Basel – III & it's Impact on the Indian Banking System
Posted in Finance Articles, Total Reads: 4815
, Published on 24 June 2013
Basel, a city of Switzerland is the headquarters of Bureau of International Settlement (BIS). BIS promotes support among central banks with a common goal. These goals mainly focus on financial stability and common standards of banking regulation. There are currently 27 nations (including India) in the committee known as Basel Committee on Bank Supervision (BCBS). Basel committee has a set of agreements know as Basel Accord. Investopedia defines Basel Accord as ‘A set of agreements set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to capital risk, market risk and operational risk. The purpose of the accords is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses.’ Till date, three Basel guidelines have been introduced by BCBS – Basel-I, Basel-II, Basel-III. Basel norms ensure that banks maintain adequate capital in times of economic strains.
Basel-I was introduced in 1988. The main focus of Basel-I was credit risk. It defined capital requirement and structure of weights for the risks associated with the banks. It also defined Risk Weighted Assets (RWA). RWA means assets with different risk profiles.Basel-I set a minimum capital requirement for RWA. India adopted Basel-I guidelines in 1999.
Basel-II guidelines were published in 2004 by BCBS. They are considered as refined version of Basel-I accord. It put down the rules for capital adequacy, risk management and disclosure requirements. Currently, the basic features of Basel-II norms are implemented in India; advanced features are yet to be implemented.
The 2008 Global Crisis
The flaws in the sub-prime mortgage loans and the securities based on them led to loss of liquidity and became a solvency issue for the financial sector. Too-big-to-fall companies failed to deliver results and led the financial sector into the crisis. Banks had no liquidity and they stopped lending to the real-estate sector. The financial crisis thus became the economic crisis. Banks were rescued by injecting money into the system and losses being absorbed by the intervening authorities. This crisis led the nations to realise the need to strengthen the financial regulatory system. Immediately after, in July 2009, Basel-II norms were updated and enhanced to Base-II.5 to plug the loopholes of Basel-II norms.
In the wake of the financial crisis of 2008, Basel-III accord was released in 2010. It identified the loopholes of Base-II accord on the banks’ debt regulation. Basel-II did not have any regulation on the amount of debt the banks could take and the short term funding regulations. Basel-III norms are targeting capital-intensive activities. The main aim of these rules is to increase the shock absorbing capacity of the banks at the time of crisis and to decrease the probability of the crisis.
The main areas of focus of the Basel-III norms are:
Capital – Basel-III targets banks to maintain minimum capital adequacy of 11.5%; an increase from the earlier 9%.
RiskCoverage – To capture risks associated with the excessive exposure of banks to derivative products not earlier captured in Basel-I or II.
Leverage – To account for the risk of excessive leverage due to low risk assets
Liquidity – To save banks from liquidity shocks.
The deadline for banks to be Basel-III compliant is 31-Dec-2018 for International Banks and 31-Mar-2018 for Indian Banks. A different date for Indian Banks was selected to align the date with the Indian fiscal year.
Pros of Basel–III accord on Indian Banks
Basel-III reforms will bring about a radical change in the Indian Banking Industry. These norms will make Indian banks less susceptible to crisis, more stable and stronger. The soundness of the banks can be improved by proper implementation of the Basel-III agreements. In India, banks are still operating on the Basel-II norms and not all of these norms have been adopted into the system. To gain the benefits of the Basel-III, the banks need to move forward by start operating on the advanced risk management approaches of the Basel-II and to gradually move to the Basel-III norms. This is highly important for the banks with international presence. The adoption of the advanced approaches would help banks to efficiently manage their capital and improve profitability. A better implementation of the Basel-III will thus allow banks to take advantage of better opportunities within the country and abroad.
Cons of Basel–III accord on Indian Banks
India is a growing economy. As the economy grows, so will the demand for credit. As the demand for credit grows, the capital requirement of the banks will grow. But in Basel-III, there is a greater demand for capital backup. This increase in demand comes at a time when the economy is recovering from economic slowdown. Due to this, the banks will not be able to lend money. With increase in credit demand and lack of money to lend, the borrowing rates will increase which will further lead to slowing down of the economy.
Basel-III norms would also require additional costs for its implementation which will affect the profitability and returns for the Indian banks. According to RBI’s estimates, Indian banks will require a capital of Rs 5 lakh crore over the next five years, of which Rs 1.75 lakh crore will have to be equity capital. Within the Rs 1.75 lakh crore, anywhere between Rs 70,000-1,00,000 crore will have to raised through the market, depending on to what extent the government will infuse capital in state-owned banks. It is known that the cost of equity capital is high. Implementation of Basel III is expected to result in a decline in Indian banks' RoE in the short-term.
Implementation of Basel-III will definitely cost banks but this should not be the only criteria to decide whether to implement these norms or not. Without doubt, the Basel-III will lead to much safer financial system and will reduce chances of banking crisis. Indian banking system is integrated with the global banking system and deviation from the global banking standards will prevent foreign banks from entering into the Indian economy. Also, with greater integration with the global banks, India needs to mitigate the risk thus associated with the global financial system by applying Basel-III practices.
The article has been authored by Jnika Tuteja, XIM, Bhuwaneshwar