2012-13

Faculty of Management Studies

Banaras Hindu University

Compliance of Indian Banks to Basel III Norms

Under the Guidance of:Dr. Raj Kumar

Professor

Submitted By:Amit Kumar Vishwakarma

MBA (IB): 2011-13Enrolment No: 306546

Dissertation Project Report on:

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DECLARATION

I hereby declare that the work that being presented in this Project entitled “COMPLIANCE OF INDIAN BANKS TO BASEL III NORMS ” in partial fulfilment of the requirements for the degree of the Master of Business Administration in International Business at Faculty of Management Studies, Banaras Hindu University is mine original work carried out by me under the supervision of Dr. Raj Kumar, FMS BHU.

Amit Kumar Vishwakarma

MBA-(IB) 4thSemester (2012-2013)

Exam Roll No:11382MA006

Enrolment No: 306546

Faculty of Management Studies

Banaras Hindu University

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AcknowledgementNo task is a single man’s effort. Various factors, situations and persons integrate together to form

a background for accomplishment of a task. The valuable cooperation and guidance, directly or

indirectly of various people has contributed a lot to the successful completion of the Project

undertaken.

This dissertation report entitled “Compliance of Indian Banks to Basel III Norms” has been

prepared as a partial fulfilment of Master of Business Administration - International Business

(MBA-IB) program at FMS, BHU. The report is the outcome of a lot of work and commitment

but this would never have been completed without the incredible amount of help and support I

received from many people. I would like to thank, without implicating, all of them.

I would like to express my sincere gratitude and appreciation to Prof. Raj Kumar sir, Faculty of

Management Studies, Banaras Hindu University for his valuable guidance throughout this

dissertation. I had been fortunate enough to have him as a wonderful guide and for his open and

gracious contribution of time, counsel, cooperation and support, encouraging and providing all

information in completing my research report successfully.

I express my sincere appreciation to Prof. R.K. Pandey (Dean FMS, BHU) and all other

members of Faculty of Management Studies, BHU for their advice and unstinted support.

Without their help and cooperation, I could not have completes this dissertation.

Any shortcomings and weakness regarding this project is apologized. Suggestions and

recommendations regarding this project are heartily welcome.

……………………….

Amit Kumar Vishwakarma

MBA-IB 4thSemester

FMS, BHU

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Table of Contents

1. Introduction 3

2. Industry Profile 6

3. Literature Review 15

4. Research Methodology 33

5. Analysis & Interpretation 34

6. Findings 53

7. Suggestions 54

8. Bibliography 56

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IntroductionIndian banking is the lifeline of the nation and its people. Banking has helped in developing the vital sectors of the economy and usher in a new dawn of progress on the Indian horizon. The sector has translated the hopes and aspirations of millions of people into reality. But to do so, it has had to control miles and miles of difficult terrain, suffer the indignities of foreign rule and the pangs of partition. Today, Indian banks can confidently compete with modern banks of the world. Before the 20th century, usury, or lending money at a high rate of interest, was widely prevalent in rural India. Entry of Joint stock banks and development of Cooperative movement have taken over a good deal of business from the hands of the Indian money lender, who although still exist, have lost his menacing teeth. In the Indian Banking System, Cooperative banks exist side by side with commercial banks and play a supplementary role in providing need-based finance, especially for agricultural and agriculture-based operations including farming, cattle, milk, hatchery, personal finance etc. along with some small industries and self-employment driven activities. Generally, co-operative banks are governed by the respective co-operative acts of state governments. But, since banks began to be regulated by the RBI after 1st March 1966, these banks are also regulated by the RBI after amendment to the Banking Regulation Act 1949. The Reserve Bank is responsible for licensing of banks and branches, and it also regulates credit limits to state co-operative banks on behalf of primary co-operative banks for financing SSI units.Banking in India originated in the first decade of 18th century with The General Bank of India coming into existence in 1786. This was followed by Bank of Hindustan. Both these banks are now defunct. After this, the Indian government established three presidency banks in India. The first of three was the Bank of Bengal, which obtains charter in 1809, the other two presidency bank, viz., the Bank of Bombay and the Bank of Madras, were established in 1840 and 1843, respectively. The three presidency banks were subsequently amalgamated into the Imperial Bank of India (IBI) under the Imperial Bank of India Act, 1920 – which is now known as the State Bank of India. A couple of decades later, foreign banks like Credit Lyonnais started their Calcutta operations in the 1850s. At that point of time, Calcutta was the most active trading port, mainly due to the trade of the British Empire, and due to which banking activity took roots there and prospered. The first fully Indian owned bank was the Allahabad Bank, which was established in 1865. By the 1900s, the

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market expanded with the establishment of banks such as Punjab National Bank, in 1895 in Lahore and Bank of India, in 1906, in Mumbai – both of which were founded under private ownership. The Reserve Bank of India formally took on the responsibility of regulating the Indian banking sector from 1935. After India�s independence in 1947, the Reserve Bank was nationalized and given broader powers. As the banking institutions expand and become increasingly complex under the impact of deregulation, innovation and technological upgradation, it is crucial to maintain balance between efficiency and stability. During the last 30 years since nationalization tremendous changes have taken place in the financial markets as well as in the banking industry due to financial sector reforms. The banks have shed their traditional functions and have been innovating, improving and coming out with new types of services to cater emerging needs of their 5 customers. Banks have been given greater freedom to frame their own policies. Rapid advancement of technology has contributed to significant reduction in transaction costs, facilitated greater diversification of portfolio and improvements in credit delivery of banks. Prudential norms, in line with international standards, have been put in place for promoting and enhancing the efficiency of banks. The process of institution building has been strengthened with several measures in the areas of debt recovery, asset reconstruction and securitization, consolidation, convergence, mass banking etc. Despite this commendable progress, serious problem have emerged reflecting in a decline in productivity and efficiency, and erosion of the profitability of the banking sector. There has been deterioration in the quality of loan portfolio which, in turn, has come in the way of bank’s income generation and enhancement of their capital funds. Inadequacy of capital has been accompanied by inadequacy of loan loss provisions resulting into the adverse impact on the depositors� and investors� confidence. The Government, therefore, set up Narasimham Committee to look into the problems and recommend measures to improve the health of the financial system. The acceptance of the Narasimham Committee recommendations by the Government has resulted in transformation of hitherto highly regimented and over bureaucratized banking system into market driven and extremely competitive one. The massive and speedy expansion and diversification of banking has not been without its strains. The banking industry is entering a new phase in which it will be facing increasing competition from non-banks not only in the domestic market but in the international markets also. The operational structure of banking in India is expected to undergo a profound

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change during the next decade. With the emergence of new private banks, the private bank sector has 6 become enriched and diversified with focus spread to the wholesale as well as retail banking. The existing banks have wide branch network and geographic spread, whereas the new private banks have the clout of massive capital, lean personnel component, the expertise in developing sophisticated financial products and use of state-of-the-art technology. Gradual deregulation that is being ushered in while stimulating the competition would also facilitate forging mutually beneficial relationships, which would ultimately enhance the quality and content of banking. In the final phase, the banking system in India will give a good account of itself only with the combined efforts of cooperative banks, regional rural banks and development banking institutions which are expected to provide an adequate number of effective retail outlets to meet the emerging socio-economic challenges during the next two decades. The electronic age has also affected the banking system, leading to very fast electronic fund transfer. However, the development of electronic banking has also led to new areas of risk such as data security and integrity requiring new techniques of risk management. Cooperative (mutual) banks are an important part of many financial systems. In a number of countries, they are among the largest financial institutions when considered as a group. Moreover, the share of cooperative banks has been increasing in recent years; in the sample of banks in advanced economies and emerging markets analyzed in this paper, the market share of cooperative banks in terms of total banking sector assets increased from about 9 percent in mid- 1990s to about 14 percent in 2004.

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Industry ProfileThe growth in the Indian Banking Industry has been more qualitative thanquantitative and it is expected to remain the same in the coming years. Based onthe projections made in the "India Vision 2020" prepared by the PlanningCommission and the Draft 10th Plan, the report forecasts that the pace ofexpansion in the balance-sheets of banks is likely to decelerate. The total assetsof all scheduled commercial banks by end-March 2010 is estimated at Rs40,90,000crores. That will comprise about 65 per cent of GDP at currentmarket prices as compared to 67 per cent in 2002-03. Bank assets are expectedto grow at an annual composite rate of 13.4 per cent during the rest of thedecade as against the growth rate of 16.7 per cent that existed between 1994-95and 2002-03. It is expected that there will be large additions to the capital baseand reserves on the liability side.The Indian Banking industry, which is governed by the Banking Regulation Actof India, 1949 can be broadly classified into two major categories,nonscheduledbanks and scheduled banks. Scheduled banks comprise commercialbanks and the co-operative banks. In terms of ownership, commercial banks canbe further grouped into nationalized banks, the State Bank of India and its groupbanks, regional rural banks and private sector banks (the old/ new domestic andforeign). These banks have over 67,000 branches spread across the country.The Public Sector Banks(PSBs), which are the base of the Banking sector inIndia account for more than 78 per cent of the total banking industry assets.Unfortunately they are burdened with excessive Non Performing assets (NPAs),massive manpower and lack of modern technology. On the other hand thePrivate Sector Banks are making tremendous progress. They are leaders inInternet banking, mobile banking, phone banking, ATMs. As far as foreignbanks are concerned they are likely to succeed in the Indian Banking Industry.

In the Indian Banking Industry some of the Private Sector Banks operating areIDBI Bank, ING Vyasa Bank, SBI Commercial and International Bank Ltd,Bank of Rajasthan Ltd. and banks from the Public Sector include PunjabNational bank, Vijaya Bank, UCO Bank, Oriental Bank, Allahabad Bank amongothers. ANZ Grindlays Bank, ABN-AMRO Bank, American Express Bank Ltd,Citibank are some of the foreign banks operating in the Indian BankingIndustry.As far as the present scenario is concerned the Banking Industry in India isgoing through a transitional phase. The first phase of financial reforms resultedin the nationalization of 14 major banks in 1969 and resulted in a shift fromClass

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banking to Mass banking. This in turn resulted in a significant growth inthe geographical coverage of banks. Every bank had to earmark a minimumpercentage of their loan portfolio to sectors identified as “priority sectors”. Themanufacturing sector also grew during the 1970s in protected environs and thebanking sector was a critical source. The next wave of reforms saw thenationalization of 6 more commercial banks in 1980. Since then the number ofscheduled commercial banks increased four-fold and the number of bankbranches increased eight-fold.After the second phase of financial sector reforms and liberalization of thesector in the early nineties, the Public Sector Banks (PSB) s found it extremelydifficult to compete with the new private sector banks and the foreign banks.The new private sector banks first made their appearance after the guidelinespermitting them were issued in January 1993. Eight new private sector banksare presently in operation. These banks due to their late start have access tostate-of-the-art technology, which in turn helps them to save on manpower costsand provide better services.

Table: Top 10 banks having largest credit share

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STRUCTURE OF INDIAN BANKING INDUSTRY

Banking Industry in India functions under the sunshade of Reserve Bank of India - the regulatory,central bank. Banking Industry mainly consists of:• Commercial Banks• Co-operative BanksThe commercial banking structure in India consists of: Scheduled Commercial BanksUnscheduled Bank. Scheduled commercial Banks constitute those banks which have beenincluded in the Second Schedule of Reserve Bank of India (RBI) Act, 1934.RBI in turn includes only those banks in this schedule which satisfy the criteria laid down videsection 42 (60) of the Act. Some co-operative banks are scheduled commercial banks althoughnot all co-operative banks are. Being a part of the second schedule confers some benefits to thebank in terms of access to accommodation by RBI during the times of liquidity constraints. At thesame time, however, this status also subjects the bank certain conditions and obligation towardsthe reserve regulations of RBI.For the purpose of assessment of performance of banks, the Reserve Bank of India categorizethem as public sector banks, old private sector banks, new private sector banks and foreignbanks.

Fig:The commercial banking structure in India

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Indian banks enjoyed higher levels of money supply, credit and deposits as a percentage of GDP in FY11 as compared to that in FY10 showing improved maturity in the financial sector. Credit growth remained high in the first half of FY11 on account of increased demand from industry and the service sector. Personal loans grew significantly by 17% during 2010-11 as compared with 4.1% during the previous year.

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LiteratureReview

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About the Basel Committee

The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. At times, the Committee uses this common understanding to develop guidelines and supervisory standards in areas where they are considered desirable. In this regard, the Committee is best known for its international standards on capital adequacy; the Core Principles for Effective Banking Supervision; and the Concordat on cross-border banking supervision.

The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. The present Chairman of the Committee is Mr Stefan Ingves, Governor of SverigesRiksbank.The Committee encourages contacts and cooperation among its members and other banking supervisory authorities. It circulates to supervisors throughout the world both published and unpublished papers providing guidance on banking supervisory matters. Contacts have been further strengthened by an International Conference of Banking Supervisors (ICBS) which takes place every two years.

The Committee's Secretariat is located at the Bank for International Settlements in Basel, Switzerland, and is staffed mainly by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it stands ready to give advice to supervisory authorities in all countries. Mr Wayne Byres is the Secretary General of the Basel Committee.

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History of the Basel Committee and its MembershipThe Basel Committee on Banking Supervision was established as the Committee on BankingRegulations and Supervisory Practices by the central-bank Governors of the Group of Tencountries at the end of 1974 in the aftermath of serious disturbances in international currencyand banking markets (notably the failure of BankhausHerstatt in West Germany). Thefirstmeeting took place in February 1975 and meetings have been held regularly three or fourtimes a year since.The Committee does not possess any formal supranational supervisory authority. Itsconclusions do not have, and were never intended to have, legal force. Rather, it formulatesbroad supervisory standards and guidelines and recommends statements of best practice inthe expectation that individual authorities will take steps to implement them through detailedarrangements –statutory or otherwise – which are best suited to their own national systems.In this way, the Committee encourages convergence towards common approaches andcommon standards without attempting detailed harmonisation of member countries'supervisory techniques. More than 100 documents providing guidance on a wide range ofsupervisory topics appear on the BIS website.One important objective of the Committee's work has been to close gaps in internationalsupervisory coverage in pursuit of two basic principles: that no foreign banking establishmentshould escape supervision; and that supervision should be adequate. In May 1983 theCommittee finalised a document Principles for the Supervision of Banks' ForeignEstablishments which set down the principles for sharing supervisory responsibility for banks'foreign branches, subsidiaries and joint ventures between host and parent (or home)supervisory authorities. This document is a revised version of a paper originally issued in1975 which came to be known as the "Concordat". The text of the earlier paper wasexpanded and reformulated to take account of changes in the market and to incorporate theprinciple of consolidated supervision of international banking groups (which had beenadopted in 1978). In April 1990, a Supplement to the 1983 Concordat was issued with theintention of improving the flow of prudential information between banking supervisors indifferent countries. In June 1992 certain principles of the Concordat were reformulated asMinimum Standards. These Standards were communicated to other banking supervisoryauthorities who were invited to endorse them, and in July 1992 the Standards werepublished.

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There was a strong recognition within the Committee of the overriding need for amultinational accord to strengthen the stability of the international banking system and toremove a source of competitive inequality arising from differences in national capitalrequirements. Following comments on a consultative paper published in December 1987, acapital measurement system commonly referred to as the Basel Capital Accord (or the 1988Accord) was approved by the G10 Governors and released to banks in July 1988. Thissystem provided for the implementation of the framework with a minimum capital ratio ofcapital to risk-weighted assets of 8 percent by end-1992. Since 1988, this framework hasbeen progressively introduced not only in member countries but also in virtually all othercountries with active international banks. In September 1993, a statement was issuedconfirming that all the banks in the G10 countries with material international bankingbusiness were meeting the minimum requirements laid down in the 1988 Accord.In June 1999, the Committee issued a proposal for a new capital adequacy framework toreplace the 1988 Accord, and this has been refined in the intervening years, culminating inthe release of the New Capital Framework on 26 June 2004. The new Framework consists ofthree pillars: minimum capital requirements, which seek to develop and expand on thestandardised rules set forth in the 1988 Accord; supervisory review of an institution's capitaladequacy and internal assessment process; and effective use of disclosure as a lever tostrengthen market discipline and encourage safe and sound banking practices. TheCommittee believes that, taken together, these three elements are the essential pillars of aneffective capital framework. The new Framework is designed to improve the way regulatorycapital requirements reflect underlying risks and to better address the financial innovationthat has occurred in recent years, as shown, for example, by asset securitisation structures.The changes aim at rewarding the improvements in risk measurement and control that haveoccurred and providing incentives for such improvements to continue.The Committee issued in July 2009 a package of documents to strengthen the Basel IIcapital framework, with regard notably to the treatment of certaincomplex securitization positions, off-balance sheet vehicles and trading book exposures. This package also coveredkey aspects of risk managements and disclosure in the context of the Pillar 2 and the Pillar 3rules. These enhancements are part of a broader effort the Committee has undertaken tostrengthen the regulation and supervision of internationally active banks, in

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light ofweaknesses revealed by the financial market crisis which started in 2007. The 2008publications of the Committee, on liquidity and on valuation issues in particular, reflected partof these efforts, but further developments on other aspects are ongoing. In order to providean appropriate and timely response to events which go beyond the sole banking sphere, theCommittee has been liaising more closely since the beginning of the crisis with other relevantinternational financial bodies, like in particular the Financial Stability Forum.The Basel Committee maintains close relations with a number of fellow bank supervisorygroupings. These include the Offshore Group of Banking Supervisors, with members fromthe principal offshore banking centres; and supervisory groups from the Americas, theCaribbean, from the Arab States, from the SEANZA countries of the Indian sub-continent,South-East Asia and Australasia, from central and eastern European countries, from theAfrican continent and from Central Asia and Transcaucasia. The Committee assists thesegroups in a variety of ways, by providing suitable documentation, participating as appropriatein the meetings, offering limited Secretariat assistance and hosting meetings between theprincipals to coordinate future work.

Chairman: Christian Noyer, Paris

Secretariat: Bank for International Settlements

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Basel III Framework"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. These 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.

The reforms target:

bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress.

macroprudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time.

These two approaches to supervision are complementary as greater resilience at the individual bank level reduces the risk of system wide shocks.

The original Basel III rule from 2010 was supposed to require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of "risk-weighted assets" (RWA). Basel III introduced "additional capital buffers", (i) a "mandatory capital conservation buffer" of 2.5% and (ii) a "discretionary counter-cyclical buffer", which would allow national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduced a minimum "leverage ratio" and two required liquidity ratios. The leverage ratio was calculated by dividing Tier 1 capital by the bank's average total consolidated assets; the banks were expected to maintain the leverage ratio in excess of 3%. The "Liquidity Coverage Ratio" was supposed to require a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days; the Net Stable Funding Ratio was to require the available amount of stable funding to exceed the required amount of stable funding over a one-year period of extended stress.

Basel II-The New Capital Adequacy Framework

The structure of Basel II framework has its foundation on three mutually reinforcing pillarsthat allow banks and bank supervisors to evaluate

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properlythe various risks that banks face and realign regulatory capital more closely with inherentrisks . These three pillars are discussed as under:

Pillar I: Minimum Capital requirement

The first pillar of Basel II deals with maintenance of regulatory capital, i.e. minimum capitalrequired by banks as per their risk profile. As in Basel I, Basel II also has same provisionsrelating to regulatory capital requirements i.e. 8 % Capital Adequacy Ratio (CAR). CARunder Basel II is the ratio of Regulatory Capital to risk weighted assets which signifies theamount of regulatory capital to be maintained by banks to guard against various risksinherent in banking system.

Capital Adequacy Ratio =Total Regulatory Capital (Tier I + Tier II + Tier III) / Risk weighted Assets (Credit risk + Market risk+ Operational risk)

The risks covered under CAR in Basel II are credit risk, market risk and operational risk.Pillar I focuses on new approaches for calculating minimum capital requirements undercredit risk, market risk and operational risk vary from simple to sophisticated and allow banksupervisors to choose an approach that seems most appropriate according to their riskprofile, activities and internal control.

Pillar II: Supervisory Review

The Second Pillar of Basel II provides key principles for supervisory review, riskmanagement guidance and supervisory transparency and accountability as under:

Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.

Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios and should take appropriate action if they are not satisfied with the result of this process.

Supervisors should expect banks to operate above the minimum regulatory capital ratios.

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Supervisors should intervene at an early stage to prevent capital from declining below benchmark level.

Pillar II cast responsibility on the supervisors to exercise best ways to manage the risksspecific to that bank and also to review and validate banks risk measurement modes.

All the supervisors should evaluate the activities and risk profiles of individual banks todetermine whether those organizations should hold higher levels of capital than theminimum requirements and to see whether is any need for remedial action to ensure thateach financial institution adopts effective internal processing for risk management.

Pillar III: Market Discipline

The objective of Pillar III is to improve market discipline through effective public disclosureto complement requirements under Pillar I and Pillar II. Pillar III relates to periodicaldisclosures to regulators, board of bank and market about various parameters which indicaterisk profile of the bank. It introduces substantial new public disclosure requirements andallows market participants to analyze key pieces of information on the scope of application,risk exposures, risk assessment and management processes and hence the capital adequacy ofthe institution. The disclosures provided under Pillar III must fulfill the criteria ofcomprehensiveness, relevance, timeliness, reliability, comparability and materiality ofdisclosure to enable the interested parties to make informed decision about the bank.

The Three pillars of Basel II framework provides a kind of “triple protection “ byencompassing three complementary approaches that work together towards ensuring thecapital adequacy of institutional practices prevalent in the banks .Taken individually eachpillar has its merits ,but they are even more efficient when they are synergized in a commonframework.

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Basel III: New Capital and Liquidity Standards

1. What are the Basel III capital and liquidity standards?Basel III proposes many new capital, leverage and liquidity standards to strengthen the regulation, supervision and risk management of the banking sector. The capital standards and new capital buffers will require banks to hold more capital and higher quality of capital than under current Basel II rules. The new leverage ratio introduces a non-risk based measure to supplement the risk-based minimum capital requirements. The new liquidity ratios ensure that adequate funding is maintained in case of crisis.

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2. What are the key elements of the new regulations?The new regulations raise the quality, consistency and transparency of the capital base and strengthen the risk coverage of the capital framework. The major elements of the proposals are noted below.

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3. What is the impact on capital requirements?Capital requirements will progressively and significantly increase and the cost of capital should be closely monitored. The diagram below demonstrates that increasing capital ratios (Core Tier 1, Tier 1, Conservation buffer, Countercyclical buffer), stricter rules on eligible capital and higher capital requirements (RWA increase for some asset classes) are causing this increase.

The diagram below outlines how the Basel III minimum add-on, conservation buffer and counter-cyclical buffer will affect the core, tier 1 and tier 1+ 2 ratios.

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4. What are the major changes to credit risk and counterparty credit risk?Basel III introduces capital requirements to cover Credit Value Adjustment risk and higher capital requirements for securitization products. Derivatives and Repos cleared through CCPs are no longer risk-free and have a 2% risk weight and clearing members shares in CCPs default funds shall be capitalized. Additionally, Basel III introduces a higher correlation factor (applicable to internal ratings based approaches) to risk weight large and unregulated financial institutions andchanges concerning collateral eligibilities and haircuts rules.5. What does the new framework look like?The diagram below outlines the major differences between Basel II and Basel III. It is important to note that Basel III is a fundamental upheaval of Basel II, with many elements of the regulation being updated. Brand new elements in the regulations include liquidity ratios and a leverage ratio as already outlined above.

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6. What are the main challenges of the new Basel III liquidity risk requirements?Regulatory liquidity risk reports will have to be produced at least monthly with the ability, when required by regulators, to bedelivered weekly or even daily. This is challenging banks to put in place robust automated reporting solutions to meet this need.The first challenge banks will face is to consolidate clean exposures, liabilities, counterparties and market data in a centralizedrisk datamart. All portfolios’ contractual and behavioural cash flows should be made available and banks should have theability to stress those and produce liquidity gap analysis according to various scenarios. Liquidity Coverage Ratio (LCR) buffereligibility and haircut rules rely on external ratings, Basel classification of counterparties and standardized credit risk weights.The LCR numerators run-off rates as well as Net Stable Funding Ratio (NSFR) Available Stable Funding and Required StableFunding factors also depend on such information, usually only available in risk specific systems.The next challenge banks face is interfacing or merging their current risk and finance systems to meet the new Basel IIILiquidity Risk ratio requirements. The funding concentration monitoring requirement will require banks to put in place a cleanhierarchical referential of counterparties for consolidating their liabilities.Different LCR ratios will have to be produced per consolidation level and currencies. As it is already the case for credit risk rules,international banks will have to cope with various national discretions and local flavors for such new liquidity ratio rules and willhave to generate various kinds of liquidity risk regulatory reporting templates in different electronic formats per jurisdiction.

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7. What is the LCR Buffer composed of?The LCR is composed of level 1 and 2 assets as outlined below:

8. What are the key dates?The Basel Committee has outlined phase-in arrangements outlined below. Specific implementation timelines for individual countries, both members and non-members of the Basel Committee on Banking Supervision, may vary.

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CapitalPillar 1 Pillar 2 Pillar 3

Capital Riskcoverage Containing leverage

Riskmanagement and supervision

Market discipline

All

Bank

s

Qualityand level of capitalGreater focus on common equity. Theminimumwill be raised to 4.5% of risk-weighted assets, after deductions.

Capitalloss absorption at the point of non-viabilityContractualterms of capital instruments will include a clause that allows – atthediscretion of the relevant authority–write-off or conversion to commonshares if the bank is judged to benon-viable.This principle increasesthecontribution of the private sectorto resolving future banking crises andtherebyreduces moral hazard.

Capitalconservation buffer Comprising common equity of 2.5% of risk-weighted assets, bringing the total common equity standard to 7%. Constraint on a bank’s discretionary distributions will be imposed when banks fall into the buffer range.

Countercyclical bufferImposedwithin a range of 0-2.5%comprisingcommon equity, whenauthoritiesjudge credit growth isresulting in an unacceptable build upofsystematic risk.

SecuritisationsStrengthens the capital treatment for certaincomplexsecuritisations. Requires banks to conductmore rigorous credit analyses of externally ratedsecuritisationexposures.

Trading bookSignificantlyhigher capital for trading andderivatives activities, as well as complexsecuritisationsheld in the trading book.Introduction of a stressed value-at-risk frameworkto help mitigate procyclicality. A capital chargefor incremental risk that estimates the default andmigrationrisks of unsecuritised credit products andtakes liquidity into account.

Counterparty credit riskSubstantialstrengthening of the counterpartycredit risk framework. Includes: more stringentrequirements for measuring exposure; capitalincentives for banks to use central counterpartiesforderivatives; and higher capital for inter-financialsector exposures.

Bankexposures to central counterparties (CCPs) The Committee has proposed that trade exposures to a qualifying CCP will receive a 2% risk weightanddefault fund exposures to a qualifying CCP will be capitalised according to a risk-based method that consistently and simply estimates risk arising from such default fund.

Leverage ratioA non-risk-basedleverage ratiothatincludesoff-balancesheetexposureswillserve as abackstop to therisk-based capitalrequirement. Alsohelpscontainsystem wide buildupof leverage.

SupplementalPillar 2 requirements.Address firm-wide governance and risk management; capturing the risk of off-balance sheet exposuresand securitisation activities; managing risk concentrations;providing incentives for banksto better manage risk and returns overthelong term; sound compensation practices; valuation practices;stresstesting; accounting standards for financial instruments; corporate governance; and supervisory colleges.

Revised Pillar 3 disclosures requirementsThe requirements introduced relate to securitisation exposures and sponsorship ofoff-balance sheet vehicles. Enhanced disclosures onthedetail of the componentsof regulatory capital and their reconciliationto the reported accounts will be required, including a comprehensive explanation of howabank calculates its regulatory capital ratios.

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Research Methodology

Research Problem: To study the different aspects of Basel III regulations with special reference to Indian Banking.

Research Objectives:The Basel IIII regulations are guidelines which all the banks should comply. The regulations change time to time in tandem with the global financial conditions. But the to comply to the regulations is a very complicated tasks for the banks as it needs strategic planning. The study tries to identify the complications and hurdles in adopting the regulations.The objectives of the research can broadly be divided as:• To study the various aspects of Basel III framework and its distinctive features.• To assess the need of Basel III regulations in global banking environment.• To study the compliance of Indian banks to Basel III regulations.

Research DesignAs the research project iscompletely a theoreticalstudy wherein the different aspects of Basel III regulations have been pursued and presented before you, the methodology applied is of a Descriptive Research Design.

Data Collection DesignAlthough the use of collected data is minimal (the dissertation being a theoretical study ofBasel III regulations), the data used, if anywhere, are Secondary Data.

Data Presentation ToolsTables, line graphs, pie charts, bar diagrams and other charts have been used to present data in an efficient and decipherable manner.

Research ScopeThe research covers the compliance of Indian banks to Basel III regulations at large. The implications of these regulations on Indian banks and on Indian financial market has been thoroughly studied. Towards theend, conclusions has been drawn as to what will be the after effects of these regulations.

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Analysis &Interpretation

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Where Indian Banks are:

2010 2011 2012 2013 2014 2015 2016

Internal Models Approach for Market Risk• Final Guidelines for IMA issued in April

2010.• The earliest date of making application by

banks to RBI is 1st April 2010.

Internal Rating Based Approach for Credit Risk (Foundation as well as Advanced)

• The earliest date for making application by banks 1st April 2012

• Guidelines note under process

Advanced Measurement Approach for Operational Risk

• Draft Guidelines note on 6th January 2011.• The earliest date for making application

by banks 1st April 2012

Basel III: Regulatory Framework (contd. Next slide)

• Guidelines issued in December 2010.• Common equity requirement at 4.5% by

1st January 2015• Tier 1 capital requirement at 6% by 1st

January 2015.

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Basel III : Key Components

37

38

39

Basel III is BOTH a firm-specific, risk based framework and a system-wide, systemic risk-based framework .

Basel III : Key Components

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Public sector banks (PSBs) – Marginal reduction in Tier 1 Capital. - Use of preference share

capital and perpetual debt instruments. To support rapid loan-book expansion in the coming years,

government supports may be required to enhance core tier 1 capital, assuming that government continue to hold 51% stake. Currently, there are only seven PSBs in which government equity is more than 65%

Definition of Capital

Banks with Core Tier I less than 7% would be negatively impacted. It will have a impact on profitability and Return on equity (ROE)

Countercyclical buffers

Deductions should be from core capital may lead to reduction of amount in core capital for Indian Banks

Deductions

Basel III : Impact on Indian Banks

41

Banks having a huge trading book and off balance sheet derivative exposures will be impacted due to increased risk coverage (capital) on account of counterparty credit risk.

RWA Requirements

The implementation of liquidity ratio (LCR/NSFR) is from 2015 can lead Indian Banks to maintain additional liquidityLiquidity Ratio

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Over View of 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. 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 other proposals 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 BaselCommittee on these aspects will be considered for implementation, to the extent applicable, in future.

(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 decided by 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.

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(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 theform 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 drawn down 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

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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-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, MrAnandSinha 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.

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What is the additional capital that Indian banks have to mobilize toconform to Basel III? What are the options for, and challenges in, raising this sizeofcapital?

Admittedly, Indian banks already meet the minimum capital requirements of Basel IIIat an aggregate level, even though some individual banks may have to top up. But capitaladequacy today does not mean capital adequacy going forward. Currently, the bank credit –GDP ratio in India is around 55 per cent. If we want growth to accelerate, this ratio will have to go up as a necessary pre-condition. Besides, as our economy goes through a structural transformation, as it should, the share of the industry sector will increase and the credit-GDPratio will rise even further. What this means is that Indian banks would have been required to BIS central bankers’ speeches raise additional capital even in the absence of Basel III. In estimating the net additional burden on account of Basel III, we have to take this factor into account.

What is the size of the additional capital required to be raised by Indian banks? Itdepends on the assumption made, and there are various estimates floating around. TheReserve bank has made some quick estimates based on the following two conservativeassumptions covering the period to March 31, 2018:

(i) risk weighted assets of individual banks will increase by 20 per cent per annum; and

(ii) internal accruals will be of the order of 1 per cent of risk weighted assets.

Reserve Bank’s estimates project an additional capital requirement of 5 trillion, ofwhich non-equity capital will be of the order of 3.25 trillion while equity capital will be of the order of 1.75 trillion (Table 3).

The additional equity capital requirement of the order of 1.75 trillion raises twoquestions. First, can the market provide capital of this size? Second, what will be the burden on the Government in capitalizing public sector banks (PSBs)and what are its options?

Let us turn to the first question, whether the market will be able to provide equitycapital of this size. The amount the market will have to provide will

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depend on how much of the recapitalization burden of PSBs the Government will meet. Data in Table 3 indicate that the amount that the market will have to provide will be in the range of 700 billion– 1 trillion depending on how much the Government will provide. Over the last five years, banks have revised equity capital to the tune of 520 billion through the primary markets. Raising an additional 700 billion– 1 trillion over the next five years from the market should therefore not be an insurmountable problem. The extended period of full Basel III implementation spread over five years gives sufficient time to banks to plan the time-table of their capital rising over this period.

Moving on to the second question of the burden on the Government which owns 70 per cent of the banking system. If the Government opts to maintain its shareholding at thecurrent level, the burden of recapitalization will be of the order of 900 billion; on the otherhand, if it decides to reduce its shareholding in every bank to a minimum of 51 per cent, theburden reduces to under 700 billion.

Clearly, providing equity capital of this size in the face of fiscal constraints posessignificant challenges. A tempting option for the Government would be to issuerecapitalization bonds against common equity infusion. But this will militate against fiscaltransparency. In the alternative, would the Government be open to reducing its shareholding in PSBs to below 51 per cent? If the Government decides to pursue this option, an additional consideration is whether it will amend the statute to protect its majority voting rights.

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What are the potential challenges in implementing the countercyclical capital buffer?

As we noted earlier, a critical component of the Basel III package is acountercyclical capital buffer which mandates banks to build up a higher level of capital ingood times that could be run down in times of economic contraction, consistent with safetyand soundness considerations. This is conceptually neat, but is challenging in operationalterms, as indeed evidenced by Spain’s recent experience. The foremost challenge isidentifying the inflexion point in an economic cycle which should trigger the release of thebuffer. It is quite evident that both tightening too early or too late can be costly inmacroeconomic terms. The identification of the inflexion point therefore needs to be basedon objective and observable criteria. It also needs long series data on economic cycles. So,what we need is both a better database and more refined statistical skills in analyzingeconomic cycles.

The countercyclical capital buffer as prescribed in Basel III was initially based on thecredit / GDP metric. Is this a good economic indicator from the Indian perspective? A studyundertaken by the Reserve Bank shows that the credit to GDP ratio has not historically beena good indicator of build up of systemic risk in our banking system.

Furthermore, some economic sectors such as real estate, housing, micro financeand consumer credit are relatively new in India, and banks have only recently begunfinancing them in a big way. The risk build up in such sectors cannot accurately be capturedby the aggregate credit to GDP ratio. The Reserve Bank has so far calibrated countercyclicalpolicies at the sectoral level, and I believe we need to continue to use that approach. TheBasel Committee also has now recognized that no single variable can fully capture thedynamics of the economic cycle. Appropriate calibration of the buffer requires countryspecific judgement backed by a broad range of other simple indicators used in financialstability assessments.

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13.62%

13.93%

14.36%

13.00%

12.78%

13.43%

12.23%

15.37%

12.77%

11.48%

12.71%

14.78%

12.54%

14.16%

13.10%

13.49%

12.70%

13.21%

12.51%

12.80%

12.50%

8.12%

8.18%

9.20%

8.57%

6.41%

8.54%

6.83%

9.25%

8.16%

6.35%

11.13%

8.67%

9.28%

9.11%

7.68%

9.28%

8.24%

7.06%

7.91%

8.16%

7.69%

7.72%

7.81%

8.43%

7.51%

5.61%

7.99%

4.71%

8.19%

7.33%

4.37%

10.50%

7.68%

8.63%

8.04%

7.14%

8.60%

7.17%

4.90%

7.06%

6.85%

6.40%

0.0

%

2.0

%

4.0

%

6.0

%

8.0

%

10

.0%

12

.0%

14

.0%

16

.0%

18

.0%

Allahabad Bank

Andhra Bank

Bank of Baroda

Bank of India (Consolidated)

Bank of Maharashtra

Canara Bank

Central Bank of India

Corporation Bank

Dena Bank

IDBI Bank

Indian Bank

Indian Overseas Bank

Oriental Bank of Commerce

Punjab National bank

Punjab & Sind Bank

State Bank of India - Group

Syndicate Bank

UCO Bank

Union Bank

United Bank

Vijaya Bank Common Equity Tier 1

Tier-1 (Net of Deduction) %

CRAR

Basel III impact on Public Sector Banks4.5% 7% 10.5%

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19.28%

19.15%

18.36%

17.44%

15.89%

15.80%

15.39%

15.33%

14.91%

12.85%

17.31%

12.92%

16.92%

13.26%

12.79%

11.18%

12.42%

9.65%

10.11%

11.84%

17.31%

12.12%

16.92%

13.13%

12.79%

10.89%

12.42%

9.65%

9.62%

0.0

%

2.0

%

4.0

%

6.0

%

8.0

%

10

.0%

12

.0%

14

.0%

16

.0%

18

.0%

20

.0%

Yes Bank

Kotak Group

ICICI Group

Federal Bank

HDFC Bank

Jammu & Kashmir Bank

Axis Bank

South Indian Bank

Indusind

ING Vysya Bank Common Equity Tier 1

Tier-1 (Net of Deduction) %

CRAR

Basel III impact on Private Sector Banks

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Public Sector Banks:

Private Sector Banks:

As per the March 2010 dataset

The Average Common Equity Tier 1 capital of Public Sector Banks is 7.27% and average CRAR is 13.21%. The Maximum and minimum of the core capital (common equity tier 1) are 10.50% and 4.37%. Core Capital - One Bank is below Basel III prescribed CET Tier 1 - Three Banks are falling short of Basel III prescribed Tier I capital (net of deductions). The CRAR of all the public sector banks is above 10.5%.

As per the March 2010 dataset

The Average Common Equity Tier 1 capital of Private Banks is 12.67% and average CRAR is 14.91%. The Private Banks are well cushioned above the Basel III defined Core (Common Equity Tier 1) capital The Maximum and minimum of the core capital (common equity tier 1) are 17.31% and 9.62%. The CRAR of all the private banks is above 10.5%.

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The Compliance process of Indian Banks to Basel IIIThe minimum capital for common equity, the highest form of loss absorbing capital, will beraised from the current 2% level, before the application of regulatory adjustments to 4.5%,after the application of regulatory adjustments. This increase will be phased in to apply fromJan 1, 2013. In addition to the above, the committee recommended a 2.5% of additional coreequity capital as a conservation buffer above the regulatory minimum taking the aggregateminimum core equity required to 7%. The conservation buffer is also phased in to applyfrom Jan 1, 2016 and will come into full effect from Jan 1, 2017.Certain regulatory deductions (material holdings, deferred tax assets, mortgage servicingrights etc) that are currently applied to tier 1 capital and/or tier 2 capital or treated as RWAwill now be deducted from Core equity capital. This will also be progressively phased inover a five year period commencing 2014.

Regulatory buffers, provisions, and cyclicality of the minimumThe capital conservation buffer should be available to absorb banking sector lossesconditional on a plausibly severe stressed financial and economic environment. Thecountercyclical buffer would extend the capital conservation range during periods of excesscredit growth, or other indicators deemed

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appropriate by supervisors for their nationalcontexts. Both buffers could be run down to absorb losses during a period of stress.

Deductions from Core Tier 1Minority interest - The excess capital above the minimum of a subsidiary that is a bank will be deducted in proportion to the minority interest share. Investments in other financial institutions - The gross long positions may be deducted net of short and the proposals now include an underwriting exemption. Minority interest in a banking subsidiary is strictly excluded from the parent bank’s common equity if the parent bank or affiliate has entered into any arrangements to fund directly or indirectly minority investment in the subsidiary whether through an SPV or through another vehicle or arrangement.

Other deductionsThe other deductions from Common Equity Tier 1 are: goodwill and other intangibles (excluding Mortgage Servicing Rights), Deferred Tax Assets, investments in own shares, other investments in financial institutions, shortfall of provision to expected losses, cash flow hedge reserve, cumulative changes in own credit risk and pension fund assets. The following items may each receive limited recognition when calculating the common equity component of Tier 1, with recognition capped at 10% of the bank’s common equity component: Significant investments in the common shares of unconsolidated

financial institutions (banks, insurance and other financial entities). “Significant” means more than 10% of the issued share capital;

Mortgage servicing rights (MSRs); and Deferred tax assets (DTAs) that arise from timing differences.

A bank must deduct the amount by which the aggregate of the three items above exceeds15% of its common equity component of Tier 1.With the RBI flagging off the implementation of Basel III guidelines, Indian banks have toplan for more capital in the years ahead. They are well placed to meet the higher capitalrequirements and can strengthen their competitive positions vis –a vis international banks –provided the government can deliver on its own responsibilities towards public sector banks.The RBI has set a more demanding schedule for Basel III implementation than the Bank forinternational Settlements. The BIS has set the deadline for the full implementation as 2019.The RBI would like the Indian banks to comply by 2017.

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Findings

Higher Capital Requirement: Presently, in India, most banks' common equity ratio falls in the range of about 6-10 per cent. Hence, banks may able to comply with the higher capital requirement as per Basel III norms at least till 2014/15. This, without infusing any fresh equity, even while taking into account the marginal increase in capital requirement.

The increase in the minimum capital ratio, combined with loan growth outpacing internal capital generation in most government banks, will lead to a shortfall of capital. This will mount mainly between 2015/16 and 2017/18 due to introduction of a Capital Conservation Buffer (CCB).

The requirement of capital will be less to large private sector banks due to their higher capital ratios and stronger profitability. However, some public sector banks are likely to fall short of the revised core capital adequacy requirement and would therefore depend on government support to augment their core capital. The additional equity capital requirements in the public sector banks, mainly due to Basel III norms in the next five years, work out to around Rs 1,400-1,500 billion.

Pressure on Return on Equity: To meet the new norms, apart from government support a significant number of banks have to raise capital from the market. This will push the interest rate up, and in turn, cost of capital will rise while return on equity (RoE) will come down. To compensate the RoE loss, banks may increase their lending rates. However, this will adversely affect the effective demand for loan and, thereby, interest income. Further, with effective cost of capital rising, the relative immobility displayed by Indian banks with respect to raising fresh capital is also likely to directly affect credit offtake in the long run. All these affect the profitability of banks.

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Conclusion Basel standards, by and large, were an outcome of international

cooperation among central banks on the face of indiscriminate cross –border bank lending and debt repudiation from certain debtor countries. India had always set an example in implementing these standards, but the compliance was gradual and easy –paced, so as not to disrupt the banking system. The compliance levels were relaxed from time to time to accommodate even the weakest link in the banking chain. The idea was to enable the entire system to adapt these standards over a fixed time line in a way that the overall investor response and the capital market in the economy is ready for the huge resource mobilization requirements posed by the compliance by the Indian banks . However, the real issue is now whether the banks would be able to raise funds from the capital market when the investors are rather wary about the performance and returns from the banks /industries in general in the context of a general slowdown in industries coupled with inflation prevailing in the economy.

Following the debacle of new and innovative instruments, there is a need to assimilation and watch than creating an overlay and urge by RBI to expect all the Indian Banks to comply with Basel III standards in hurry ,even before the full compliance with Basel II by some weak banks in the Indian economy. Before the onslaught of the global financial crisis originating from the west, even the US and Europe were not seriously concerned about compliance with Basel norms. Now, the US and Europe are forced to do so, due to the international pressure. Given the above background, it is rather surprising that RBI would expect the Indian banks to be ready to comply with Basel standards so early by March 2017, earlier than the 2019 time frame laid down in the original Basel III framework.

Risk management in banks is abstract and analytical activity that draws heavily on advances in statistics and financial economics. But the professionalization of the field ‘is at an early stage’s to be emphasized here. Much of the risk management within banks is carried out using internally developed proprietary models. The data on these aspects is not disclosed by the banks for reasons citing ‘confidentiality’ or ‘competitiveness’.

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The link between nonperforming assets (NPA) capital adequacy and provisioning is well known to be highlighted here. The challenge is to provide incentives for banks /financial institutions to recognize losses on account of NPAs as per Basel norms. More than four years after the financial crisis began, it is so widely accepted that many of the world’s banks are burying /hiding losses and overstating their asset values ,even the BIS is saying so- in writing. It fully expects the taxpayers to pick up the tab should the need arise, too.

The lack of transparency, credibility in banks’ balance sheet fuels a vicious circle. When investors cannot trust the books, lenders can’t raise capital and may have to fall back on their home countries ‘governments for help. This further pressures sovereign finances, which in turn, weaken the banks even more. The adage ‘too big to fail ‘does not easily become applicable to banks often as the size of the banks ‘capital, operations, NPA, provisioning increases. This issue needs separate discussion as the challenge is greater and real.

Finally, it is significant to note that new and private sector banks, with their high capital adequacy ratios, enhanced proportion of common equity and better IT and other modern financial skills of the personnel, are well placed to comply with Basel III norms in general. PSU banks although dominant banks in the Indian financial system may take more time and face challenges in following the Basel III guidelines.

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Bibliography

1. Deutsche Bank, Capital Markets and Treasury SolutionsThe Road to Basel 3Implications for Credit, Derivatives & the Economy

2. BASEL III NORMS AND INDIAN BANKING:ASSESSMENT AND EMERGING CHALLENGES-C.S.Balasubramaniam

3. Basel III: Issues and Implications, kpmg.com

4. Basel III Impact on Indian Banks, February 2011, Aptivaa

5. Basel III and Its Consequences: Confronting a New Regulatory Environment, Accenture

6. DuvvuriSubbarao: Basel III in international and Indian contexts – tenquestions we should know the answers for.Inaugural address by DrDuvvuriSubbarao, Governor of the Reserve Bank of India, at the Annual FICCI – IBA Banking Conference, Mumbai, 4 September 2012.

7. www.bis.org8. www.moodysanalytics.com, Media Insigght Regulatory Basel III9. www.allbankingsolutions.com