2010 september-basel-iii (1)


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2010 september-basel-iii (1)

  1. 1. ICRA CommentProposed Basel III Guidelines: A Credit Positive for IndianBanksContacts: The proposed Basel III guidelines seek to improve the ability of banks toVibha Batra withstand periods of economic and financial stress by prescribing morevibha@icraindia.com stringent capital and liquidity requirements for them. ICRA views the+91-124-4545302 suggested capital requirement as a positive for banks as it raises the minimum core capital stipulation, introduces counter-cyclical measures,Karthik Srinivasan, and enhances banks‟ ability to conserve core capital in the event ofkarthiks@icraindia.com stress through a conservation capital buffer. The prescribed liquidity+91-22-30470028 requirements, on the other hand, are aimed at bringing in uniformity in the liquidity standards followed by banks globally. This requirement, inPuneet Maheshwari ICRA‟s opinion, would help banks better manage pressures on liquidity inpuneetm@icraindia.com a stress scenario.+91-124-4545348 The capital requirement as suggested by the proposed Basel IIISumeet Gambhir guidelines would necessitate Indian banks1 raising Rs. 600000 crore insumeetg@icraindia.com external capital over next nine years, besides lowering their leveraging+91-124-4545329 capacity. It is the public sector banks that would require most of this September 2010 capital, given that they dominate the Indian banking sector. Further, aManushree Saggar higher level of core capital could dilute the return on equity for banks.manushrees@icraindia.com Nevertheless, Indian banks may still find it easier to make the transition+91-124-4545316 to a stricter capital requirement regime than some of their international counterparts since the regulatory norms on capital adequacy in India are already more stringent, and also because most Indian banks have historically maintained their core and overall capital well in excess of the regulatory minimum. As for the liquidity requirement, the liquidity coverage ratio as suggested under the proposed Basel III guidelines does not allow for any mismatches while also introducing a uniform liquidity definition. Comparable current regulatory norms prescribed by the Reserve Bank of India (RBI), on the other hand, permit some mismatches, within the outer limit of 28 days. 1 Except foreign banks
  2. 2. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian BanksIntroductionThe key elements of the proposed Basel III guidelines include the following: 1. Definition of capital made more stringent, capital buffers introduced and Loss absorptive capacity of Tier 1 and Tier 2 Capital instrument of Internationally active banks proposed to be enhanced 2. Forward looking provisioning prescribed 3. Modifications made in counterparty credit risk weights 4. New parameter of leverage ratio introduced 5. Global liquidity standard prescribedThe Basel committee is expected to finalise the Basel III guidelines by December 2010, following which a six-year phase-in period beginning 2013 is likely to be prescribed. This note seeks to assess the impact of theproposed Basel III guidelines on Indian banks‟ capitalisation profile and their liquidity position till 2018. Theimpact of the suggested norms relating to forward looking provisioning and counterparty risk weights are notcaptured in this note, since for that more granular data would be required and these are not available currentlyin the public domain. The norms on “leverage ratio” and “net stable funding ratio” are also not discussed in thisnote as they are likely to be implemented not before 2019.Capital requirement: The new elements and their impact on Indian banksThe proposed Basel III guidelines seek to enhance the minimum core capital (after stringent deductions),introduce a capital conservation buffer (with defined triggers), and prescribe a countercyclical buffer (to be builtup in times of excessive credit growth at the national level).Changes in standard deductionsThe proposed Basel III guidelines suggest changes in the deductions made for the computation of the capitaladequacy percentages. The key changes for Indian banks include the following:Table 1: Deductions from Capital—Proposed vs. Existing RBI Norms Proposed Basel III Existing RBI Norm Impact GuidelineLimit on deductions Deductions to be made All deductibles to be deducted Positive only if deductibles exceed 15% of core capital at an aggregate level, or 10% at the individual item levelDeductions2 from Tier I All deductions from core 50% of the deductions from Tier I Negativeor Tier II capital and 50% from Tier II (except DTA and intangible assets wherein 100% deduction is done from Tier I capital )Treatment of significant Any investment exceeding For investments up to: Negativeinvestments in common 10% of issued share capital (i) 30%: 125% risk weight or riskshares of unconsolidated to be counted as significant weight as warranted by externalfinancial institutions and therefore deducted rating (ii)30-50%: 50% deduction from Tier I and 50% from Tier II 2 These typically include intangible assets and losses, Deferred Tax assets (DTA), Any gain on sale recognized upfront on securitization of assets, Securitization exposure, Investment in financial subsidiaries and associates etc.ICRA Rating Services Page 2
  3. 3. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian BanksWhile the proposal to make deductions “only if such deductibles exceed 15% of core capital” would providesome relief to Indian banks (since all such deductibles are currently reduced from the core capital), the stricterdefinition of “significant interest” and the suggested 100% deduction from the core capital (instead of 50% fromTier I and 50% from Tier II) could have a negative impact on the core capital of some banks.Capital conservation bufferThe Basel committee suggests that a new buffer of 2.5% of risk weighted assets (over the minimum corecapital requirement of 4.5%) be created by banks. Although the committee does not view the capitalconservation buffer as a new minimum standard, considering the restrictions imposed on banks and alsobecause of reputation issues, 7% is likely to become the new minimum capital requirement.The main purpose of the proposed capital buffer is two-fold: 1. It can be dipped into in times of stress to meet the minimum regulatory requirement on core capital. 2. Once accessed, certain triggers would get activated, conserving the internally generated capital. This would happen as in this scenario, the bank would be restrained in using its earnings to make discretionary payouts (dividends, share buyback, and discretionary bonus, for instance).The final contours of the norm on conservation of capital would be known by December 2010. However, theBasel committee may allow some distribution of earnings by the banks, which are in breach of the proposedcapital conservation buffer. If a bank wants to make payments in excess of the amount that the norm on capitalconservation allows, it would have the option of raising capital for such excess amount. This issue would bediscussed with the bank‟s supervisor as part of the capital planning process.Table 2: Illustration on distributable Earnings in Various ScenariosActual conservation capital as Maximum Permissible earningspercentage of required that can be distributed in theconservation capital subsequent financial year< 25% 0%25% - 50% 20%50% - 75% 40%75% - 100% 60%>100% 100%Countercyclical bufferThe Basel committee has suggested that the countercyclical buffer, constituting of equity or fully loss absorbingcapital, could be fixed by the national authorities concerned once a year and that the buffer could range from0% to 2.5% of risk weighted assets, depending on changes in the credit-to-GDP ratio. The primary objective ofhaving a countercyclical buffer is to protect the banking sector from system-wide risks arising out of excessiveaggregate credit growth. This could be achieved through a pro-cyclical build up of the buffer in good times.Typically, excessive credit growth would lead to the requirement for building up higher countercyclical buffer;however, the requirement could reduce during periods of stress, thereby releasing capital for the absorption oflosses or for protection of banks against the impact of potential problems.The key features of the buffer include the following: Credit-GDP gap could be used as a reference point Buffer to be set at the national level every year Buffer to be calculated at the same frequency as the normal capital requirement Banks could be given one year to comply with the additional capital requirement Reduction in buffer could take effect immediately Banks not meeting the norm could be restrained from distributing the earnings (in the same manner as in the case of the capital conservation buffer)ICRA Rating Services Page 3
  4. 4. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian Banks Enhancement in Loss Absorption capacity of capital of internationally active banks The Basel committee issued a consultative document in August 2010 to introduce a “write off clause” in all non-common Tier I and Tier II instruments issued by internationally active banks. The main features include the following: Capital instruments to be written off on the occurrence of trigger event In the event of write off, instrument holders could be compensated immediately in the form of common stock The trigger event is the earlier of: o The decision to make a public injection of fund or support, without which the bank would become non-viable ( as determined by National authority) o A decision that write-off is necessary to prevent the bank from becoming non-viable (as determined by the National Authority) The main purpose of the proposed contingent capital clause is to: Ensure that holders of capital bear the loss in a stress scenario before public money is infused and are not its (public funds‟) beneficiaries; and Reduce the possibility of public support for a bank under stress, as the bank‟s core capital base would get strengthened at the expense of non-core capital (Tier I and Tier II) holders.Capital instruments with this clause are likely to increase the downside risk for potential investors; therefore therisk premium could go up. However, price discovery may not be easy as it could be difficult to assess theprobability of conversion to equity or a principal write-down and the extent of loss after the event. Furtherconsidering the riskier nature of these instruments, there may be a wider notching in the credit rating of suchinstruments as compared to existing capital instruments.Additionally in case this „loss absorption clause‟ is adopted, a large number of instruments would getdisqualified for inclusion under Tier I and Tier II capital. Therefore, Indian banks would need to mobilize capitalfor replacing this as well; the quantum of capital to be replaced could be large as total non common Tier 1 andTier 2 capital of Indian bank is close to Rs. 200000 crore as on March 31, 2010 and large part of it is issued byinternationally active banks. However, transition may be not be abrupt as these instruments would be phasedout over 10 years starting 2013; their recognition would be capped at 90% in the first year and the percentagewould drop by 10% each subsequent year.Comparison on Capital RequirementOverall, with the Basel III being implemented, the regulatory capital requirement for Indian banks could go upsubstantially in the long run (refer Table 3). Additionally within in capital, the proportion of the more expensivecore capital could also increase. Moreover, capital requirements could undergo a change in various scenarios,thereby putting restriction on bank‟s ability to distribute earnings. Please refer to Annexure 2 for an Illustrationon the same.Table 3: Regulatory Capital Adequacy Levels—Proposed vs. Existing RBI Norm Proposed Basel Existing RBI III Norm NormCommon equity (after deductions) 4.5% 3.6% (9.2%)Conservation buffer 2.5% NilCountercyclical buffer 0-2.5% NilCommon equity + Conservation buffer + Countercyclical buffer 7-9.5% 3.6% (9.2%)Tier I(including the buffer) 8.5-11% 6% (10%)Total capital (including the buffers) 10.5-13% 9% (14.5%)Source: Basel committee documents, RBI, Basel II disclosure of various banks; Figures in parenthesis pertainto aggregated capital adequacy of banks covering over 95% of the total banking assets as on March 31, 2010.Please refer Annexure 1 for details.Indian banks are subjected to more stringent capital adequacy requirements than their internationalcounterparts. For instance, the common equity requirement for Indian banks is 3.6% , as against the 2% Innovative perpetual debt and perpetual non-cumulative preference share cannot exceed 40% of the 6% Tier I,thereby minimum core capital works out to be 60% of 6%, which is 3.6%ICRA Rating Services Page 4
  5. 5. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian Banksmentioned in the Basel document. At the same time, the total capital adequacy requirement for Indian banks is9%, as against the 8% recommended under Basel II. Moreover, on an aggregate basis, the capital adequacyposition of Indian banks is comfortable, and being so, they may not need substantial capital to meet the newnorms. However, differences do exist among various banks. While most of the private sector banks and foreignbanks have core capital in excess of 9%, that is not the case with some of the public sector banks, as Chart 13brings out.Once Basel III comes into force, some public sector banks are likely to fall short of the revised core capitaladequacy requirement and would therefore depend on Government support to augment their core capital. Inrecent times, Government of India (GOI) support has come via non-core Tier I, but this form of support maychange in favour of equity capital, especially for banks falling short on core capital.The expected growth in the risk weighted assets along with the requirement of more stringent capital adequacynorms would also require banks to mobilise additional capital. In a scenario of 20% annualised growth in risk-weighted assets and in internal capital generation, the volume of additional capital that would be required bythe banking sector (excluding foreign banks) as a whole over the next nine years ending March 31, 2019 worksout to be Rs. 600000 crore (over internal capital generation). Of this, the public sector banks would require 75-80% and private banks 20-25%. However, any variation in the assumed growth rate may lead to a change inthe volume of capital required. Further, in case some non-common Tier I and Tier II capital instruments getdisqualified for inclusion under regulatory capital, the requirement would go up. It could be a challenge to findthe investors, with higher risk appetite, to subscribe to the capital requirement of Indian banks.* IDBI‟s Common equity% increased to 6.1% from 4.4% as on March 31, 2010 after factoring in the RS 3119 croreequity infusion by the GOI in August-2010ICRA Rating Services Page 5
  6. 6. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian BanksImpact on return on equity Chart 3: Return on Core Tier 1 at various levels of Core Tier 1 20.00% 18.00% Return on Core Tier 1 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 6.0% 7.0% 8.0% 9.0% 9.5% Core Tier 1 CapitalAs discussed, the minimum core Tier I capital requirement may increase to 7-9.5% (9.5% includingcountercyclical buffer at the maximum level) and the overall Tier I capital to 8.5-11% (depending on thecountercyclical capital buffer level). This would impact the leveraging capital of banks and therefore their returnon equity (ROE). For instance, a bank generating 18% ROE on a core capital of 6% would generate around15% ROE (3 percentage points lower) in case it were to raise its core capital to 8%.As most private sector banks and foreign banks in India are very well capitalised, transition to Basel III may notimpact their earnings much, but the upside potential associated with higher leveraging would decline. As forpublic sector banks, those with Core Tier I less than 7% would be negatively impacted. Further, as thecountercyclical buffer has to be set annually by the RBI, this could introduce an element of variation in lendingrates and/or the ROE of banks.LiquidityTable 4: Liquidity Ratio—Proposed vs. Existing RBI Norm Proposed Basel III Existing RBI NormLiquidity Ratios Liquidity Coverage Ratio = Number of 1 2-7 8-14 15- Stock of high quality liquid days 28 assets/Net cash outflows Maximum 5% 10% 15% 20% over a 30-day time period >= Permissible 100% gap (as % of outflows) Net Stable Funding Ratio No such norm (NSFR) = Available amount of stable funding/Required amount of stable funding > =100%ICRA Rating Services Page 6
  7. 7. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian BanksThe net stable funding ratio (NSFR) is likely to be implemented from 2019. But implementation of the liquiditycoverage ratio (LCR) from 2015 may necessitate banks to maintain additional liquidity since the LCRrequirement is more stringent; also some assumptions on the rollover rates and the required liquidity forcommitted lines may be more stringent. However, considering the period of one month and the fact that mostIndian banks have upgraded their technology platforms, the transition to LCR may not be a very difficult one.ICRA Rating Services Page 7
  8. 8. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian BanksAnnexure 1: Capitalization Profile of Top Indian Banks as on March 31, 2010Public Sector Banks Core Tier-1 Core Tier-1 Tier-1 (net Tier-2 (net CRAR GOI(Amount in Rs. crore) (net of (net of of of % shareholding deductions) deductions) deductions) deductions) % % % %Allahabad Bank 5,876 7.72% 8.12% 5.51% 13.62% 55.23%Andhra Bank 4,221 7.81% 8.18% 5.75% 13.93% 51.55%Bank of Baroda 13,157 8.43% 9.20% 5.16% 14.36% 53.81%Bank of India (Consolidated) 12,230 7.51% 8.57% 4.43% 13.0% 64.47%Bank of Maharashtra 2,069 5.61% 6.41% 6.37% 12.78% 76.77%Canara Bank 12,030 7.99% 8.54% 4.89% 13.43% 73.17%Central Bank of India 4,341 4.71% 6.83% 5.40% 12.23% 80.20%Corporation Bank 5,724 8.19% 9.25% 6.12% 15.37% 57.17%Dena Bank 2,202 7.33% 8.16% 4.61% 12.77% 51.19%IDBI Bank 7,952 4.37% 6.35% 5.13% 11.48% 52.67%Indian Bank 6,603 10.50% 11.13% 1.58% 12.71% 80.00%Indian Overseas Bank 6,095 7.68% 8.67% 6.11% 14.78% 61.23%Oriental Bank of Commerce 7,297 8.63% 9.28% 3.25% 12.54% 51.09%Punjab National bank 15,207 8.04% 9.11% 5.04% 14.16% 57.80%Punjab & Sind Bank 2,127 7.14% 7.68% 5.41% 13.10% 100.0%State Bank of India - Group 75,295 8.60% 9.28% 4.21% 13.49% 59.41%State Bank of Bikaner & Jaipur 2,343 7.70% 8.35% 4.95% 13.30% State Bank of Hyderabad 3,748 7.07% 8.64% 6.26% 14.90% State Bank of Mysore 1,965 6.70% 7.59% 4.84% 12.42% State Bank of Patiala 3,505 7.52% 8.16% 5.10% 13.26% State Bank of Travancore 2,658 8.31% 9.24% 4.50% 13.74%Syndicate Bank 5,206 7.17% 8.24% 4.46% 12.70% 66.47%UCO Bank 3,482 4.90% 7.06% 6.16% 13.21% 63.59%Union Bank 8,657 7.06% 7.91% 4.60% 12.51% 55.43%United Bank 2,871 6.85% 8.16% 4.64% 12.80% 84.20%Vijaya Bank 2,478 6.40% 7.69% 4.81% 12.50% 53.87%Total - Public Sector Banks 205,119 7.66% 8.60% 4.75% 13.36%ICRA Rating Services Page 8
  9. 9. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian BanksPrivate Sector Banks (Amount in Rs. crore) Core Tier-1 Core Tier-1 Tier-1 (net Tier-2 (net CRAR (net of (net of of of % deductions) deductions) deductions) deductions) % % %Axis Bank 15,369 10.89% 11.18% 4.62% 15.80%Federal Bank 4,680 16.92% 16.92% 1.44% 18.36%HDFC Bank 20,484 13.13% 13.26% 4.20% 17.44%ICICI Group 43,106 12.12% 12.92% 6.23% 19.15%Indusind 2,140 9.65% 9.65% 5.68% 15.33%ING Vysya Bank 1,972 9.62% 10.11% 4.79% 14.91%Jammu & Kashmir Bank 2,986 12.79% 12.79% 3.10% 15.89%Kotak Group 7,490 17.31% 17.31% 1.97% 19.28%South Indian Bank 1,412 12.42% 12.42% 2.97% 15.39%Yes Bank 3,020 11.84% 12.85% 7.76% 20.61%Total - Private Sector Banks 102,659 12.42% 12.88% 5.05% 17.93%Foreign Banks (Amount in Rs. crore) Core Tier-1 Core Tier-1 Tier-1 (net Tier-2 (net CRAR (net of (net of of of % deductions) deductions) deductions) deductions) % % %Barclays Bank4 4,665 16.62% 16.62% 0.46% 17.07%Citibank - Group 15,607 17.29% 17.29% 0.57% 17.86% 5Deutsche Bank 4,171 16.50% 16.50% 0.71% 17.21%HSBC Bank 9,144 16.63% 16.63% 1.40% 18.03%RBS 1,722 6.72% 7.94% 4.56% 12.50%Standard Chartered Bank 8,037 8.94% 8.94% 3.47% 12.41%Total - Foreign Banks 43,346 13.80% 13.90% 1.87% 15.77%All SCBs (Amount in Rs. crore) Core Tier-1 Core Tier-1 Tier-1 (net Tier-2 (net CRAR % (net of (net of of of deductions) deductions) deductions) deductions) % % % 351,124 9.19% 9.97% 4.58% 14.55%4 Figures as on March 31, 20095 Figures as on December 31, 2009. Also, Core Tier-I and Tier-I are assumed to be same due to non-availability of dataICRA Rating Services Page 9
  10. 10. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian Banks Annexure 2: An illustration on movement of capital requirement and triggers under various scenarios Regulatory Capital = Core Capital + Capital Conservation Buffer + Countercyclical buffer (if any) Actual Regulatory Core Capital 8% Capital Conservation Buffer 2.5% Core Capital 4.5%Completerelease of Actualcountercycli Regulatory Actualcal buffer Core Capital Capital Conservation Countercylical Regulatory 6.5% Buffer 1% Core Capital Buffer 2.5% Normal Scenario 8%Restrictionon earning Capital Conservationdistribution Buffer 2.5% Introduction ofcontinue countercyclical buffer(although Core Capital 4.5% No restriction on earningrestrictions distributionare lower) Core Capital 4.5% Stress situation, normal credit growth High credit growth scenario Actual Actual Regulatory Regulatory Countercyclical Buffer Core Capital Countercyclical Core Capital 2.5% 8.5% Buffer 1.5% 5.5% Capital Capital Conservation Conservation Buffer 2.5% Buffer 2.5% Core Capital 4.5% Core Capital 4.5% Stress situation , high credit growth continues Higher credit growth scenario Part release of Higher level of countercyclical buffer countercyclical buffer Restriction on earning distribution Restriction on earning kicks in distribution become higher Note: Figures in circles represent the minimum regulatory requirement ICRA Rating Services Page 10
  11. 11. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian Banks Annexure3: Time lines (shading indicates transition periods) (All dates are as of 1 January) 2011 2012 2013 2014 2015 2016 2017 2018 As of 1 January2019Leverage Ratio Supervisory Parallel run Migration monitoring 1 Jan 2013-I Jan 2015 to Pillar 1 Disclosure Starts 1 Jan 2015Minimum Common Equity 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%Capital RatioCapital Conservation Buffer 0.625 1.25% 1.875% 2.50% % Minimum common equity 3.5% 4.0% 4.5% 5.125 5.75% 6.375% 7.0%plus capital conservation %bufferPhase-in of deductions 20.0% 40.0% 60.0 80.0% 100.0% 100.0%from CET1 (including %amounts exceeding thelimit for DTAs, MSRs andfinancials)Minimum Tier 1 Capital 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%Minimum Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%Minimum Total Capital plus 8.0% 8.0% 8.0% 8.625 9.25% 9.875% 10.5%conservation buffer %Capital instruments that no Phased out over 10 year horizon beginning 2013longer qualify as non-coreTier 1 capital or Tier 2capitalLiquidity coverage ratio Introduce Observ minimum ation standard period beginsNet stable funding ratio Obser Introduce vation minimum period standard begins ICRA Rating Services Page 11
  12. 12. ICRA Comment Proposed Basel III Guidelines: A Credit Positive for Indian Banks ICRA Limited An Associate of Moody’s Investors Service CORPORATE OFFICE Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon—122002 Tel.: +(91 124) 4545 300; Fax: +(91 124) 4545 350 REGISTERED OFFICE Kailash Building, 11th Floor; 26, Kasturba Gandhi Marg; New Delhi—110001 Tel.: +(91 11) 2335 7940-50; Fax: +(91 11) 2335 7014, 2335 5293 Email: info@icraindia.com Website: www.icra.inBranches: Mumbai: Tel.: + (91 22) 30470000/24331046/53/62/74/86/87, Fax: + (91 22) 2433 1390 Chennai:Tel + (91 44) 45964300, Fax + (91 44) 2434 3663 Kolkata: Tel + (91 33) 2287 8839 /2287 6617/ 2283 1411/2280 0008, Fax + (91 33) 2287 0728 Bangalore: Tel + (91 80) 43326400 Fax + (91 80) 43326409 Ahmedabad:Tel + (91 79) 2658 4924/5049/2008, Fax + (91 79) 2658 4924 Hyderabad: Tel +(91 40) 2373 5061/7251, Fax +(91 40) 2373 5152 Pune: Tel + (91 20) 2556 1194/0195/0196, Fax + (91 20) 2556 1231© Copyright, 2010, ICRA Limited. All Rights Reserved.Contents may be used freely with due acknowledgement to ICRA.All information contained herein has been obtained by ICRA from sources believed by it to be accurate and reliable.Although reasonable care has been taken to ensure that the information herein is true, such information is provided ‘as is’without any warranty of any kind, and ICRA in particular, makes no representation or warranty, express or implied, as tothe accuracy, timeliness or completeness of any such information. All information contained herein must be construedsolely as statements of opinion, and ICRA shall not be liable for any losses incurred by users from any use of thispublication or its contents.ICRA Rating Services Page 12