BASEL III

Presented By:Sumit Agarwal (33101)Manish Jain (33155)Pankaj Agrawal (33192)

Road to Basel IIIThe Basel Committee's oversight body - the Group

of Central Bank Governors and Heads of Supervision (GHOS) - agreed on the broad framework of Basel III in September 2009 and the Committee set out concrete proposals in December 2009.

The GHOS subsequently agreed on key design elements of the reform package at its July 2010 meeting.

At its 12 September 2010 meeting, agreement on the calibration and transition to implement the measures were reached.

The G20 endorsed the new capital and liquidity requirements at their November 2010 Summit in Seoul.

Why Basel III?Basel III is Basel Committee's response to the

financial crisis and are part of the global initiatives to strengthen the financial regulatory system that have been endorsed by the G20 Leaders.

Under Basel, banks basically define their own risk metrics and derivative investments, limiting the effectiveness of Basel as a practical assurance tool.

Basel II was largely a math exercise that depended on good underlying data. It failed in mortgage-related risk calculations because of discretionary determination of capital allocation tiers based on faulty ratings for mortgage-backed securities.

Basel II framework has been blamed for giving birth to the practice of shifting the risky assets from on to off- balance sheets.

Basel II was also responsible for its insensitivity for portfolio diversification and creating high leverage and heavy concentration of exposures in certain asset classes like residential mortgages and structured products.

The second pillar of Basel II that gives great discretion and authority to supervisory authorities did not practically work effectively.

Areas of concernCapital reform (including quality

and quantity of capital, complete risk coverage, leverage ratio and the introduction of capital conservation buffers and a counter-cyclical capital buffer);

Liquidity reform (short term and long term ratios); and

Other elements relating to general improvements to the stability of the financial system.

Capital RequirementsBasel 2 (minimum requirement w.r.t. risk-

weighted assets) :Core Tier 1 = 2% , Total Tier 1 = 4%Total capital = 8%

Basel 3 (minimum requirement w.r.t. risk-weighted assets) :Core Tier 1 = 4.5% , Total Tier 1 = 6%Total capital = 8%

The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 capital in both the cases.

National implementation timeline

Jan 1, 2013

•3.5% common equity

•4.5% Tier 1 capital

•8% total capital

Jan 1, 2014

•4% common equity

•5.5% Tier 1 capital

•8% total capital

Jan 1, 2015

•4.5% common equity

•6% Tier 1 capital

•8% total capital

Capital Adequacy Framework - Impact on Indian Banks

Existing capital ratios of Indian banks are above the prescribed norms◦As on June 30, 2010, the aggregate

capital to risk weighted assets ratio of the Indian banking system stood at 13.4 per cent of which Tier I capital constituted 9.3 per cent.

◦Indian banks already make most of the deductions from capital now being proposed under Basel III.

New capital buffers

Capital conservation bufferThis buffer is set at 2.5% and must consist solely of common equity, after deductions

Countercyclical bufferThis buffer is set up to 2.5% of capital in the form of common equity or other fully loss-absorbing capital

Implementation timeline for Capital Buffer

Jan 1, 2016

• 0.625%

Jan 1, 2019

• 2.5%

Implications on Indian Banks

It will impose additional costs on banks.There’s a concern about the variable

used to calibrate the countercyclical capital buffer.

To effectively deploy countercyclical measures, we also need to improve our capabilities to predict business cycles at the aggregate and sectoral levels, and identify them in real time.

This will require better quality of economic and financial data as well as improved analytical capabilities.

Liquidity RatioThe new liquidity coverage ratio aims

to ensure adequate liquidity in the event of another market dislocation.

It is meant to require a bank to maintain an adequate level of unencumbered, high quality assets that can be converted into cash to meet its liquidity needs for a 30 day time horizon under an acute liquidity stress scenario.

Net Stable Funding RatioThis ratio is defined as the ratio

of available stable funding to required stable funding.

Under the Basel III Framework, NSFR of 100% or more should be maintained.

NSFR is to promote resilience over the longer term.

Liquidity risk management: Challenges to Indian Banks

• Capability to collect relevant data accurately and granularly

• Predict the liquidity stress scenarios with reasonable accuracy

• Dilemma in reckoning SLR holdings as liquid assets

Systemically Important Financial Institutions (SIFIs)

The committee has stated that systemically important banks and financial institutions should be subject to higher requirements than NON-SIFIs ◦ by way of capital and liquidity surcharge

and enhanced supervision, improving the capacity to resolve SIFIs without recourse to taxpayer money

◦Reducing the probability and impact of a SIFI failure

◦Reduce contagion risks

Leverage ratio

These capital requirements are supplemented by a non-risk-based leverage ratio that will serve as a backstop to the risk-based measures described above.

 In July, GHOS agreed to test a minimum Tier 1 leverage ratio of 3% during the parallel run period.

Based on the results of the parallel run period, any final adjustments would be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

Containment of Financial Leverage of Banks -Impact on Indian banksLeverage in the Indian banking

system is quite moderate.Since the Tier 1 capital of many

Indian banks is comfortable (more than 8%) hence the leverage ratio would not be any binding constraint for Indian banks.

Phase-in Deductions from common Equity Tier-1

The regulatory adjustments includes amounts ◦above the aggregate 15% limit for investments in

financial institutions, mortgage servicing rights, and deferred tax assets from timing differences

◦20% of the required deductions from common equity on 1 January 2014 40% on 1 January 2015, 60% on 1 January 2016, 80% on 1 January 2017, and reach 100% on 1 January 2018.

◦ During this transition period, the remainder not deducted from common equity will continue to be subject to existing national treatments.

Timeline

Macroeconomic Impact

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