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BASEL III AND ITS IMPACT ON THE INDIAN BANKING SECTOR

Presented by:-

Sameer Patil (111)Jonathan Perriera (113)Anis Madraswala (115)Sanskruta Halepaeti (117)Durvesh Katkade (119)

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FLOW OF THE PRESENTATIONPART I: BASEL I

PARTII BASEL II

PART III BASEL III

CASE STUDY

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) to be honoured. Hence reduction in

capital. When capital is wiped out – Bank fails.

Bank failures - mainly by losses in assets – default by borrowers (Credit Risk), losses of investment in different securities (Market Risk) and frauds, system and process failures (Operational Risk)

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BASEL COMMITTEE

Committee—a group of eleven nations

Liquidation of Cologne-based Bank Herstatt

To achieve this goal G-10 countries agreed in Basel, Switzerland to form a quarterly committee

Comprising of each country’s central bank and lead bank supervisory authority

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BASEL 1 Set up an international 'minimum' amount of capital that banks

should hold.

‘minimum’ amount of capital—minimum risk-based capital adequacy

The set of agreement- mainly focuses on risks to banks the financial system

To ensure that financial institutions have enough capital on account to meet obligations absorb unexpected losses.

Focused on credit risk.

Supervision should be adequate.

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THE ACCORD Divided into 4 pillars:

1. The Constituents of Capital

2. Risk Weighting

3. A Target Standard Ratio

4. Transitional and Implementing Agreements

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PITFALLS

Limited differentiation of credit risk

Static measure of default risk

No recognition of term-structure of credit risk

Simplified calculation of potential future counterparty risk

Lack of recognition of portfolio diversification effects

Falsification of balance sheets

SHIFT FROM BASEL I TO BASEL II

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BASEL II NORMS

Basel II was intended :– to create an international standard for banking regulators– to maintain sufficient consistency of regulations.– protect the international financial system

Addition of operational risk in the existing norms

Defined new calculations of credit risk

Ensuring that capital allocation is more risk sensitive

OBJECTIVES OF BASEL II

1. Better Evaluation of Risks

2. Better Allocation of resources

3. Supervisors should review each bank’s own risk assessment and capital strategies.

4. Improved Risk management

5. To strengthen international banking systems.10

BASEL II FRAMEWORK

FAILURE OF BASEL II

Banks defined their own risk metrics and derivative investments

Depends on good underlying data

Most of the institutional cogs in the credit crisis aren’t covered

No independent standard.

Wrong assumptions in case of mortgage-related risk calculations.

Inadequate level of capital required by the new discipline

BASEL III ACCORD The G20 endorsed the new ‘Basel 3’ capital and liquidity

requirements.

Extension of Basel II with critical additions, such as a leverage ratio, a macro prudential overview and the liquidity framework.

Basel III accord provides a substantial strengthening of capital requirements.

Basel III will place greater emphasis on loss-absorbency capacity on a going concern basis

The proposed changes are to be phased from 2013 to 2015

The creation of a conservation buffer could be set up by banks during the period January 2016 to 2019. 13

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BASEL III-OBJECTIVES

Special emphasis on the Capital Adequacy Ratio Capital Adequacy Ratio is calculated as – CAR = (Tier 1 Capital + Tier 2 Capital) / Risk Weighted

Assets Reducing risk spillover to the real economy

Comprehensive set of reform measures to strengthen the banking sector.

Strengthens banks transparency and disclosures.

Improve the banking sectors ability to absorb shocks arising from financial and economic stress.

MAJOR FEATURES OF BASEL III

Revised Minimum Equity & Tier 1 Capital Requirements

Better Capital Quality Backstop Leverage Ratio Short term and long term liquidity funding Inclusion of Leverage Ratio & Liquidity Ratios Rigorous credit risk management Counter Cyclical Buffer Capital conservation Buffer

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PILLARS Minimum Regulatory Capital Requirement based on Risk weighted

assets Maintaining capital ( Credit, market and Operational Risk)

Supervisory Review Process• Regulatory Tools and Frameworks to deal with risks.

Market Discipline.• Transparency of Banks

RATIOS Leverage Ratio  ≥ 3%

Liquidity Coverage Ratio =          Stock of high quality liquid assets               ≥

 100%Net cash outflows over a 30-day period

Net Stable Funding Ratio (NSFR) =     Available amount of stable funding              ≥

 100% Required amount of stable funding

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COMPARISON OF CAPITAL REQUIREMENTSUNDER BASEL II AND BASEL III :

Requirements Under Basel II Under Basel III

Minimum Ratio of Total Capital To RWAs

8% 11.50%

Minimum Ratio of Common Equity to RWAs

2% 4.50% to 7.00%

Tier I capital to RWAs 4% 6.00%

Core Tier I capital to RWAs 2% 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 TBD (2015)

Minimum Net Stable Funding Ratio

None TBD (2018)

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IMPACT ON INDIAN BANKING SYSTEM Profitability Capital acquisition Liquidity Needs Limits on lending Bank consolidation Pressure on Yield on Assets Pressure on Return on Equity:  Stability in the Banking system

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IMPACT ON PUBLIC SECTOR

Public sector banks- needs Rs.1 trillion over 10-5 years

Some public sector banks are likely to fall short of the revised core capital adequacy requirement.

Government to recapitalize an estimated Rs 900 billion or be ready to reduce their equity stake in banks below 50%.

Increase in the requirement of capital will affect the ROE of the Public banks.

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POTENTIAL RESPONSES BY BANKS

Operational responsesRWA optimization, Stricter credit approval

processes Tactical responses

Risk-sensitive pricing, Shift to longer-term funding Reduction of securitization exposures

Strategic responses - Sale of business unit, Change of holding

structure

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CHALLENGES OF BASEL 3

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CONCLUSION

One shoe doesn’t fit all. Monetary policies of Central Banks in each

country (example RBI’s CRR, SLR, Repo etc.) make it difficult to uniformly implement BASEL norms

 Exercising controls on the capital, liquidity and leveraging of banks will ensure that they have the ability to withstand crises.

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