Basel Iii 4o504l

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THREE PILLARS OF LIFE YESTERDAY IS A STALE

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BASEL III BASEL I TO BASEL III  PRESENTERS:  IPSITA PRADHAN  RAKESH BARLA  IPSITA SWAIN

What are Basel Norms?  Basel is a city in Switzerland. It is the headquarters of

Bureau of International Settlement (BIS), which fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations.  Basel guidelines refer to broad supervisory standards formulated by this group of central banks - called the Basel Committee on Banking Supervision (BCBS).  The set of agreement by the BCBS, which mainly focuses on risks to banks and the financial system are called Basel accord. The purpose of the accord is to ensure that financial institutions have enough capital on to meet obligations and absorb unexpected losses

Overview  Journey from Basel I to Basel III

 What is the Basel III framework relating to....  Definitions of the three pillars and relationship

among the three  Amendments  Challenges in implementation of these norms  Indian scenario

BASEL I  In 1988, BCBS introduced capital measurement

system called Basel capital accord called as Basel 1  It focused almost entirely on credit risk.  It defined capital and structure of risk weights for banks. The minimum capital requirement was fixed at 8% of risk weighted assets (RWA).  India adopted Basel 1 guidelines in 1999.

BASEL II  Introduced in June 2004  The guidelines were based on three parameters,

which the committee calls it as pillars.  Capital Adequacy Requirements: Banks should maintain a minimum capital adequacy requirement of 8% of risk assets  Supervisory Review: Banks were needed to develop and use better risk management techniques  Market Discipline: This need increased disclosure requirements. Banks need to mandatorily disclose their CAR, risk exposure, etc to the central bank.

Drawbacks of Basel II  Reducing profitability of small banks and threat of    

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takeover Lack of comprehensive approach to address risks Lack of safety & Inability to strengthen the stability of financial system Failure to achieve large capital reductions Failure in enhancing the competitive equality amongst banks The quantity and quality of capital under Basel II were also deemed insufficient to contain any further risk.

OBJECTIVE OF BASEL III  TO MINIMISE THE PROBABILITY OF

REOCCURENCE OF CRISIS TO A LARGE EXTENT  TO IMPROVE BANKING SECTORS ABILITY TO ABSORB SHOCKS ARISING FROM FINANCIAL AND ECONOMIC STRESS  TO IMPROVE RISK MANAGEMENT AND GOVERNANCE  TO STRENGTHTEN BANK”S TRANSPARENCY & DISCLOSURES

What is "Basel III"  A global regulatory standard on

 bank capital adequacy  stress testing and  market liquidity risk

With a set of reform measures to improve  Regulation  supervision and  risk management

BASEL 3  In 2010, Basel III guidelines were released in

response to the financial crisis of 2008.  A need was felt to further strengthen the system as banks in the developed economies were undercapitalized, over-leveraged and had a greater reliance on short-term funding.  Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive.  The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

Basel III Reforms Main Elements • Banks to hold more and better

quality capital • Banks to carry more liquid

assets • Limit leverage of banks

• Banks to build capital buffers

Amendments  Basel III will require banks to hold 4.5% of common

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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 also introduces additional capital buffers (i) a mandatory capital conservation buffer of 2.5% and (ii) a discretionary countercyclical buffer, which allows national regulators to require up to another 2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum leverage ratio and two required liquidity ratios. The leverage ratio is calculated by dividing Tier 1 capital by the bank's average total consolidated assets the banks area expected to maintain the leverage ration in excess of 3%. The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30 days .

 The Net Stable Funding Ratio requires the

available amount of stable funding to exceed the required amount of stable funding over a oneyear period of extended stress  The quality of the 9% capital required is higher. At present, bank capital is split almost evenly between tier 1 and tier 2. Under Basel 3, tier 1 will constitute 7% out of the total 9%.  Banks will be required to have a capital conservation buffer, comprising common equity, of 2.5%. That takes the total capital requirement to 11.5%

 Going by the new rules, the predominant component

of capital is common equity and retained earnings.  The new rules restrict inclusion of items such as deferred tax assets, mortgage-servicing rights and investments in financial institutions to not more than 15% of the common equity component.  These rules aim to improve the quantity and quality of the capital.  The new norms are based on renewed focus of central bankers on macro-prudential stability, In other words, global regulators are now focusing on financial stability of the system as a whole rather than micro regulation of any individual bank.

Micro- prudential elements To minimize the risk contained with individual institutions The elements are:  Definition of capital  Enhancing risk coverage of capital  leverage ratio  International liquidity framework

Macro- prudential elements T o take care of the issues relating to the systemic risk The elements are:  Leverage ratio  Capital conservation buffer  Countercyclical capital buffer  Addressing the procyclicality of provisioning requirements  Addressing the too- big to- fail problems  Addressing reliance on external credit rating agencies.

PILLAR 1 –MINIMUM CAPITAL REQUIREMENTS  CALCULATE REQUIRED CAPITAL BASED ON

 CREDIT RISK  MARKET RISK  OPERATIONAL RISK  The norms also require banks to maintain Tier I

capital at 7% of risk weighted assets.  Tier I capital, or core capital, includes a bank’s equity capital and disclosed reserves.

Elements of Tier II capital  (i) General Provisions and Loss Reserves

 (ii) Debt Capital Instruments issued by the banks;  (iii) Preference Share Capital Instruments

[Perpetual Cumulative Preference Shares (PS) / Redeemable Non-Cumulative Preference Shares  (RNS) / Redeemable Cumulative Preference Shares (RS)] issued by the banks  (iv) Stock surplus (share ) resulting from the issue of instruments

TYPES OF RISK  CREDIT RISK- Risk of non payment of debt

 OPERATIONAL RISK-may be defined as the risk

of loss resulting from inadequate or failed internal process, people and systems  MARKET RISK- is the risk of losses due to change in Market Price of an Asset  Foreign exchange and Commodity Risk are part of it

PILLAR 2-SUPERVISORY REVIEW PROCESS  It is intended to ensure that Banks have

sufficient capital to all risks associated with business.  BANKS SHOULD HAVE STRONG INTERNAL PROCESS  In India RBI has issued the guidelines to the Banks that they must have an internal supervisory process called ICAAP(Internal Capital Adequacy Process)

PILLAR 3-ENHANCED DISCLOSURE  FOCUSES ON INCREASING THE

DISCLOSURES THAT BANKS MUST PROVIDE TO INCREASE THE TRANSPARENCY  PROVIDE MARKET DISCIPLINE  INTENDS TO PROVIDE INFORMATION ON BANKS EXPOSURE TO RISK SUCH AS THE CAPITAL STRUCTURE AND APPROACHES TO ACCESS THE CAPITAL ADEQUACY

Net Stable Funding Ratio (NSFR) Purpose:  Establish minimum acceptable amount of stable

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funding based on liquidity characteristics of bank’s assets and activities over one-year horizon Incentivise structural changes in liquidity risk profile of banks away from short-term funding mismatches and toward More stable, longer-term funding of assets and business activities Ensure that investment banking inventories, offbalance sheet exposures, securitisation pipelines and other assets and activities are funded with at least minimum amount of stable liabilities in relation to liquidity risk profile of bank Available Stable Funding must equal or exceed Required Stable Funding

Current Scenario  Indian banks will have to bring in an additional

capital of Rs 5 lakh crore to meet the Basel III norms, RBI Governor D Subbarao said. The share of equity capital has to be 1.75 lakh crore and non-equity Rs 3.25 lakh crore.  The government, which owns 70% of the banking system, alone will have to pump in Rs 90,000 crore equity to retain its shareholding in the Public Sector Banks (PSBs) at the current level to meet the norms.  He said the government has two options - either to maintain its shareholding at the current level or bring down its shareholding at 51%.  The new norms are to be implemented in a phased manner by banks by March 2018.

Effects of Implementation  Strengthen the capital base and liquidity of banks     

thereby promoting a more resilient banking sector Improve the banking sector’s ability to absorb shocks arising from financial and economic stress Addressing systemic risk and interconnectedness Banks with Core Tier I less than 7% would be negatively impacted. It will impact Bank’s profitability and Return on equity (ROE) Banks will have to hold more long-term funding, based on the net stable funding ratio that measures the maturity and liquidity of assets on the balance sheet over a one year period

 The definition of what counts as tier one will narrow 

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and Assets will have higher Risk Weightings There will also be additional requirements for large banks deemed vital to the global financial system, so called Systemically Important Financial Institutions (SIFIs) The current proposed leverage level is 3 percent of core tier one capital. However, the impact of total capital and common equity will be tracked during testing periods Measures of leverage will be based on gross exposure, instead of on a risk weighted basis Banks will have to hold enough cash and other

Liquidity Coverage Ratio  Requires bank to maintain unencumbered high-quality

assets sufficient to meet 100% (or more) of net cash outflows over 30-day period under stipulated stress scenario  Liquid assets would include cash and Central bank reserves, to the extent that they can be drawn down in times of stress  Marketable securities representing claims on or claims guaranteed by sovereigns, central banks, noncentral government public sector entities (PSEs) and  Debt securities representing claims on non-0% risk weighted sovereigns or central banks issued in domestic currencies in country in which liquidity risk is being taken or in bank’s home country

A global minimum liquidity standard Liquidity Coverage Ratio (LCR)  The ratio is intended to ensure that a bank maintains adequate levels of unencumbered high quality assets to meet its liquidity needs.  Measured as the ratio of the bank’s high quality liquid assets (numerator), divided by its net cash outflows over a 30-day period (denominator)  The high quality assets included in the numerator include only Cash, central bank reserves that can be accessed during times of stress, marketable securities meeting certain criteria, and government or central bank debt  The denominator will be calculated by taking into certain “run-off factors”  LCR will be introduced as an observation exercise in 2011, and will be imposed as a rule as from 2015.

High-quality liquid assets LCR

= Net Cash Outflow (30 days)

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Capital Conservation Buffer  The capital conservation buffer (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. The requirement is based on simple capital conservation rules designed to avoid breaches of minimum capital requirements.  Therefore, in addition to the minimum total of 8% banks will be required to hold a capital conservation buffer of 2.5% of RWAs in the form of Common Equity to withstand future periods of stress

 Banks are required to maintain a minimum Pillar 1

Capital to Risk weighted Assets Ratio (CRAR) of 9 % on an on-going basis (other than capital conservation buffer and countercyclical capital buffer).  The Reserve Bank will take into the relevant risk factors and the internal capital adequacy assessments of each bank to ensure that the capital held by a bank is commensurate with the bank’s overall risk profile.  This would include, among others, the effectiveness of the bank’s risk management systems in identifying, assessing,measuring, monitoring and managing various risks including interest rate risk in the banking book, liquidity risk, concentration risk and residual risk.

Challenges of basel3 implementation 1.

Functional challenges

2. Technical challenges 3. Organizational challenges

Functional challenges  Developing specifications for the new regulatory

requirements, such as the mapping of positions (assets and liabilities) to the new liquidity and funding categories in the LCR and NSFR calculations.  The specification of the new requirements for trading book positions and within the CCR framework (e.g. CVA) as well as adjustments of the limit systems with regard to the new capital and liquidity ratios .  Crucial is the integration of new regulatory requirements into existing capital and risk management as some measures to improve new ratios (e.g. liquidity ratios) might have a negative effect on existing figures .

Technical challenges  The technical challenges includes the availability

of data, data completeness, and data quality and data consistency to calculate the new ratios .  The financial reporting system with regard to the

new ratios and the creation of effective interfaces with the existing risk management systems .

Operational challenges  The technical challenges includes the availability of data,

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data completeness, data quality and data consistency to calculate the new ratios . The financial reporting system with regard to the new ratios and the creation of effective interfaces with the existing risk management systems . Basel III also introduces a non-risk based leverage ratio of 3 percent. Group1 banks are failed in maintaining the this leverage ratio The banks will experience increased pressure on their Return on Equity ( RoE ) due to increased capital and liquidity costs, which along with increased RWAs will put pressure on margins across all segments Increasing NPAs in PSU banks calls for more capital which will lead to selling off Non Core assets

Issues relating to SLR and LCR ….  India, banks are statutorily required to hold

minimum reserves of high-quality liquid assets at 24% of net demand and time liabilities.  The proportion of liquid assets in total assets of banks will increase substantially, if the SLR reserves are not reckoned towards the LCR (Liquidity coverage ratio) and banks are to meet the entire LCR with additional liquid assets, thereby lowering their income significantly.  RBI is examining to what extent the SLR requirements could be reckoned towards the liquidity requirement under Basel III.

Effect on Profitability  The impact of credit requirements on the profitability

of banks would depend upon sensitivity of lending rates to capital structure of banks and sensitivity of the credit growth to the lending rates.  When banks with low core Tier I shore up their capital to around 9% required, their return on equity ( RoE ) could drop by 1-4%.  Basel III will force banks to plough back a larger chunk of their profit into the balance sheet.  Banks might have to rationalize dividend policies so that more profit could be retained and used as capital, indicating a lower dividend for the government.

Benefits of Implementation…  Strengthen the financial system of both

developing and developed countries by addressing the weaknesses in the measurement of risk under Basel II framework revealed during the crisis.  Delivers a much safer financial system with reduced probability of banking crises at affordable costs. The impact of costs is minimized through long phase-in.  It is expected that as the proportion of equity in the capital structure of banks rises, it would reduce the incremental costs of raising further equity as well as non-common equity capital.

Updates  The Reserve Bank today hinted at allowing part

of the statutory liquidity ratio (SLR) holdings of banks to be treated as liquid assets under the Basel-III guidelines, which will come into effect next fiscal.  The global regulators extended deadline for Basel-III compliance by a year to 2019. They also broadened the definition of liquid assets to include shares, retail mortgage-backed securities, among others.  Dr. Subbarao said that effective implementation of Basel III was going to make Indian banks stronger, more stable and sound so that they could deliver value to the real sectors of the

BUDGET 2013  Capital infusion of Rs. 14,000 crore in public

sector banks has been proposed which would focus on the need to strengthen the financial services sector and help to meet the stringent requirements under the BASEL III norms,

THANK YOU FOR YOUR TIME AND PATIENT HEARING!!  ANY QUESTIONS??