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
atul_mdb@rediffmail.com

Inculcating a Sense of Banking Consolidation

At global arena, last few years would be recalled for all troublesome reasons in banking sector…havocking recession and later relentless banking failures, bailouts, grim faces of western regulators were suffice to epitomize the gravity of situation which on most of occasion appeared as out of hand. In India too, financial sector at large faced the ire of world-wide recession although the scale was much lower in comparison of western counterparts owing to differences of regulatory norms and variation of disastrous greed.
Obviously cutting edge of Indian financial sector in the wake and after recession allowed it to practice on its own propositions unlike western economies and U.S.A particularly where the focus is now shifting again towards the days of Glass-Steagall Act that originated to contain the financial crisis, immediately after the depression-I in 1933.

Regardless of its intrinsic values, this act diluted over a long period starting in the 1980’s and eventually withdrawn through the Gramm-Leach-Billey Act or Financial Services Modernization Act in 1999, that grossly paved the way for financial innovation and proliferation. Here, policymakers need to check the weak spots in the system and install checks and balances to strengthen them, and avoid any systematic failure;for Indian regulators, it would be equally imperative to make advance efforts on banking and financial reform with keeping in mind the ground realities.
In Indian context, banking consolidation is the most pertinent case en route to financial sector reform which can lead Indian economy to a new trajectory of growth;banking consolidation makes strong sense here but it must be also accompanied by banking sector reform.The process for amalgamation of Public Sector Banks {PSBs}is directed by The Banking Companies {Acquisition and Transfer Understanding} Act,1970-according to the act, the central government may after consultation with the RBI can formulate a scheme to carry out the process of amalgamation of PSBs.

Even now, the country ‘s largest bank, State Bank of India {SBI}accounts for 30% of total banking stake and no other public sector bank is poising any competition with it, as Punjab National Bank merely sharing the 6% footprints of total Indian banking business. So, apprehensions of western regulators that “too big bank may vulnerable to fail” is hardly rational from India’s point of view as even after considerable restructuring of PSBs, they will remain much smaller than major western banks.
In the past half a century, in most rich countries, the financial sector has become too much large for the real economy-in recent survey of the magazine Economist, it was found that, relative to the size of the economy, banks in the UK are 10 times bigger now than they were four decades back-more or less, this is also the reality of U.S.A but Indian banking pitched distinctly, so they now have reason to knock the opportunities in different manner.With considering on factors such as cultural synergies, geographical presence, profitability and market share-three sorts of merger policy would be pragmatic-I. Merger of Associates banks with the SBI, II. Expansion in Regional Rural Banks merger at further state and later swiftly at national level and III. Voluntary mergers among the nationalized banks, where they must be given choice and feasibility to decide.

Government and regulators must play an enabling role by distressing the fear of proposed maneuverings by ensuring all good materialization for employees and clients through its expanded resources. Two appointment {of consultants} have made in this regards by the Finance Ministry-both of them, Mckinsey&Co and Ernst&Young are foreseeing economies of scale as big factor for PSBs to move in the direction of consolidation, a basic assumption of 7-8% market share by the merger of two banks are foremost in their recommendations but its enactment would depend lot on the measures of regulators and their intertwining with deeper nuances of potential change.
RRBs deserve token appreciation for their daring initiatives of consolidation which left all happy changes in their business and outward reach, which was a long due for them to diversify aggressively. Government and regulators in proper consultations with the all PSBs should find a consensus decision to lead Indian banking to the next level by essentially approaching on the issues of human resource development and more professionalism to mark the differences.
Atul Kumar Thakur
April 25th 2010, Sunday, New Delhi
atul_mdb@rediffmail.com

SMEs Financial Worries

SMEs have emerged as the most vibrant sector of the Indian economy accounting for about 95% of industrial units in the country. The sector contributes approximately 40% of value edition in manufacturing and around 45% exports. It has emerged as a panacea for providing employment to around 42 million persons and promoter of inclusive economic growth.
The Planning Commissions Working Group on SMEs for the 11th Five Year Plan has estimated that SMEs need approximately Rs3000 billion in working and term loans during the plan period. This sector remains neglected since long time; a reliable database on the sector concerning with heterogeneous range of activities is the need of hour which would boost the proper policy framing.

The next step should be developing a capital market exclusively for SMEs on the lines of Alternate Investment Market (AIMs) of London, NASDAQ, NSE and even NIKKEI have separate windows for small companies. Earlier OTCEI and INDONEXT were promoted by BSE for the same purpose albeit both experiments failed; hence optimum precaution must be put in place in any further endeavors in this regard.
In present circumstances SMEs are unable to borrow sufficient funds that is absolutely alarming for both the immediate and long term perspectives; the share of Micro enterprise in net bank credit witnessed a sharp decline from 42 percent from 2002-03 to 2.8 percent in 2007-08.

The share of enterprise with an investment below Rs5 lakh fails more drastically from 2.2 percent to 1.6 percent of total bank credit over the same period. Besides SMEs sector also requires dedicated Venture Capital Funds that must be willing to invest anything between Rs2 crore and Rs50 crore to facilitate innovation in SMEs.
Presently, Private Venture Capital funds prefer to invest Rs50 crore or more and are hence irrelevant to SMEs. In view of the enormous demand for equity capital for SMEs in the country, a major initiative is required in this direction.

Challenges are heading much faster; according to All India Census (2001-02), only 14.2 percent of the registered and 3.09 percent of the unregistered Small Scale Industries (SSIs) had availed themselves of bank finances.
SMEs are vehicle of inclusive with huge potential for employment generation, therefore it wouldn’t be viable to surpass the rudimentary requirements of this sector; Basel II Norms on Banking Supervision and Mandelson plan in UK could be the fine example before Indian government to infuse financial support to SMEs.
MSMEs (Medium and Small Scale Industries) Act, 2006 modified the title enterprise instead of industry to provide proper recognition to the service sector and conferred pride of place to Micro-enterprises; ceilings are also redefined now as up to Rs25 lakh is called a Micro enterprise, up to Rs5 crore Small enterprise, up to Rs10 crore as Medium enterprise.

These modifications necessitate for change in lending pattern of financial institutions; adjustment must be made to tap the various financial requirements of SMEs. Task force constituted by the Central government and initiation of SME Rating Agency (SMERA), a group venture of SIDBI, Dun & Bradstreet Information services India ltd and several leading banks of the country are welcome initiatives for the sake of SMEs and hope that it would boost the much needed morale of entrepreneurship in the country.
Atul Kumar Thakur
October3rd2009, New Delhi
atul_mdb@rediffmail.com