6%.
BOB has privately placed non-convertible, redeemable, un-
secured Basel III Tier 2 Bonds worth Rs. 1000 Cr. @ 9.73% p.a.
and Govt. Stake is 55.41%.
PNB has raised Rs. 1000 Cr. Through Tier 2 Bonds @ 9.65% and
Govt. Stake is 57.87%.
BOI allotted Rs. 1000 Cr. Basel III, unsecured Tier 2 Bonds @
9.80 % via private placement and Govt. Stake is 66.70%.
Canara Bank is about to place Tier 2 Bonds @ 9.70% to raise Rs.
1000 Cr. per Basel requirement and Govt. Stake is 67.72%.
Impact on Public Sector Banks
• Presently PSU banks carry adequate CAR.
• Over next few years, Tier I Capital specially Equity Shares will
be of prime importance instead of CAR.
• Public Sector Banks need Rs. 4.15 trillion additionally to meet
the requirement – Rs. 2.72 trillion for non-equity capital and
approx Rs. 1.43 trillion for equity capital over a period.
• Government to recapitalize an estimated Rs. 900 billion at
existing stake holding position or Rs. 660 billion if reduce its
shareholding down to 51%.
• Some public sector banks are likely to fall short of the revised
core capital adequacy requirement.
• Increase in requirement of capital will affect the ROE of the
Transitional Arrangements-Scheduled Commercial Banks (excluding LABs and RRBs)
As on March 27, 2014 (% of RWAs)
Minimum capital ratios
Minimum Common Equity Tier
4.5 5 5.5 5.5 5.5 5.5 5.5
Capital conservation buffer
- - - 0.625 1.25 1.875 2.5
Minimum CET1+ CCB 4.5 5 5.5 6.125 6.75 7.375 8
Minimum Tier 1 capital 6 6.5 7 7 7 7 7
Minimum Total Capital* 9 9 9 9 9 9 9
Minimum Total Capital +CCB 9 9 9 9.625 10.25 10.875 11.5
Phase-in of all deductions from
CET1 (in %) #
20 40 60 80 100 100 100
* The difference between the minimum total capital requirement of 9% and the Tier 1 requirement can be met
with Tier 2 and higher forms of capital;
# The same transition approach will apply to deductions from Additional Tier 1 and Tier 2 capital.
Basel III- Implementation Phase -
• One shoe doesn’t fit all
• Basel 3 is an evolution & improvement over Basel 2
• Though India was well positioned in financial crisis compare
to global economy, require to increase vigilance
• Private Banks and Foreign Banks are in advantageous
position against public sector banks in terms of - CAR, IT
Infrastructure, Better skilled persons.
• PSBs would take more time to implement Basel 3
• Constant regulatory assessment towards sound practices
followed by banks
• Better approach to Risk Management
• Effective Data Management System
• Effective & SPEEDY implementation would help banks to stay