The global financial crisis exhibited various weaknesses in the global regulatory framework in banks and risk management practices. Thus, to address the lesson of the 2008 global financial crisis, the Basel Committee on Banking Supervision (BCBS) has introduced the new Basel III framework. This new framework includes firm-specific approaches but also incorporates macro-prudential measures to address systemic risk. The main coverage of Basel III is the introduction of (a) quality, consistency and transparency of the capital base, (b) global liquidity standards, and (c) stronger supervision, risk management and disclosure standards. In this context, it may be mentioned that during 2011-12, RBI made significant strides towards implementation of Basel III norms which will strengthen the banking system further.
To meet the new norms, a significant number of banks have to raise capital from the market, which will push the interest rate further, which will turn into a higher cost of capital and lower ROEs. This will affect the profitability margin of the banks in the future. Further, with the introduction of loss-absorbing features, a large number of instruments are expected to be disqualified for inclusion under additional tier I (ATI) and tier II capital. As a result, to replace the disqualified instruments, additional capital requirements in Indian banks would go up further from January 2013 onwards. In the current market scenario, unless the return of this type of instrument is attractive enough, there would be very limited demand from potential investors, which will also create much difficulty for banks in raising such capital over the next 3-5 years. It is interesting to note that, apart from affecting the bank?s profit margin through lower ROEs on account of higher capital requirements, the new Basel III norms will also have some adverse impact on the Indian economy.
To comply with the Basel III norms in India, the net (difference between additional equity capital requirements under Basel III and additional equity capital requirements under Basel II) equity capital requirements of PSBs will be around R750-800 billion, for which the government has to allocate a huge amount of capital, as around 70% of our banks come under the public sector category. How much the market will have to provide would depend on how much of the PSBs? recapitalisation burden the government will meet. The only option by which the government can reduce its burden is by reducing its shareholding in PSBs to below 51%. But, considering the statute to protect its majority voting rights, I think the government will not opt for this. Therefore, considering the higher budgetary deficit and comparatively poor financial health of the government at this juncture, the infusion of huge amount of funds into PSBs will not only increase the government?s financial burden but it may also jeopardise the growth of the Indian economy as there are three sources that will increase the demand for credit in the near future:
The Indian economy will be shifting increasingly from services to manufacturers, and the credit intensity of manufacturing is higher per unit of GDP than that for services. To achieve a higher growth path, India needs to at least double its investments in infrastructure, which requires a higher demand for credit. Financial inclusion, which is one of the main agendas for both the government and RBI, will increase the demand for credit from the banks.
It is interesting to note that Basel III is designed as a set of corrective measures for advanced economy banks which had failed due to systemic risk originating from regulatory gaps. However, Indian banks, which remained sound through the crisis, should not be burdened at this juncture as the implementation of Basel III in India will not only affect the growth of Indian economy but also the profitability of banks, which, in turn, will further aggravate the ill-health of the Indian economy. Thus, what is economically more important at this juncture is to give more importance to growth rather than to increasing capital requirements in the banking sector, which is more or less stable. In this context, RBI guidelines on Basel III norms, which are much more stringent?minimum common equity 5.5% versus 4.5%; implementation on March 31, 2018 versus January 1, 2019?than BCBS guidelines, need some modification along the following lines:
To reduce the common equity requirement and leverage ratio in line with BCBS requirement.
To postpone the date of implementation of the minimum common equity for PSBs at least for 2-3 years. This is because the minimum tier I capital is already much higher in private and foreign banks as compared to PSBs. In the case of PSBs, the principal owner and shareholder is the government, so these banks are much more controlled. Further, India does not have a level playing field between private and public sector banks. Apart from normal banking business, PSBs also have to comply with additional government directives such as waiver scheme for farmers, financial inclusion, directed lending, etc, which are not so stringent for private players.
To prolong the implementation schedule of entire Basel III guidelines.
To develop an active market for the instrument of loss-absorption capital, there is a need for clear directives from the regulator regarding target potential investors (like pension fund owners, strategic investors, insurance companies, etc), minimum quantum of investments and attractive risk-adjusted returns on these instruments vis-a-vis normal bonds.
While financial innovation produces many benefits for the financial system, it can as well jeopardise financial stability if it is not properly managed and supervised. Considering this and taking into account the last global financial crisis, it may be mentioned that Basel III has provided a strong basis for a more stable banking system. In this context, it is interesting to note that though Indian banks remained sound through the crisis, India?being a part of the global economy?cannot completely deviate from Basel III norms. Though it has some cost to our economy in the short run, in the long run, this norm will help Indian banks compete globally through an improved risk management system. Thus, considering the current economic scenario and taking into account the cost-benefit analysis of Basel III implementation in India, if the current RBI norms on Basel III can be modified as mentioned above, it will be a win-win situation.
The author is deputy general manager, risk department, IDBI Bank. Views are personal
