Neelam Jha, MBA, CAIIB, Certified Bank Trainer, Faculty (Central Bank of India) SPBT College
Abstract
Basel I & II were devised by BIS (Bank for International Settlements) as an endeavor to set international norms for prudential risk management in banks. However the crisis of 2007-08 raised questions on the efficacy of Basel II andincidents like failure of Lehman Brothers shook the entire financial world. Against the background of the global banking crisis of 2008, which sent the financial markets in a tizzy, Basel III norms were formulated in 2010 under which banks had to increase capital, liquidity and also reduce leverage. Basel III predominantly focuses to boost bank‘s capital and get them to move away from short-term funding. The timeline given by Reserve Bank of India to Indian Banks to implement Basel III guidelines is March 2019. Banks have gargantuan impact on economy. Collapse of a big bank is one of the most alarming shocks for any economy. BASEL III has a methodology for identifying G SIB‘s (Global Systemically Important Banks) & D SIB‘s (Domestic Systemically Important Banks) and assessing a Higher Loss Absorbing (HLA) requirement, i.e. G- SIB‘s & D SIB‘s to hold more CET1 Capital. It has a mechanism to incentivize D-SIBs with higher scores not to increase their systemic importance in future. But in the Indian context is this requirement in conformity with the idea of mergers and creating four or five big banks? It assumes greater significance for Indian banks particularly PSB‘s who are grappling with inadequate capital, deteriorating asset quality & swelling NPA‘s. Already RBI has placed twelve PSB‘s under PCA (Prompt Corrective Action) due to breaching of risk threshold indicators viz High NPA, Insufficient CET 1 Capital & negative ROA.
Key words: Basel III, capital adequacy, Indian banks, Risk management, PCA
Introduction: Risks are innate to banking. A bank often strives to mitigate the risks on one hand & earn rewards in form of profits for risk bearing. Hence the need of risk management & supervision is imperative for banking sector. When we look at the banking scenario of the seventies, we observe that the reverberations of failure of Bankhaus Herstatt in West Germany and serious disturbances in international currency and banking markets steered the establishment of Basel Committee. Committee of Banking Regulations and Supervisory Practices by the Central Bank Governors of the Group of Ten countries at the end of 1974. The primary focus of the committee was supervision of banks.However Latin American debt crisis and its implication for the world economy necessitated the formation of BASEL I (1988) which accorded top priority to Capital adequacy and stability in banking system. In wake of rising international risks the accord called for minimum ratio of capital to risk-weighted assets at 8%. CRAR ensured minimum capital to cover depositor‘s money from risky assets. But it failed to take into account operational, strategic & other types of risks. It also lacked diversified recognition for loans to diverse sectors of the economy.
Due to these reasons it was replaced with BASEL II to enhance quality of risk management along with supervision by eliminating regulatory arbitrage and put in place three important pillars:
Minimum Capital Requirements
Supervisory review
Market discipline
Banks act as the substratum for economic growth of the country as they provide credit to various sectors of the economy. During the crisis of 2008, it was observed that many of the big international banks had inadequate capital on one hand and excessive on and off-balance sheet leverage on the other. Many banks engaged in a short term funding regime that was exceedingly volatile and there were various instances when wholesale liabilities were invested in non liquid assets. This caused the banks health to deteriorate and there was panic in the economy. The confidence in the banking sector was further hit by subprime mortgage crisis. One size fit all approach of BASEL was criticized due to inefficient handling of the global crisis of 2007- 2009.
51 KES Shroff College of Arts and Commerce, Kandivali, Mumbai
This called for a more resilient banking system and led to BASEL III: A global regulatory framework for banking systems in December 2010.
Basel III reforms aim to strengthen the banking systemat micro as well as macro levels. It charts a roadmap for individual banks to become more resilient in face of distress scenario. At the macro level it prioritizes addressing of system generated risks, which can build up and aggravate the banking sector. It focuses on improving the quantity and quality of bank capital so as to have a vigorous liquidity buffer to withstand phases of financial market stress. As per BASEL III, the global regulatory and supervisory standards mainly seek to ensure the following:
(i) Banks should be in a better position to absorb losses on both a going concern and a gone Concernbasis.
(ii) Improving the risk coverage of the capital framework
(iii)Introducing leverage ratio to serve as a backstop to the risk-based capital measure (iv) Raise the standards for the supervisory review process (Pillar 2) and public disclosures (Pillar 3)etc.
(v)There is also provision of the capital conservation buffer and the countercyclical buffer to protect the banking sector from periods of excess credit growth.
Scope & Objective:The scope &objective of this research paper is to critically examine the implications of BASEL III vis a vis the fact that Indian banking sector is facing crises other than Capital & Leverage issues which form the crux of BASEL.
Research Methodology:The study is inherently descriptive with intent to diagnose the problems ailing the Indian Banks. It also aids in establishing procedures of strengthening the banking system along with BASEL 3. Source of data collection is secondary in nature.
Analysis & Interpretation:The provisions of BASEL norms are comparatively less suited to Indian banking conditions, which is seemingly well regulated by RBI.A quick glance at the history of Indian banking since nationalization, shows that there have been ups and downs ,but no bank has failed in Independent India.RBI stipulates tougher standards than BASEL norms (as shown in table below)and has introduced its various approaches gradually in phases .
The following table shows RBI‘s Transitional Arrangements-Scheduled Commercial Banks (excluding LABs and RRBs) in black whereas BASEL III phase in arrangements as BASEL norms are shown in red (% of RWAs)
2014 2015 2016 2017 2018 2019 Minimum capital ratios 31 Mar 01 Jan 31 Mar 01 Jan 31 Mar 01 Jan 31 Mar 01 Jan 31 Mar 01 Jan 31 Mar 01 Jan Min CET 1 5.0 4.5 5.5 4.5 5.5 4.5 5.5 4.5 5.5 4.5 5.5 4.5 CCF 0.0 0.0 0.0 0.0 0.625 0.625 1.25 1.25 1.875 1.875 2.5 2.5 Min common equity + CCF 5.0 4.5 5.5 4.5 6.125 5.125 6.75 5.75 7.375 6.375 8.0 7.0 Min Tier 1 Capital 6.5 6.0 7.0 6.0 7.0 6.0 7.0 6.0 7.0 6.0 7.0 6.0 Min Total Capital 9.0 8.0 9.0 8.0 9.0 8.0 9.0 8.0 9.0 8.0 9.0 8.0 Min Total Capital + CCF 9.0 8.0 9.0 8.0 9.625 8.625 10.25 9.25 10.875 9.875 11.5 10.5
52 KES Shroff College of Arts and Commerce, Kandivali, Mumbai Phase–in of all deductions from CET 1(in %) 40 40 60 40 80 60 100 80 100 100 100 100
CET: Common Equity Capital CCF: Capital Conservation Buffer
One of the important foundations of BASEL III is capital adequacy.But is having more capital a guarantee that bank would not fail? In words of Walter Bagehot (the former editor of The Economist) , ―A well run bank needs no capital and no amount of capital can rescue a badly run bank.‖ Taking it further lets analyze the current banking scenario in India. Since 2015, when Asset Quality Review exercise was initiated by RBI for six quarters for cleansing of balance sheets by banks , NPA‘s have been mounting and profits dwindling (as shown in chart below):
(Amt in Rs. Billion)
(Source: Indian Banking Sector at a glance: RBI)
Since RBI mandated AQR was put into action, the GNPA of banks in India has risen 2.5 times. For an economy like ours this was quite tough. Provisioning for these bad loans was another big challenge that banks faced. And to add to their woes the credit growth in last few years is on decline. It is only the retail loans which have been the saving grace.It is generally observed that to sustain a GDP, the credit growth of banks has to be 2.5 times of GDP. However the reducing credit growth of banks coupled with deteriorating asset quality is causing serious trouble for banking sector. Since last four years the credit growth rate of banks has slowed down. The GDP figures are also declining.Although Indian economy is still growing faster than most economies of the world, yet the reversal of growth rate of GDP does not augur well for the economy. What is more worrying is that the credit off take has stagnated.Scheduled Commercial Bank‘s are going through a critical phase (their return on equity has nosedived) when we look at the data for Return on Asset & Return on Equity & Net Interest Margin (as shown in chart below) for the last five years.
0 1000 2000 3000 4000 5000 6000 7000 8000 PROFIT GROSS NPA(Amt in Rs. Billion)
53 KES Shroff College of Arts and Commerce, Kandivali, Mumbai