BASEL III Objectives: According to the BCBS, the Based III proposals have two main objectives.

These are : 1. To strengthen the regulations regarding capital base and liquidity of banks with the goal of promoting a more resilient banking sector. 2. To improve the banking sectors ability to absorb shocks arising from financial and economic stress. These twin objectives are proposed to be achieved by bring in new norms and modifying some of the existing ones in the following three main areas :

a) Capital reforms Redefining both the quantity and quality of capital. Introduction of capital conservation buffer. Introduction of counter-cyclical capital buffer Introduction of leverage ratio

It also intends to harmonise the definition of capital across the globe-all countries would follow the same definition for Tier I & II capital. b) Liquidity reforms Introducing long term and short term ratios

c) Other elements relating to general improvement in the stability for the financial system ( more importantly systemic risk and interconnectedness)
Tier I capital In the total capital requirement of 8 percent, the Tier I capital requirement has been increased to 6 percent from 4 percent. Common equity and retained earnings should be the predominant components instead of debt instruments, well above the current 50 percent rule. The difference between the total requirement of 8 percent and the tier I requirement can be met by tier II capital.

Capital will be required to be maintained as given below :

 Core Tier I capital Under Tier I capital, the minimum capital of common equity ( core capital) , the highest form of loss absorbing capital, will be raised from the current level of 2 percent to 4.5 percent. This is to be adhered to after making the necessary regulatory adjustments. ( After subtracting perpetual debts, such as innovative perpetual debts, from Tier I , what is left is core Tier I capital). This increase will be phased in to apply from Jan, 2016 and will come into full effect from Jan, 2019

Capital conservation buffer In addition to the increased core capital, an additional core capital of 2.5 percent is recommended as a capital conservation buffer. This is also be met by common equity only. This will take the minimum core equity requirement to 7 percent (4.5 percent + 2.5 percent). Countercyclical buffer capital The national regulators can also specify a countercyclical buffer capital upto 2.5 percent ( 0 percent to 2.5 percent) from macro prudential objectives according to the individual national circumstances.

 Deductions from Tier I capital Some components of the existing Tier I capital will be disqualified under the new regime. This would, inter alia, include investment in financial subsidiaries and associates , goodwill, other intangibles, deferred tax assets, securitization exposures, etc. Certain hybrid Tier I components will be gradually phased out. An important thing to note here is that as per existing norms certain items mentioned above can be deducted 50 percent from Tier I and 50 percent from Tier II now, whereas in the new regime all deductions will be from core capital.

 Leverage ratios Banks assets are funded predominantly by borrowed funds which includes deposits from public. In our banking system also, the size of deposits from public exceeds the capital of the banks manifold. This means that banking business is a highly leveraged one. The new norms seek to reduce the build up of excess leverage (ratio of Tier I capital: total assets) so as to reduce the risk of failure.

 Basel III sets the leverage ratio 3 percent, i.e. a banks total assets including both on and off- balance sheet assets, should not be more than 33 times of banks capital . The leverage ratio is to be implemented on a gross and unweighted basis without taking into account the risk associated with the assets of the bank. This ratio will be effective from January 2018. However, the supervisory monitoring commences from January,2011 and runs through January,2013.

BASEL II Tier I Capital Tier I Core Tier I

BASEL III

INDIA *

4.0% 2.0%

6.0% 4.5%

6.0%

Tier I + Tier II
Conservation buffer

8.0%
NA

8.0%
2.5%

9.0%
NA

Counter cyclical buffer NA

Total Capital requirements

0/25%
10.5%13.0%

NA
9.0%

8.0%

The liquidity standards are divided into 2 types:

a. Short term : Liquidity coverage ratio (LCR) b. Long term: Net stable funding ratio (NSFR) Liquidity coverage ratio (LCR)
It requires a bank to maintain an adequate levels of unencumbered, high quality assets that can be converted into cash to meet its liquidity needs over a 30-days time horizon, under an acute liquidity stress scenario. In other words, banks have to maintain high quality liquid assets that are sufficient to cover the net cash outflows for a 30 day period.

 The weightage factors for assets vary from 0 percent to 5 percent for cash and Govt. bonds to 85 percent for retail loans and 100 percent for other assets. In respect of liabilities, the weightier factors vary from 0 percent to 100 percent as follows: Tier I capital 100 percent Core retail deposits 90 percent Unsecured wholesome funding 50 percent ECB funding 0 percent

Proposed Basel III

Existing RBI norm

Liquidity Ratios

Liquidity Coverage Ratio = Stock of high quality liquid assets / Net cash outflow over a 30 day time period > = 100% Net Stable Funding Ratio (NSFR) = Available amount of stable funding / Required amount of stable funding >=100%

Number of days

2-7 10 %

8-14 15%

15-28 20%

Maximum 5 Permissible gap (as % % of outflows)

No such norm

 Indian scenario
Table 4 depicts the position of capital of Indian banks ( as on June,2010) vis--vis the Basel II norms . This table shows that Indian banks are better positioned to meet the capital norms than their western counterparts. As regards the leverage ratio, Indian banks have comfortable Tier I capital of about 10 percent and their exposure to off balance sheet items like derivatives is also less in comparison to their western counterparts. The leverage of banks in India is moderate. Hence, it may not be difficult proposition to comply with the leverage requirements also.

 Coming to the liquidity ratios, most of our banks do not rely much on short term or wholesale overnight funding. Most of them still follow retail banking model only. Further , as per the extant RBI stipulations, a good portion of resources mobilized is parked in SLR bonds, which would provide adequate liquidity in the times of need. But , the RBI governor has indicated that our banks need to develop their capability to collect the required data accurately and more granularly.

Parameter

Basel III requirement

Actual value for Indian banks as on June 30,2010 Under Basel II Under Basel III

Capital to risk weighted assets ratio (CRAR)

10.5%

14.4%

11.7%

Tier I capital

8.5%

10.0%

9.0%

Common equity

7.0%

8.5%

7.4%

 However going forward , Indian banks need to make efforts to further shore up their capital base to meet their ever increasing balance sheet size. The credit rating agency, ICRA, has estimated that in a scenario of 20 percent annualized growth in risk weighted assets and internal capital generation, the volume of additional capital that would be required by the banking sector over next 9 years ending March, 2019 works out to be INR 600,000 crore