Post-Crisis Reforms to Banking Regulation and Supervision

Think Global, Act Local

Global Banking : Paradigm Shift

FICCI-IBA Conference

Mumbai

September 7, 2010

Dr. D. SubbaraoGovernor, Reserve Bank of India

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Basel III Reform AgendaThrust

• Fortify banking system

• Correct incentive framework

• Ensure long term stability

• Focus on both microprudential and macroprudential dimensions

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Basel III ReformsMain Elements

• Banks to hold more and better quality capital

• Banks to carry more liquid assets

• Limit leverage of banks

• Banks to build capital buffers

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Basel III

Actual calibration and phasing in

after further assessment

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Banking 2020 Making the Decade’s Promise Come True

How best can banks contribute to the double digit growth and rapid poverty reduction that we are aspiring to?

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Capital Adequacy FrameworkBCBS Proposals

• Improving quality, consistency and transparency of capital

• Improving risk coverage of the Basel II Framework

• Existing capital ratios of Indian banks are above the prescribed norms

• Unlikely to be significantly impacted by proposed norms

• Possibly some negative impact from

– the shifting of deductions from regulatory capital to common equity

– large OTC bilateral derivatives positions

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Capital Adequacy Framework

Impact on Indian Banks

Containment of Financial Leverage of Banks

BCBS Proposal

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Introduction of a leverage ratio which will be a simple, transparent, non-risk based measure

Containment of Financial Leverage of Banks

Impact on Indian banks

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• Leverage in the Indian banking system is quite moderate

• Should SLR portfolio be excluded from estimation of leverage ratio?

Reducing the Pro-cyclicality ofFinancial Sector Regulation

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A major flaw in Basel II is its inherent procyclicality

Reducing ProcyclicalityBCBS Proposals

• Calculation of capital on more conservative default probabilities

• Promote forward looking provisions

• Introduce capital buffers that can be used under stress

• Contain excess credit growth

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Reducing the Pro-cyclicality ofFinancial Sector Regulation

Challenges

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• How do we identify the inflection point?• Is there a single macroeconomic indicator that can

signal both good and bad times?• Are economic cycles not synchronised in global

setting?• How do we deal with abrupt release of capital buffer

which may become necessary? • How to determine the appropriate size of capital

buffer?• How to design a simple, transparent, low-cost capital

buffer?

Reducing the Pro-cyclicality of Financial Sector Regulation

Indian Perspective

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• Is Credit-GDP ratio an appropriate macroeconomic variable to calibrate countercyclical capital buffer?

• Need to improve our capabilities to predict business and sectoral cycles and identify them in real time

Liquidity Risk Management

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Financial crisis highlighted feedback loops through which institutional liquidity constraints cascade into systemic solvency crises.

Liquidity Risk Management BCBS Proposals

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• Liquidity Coverage Ratio

• Net Stable Funding Ratio

• Liquidity-risk monitoring tools

Liquidity Risk Management Indian Perspective

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• Capability to collect relevant data accurately and granularly

• Predict the liquidity stress scenarios with reasonable accuracy

• Dilemma in reckoning SLR holdings as liquid assets

Dealing with Systemically Important Financial Institutions (SIFIs)

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• Development of indicators of systemic risk

• Identification of SIFIs

• Developing differential regulatory and supervisory systems for SIFIs

• Resolution of SIFIs

• Reducing the probability and impact of a SIFI failure

• Reduce contagion risks

Tasks

Dealing with Systemically Important Financial Institutions (SIFIs) Issues that Need to be Addressed

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• Evolving objective criteria for identifying SIFI

• Application of the criteria

• Distinction between SIFI and non-SIFI – ‘moral hazard’ downside

Containment of Systemic Risk India Perspective

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• Supplementary exercise to identify SIFIs in the domestic context

• Upgradation of regulatory and supervisory framework for financial conglomerates

• Enlarge number of financial transactions under multilateral settlements through CCPs

Regulation of Compensation Practices of Banks

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• Compensation structures engendered perverse incentives

• Reform proposals to aim at correcting perverse incentives

Regulation of Compensation Practices of Banks Indian Perspective

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• Reform of bank compensation structures is relevant in India only to 30 per cent of the non-public sector industry segment

• RBI draft guidelines on Compensation of Whole Time Directors/Chief Executive Officers /Risk Takers and Control Staff

• Need to revisit public sector compensation structures?

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International Financial Reporting Standards (IFRS)

Accounting standards setters and prudential supervisors should work together to identify solutions for promoting stability and improving transparency.

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International Financial Reporting Standards (IFRS)

Indian Perspective

• Banks covered by Indian GAAP (Generally Accepted Accounting Principles)

• April 1, 2013 deadline for IFRS convergence by banks

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International Financial Reporting Standards (IFRS)

Indian Perspective

Challenges

• Accounting Standard IFRS 9 – still evolving

• Modification of IT systems

• Upgradation of staff skills – capacity building

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Macroeconomic Impact of the Proposed BCBS Reforms

BIS

•The cost-benefit calculus will possibly be negative in the short-term, albeit modestly, but will be distinctly positive in the medium to long term

IIF

•Estimates significantly higher sacrifice ratios

•Agreement that the financial system will be stronger in the longer term

Implementation of Basel III in India

• Implementation of Basel III will be a challenge

• Impact of Basel III will be different on different banks

• Public sector banks – should anticipate no problem in building capital buffers

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Conclusion - Concerns

• Calibration of the standards and their phasing in so as not to impede recovery

• Banks apprehend they cannot use capital buffers in the event of a downturn

• ‘Comply or explain’ framework may be interpreted as wilful non-compliance or unwarranted regulatory forbearance

Conclusion

Challenge on delivering on the promise for the next decade – ‘think global and act local’

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