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BASEL III BASEL III –– A Journey towards futureA Journey towards future

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Basel III and Its Impact

Basel III : Objective

�The Basel Committee on Banking Supervision (BCBS) issued a

�Comprehensive reform package entitled “Basel III: A global

regulatory framework for more resilient banks and banking

systems” in December 2010

�Objective is to improve the banking sector’s ability to absorb

shocksshocks

arising from financial and economic stress, whatever the

source, thus

reducing the risk of spill over from the financial sector to the

real economy.

So Originated out of crisis management concern driven by global

financial meltdown, sovereign reforms package and capability to

absorb shocks

Basel III : Key Components

Capital

Ratios/targets

1 Capital definition

2 Countercyclical buffers

3 Minimum capital standards

4 Leverage ratio

5 Systemic risk

RWA

Requirement

s

6 Counterparty risk

7 Trading book and securitization

(also known as Basel II.5)

Liquidity

Standards

8 Liquidity coverage ratio

9 Net stable funding ratio

� Basel III is BOTH a firm-specific, risk based framework and a system-wide, systemic risk-based

framework

Basel III : Key Components

Capital Constituents – Fine prints

• CET1 : Paid up Capital + Share premium + Stat reserve + Cap reserve +

disclosed free reserve + Balance in P/L account LESS regulatory adjustment &

deductions

• AD Tier 1 : PNCPS + share premium due to Addl. Capp issue + Debt capital

instrument LESS regulatory adjustment & deductions

• Tier 2 : General provision and loan loss reserve + Debt capital instrument +

Preference Share Capital Instruments + Share premium due to Tier 2 +

revaluation reserve at a discount of 55% LESS regulatory adjustment &revaluation reserve at a discount of 55% LESS regulatory adjustment &

deductions

Regulatory adjustments and deductions

Crisis demonstrated that credit losses and write-downs were absorbed by

Common Equity. Thus, it is the Common Equity base which best absorbs losses

on a going concern basis. Therefore, under Basel III, most of the deductions are

required to be applied to Common Equity. Thus arises the regulatory

adjustments / deductions which will be applied to regulatory capital both at

solo and consolidated level.

New demons : Counter cyclical capital Buffer and Leverage Ratio

Countercyclical capital buffer is designed to achieve the broader macro-

prudential goal of protecting the banking sector from periods of excess

aggregate credit growth. For a given country, this buffer will only be in effect

when there is excess credit growth that results in a system-wide build-up of

risk. The countercyclical capital buffer would be introduced as an extension of

the capital conservation buffer range within a range of 0 – 2.5% of RWAs in

form of Common Equity or other fully loss absorbing capital

Underlying features some of the crisis was the build-up of excessive on and Underlying features some of the crisis was the build-up of excessive on and

off-balance sheet leverage in the banking system. In many cases, banks built

up excessive leverage while still showing strong risk based capital ratios.

Subsequently, the banking sector was forced to reduce its leverage in a manner

that not only amplified downward pressure on asset prices, but also got

trapped in the loop between losses, declines in bank capital and contraction in

credit availability. Therefore, under Basel III, a simple, transparent, non-risk

based regulatory leverage ratio has been introduced. This is proposed to be

calibrated with a Tier 1 leverage ratio of 3% . The ratio will be captured with all

assets and off balance sheet (OBS) items at their credit conversion factors and

derivatives

Capital Requirement under BASEL III in India

BASEL II BASEL III

Tier 1 Capital : Core capital –

At least 6% of RWA

Innovative Capital < =15%

Tier 2 : Supplemental

Subordinated debt <= 50%

Total Capital : 9 % of RWA

But Tier 1 Capital > Tier 2 Cap

Tier 1 Capital : Going concern cap

a. Common Equity Tier 1

b. Additional Tier 1

CET : 5.5% of RWA with CR, MR & OR

Min Tier 1 : 7%

Addl. Tier 1 : Max 1.5%

Tier 2 Capital : Gone concern Cap

Banks can admit additional capital as AT1 and T2 if CET 1 is 8%

But Tier 1 Capital > Tier 2 Cap Tier 2 Capital : Gone concern Cap

Max Tier 2 : 2%

Total Capital : 9 % of RWA (although BCBS says 8%)

PLUS

Capital conservation buffer ( withinCET1) : 2.5%

SO

Min Total Capital Requirement : 11.5%

Evolution from Basel I to Basel III

RWA

Capital

Ratios and

Targets

Tighter capital definition

Capital buffers

Leverage ratio

Higher minimum ratios

Systemic add-on

Pillar-2 ICAAP

Pillar-3 DisclosureCounterparty risk

1

2

3

4

5

6

Basel I Basel II Basel II.5 Basel III

Liquidity

Standards

RWA

Requirement

s

Tier 1 and 2 definition

New Pillar-1 Credit risk

Pillar-1 Operational risk

Pillar-2 ICAAP

Pillar-1 Credit risk

Pillar-1 Market risk

Securitisation revision

Trading book revisions

Incremental risk

Coverage ratio

Net stable funding ratio

7

8

9

Migration to Basel III

The implementation of the capital adequacy guidelines based on the Basel III capital

regulations will begin as on January 1, 2013.

This means that as at the close of business on January 1, 2013, banks must be able to

declare / disclose capital ratios computed under the amended guidelines.

However, as on December 31, 2012 banks should calculate the capital adequacy

according to existing Basel II framework. Banks should get the capital adequacy

computation as on January 1, 2013 verified by their external auditors and keep the computation as on January 1, 2013 verified by their external auditors and keep the

verification report on record.

Enhanced Capital Requirement and phase in Period

As % to Risk weighted

Assets

Jan 1

2013

Jan 1

2014

Jan 1

2015

Minimum Common Equity

Tier 1 capital (CET1 capital)

3.5% 4.0% 4.5%

Minimum Tier 1 Capital 4.5% 5.5% 6.0%

Minimum Total capital 8.0 % 8.0% 8.0%

In addition introduced capital conservation buffer (CCB) requirement 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. This is based on simple capital conservation rules to avoid breaches of

minimum cap requirements.

Addl. 2.5% is CCB in phased manner since Jan, 2016.

So total CET1 requirement is 6% and total capital requirement is 10.5%

Capital Base – Transitional arrangements

2011 2012 2013 2014 2015 2016 2017 2018 2019

Min Common Equity Ratio 3.5% 4.0% 4.5% 4.5% 4.5% 4.5% 4.5%

Capital conservation buffer 0.625% 1.25% 1.875% 2.5%

Min common equity + cap

conservation buffer

3.5% 4.0% 4.5% 5.125% 5.75% 6.375% 7.0%

Phase in of deductions from

Common Equity

20% 40% 60% 80% 100% 100%

Minimum Tier 1 4.0% 4.0% 4.5% 5.5% 6.0% 6.0% 6.0% 6.0% 6.0%

Minimum Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

From 1 January:

Minimum Total Capital 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Min Total Capital + cap

conservation buffer

8.0% 8.0% 8.0% 8.0% 8.0% 8.625% 9.25% 9.875% 10.5%

Capital instruments that no

longer qualify as Tier 1 or Tier

2

Phased out over 10 year period starting 2013

Leverage Ratio Supervisory

Monitoring

Parallel run Jan 13 to Jan 17 Migration

Disclosure starts Jan 15 To Pillar I

Liquidity Coverage Ratio Observation till 2014 Introduce minimum standard

from Jan 2015

Net stable fund ratio Observation till 2018 Introduce

minimum

standard from Jan

2018

2010 2011 2012 2013 2014 2015 2016

Internal Models Approach for

Market Risk

• Final Guidelines for IMA issued in April 2010.• The earliest date of making application by banks

to RBI is 1st April 2010.

Internal Rating Based Approach for Credit Risk (Foundation as well as Advanced)• The earliest date for making application by

Where we are in terms of Basel II & III migration?

• The earliest date for making application by banks 1st April 2012

• Guidelines note under process

Advanced Measurement Approach for Operational Risk• Draft Guidelines note on 6th January 2011.• The earliest date for making application by

banks 1st April 2012

Basel III: Regulatory Framework (contd. Next slide)• Guidelines issued in December 2010.• Common equity requirement at 4.5% by 1st

January 2015• Tier 1 capital requirement at 6% by 1st January

2015.

Looking Critically : Capital buffers

Issues Basel III proposals

• Procyclical amplification of financial shocks

in banking system, financial markets and

wider economy. Amplified through:

• Basel II risk sensitivity

• Accounting standards for both mark-to-

market assets and held-to-maturity loans

• Build up and release of leverage among

FIs, firms, and consumers

• Measures to dampen cyclicality in IRB

minimum capital requirements

• Forward-looking provisioning

• Capital conservation buffer

• Discretionary countercyclical buffer

• Stress buffer range

Criticality

• On-going analyses needed to determine extent procyclicality of minimum capital

requirements

• Role of Pillar 2 internationally remains unclear

• Essential to identify appropriate indicators to take timely action/release buffers

• Unaddressed issues such as tightening underwriting standards and reducing credit

supply

FIs, firms, and consumers

Looking Critically : Leverage ratio


• Pre-crisis build up of excessive

leverage in the banking system

• Crisis market pressure to reduce

leverage, amplified downward

pressure on asset prices

• Capture Off-Balance Sheet (OBS) items

• Constrain build-up of leverage in the

banking sector

• Mitigate destabilising deleveraging

which damages financial system and

economy

• Reinforce risk-based requirements

with a simple, non-risk-based backstop

Criticality

with a simple, non-risk-based backstop

measure based on gross exposure

• Limiting excessive credit growth

• Better as a backstop measure in Pillar 2 – not a hard Pillar 1 measure

• Range of ratios needed for different types of firm and business units within groups

Looking Critically : Liquidity and Net Stable Funding Ratio (NSFR)


• Improve liquidity risk management and

buffers

• 30-day stress buffer

• Reduce maturity mismatch through

NSFR

• Banks struggled to maintain adequate

liquidity

• Lack of focus on liquidity risk

• Inaccurate and ineffective

management of liquidity risk

• Unprecedented levels of liquidity

Criticality

• Ensure that inventories, OBS exposures

and securitisation pipelines are funded

with a minimum amount of stable

liabilities

• Unprecedented levels of liquidity

support were required from central

banks

• Liquidity concentration risk

• Implications for availability, costs and maturity transformation

• Trade-off between size and quality of buffer

• NSFR should be used as a Pillar 2 backstop measure

• Need for more harmonisation of liquidity risk regulatory / supervisory frameworks

Looking Critically : Systemic effects


• Interconnectedness of financial

institutions transmitted negative

shocks across the financial system

and economy

• Systemic impacts are beyond the

control of a single FI or supervisor

• Develop practical approaches to assist

supervisors to measure importance of

banks to financial stability and economic

growth

• Review policy options to reduce the

probability and impact of failure of

systemically important banks

Criticality

systemically important banks

• Evaluate pros and cons of a capital

surcharge for systemically important

banks

• Consider liquidity surcharge and other

supervisory tools

• Focus macro-supervision first on oversight of market-wide macroeconomic

indicators

• Focus on the overall impact of failure, not the risk

• Capital is usually not the answer: raise capital levels as a final option, not the first

• Be aware of market distortions caused by excessive regulation

6. Systemic buffer (tbc)

10. Impact of future accounting changes

7.Economic growth buffer

8. Market buffer

5. Countercyclical buffer (0.0% - 2.5%)

11.Volatility buffer

4.Conservation buffer (2.5%)

Target

CT1

ratio

9. Management buffer

Build capital dose by dose : not merely for regulation but for

stakeholders

Basel II

minimum

(2.0%)

1.TTC adjustments.

2. Basel III RWAs

Basel III

minimum

(4.5%)

Basel III

3. Definition change

4.Conservation buffer (2.5%)

Basel III and other

regulatory changes

Additional considerations

in setting target CT1 ratio

Pin Point : “Going Concern” Vs “Gone Concern”

Ex

pe

cte

d L

oss

Loss distribution (not to scale)Probability

Profit =

zero

Tier 1 = x%; “regulatory

insolvency” triggered

Ex

pe

cte

d L

oss

Accounting

insolvency

Ea

rnin

gs

Su

rplu

s co

re

eq

uit

y

Tie

r 2

Going concern Gone concern

Tie

r 1

Available total capital (illustrative)

Available Core Tier 1 (illustrative)

Non-core T1 instruments phase out 2013 - 2022 New deductions phase in 2014 - 2019

T1 and T2 instruments phase out 2013 – 2022 New deductions phase in 2014 – 2019

10.5% including Conservation Buffer – 1/1/19

Capital ratio%

New total capital

Basel III – putting the squeeze on capital : Can play around

3.5%

4%

4.5%

5.125%5.75%

6.375%

8%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

4.5% minimum -- 1/1/15

7% (including Conservation Buffer) – 1/1/19

New available CT1Minimum Total Capital

Minimum Core Tier 1 (common equity)

2%

Capital planning

• Was always required under Basel II Pillar 2

• But is now much more important

• Need to map supply and demand against the transition

timetable

• Be wary of comparing ratios under Basel II with Basel III

(definitional changes)(definitional changes)

• Look at internal capital structure for efficiencies (esp

changes in deductions)

Capital Charge : Do not Miss the Fine prints

• Capital charge on credit risk

• Claims on Banks

• Claims on capital instruments of FIs, NBFC

• Claims on commercial entities

• Securitization exposure

• Capital charge for counterparty credit risk

• Roughly two thirds of CCR loss are due to CVA ( Credit Valuation

Adjustment)

• Capital to absorb such loss

Basel III in the Indian context

– Regulators are now focusing on financial stability of the system as a whole rather than just micro regulation of any individual bank.

– Existing stringent capital requirement in India may help the banks to transition to Basel III

– The capital requirement as suggested by the proposed Basel III guidelines would necessitate Indian banks raising Rs. III guidelines would necessitate Indian banks raising Rs. 600,000 crore in external capital over next 8-9 years, out of which 70%-75% would be required for the Public sector banks and rest for the private sector banks

– Lowering of leveraging capacity likely to impact RoEs

Basel III in the Indian context : Key Challenges

• Indian banks on average have Tier 1 capital ratios of around 7.5% to 8%, which prima facie

meet the proposed Basel III requirements

• BUT: beware of definitional changes

• Transition to Basel III may not impact earnings much, but the upside potential associated with higher leveraging would decline.

• Further, as the countercyclical buffer has to be set periodically by the RBI, this could introduce an element of variation in lending rates and/or the ROE of banks

• Implementation of the liquidity coverage ratio (LCR) from 2015 may necessitate banks to maintain additional liquidity; also some assumptions on the rollover rates and the required liquidity for committed lines may be more stringent.But, considering the period of one liquidity for committed lines may be more stringent.But, considering the period of one month and the fact that most Indian banks have upgraded their technology platforms, the transition to LCR may not be a very difficult one

• While the proposal to make deductions “only if such deductibles exceed 15% of core capital” would provide some relief to Indian banks ,

• The suggested 100% deduction from the core capital (instead of 50% from Tier I and 50% from Tier II) could have a negative impact on the core capital of some banks.

Basel III : Impact on Indian P S Banks

� Marginal reduction in Tier 1 Capital. - Use of preference share capital and perpetual debt instruments.

� To support rapid loan-book expansion in the coming years, government supports may be required to enhance core tier 1 capital, assuming that government continue to hold 51% stake. Currently, there are only seven PSBs in which government equity is more than 65%

Definition of

Capital

Banks with Core Tier I less than 7% would be negatively � Banks with Core Tier I less than 7% would be negatively

impacted.

� It will have a impact on profitability and Return on equity

(ROE)

Countercyclical

buffers

� Deductions should be from core capital may lead to reduction

of amount in core capital for Indian BanksDeductions

Basel III : Impact on Indian Banks

PUBLIC SECTOR BANKS

As per the March 2010 dataset

� The Average Common Equity Tier 1

capital of Public Sector Banks is 7.27%

and average CRAR is 13.21%.

� The Maximum and minimum of the

core capital (common equity tier 1)

are 10.50% and 4.37%.

PRIVATE BANKS


� The Average Common Equity Tier

1 capital of Private Banks is 12.67%


� The Private Banks are well

cushioned above the Basel III are 10.50% and 4.37%.

� Core Capital - One Bank is below Basel

III prescribed CET

� Tier 1 - Three Banks are falling short of

Basel III prescribed Tier I capital (net

of deductions).

� The CRAR of all the public sector

banks is above 10.5%.

cushioned above the Basel III

defined Core (Common Equity Tier

1) capital

� The Maximum and minimum of

the core capital (common equity

tier 1) are 17.31% and 9.62%.

� The CRAR of all the private banks is

above 10.5%.

Basel III impact on Public Sector Banks

14.78%

12.54%

14.16%

13.10%

13.49%

12.70%

13.21%

12.51%

12.80%

12.50%

8.67%

9.28%

9.11%

7.68%

9.28%

8.24%

7.06%

7.91%

8.16%

7.69%

10.50%

7.68%

8.63%

8.04%

7.14%

8.60%

7.17%

4.90%

7.06%

6.85%

6.40%

Indian Overseas Bank

Oriental Bank of Commerce

Punjab National bank

Punjab & Sind Bank

State Bank of India - Group

Syndicate Bank

UCO Bank

Union Bank

United Bank

Vijaya Bank Common Equity Tier 1

Tier-1 (Net of Deduction) %

CRAR

4.5% 7% 10.5%



capital of Public Sector Banks is 7.27%




13.62%

13.93%

14.36%

13.00%

12.78%

13.43%

12.23%

15.37%

12.77%

11.48%

12.71%

8.12%

8.18%

9.20%

8.57%

6.41%

8.54%

6.83%

9.25%

8.16%

6.35%

11.13%

7.72%

7.81%

8.43%

7.51%

5.61%

7.99%

4.71%

8.19%

7.33%

4.37%

10.50%

0.0

%

2.0

%

4.0

%

6.0

%

8.0

%

10

.0%

12

.0%

14

.0%

16

.0%

18

.0%

Allahabad Bank

Andhra Bank

Bank of Baroda

Bank of India (Consolidated)

Bank of Maharashtra

Canara Bank

Central Bank of India

Corporation Bank

Dena Bank

IDBI Bank

Indian Bank core capital (common equity tier 1)

are 10.50% and 4.37%.

� Core Capital - One Bank is below

Basel III prescribed CET

� Tier 1 - Three Banks are falling short

of Basel III prescribed Tier I capital

(net of deductions).

� The CRAR of all the public sector

banks is above 10.5%.

15.80%

15.39%

15.33%

14.91%

11.18%

12.42%

9.65%

10.11%

12.79%

10.89%

12.42%

9.65%

9.62%

Axis Bank

South Indian Bank

Indusind

ING Vysya Bank Common Equity Tier 1


CRAR

Basel III impact on Private Banks

4.5% 7% 10.5%



capital of Private Banks is 12.67% and

average CRAR is 14.91%.

19.28%

19.15%

18.36%

17.44%

15.89%

12.85%

17.31%

12.92%

16.92%

13.26%

12.79%

11.84%

17.31%

12.12%

16.92%

13.13%

12.79%

0.0

%

2.0

%

4.0

%

6.0

%

8.0

%

10

.0%

12

.0%

14

.0%

16

.0%

18

.0%

20

.0%

Yes Bank

Kotak Group

ICICI Group

Federal Bank

HDFC Bank

Jammu & Kashmir Bank � The Private Banks are well cushioned

above the Basel III defined Core

(Common Equity Tier 1) capital



are 17.31% and 9.62%.

� The CRAR of all the private banks is

above 10.5%.

18.03%

12.41%

15.77%

16.50%

8.94%

7.94%

16.50%

8.94%

6.72%

Deutsche Bank

Standard Chartered Bank

RBS

Common Equity Tier 1


CRAR

Basel III impact on Foreign Banks

4.5% 7% 10.5%



capital of Foreign Banks is 13.78%


� The Foreign Banks are well cushioned

above the Basel III defined Core


17.07%

17.86%

17.21%

17.29%

16.63%

16.62%

17.29%

16.63%

16.62%

0.0

%

2.5

%

5.0

%

7.5

%

10

.0%

12

.5%

15

.0%

17

.5%

20

.0%

Citibank -Group

HSBC Bank

Barclays Bank




are 17.29% and 6.72%.

� The CRAR of all the foreign banks is

above 10.5%.

� However, these are as per the March

2010 dataset and the implementation

of definition of capital as per Basel III

are not taken into consideration.

know basel iii - peerless-rkm-skills.org filebasel iii is both a firm-specific, risk based framework...

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