ackGround for Basel III :

In a separate article I have already discussed the details of the Basel III accord as
released by Basel Committee on BankingSupervision. In this article we will be dealing
with the broad guidelines as issued by RBI for implementation of Basel 3 Accord. We
are aware that originally Basel Committee was formed in 1974 by a group of central
bank governors from 10 countries. Earlier guidelines were known as Basel I and Basel
II accords. Later on the committee was expanded to include members from nearly 30
countries , including India. Inspite of implementation of Basel I and II guidelines, the
financial world saw the worst crisis in early 2008 and whole financial markets
tumbled.

One of the major debacles was the fall of Lehman Brothers. One of the

interesting comments on the Balance Sheet of Lehman Brothers read : Whatever was
on the left-hand side (liabilities) was not right and whatever was on the right-hand side
(assets) was not left. Thus, it became necessary to re-visit Basel II and plug the
loopholes and make Basel norms more stringent and wider in scope.

BCBS, through Basel III, put forward norms aimed at strengthening both sides of
balance sheets of banks viz. (a) enhancing the quantum of common equity; (b)
improving the quality of capital base (c) creation of capital buffers to absorb shocks; (d)
improving liquidity of assets (e) optimising the leverage through Leverage Ratio (f)
creating more space for banking supervision by regulators under Pillar II and (g)
bringing further transparency and market discipline under Pillar III.

Thus, Basel III

norms were released by BCBS and individual central banks were asked to implement
these in a phased manner. RBI (India's central bank) too issued draft guidelines in the
initial stage and then came up with the final guidelines.

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Over View f the RBI Guidelines for Implementation of Basel III guidelines :

The final guidelines have been issued by Reserve Bank of India for implementation of
Basel 3 guidelines on 2nd May, 2012. Full detailed guidelines can be downloaded from

RBI website, by clicking on the following link : Implementation of Base III

Guidelines.

Major features of these guidelines are :

(a) These guidelines would become effective from January 1, 2013 in a

phased manner. This means that as at the close of business on January 1, 2013, banks
must be able to declare or disclose capital ratios computed under the amended
guidelinesThe Basel

III capital ratios will be fully implemented as on March

31, 2018
(b) The capital requirements for the implementation of Basel III
guidelines may be lower during the initial periods and higher during the
later years. Banks needs to keep this in view while Capital Planning;
(c) Guidelines on operational aspects of implementation of the
Countercyclical Capital Buffer. Guidance to banks on this will be issued
in due course as RBI is still working on these. Moreover, some other
proposals viz. Definition of Capital Disclosure Requirements,
Capitalisation of Bank Exposures to Central Counterparties etc., are
also engaging the attention of the Basel Committee at
present. Therefore, the final proposals of the Basel
Committee on these aspects will be considered for implementation, to
the extent applicable, in future.
(d) For the financial year ending March 31, 2013, banks will have to
disclose the capital ratios computed under the existing guidelines (Basel
II) on capital adequacy as well as those computed under the Basel III
capital adequacy framework.
(e) The guidelines require banks to maintain a Minimum Total Capital
(MTC) of 9% against 8% (international) prescribed by the Basel
Committee of Total Risk Weighted assets. This has been decided by
Indian regulator as a matter of prudence. Thus, it requirement in this

regard remained at the same level. However, banks will need to raise
more money than under Basel II as several items are excluded under the
new definition.
(f) of the above, Common Equity Tier 1 (CET 1) capital must be at least
5.5% of RWAs;
(g) In addition to the Minimum Common Equity Tier 1 capital of 5.5% of
RWAs, (international standards require these to be only at 4.5%) banks
are also required to maintain a Capital Conservation Buffer (CCB) of
2.5% of RWAs in the form of Common Equity Tier 1 capital.

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. In case suchbuffers have been
drawn down, the banks have to rebuild them through reduced
discretionary distribution of earnings. This could include reducing
dividend payments, share buybacks and staff bonus.
(h) Indian banks under Basel II are required to maintain Tier 1 capital of
6%, which has been raised to 7% under Basel III. Moreover, certain
instruments, including some with the characteristics of debts, will not be
now included for arriving at Tier 1 capital;
(i) The new norms do not allow banks to use the consolidated capital of
any insurance or non financial subsidiaries for calculating capital
adequacy.
(j) Leverage Ratio :

Under the new set of guidelines, RBI has set the leverage ratio at 4.5% (3% under

Basel III). Leverage ratio has been introduced in Basel 3 to regulate banks which have huge trading
book and off balance sheet derivative positions. However, In India, most of banks do not have large
derivative activities so as to arrange enhanced cover for counterparty credit risk. Hence, the pressure on
banks should be minimal on this count.

(k) Liquidity norms:

The Liquidity Coverage Ratio (LCR) under Basel III requires banks to hold enough
unencumbered liquid assets to cover expected net outflows during a 30-day stress period. In India, the
burden from LCR stipulation will depend on how much of CRR and SLR can be offset against
LCR. Under present guidelines, Indian banks already follow the norms set by RBI for the statutory
liquidity ratio (SLR) and cash reserve ratio (CRR), which are liquidity buffers. The SLR is mainly
government securities while the CRR is mainly cash. Thus, for this aspect also Indian banks are better
placed over many of their overseas counterparts.

(l) Countercyclical Buffer: Economic activity moves in cycles and banking system is inherently procyclic. During upswings, carried away by the boom, banks end up in excessive lending and unchecked
risk build-up, which carry the seeds of a disastrous downturn. The regulation to create additional
capital buffers to lend further would act as a break on unbridled bank-lending. The detailed guidelines for
these are likely to be issued by RBI only at a later stage.

On the day of release of these guidelines, analysts felt that India may
need at least $30 billion (i.e. around Rs 1.6 trillion) to $40 billion as
capital over the next six years to comply with the new norms. It was also
felt that this would impose a heavy financial burden on the government,
as it will need to infuse capital in case it wanst to continue its hold on
these PS Banks. RBI Deputy Governor, Mr Anand Sinha viewed that the
implementation of Basel II may have a negative impact on India's growth
story. In FY 2012-13, Government of India is expected to provide Rs
15888 crores to recapitalize the banks. as to maintain capital adequacy of
8% under old Basel II norms.

Some Major Developments after 2nd May 2012 (i.e. the date when RBI
issued Basel III guidelines) :
(A) On 30th October 2012, RBI in its Second Quarter Review of
Monetary Policy 2012-13 has declared as follows :

(i)

"Basel

III

Disclosure

Requirements

on

Regulatory

Capital

Composition
87. ....... The Basel Committee on Banking Supervision (BCBS) has finalised
proposals on disclosure requirements in respect of the composition of regulatory
capital, aimed at improving transparency of regulatory capital reporting as well as
market discipline. As these disclosures have to be given effect by national authorities
by

June

30,

2013,

it

has

been

decided:

to issue draft guidelines on composition of capital disclosure requirements by endDecember 2012.

(ii)

Banks

Exposures

to

Central

Counterparties

(CCP)

88. The BCBS has also issued an interim framework for determining capital
requirements for bank exposures to CCPs. This framework is being introduced as an
amendment to the existing Basel II capital adequacy framework and is intended to
create incentives to increase the use of CCPs. These standards will come into effect
on

January

1,

2013.

Accordingly,

it

has

been

decided:

to issue draft guidelines on capital requirements for bank exposures to central

counterparties, based on the interim framework of the BCBS, by mid-November
2012.

(iii)

Core

Principles

for

Effective

Banking

Supervision

89. The Basel Committee has issued a revised version of the Core Principles in
September

2012

to

global financial crisis.

reflect
In

the
this

lessons

learned

context,

during
it

is

the

recent

proposed:

to carry out a self-assessment of the existing regulatory and supervisory practices

based on the revised Core Principles and to initiate steps to further strengthen the

regulatory

and

supervisory

mechanism.

asel III or Basel 3 released in December, 2010 is the third in the series of Basel
Accords. These accords deal with risk management aspects for the banking sector. In
a nut shell we can say that Basel iii is the global regulatory standard (agreed upon by
the members of the Basel Committee on Banking Supervision) on bank capital
adequacy, stress testing and market liquidity risk. (Basel I and Basel II are the earlier
versions of the same, and were less stringent)

What does Basel III is all About ?

According to Basel Committee on Banking Supervision "Basel III is a comprehensive

set of reform measures, developed by the Basel Committee on Banking Supervision, to
strengthen the regulation, supervision and risk management of the banking sector".

Thus, we can say that Basel 3 is only a continuation of effort initiated by the Basel
Committee on Banking Supervision to enhance the banking regulatory framework under
Basel I and Basel II. This latest Accord now seeks to improve the banking sector's
ability to deal with financial and economic stress, improve risk management and
strengthen the banks' transparency.

What are the objectives / aims of the Basel III measures ?

Basel 3 measures aim to:

improve the banking sector's ability to absorb shocks arising from financial and
economic stress, whatever the source

improve risk management and governance

strengthen banks' transparency and disclosures.

Thus we can say that Basel III guidelines are aimed at to improve the ability of banks to
withstand periods of economic and financial stress as the new guidelines are more
stringent than the earlier requirements for capital and liquidity in the banking sector.

How Does Basel III Requirements Will Affect Indian Banks :

The Basel III which is to be implemented by banks in India as per the guidelines issued
by RBI from time to time, will be challenging task not only for the banks but also for
GOI. It is estimated that Indian banks will be required to rais Rs 6,00,000 crores in
external capital in next nine years or so i.e. by 2020 (The estimates vary from
organisation to organisation). Expansion of capital to this extent will affect the returns
on the equity of these banks specially public sector banks. However, only consolation
for Indian banks is the fact that historically they have maintained their core and overall
capital well in excess of the regulatory minimum.

What are Three Pillars of Basel II Norms or What are the changes in Three Pillars of
Basel iii Accord ?

Basel III: Three Pillars Still Standing :

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Any one who has ever heard about Basel I and II, is most likely must have heard about
Three Pillars of Basel. Three Pillar of Basel still stand under Basel 3.
Basel III has essentially been designed to address the weaknesses that become too
obvious during the 2008 financial crisis world faced. The intent of the Basel
Committee seems to prepare the banking industry for any future economic downturns..
The framework enhances bank-specific measures and includes macro-prudential
regulations to help create a more stable banking sector.

The basic structure of Basel III remains unchanged with three mutually reinforcing
pillars.

Pillar 1 : Minimum Regulatory Capital Requirements based on Risk Weighted Assets

(RWAs) : Maintaining capital calculated through credit, market and operational risk
areas.
Pillar 2 : Supervisory Review Process : Regulating tools and frameworks for dealing
with peripheral risks that banks face.
Pillar 3: Market Discipline : Increasing the disclosures that banks must provide to
increase the transparency of banks

What are the Major Changes Proposed in Basel III over earlier Accords i.e. Basel I and
Basel II?
What are the Major Features of Basel III ?

(a) Better Capital Quality : One of the key elements of Basel 3 is the introduction
of much stricter definition of capital. Better quality capital means the higher lossabsorbing capacity. This in turn will mean that banks will be stronger, allowing them
to better withstand periods of stress.

(b) Capital Conservation Buffer:

Another key feature of Basel iii is that now banks

will be required to hold a capital conservation buffer of 2.5%. The aim of asking to
build conservation buffer is to ensure that banks maintain a cushion of capital that can
be used to absorb losses during periods of financial and economic stress.

(c) Countercyclical Buffer: This is also one of the key elements of Basel III. The
countercyclical buffer has been introducted with the objective to increase capital
requirements in good times and decrease the same in bad times. The buffer will slow
banking activity when it overheats and will encourage lending when times are tough i.e.
in bad times. The buffer will range from 0% to 2.5%, consisting of common equity or
other fully loss-absorbing capital.

(d) Minimum Common Equity and Tier 1 Capital Requirements : The minimum
requirement for common equity, the highest form of loss-absorbing capital, has been
raised under Basel III from 2% to 4.5% of total risk-weighted assets. The overall Tier
1 capital requirement, consisting of not only common equity but also other qualifying
financial instruments, will also increase from the current minimum of 4% to
6%. Although the minimum total capital requirement will remain at the current 8%
level, yet the required total capital will increase to 10.5% when combined with the
conservation buffer.

(e) Leverage Ratio:

A review of the financial crisis of 2008 has indicted that the value

of many assets fell quicker than assumed from historical experience. Thus, now Basel
III rules include a leverage ratio to serve as a safety net. A leverage ratio is the relative
amount of capital to total assets (not risk-weighted). This aims to put a cap on swelling
of leverage in the banking sector on a global basis. 3% leverage ratio of Tier 1 will be
tested before a mandatory leverage ratio is introduced in January 2018.

(f) Liquidity Ratios: Under Basel III, a framework for liquidity risk management will
be created. A new Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio
(NSFR) are to be introduced in 2015 and 2018, respectively.

(g) Systemically Important Financial Institutions (SIFI) : As part of the macroprudential framework, systemically important banks will be expected to have lossabsorbing capability beyond the Basel III requirements. Options for implementation
include capital surcharges, contingent capital and bail-in-debt.

Comparison of Capital Requirements under Basel II and Basel III :

Requirements
Minimum Ratio of Total
Capital To RWAs
Minimum Ratio of

Under
Under Basel
Basel
III
II
8%

10.50%

2%

4.50% to

Common Equity to RWAs

Tier I capital to RWAs
Core Tier I capital to
RWAs
Capital Conservation
Buffers to RWAs
Leverage Ratio
Countercyclical Buffer
Minimum Liquidity
Coverage Ratio
Minimum Net Stable
Funding Ratio
Systemically important
Financial Institutions
Charge

4%

7.00%
6.00%

2%

5.00%

None

2.50%

None

3.00%
0% to
2.50%

None

None TBD (2015)

None TBD (2018)
None TBD (2011)

Click Here for: TimeLine For Implementation of Basel III ( Phase in

Arrangement for Basel III )
Click Here for: Basel iii Accord for Capital Adequacy - Summary

The Central banks of individual countries, which decide to implement Basel

III norms, will issue their own norms and timeframes for implementation of
the above broad goals to be achieved. In India the same are issued by
Reserve Bank of India. Originally, RBI had issued draft guidelines. However,
now final guidelines have been issued in May 2012, and banks have been
asked to implement the same as per schedule given by RBI