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What is Basel iii or What is Basel 3 Accord or Meaning and Definition of Basel III Accord:-

Basel III or Basel 3 released in December, 2010 is the third in the series of Basel Accords. These accordsdeal with risk management aspects for the banking sector. In a nut shell we can say that Basel iii is the

global regulatory standard (agreed upon by the members of the Basel Committee on Banking

Supervision) on bank capital adequacy, stress testing and market liquidity risk. (Basel I and Basel II are

the earlier versions of the same, and were less stringent)

What does Basel III is all About ?

According to Basel Committee on Banking Supervision "Basel III is a comprehensive set of reform

measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation,

supervision and risk management of the banking sector".

Thus, we can say that Basel 3 is only a continuation of effort initiated by the Basel Committee on

Banking Supervision to enhance the banking regulatory framework under Basel I and Basel II. This latest

Accord now seeks to improve the banking sector's ability to deal with financial and economic stress,

improve risk management and strengthen the banks' transparency.

What are the objectives / aims of the Basel III measures ?

Basel 3 measures aim to:

improve the banking sector's ability to absorb shocks arising from financial and economic stress,

whatever the source

improve risk management and governance

strengthen banks' transparency and disclosures.

Thus we can say that Basel III guidelines are aimed at to improve the ability of banks to withstand

periods of economic and financial stress as the new guidelines are more stringent than the earlier

requirements for capital and liquidity in the banking sector.

How Does Basel III Requirements Will Affect Indian Banks :

The Basel III which is to be implemented by banks in India as per the guidelines issued by RBI from time

to time, will be challenging task not only for the banks but also for GOI. It is estimated that Indian banks

will be required to rais Rs 6,00,000 crores in external capital in next nine years or so i.e. by 2020 (The

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estimates vary from organisation to organisation). Expansion of capital to this extent will affect the

returns on the equity of these banks specially public sector banks. However, only consolation for Indian

banks is the fact that historically they have maintained their core and overall capital well in excess of the

regulatory minimum.

What are Three Pillars of Basel II Norms or What are the changes in Three Pillars of Basel iii Accord ?

Basel III: Three Pillars Still Standing :

Any one who has ever heard about Basel I and II, is most likely must have heard about Three Pillars of

Basel. Three Pillar of Basel still stand under Basel 3.

Basel III has essentially been designed to address the weaknesses that become too obvious during the2008 financial crisis world faced. The intent of the Basel Committee seems to prepare the banking

industry for any future economic downturns.. The framework enhances bank-specific measures and

includes macro-prudential regulations to help create a more stable banking sector.

The basic structure of Basel III remains unchanged with three mutually reinforcing pillars.

Pillar 1 : Minimum Regulatory Capital Requirements based on Risk Weighted Assets (RWAs) :

Maintaining capital calculated through credit, market and operational risk areas.

Pillar 2 : Supervisory Review Process : Regulating tools and frameworks for dealing with peripheral risks

that banks face.

Pillar 3: Market Discipline : Increasing the disclosures that banks must provide to increase the

transparency of banks

What are the Major Changes Proposed in Basel III over earlier Accords i.e. Basel I and Basel II?

What are the Major Features of Basel III ?

(a) Better Capital Quality : One of the key elements of Basel 3 is the introduction of much stricter

definition of capital. Better quality capital means the higher loss-absorbing capacity. This in turn will

mean that banks will be stronger, allowing them to better withstand periods of stress.

(b) Capital Conservation Buffer: Another key feature of Basel iii is that now banks will be required to

hold a capital conservation buffer of 2.5%. The aim of asking to build conservation buffer is to ensure

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that banks maintain a cushion of capital that can be used to absorb losses during periods of financial and

economic stress.

(c) Countercyclical Buffer: This is also one of the key elements of Basel III. The countercyclical buffer

has been introducted with the objective to increase capital requirements in good times and decrease

the same in bad times. The buffer will slow banking activity when it overheats and will encouragelending when times are tough i.e. in bad times. The buffer will range from 0% to 2.5%, consisting of

common equity or other fully loss-absorbing capital.

(d) Minimum Common Equity and Tier 1 Capital Requirements : The minimum requirement for

common equity, the highest form of loss-absorbing capital, has been raised under Basel III from 2% to

4.5% of total risk-weighted assets. The overall Tier 1 capital requirement, consisting of not only

common equity but also other qualifying financial instruments, will also increase from the current

minimum of 4% to 6%. Although the minimum total capital requirement will remain at the current 8%

level, yet the required total capital will increase to 10.5% when combined with the conservation buffer.

(e) Leverage Ratio: A review of the financial crisis of 2008 has indicted that the value of many assets

fell quicker than assumed from historical experience. Thus, now Basel III rules include a leverage ratio

to serve as a safety net. A leverage ratio is the relative amount of capital to total assets (not risk-

weighted). This aims to put a cap on swelling of leverage in the banking sector on a global basis. 3%

leverage ratio of Tier 1 will be tested before a mandatory leverage ratio is introduced in January 2018.

(f) Liquidity Ratios: Under Basel III, a framework for liquidity risk management will be created. A new

Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced in 2015 and

2018, respectively.

(g) Systemically Important Financial Institutions (SIFI) : As part of the macro-prudential framework,

systemically important banks will be expected to have loss-absorbing capability beyond the Basel III

requirements. Options for implementation include capital surcharges, contingent capital and bail-in-

debt.

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Comparison of Capital Requirements under Basel II and Basel III :Requirements Under Basel II Under Basel III

Minimum Ratio of Total Capital To RWAs 8% 10.50%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)Systemically important Financial Institutions

ChargeNone TBD (2011)

Over View f the RBI Guidelines for Implementation of Basel III guidelines :

The final guidelines have been issued by Reserve Bank of India for implementation of Basel 3 guidelines

on 2nd May, 2012. Full detailed guidelines can be downloaded from RBI website, by clicking on the

following link : Implementation of Base III Guidelines. Major features of these guidelines are :

(a) These guidelines would become effective from January 1, 2013 in a phased manner. This means that

as at the close of business on January 1, 2013, banks must be able to declare or disclose capital ratios

computed under the amended guidelines The Basel III capital ratios will be fully implemented as on

March 31, 2018

(b) The capital requirements for the implementation of Basel III guidelines may be lower during the

initial periods and higher during the later years. Banks needs to keep this in view while Capital Planning;

(c) Guidelines on operational aspects of implementation of the Countercyclical Capital Buffer. Guidance

to banks on this will be issued in due course as RBI is still working on these. Moreover, some otherproposals viz. Definition of Capital Disclosure Requirements, Capitalisation of Bank Exposures to

Central Counterparties etc., are also engaging the attention of the Basel Committee at present.

Therefore, the final proposals of the Basel

Committee on these aspects will be considered for implementation, to the extent applicable, in future.

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(d) For the financial year ending March 31, 2013, banks will have to disclose the capital ratios computed

under the existing guidelines (Basel II) on capital adequacy as well as those computed under the Basel III

capital adequacy framework.

(e) The guidelines require banks to maintain a Minimum Total Capital (MTC) of 9% against 8%

(international) prescribed by the Basel Committee of Total Risk Weighted assets. This has been decidedby Indian regulator as a matter of prudence. Thus, it requirement in this regard remained at the same

level. However, banks will need to raise more money than under Basel II as several items are excluded

under the new definition.

(f) of the above, Common Equity Tier 1 (CET 1) capital must be at least 5.5% of RWAs;

(g) In addition to the Minimum Common Equity Tier 1 capital of 5.5% of RWAs, (international standards

require these to be only at 4.5%) banks are also required to maintain a Capital Conservation Buffer

(CCB) of 2.5% of RWAs in the form of Common Equity Tier 1 capital. CCB is designed to ensure that

banks build up capital buffers during normal times (i.e. outside periods of stress) which can be drawndown as losses are incurred during a stressed period. In case suchbuffers have been drawn down, the

banks have to rebuild them through reduced discretionary distribution of earnings. This could include

reducing dividend payments, share buybacks and staff bonus.

(h) Indian banks under Basel II are required to maintain Tier 1 capital of 6%, which has been raised to 7%

under Basel III. Moreover, certain instruments, including some with the characteristics of debts, will not

be now included for arriving at Tier 1 capital;

(i) The new norms do not allow banks to use the consolidated capital of any insurance or non financial

subsidiaries for calculating capital adequacy.

(j) Leverage Ratio : Under the new set of guidelines, RBI has set the leverage ratio at 4.5% (3% under

Basel III). Leverage ratio has been introduced in Basel 3 to regulate banks which have huge trading

book and off balance sheet derivative positions. However, In India, most of banks do not have large

derivative activities so as to arrange enhanced cover for counterparty credit risk. Hence, the pressure

on banks should be minimal on this count.

(k) Liquidity norms: The Liquidity Coverage Ratio (LCR) under Basel III requires banks to hold enough

unencumbered liquid assets to cover expected net outflows during a 30-day stress period. In India, the

burden from LCR stipulation will depend on how much of CRR and SLR can be offset against LCR.

Under present guidelines, Indian banks already follow the norms set by RBI for the statutory liquidity

ratio (SLR) and cash reserve ratio (CRR), which are liquidity buffers. The SLR is mainly government

securities while the CRR is mainly cash. Thus, for this aspect also Indian banks are better placed over

many of their overseas counterparts.

(l) Countercyclical Buffer: Economic activity moves in cycles and banking system is inherently pro-cyclic.

During upswings, carried away by the boom, banks end up in excessive lending and unchecked risk build-

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up, which carry the seeds of a disastrous downturn. The regulation to create additional capital buffers to

lend further would act as a break on unbridled bank-lending. The detailed guidelines for these are likely

to be issued by RBI only at a later stage.

On the day of release of these guidelines, analysts felt that India may need at least $30 billion (i.e.

around Rs 1.6 trillion) to $40 billion as capital over the next six years to comply with the new norms. It

was also felt that this would impose a heavy financial burden on the government, as it will need to

infuse capital in case it wanst to continue its hold on these PS Banks. RBI Deputy Governor, Mr Anand

Sinha viewed that the implementation of Basel II may have a negative impact on India's growth story.

In FY 2012-13, Government of India is expected to provide Rs 15888 crores to recapitalize the banks. as

to maintain capital adequacy of 8% under old Basel II norms.

Some Major Developments after 2nd May 2012 (i.e. the date when RBI issued Basel III guidelines) :

(A) On 30th October 2012, RBI in its Second Quarter Review of Monetary Policy 2012-13 has declared

as follows :

(i) "Basel III Disclosure Requirements on Regulatory Capital Composition

87. ....... The Basel Committee on Banking Supervision (BCBS) has finalised proposals on disclosure

requirements in respect of the composition of regulatory capital, aimed at improving transparency ofregulatory capital reporting as well as market discipline. As these disclosures have to be given effect by

national authorities by June 30, 2013, it has been decided:

to issue draft guidelines on composition of capital disclosure requirements by end-December 2012.

(ii) Banks Exposures to Central Counterparties (CCP)

88. The BCBS has also issued an interim framework for determining capital requirements for bank

exposures to CCPs. This framework is being introduced as an amendment to the existing Basel II capital

adequacy framework and is intended to create incentives to increase the use of CCPs. These standards

will come into effect on January 1, 2013. Accordingly, it has been decided:

to issue draft guidelines on capital requirements for bank exposures to central counterparties, based on

the interim framework of the BCBS, by mid-November 2012.

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(iii) Core Principles for Effective Banking Supervision

89. The Basel Committee has issued a revised version of the Core Principles in September 2012 to reflect

the lessons learned during the recent global financial crisis. In this context, it is proposed:

to carry out a self-assessment of the existing regulatory and supervisory practices based on the revised

Core Principles and to initiate steps to further strengthen the regulatory and supervisory mechanism.

(B) On 7th November, 2012 :L RBI has issued final guidelines in respect of Lquidity Risk Management by

Banks