Thursday, October 21, 2010

Reckoning Basel-III Norms!

Following the recent financial meltdown, the leaders of the group of G-20economies asked the Basel Committee on Banking Supervision{BCBS} to reach the new rules needed to prevent another financial crisis in future. The aim was to mitigate the greed ridden financial crisis instead to block the real factors behind it; real notion of Basel-III norms could be sensed out with the statement of Hant Wellink, head of Basel Committee on Banking Supervision-“Partly banks will have to retain profit for years which they can not use to pay shareholders or bonuses.
For another part, this will vary from bank to bank; they will have to get it from the capital market. I think it will make a new crisis less likely. Chances are much smaller, we have made calculations on this but we can’t rule it out completely”. Last Para reflect the genuine apprehension ahead in financial market…so; life even after the Basel-III norms wouldn’t remain indifferent from regulatory considerations.

Basel-III norms, with its underlying proposition of insulating banks from adverse shocks by adequately enhancing the amount of its own capital holding compared to overall deposits and other borrowing can be regarded as an improved and standard set of rules over the existing Basel-II norms. Rule of Basel-III norms written by the Bank of International Settlement’s Committee on Banking Supervision {BCBS} with lucid mandates to define the reform agenda for the banking sector across the world. The new rule comprehensively entails how to asses risks and capital management anticipating theirs risk bearing.
On September20,2010 {Sunday}, agreement finally taken place on Basel-III at a meeting of Central bank Governors and top Supervisors from 27 countries chaired by ECB President, Jean Clande Trichet. They reached to the consensus with focusing on prevention of any further International Credit Crisis with provisioning more than triple of top quality capital as reserve for addressing any meltdown sort of occurrences.

Predominant component of capital is common equity and retained earnings-new rules restrict inclusion of items such as deferred tax assets, mortgage-servicing rights and investments in financial institutions to no more than 15%of the common equity component. Here strong bank would avail an edge as now they can put excess cash to better use though with ample transition period for raising funds to compliance shouldn’t be any big issue for even smaller banks. The new norms are centered around the renewed focus of Central bankers on Macro-prudential stability. The global financial meltdown following the crisis in U.S Sub-prime market has shaped the entire propositions. Earlier guidelines, popularly known as Basel-II was focused on Macro prudential regulation, those features being carried out in Basel-III norms as well with added advanced support. That systemizes the changed motives of regulators now-they have eagle eyes on financial stability of the system in totality rather than Micro regulation of any individual bank.
Under the Basel-III norms, Key Capital Ratio has been raised to 7%of risky assets-Tier-I capital that includes common equity and perpetual preferred stock will be raised from 2 to 4.5% starting in phases from January2013 to be accomplished by January2015. Moreover, banks will have to set aside another2.5%as a contingency for future stress, taking the overall capital ratio or Capital Conservation Buffer to 7%. Banks that would fail to comply after the stipulated timeline would be unable to pay dividends, though they will not be forced to raise cash.

A further counter-cyclical buffer in average of 0%-2.5%of common equity is to be imposed depending on specific circumstances of an economy to protect the banking sector from periods of excess aggregate credit growth. In addition, a liquidity buffer, much like our Statutory Liquidity Ratio {SLR} is to be made mandatory by January2018 to check the risk based measures and higher capital norms for systemically important bank. On paper, Basel-III will triple the quantum of capital, banks will need to maintain but whether it will risk-proof the banking sector is doubtful. So, regulation would decide whether Basel-III norms is light touch set of rule or indeed an effective panacea for hassle free and ethical functioning of banking system.

Impact on Indian banks: - RBI Governor, D.Subbarao is stoutly confident that Indian banks not likely to be adversely impacted by the new capital rules. At the end of June30, 2010; the aggregate capital to risk –weighted assets ratio of the Indian banking system stood at 13.4% of which Tier-I capital constituted 9.3%. So, it wouldn’t leave any pressure on Indian banks in near future albeit there may be some negative impact arising from shifting some deductions from Tier-I and Tier-II capital to common equity.
Despite strong fundamentals, RBI should ensure even more capital than essentially stipulated limit under the Basel-III norms; besides stress must be given on long term capital inflow rather on risky short term investments. Besides, innovative credit policies, RBI should also stringently ensure the well capitalized subsidiary structure for foreign banks and financial institutions operating in India, since the stability of Indian banking system have lot to with it.

Young Committee that recommended for the establishment of Bank of International Settlements {BIS} in1930 had enough sense for volatility in International financial market and greed’s of bankers. Actual effects of even best designed rules are of no value if lacked by the competent, proactive and fearless supervision. Strengthening the global banking system should be and must be the aim of every new financial rules but it’s equally imperative to stop the adverse lobbying that makes regulation nothing more than a print order. We can easily assume this from recently enacted Dodd Frank Act {Wall Street and Consumer Protection Act} in U.S.A which loosing its effects under the stern pressure from affluent lobbyist.
Regulation couldn’t have any parallel while enforcing a law; our regulatory strength has recently tested during the world wide financial meltdown-Indian banking relatively emerged unscratched comparing the western counterparts. More attention is needed from developed world for compliance of rules envisaged under the Basel-III norms-make or break of this rule would be decided by the both Individual as well collective performances of economies. Co-operation at international level would be the real bone of contention for an ambitious rule like Basel-III…meanwhile let’s watch the movements around the financial circle!
Atul Kumar Thakur
October20, 2010, Wednesday, New Delhi


  1. Absolutely fantastic..grappling with the complex finances made me truly aware about the derivation of follies that shatter the structure of financial market-Meenakshi Natarajan

  2. Let's see the performance of regulatory authorities across the world,as even the earlier BASEL-II norms was not so bad..but there can't be any ambiguity of increaed cautiousness as you have lucidly pointed out in your reserach-Nikhil DevSen

  3. Insightful analysis on a very fresh regulation.Norms of Basel generally leaves huge impact over the banking system across the world.Hope best for our Indian banking sector...Ashutosh Thakur,New Delhi

  4. Dear Atul
    Once again sorry for the delayed response . Been busy with one thing and another . It is really a well researched and compact piece . Keep up the good work .