[Economy] BASEL III Norms and India

Capital Adequacy ratio(CAR)-  is a ratio of a bank's capital to its risk. RBI track a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements. It is expressed as a percentage of a bank's risk weighted credit exposures. 

Also known as "Capital to Risk Weighted Assets Ratio (CRAR)."

More CAR is signifying better and stable bank.

What are Basel norms?

Basel is a set of standards and practices developed for global banks to ensure that they maintain adequate capital to withstand periods of economic strain. It is a comprehensive set of reform measures designed to improve the regulation, disclosures and risk management within the banking sector.

In simple terms, It provides internationally accepted detailed guidelines about how much money should a bank keep aside, to deal with financial crisis.
Even if loan-takers run away without paying, Bank should have money to give back to deposit holders.

More risk the bank takes, more money it has to keep aside in reserve to counter the risk.

Q: What does Basel III norm stipulate?

Basel III establishes tougher capital standards through more restrictive capital definitions, higher risk-weighted assets (RWA), additional capital buffers and higher requirements for minimum capital ratios. It also introduces new strict liquidity requirements. (basically compared to BASEL I & II , this tym  more money will have to be kept in the banks and less money to lend..thus less liquidity in the system.)

Q: Why Basel III?

It is widely felt that the shortcoming in Basel II norms is what led to the global financial crisis of 2008. That is because Basel II did not have any explicit regulation on the debt that banks could take on their books.

Q: What is the biggest criticism against Basel III?

That the stringent capital requirements come at a time when the global economy is in the midst of a slowdown. This will leave banks with less money to lend, in turn pushing up the cost of borrowing; and thereby further aggravating the slowdown.

Q: What is the deadline for banks to become Basel III compliant? 

For international banks the deadline is December 31, 2018 and March 31, 2018 for Indian banks.

Q: Why are Indian banks concerned about Basel III norms?

Just like for international banks, Basel III norms will affect the profitability and return ratios of Indian banks as well. Something which is admitted by the RBI.

Basel III requires higher and better quality capital. Admittedly, the cost of equity capital is high. The average Return on Equity (RoE) of the Indian banking system for the last three years has been approximately 15%. Implementation of Basel III is expected to result in a decline in Indian banks' RoE in the short-term.

RoE means the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

Q: Indian banks are much better off than global banks that caused the financial crisis. Why then should Indian banks then comply with Basel III norms?

The RBI said: India should transit to Basel III because of several reasons. By far the most important reason is that as India integrates with the rest of the world, as increasingly Indian banks go abroad and foreign banks come on to our shores, we cannot afford to have a regulatory deviation from global standards. Any deviation will hurt us both by way of perception and also in actual practice. Also, it is important that Indian banks have the cushion afforded by improved risk management systems to withstand shocks from external systems, especially as they deepen their links with the global financial system going forward.

Issues related to Basel 3 norms in Indian context

RBI has estimated that the amount needed in capital for these new requirements is  roughly 1.4 times the amount India’s banks have raised from equity and bond market in the last five years. Since India’s growth dropped to nearly 4.7% and banking sector’s NPA rose to a five-year high, hence banks will not find easy money from markets. Also in the election year, P Chindambaram has already announced he wud works towards fiscal consolidation so no capital influx from govt side either.

And considering the current CAR, private banks fare better than state banks hence it wud be more difficult fr state banks to fulfil basel norms. Also state banks are worst performers in NPA and thus weak share performance. 

GoI is aware of the funding crunch its state banks face. To ease the pressure govt and RBI have floated the idea of setting up a financial holding company that raises capital and inject into state banks. The holding company can issue bonds to local and international markets and thus simplifying the capital injection process. But the problem with this idea is rating agencies consider bonds issued from a holding company as subordinate to the bonds issued directly by banks.

Possible solutions ahead for India

One way to reduce the amount of capital its state banks need would be to consolidate weaker banks with stronger ones. This would leave more funding from both international and local capital markets. Also govt capital injection share for each bank will be more in this case. However, some experts believe it offers sizeable risks. A bank buying a peer with a lot of bad loans or weak capital ratio would have to raise additional capital on top of cost of the acquisition and its own rising  BASEL-3 related capital needs. It is likely to be a complex process. It can make or break a merged bank’s ability to raise capital.

Thus the best possible solution is the most painful: the RBI and govt should compel the banks to take control of bad loans (NPAs). They should be forced to select borrowers based on proper due diligence and not on relationships.

Govt also need to learn the lessons, It likes to lean on its pet banks to lend to systematically imp sectors such as agriculture and trading and then to not chase the debtors for prompt repayment. If govt allows banks to assess risk before offering money it wud be good fr that industry in becoming more efficient as well for bank in reducing its NPAs.

And also slow govt policy machinery has led to poor output from these industries who have taken loans, thus no output has led to no repayment of loans. Govt needs to look into this aspect as well.

Basel 3 norms have highlighted the shady Indian state bank practices but it also offers a rare opportunity for govt. To instil fiscal discipline into its banking institutions and India should seize it. 

1 comment:

  1. Basel 3 should be obeyed by Indian banks by 31 march 2019 ( not 2018)
    Please correct this fact as many are taking photocopies of ur article