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Banking Sector in India after BASEL – II

Banking Sector in India after BASEL – II

the new era of Bank reforms…

BASEL-II recommendations for their refused classifications now command an important place in the policies of banking sector in India aiming to flourish in the global market. BASEL-II entails forming rigorous risk and capital management systems designed to ascertain that a bank holds capital reserves any related risks.

The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the Central Governors of a group of ten countries in 1985. It consists of senior representatives of Bank Supervisory Authorities and Central Banks from Belgium, Canada, France, Germany. Italy. Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland. the United Kingdom and the United States of America. It usually meets at the Bank for International Settlements in Basel, where its permanent Secretariat is located.
Basel-I Introductory Stage
The BCBS first came out with 1988 capital accord for banks, taking into account the elements of risk in various types of assets in the balance sheet as well as off-balance sheet business.
Under the Basel-I accord, only the credit risk element was considered and the minimum requirement of capital funds was fixed at 8% of the total risk weighted assets. Risk adjusted assets would mean weighted aggregate of funded and non-funded items. Degrees of credit risk expressed as percentage weightings have been assigned to balance sheet assets and conversion factors to off-balance sheet items.
In India, banks are required to maintain a minimum Capital to Risk-weighted Asset Ratio (CRAR) of 9% on an ongoing basis. The banks' overall minimum capital requirement will be the sum of the following:
·     Capital requirement for. credit risk on all credit exposures excluding items comprising trading book and including counterparty credit risk on all OTC derivatives on the basis of the risk weights.
·     Capital requirement for market risks in the trading book.
Basel-II Norms
BCBS brought out a report called 'International Convergence of Capital Measurement and Capital Standards'. A revised framework 2004 also commonly called Basel Report-II.
            The report presents the outcome of the Basel       Committee        on         banking
supervision's work over recent years to secure international convergence on revisions to supervisory regulations governing the capital adequacy of internationally active banks.
The fundamental objective of the committee's work towards revision of the 1988 accord has been to develop a framework that would further strengthen the soundness and stability of the international banking system while maintaining sufficient consistency that capital adequacy regulation will not be a significant source of competitive inequality among internationally active banks.
A significant innovation of the revised framework is the greater use of assessments of risk provided by banks internal systems as inputs to capital calculations.
The Basel Committee's revised framework is based on three pillars
·   Minimum capital requirements
·   Supervisory review process
·   Market discipline
The Committee has also highlighted the need for banks and supervisors to give appropriate attention to the second and third pillars of the revised framework. It is critical that the minimum capital requirements of the first pillar be accompanied by a robust implementation of the second, including efforts by banks to assess their capital adequacy and by supervisors to review such assessments.
Minimum Capital Requirements
The capital base of the bank consists of Tier-1. Tier-2 and Tier-3 capital. The sum of Tier-1. Tier-2 and Tier-3 elements will be eligible for inclusion in the capital base, subject to the following limits
·     The total of Tier-2 will be limited to a maximum of 100% of total Tier- I elements.
·     Subordinated term debt will be limited to a maximum of 50% of Tier- elements.
·     Tier-3 capital be limited to 250% of bank's Tier-1 capital that is required to support market risks.
·     Asset revaluation reserves, which take the form of latent gains on unrealised securities, will be subject to a discount of 55%.
Credit Risk is defined as the possibility of losses associated with diminution in the credit quality of borrowers or counter parties. Credit risk may take different forms i.e., direct lending, guarantees of letter of credit, treasury operations, securities trading business.
Market Risk With progressive deregulation. market risk arising from adverse changes in market variables, such as liquidity risk, interest rate risk, foreign exchange rate risk, commodity and equity price risk.
Operational Risk The most important type of operational risk involves breakdown in internal controls and corporate governance. Such breakdown can lead to financial loss through error, fraud or failure. The interest of the bank to be compromised.
Supervisory Review
The committee has identified four key principles of supervisory review :
·   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.
·   Supervisor 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.
·   Supervisors should expect banks to operate above the minimum regulatory capital ratios.
·   Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk.
Market Discipline
The committee aims to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes.
            The committee believes that providing disclosures is an effective means of informing the market about a bank's exposure to those risks and provides a consistent and under standable disclosure framework that enhances comparability.
Proposed Basel-III Guidelines
·   The proposed Basel-iii guidelines seek to improve the ability of banks to withstand periods of economic and financial stress by prescribing more stringent capital and liquidity requirements for them.
Regulatory Capital Adequacy Levels
(Proposed vs Exiting RBI Norm)
Adequacy Level
Proposed Basel-III Norm
Existing RBI Norm
Common equity (after deduction)
Conservation buffer
Countercyclical buffer
Common equity + Conservation buffer
Countercyclical buffer

Test-1 (including the buffer)
6% (10%)
Total capital (including the buffers)
9% (14.5%)

·   The Basel Committee is expected to introduce the Basel-Ill guidelines in six years phase-in period beginning 2013.
·   The proposed Basel-III guidelines seek to enhance the minimum core capital, introduce a capital conservation buffer and prescribe a countercyclical buffer, to be built up in times of excessive credit growth at the national level.

RBI Guidelines for Implementation of Basel – III

·         Basel-III guidelines would became effective from January 1, 2013, in a phased manner. 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.
·         Common equity Tier, capital must be at least 5.5% of RWAs.
·         The capital requirements for the implementation of Basel III guidelines may be lower during the initial periods and higher during the later years.
·                   Banks to maintain a minimum total capital of 9% against 8% prescribed by the Basel Committee of total risk-weighted assets.
·         In addition to the minimum common equity Tier-1 capital of 5.5% of RWAs Banks are also required to maintain a capital conservation buffer of 2.5% of RWAs in the form of common equity Tier-1 capital.
·         Indian Banks under Basel-II are required to maintain Tier-1 capital of 6% which has been raised to, 7% under Basel-III.
·         The new norms do not allow banks to use the consolidated capital of any insurance or non-financial subsidiaries for calculating capital adequacy.
·         Under the new guidelines, RBI set the leverage ratio at 4.5% (3% under Basel-III). Leverage ratio has been introduced in Basel-III to regulate banks which have huge trading book and off-balance sheet derivative positions.
·         The liquidity coverage ratio under Basel III requires banks to hold enough unencumbered liquid assets to cover expected net outflows during a 30-day stress period.
·         India may need at least $ 30 billion (around 1.6 trillion) to $ 40 billion as capital over the next six years to comply with the new norms.
·         In financial year 2012-12, Government of India is expected to provide 15888 crore to recapitalise the banks. As to maintain capital adequacy of 8% under Basel-II norms.
·         Guidelines on operational aspects of implementation of the counter cyclical capital buffer, definition of capital disclosure requirements, capitalisation of bank exposure to central counter parties etc, will be issued in due course as RBI is still working on them.

Capital Adequacy Ratio (CAR)

Capital Adequacy refers to percentage ratio of a financial institution's primary capital to its assets (loan and advances), used as a measure of its financial strength and stability. According to the capital adequacy standard set by BIS, Banks must have a primary capital base equal at least to 8% of their assets.
Capital Adequacy Ratio is defined as the proportion of a bank's total assets that is held in the form of shareholder's equity and certain other defined classes of capital. It is a measure of bank's ability to meet the needs of its depositors and other creditors. In short, it is a measure of bank's capital and it is expressed as a percentage of bank's weighted credit exposures.
It is also known as 'Capital to Risk-weighted Assets Ratio' (CHAR)
CAR =    Tier -I Capital+ Tier - 2 Capital
                 Risk - weighted Assets
Tier-1 Capital It incluces paid-up capital, statutory reserves, other disclosed free reserves, and capital reserves representing surplus arising out of sale proceeds of assets-minus-equity investments in subsidiaries, intangible assets, and losses in the current period and those brought forward from previous periods.
Tier-2 Capital It consists of undisclosed reserves and commulative perpetual preference shares, revaluation reserves, general provisions and loss reserves up to a maximum of 1.25% of weighted risk assets, investment fluctuation reserve not subject to 1.25% restriction, hybrid debt capital instruments (bonds) and subordinated debt (long term unsecured loans).
Risk-Weighted Assets It means fund-based assets such as cash, loans, investments and other assets. Degree of credit risk expressed as percentage weights have been assigned by RBI to each asset.

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