All you wanted to know about Basel norms
Basel is a set of standards and practices developed for global banks to ensure that they maintain adequate capital to withstand periods of economic strain.
Q: What are Basel norms?
Basel is a set of standards and practices developed for global banks to ensure that they maintain adequate capital to withstand periods of economic strain. It is a comprehensive set of reform measures designed to improve the regulation, disclosures and risk management within the banking sector.
Q: What did Basel I and Basel II focus on?
Basel I norms was introduced in 1998, focused almost entirely on credit risk. It defined capital requirement and structure of risk weights for banks.
Basel II was introduced in 2004, laid down guidelines for capital adequacy, risk management and disclosure requirements.
Q: Why Basel III?
It is widely felt that the shortcoming in Basel II norms is what led to the global financial crisis of 2008. That is because Basel II did not have any explicit regulation on the debt that banks could take on their books, and focused more on individual financial institutions, while ignoring systemic risk. To ensure that banks don’t take on excessive debt, and that they don’t rely too much on short term funds, Basel III norms were proposed in 2010.
Q: What does Basel III norm stipulate?
Basel III establishes tougher capital standards through more restrictive capital definitions, higher risk-weighted assets (RWA), additional capital buffers and higher requirements for minimum capital ratios. It also introduces new strict liquidity requirements.
Q: What is the biggest criticism against Basel III?
That the stringent capital requirements come at a time when the global economy is in the midst of a slowdown. This will leave banks with less money to lend, in turn pushing up the cost of borrowing; and thereby further aggravating the slowdown.
Q: Why are many banks opposed to Basel III norms?
Basel III norms will require banks to undertake significant process and system changes to make upgrades, particularly in the areas of stress testing, liquidity and capital management infrastructure. The reforms could fundamentally impact profitability and require sweeping changes in the business models of many banks
Q: What is the deadline for banks to become Basel III compliant?
For international banks the deadline is December 31, 2018 and March 31, 2018 for Indian banks.
Q: Why the earlier deadline for Indian banks?
The RBI said that: We did this to align our date with the close of the Indian fiscal year, which is March 31. We could have gone up to March 31, 2019, but that would have overshot the Basel III prescription by three months and would have attracted adverse notice.
Q: Why are Indian banks concerned about Basel III norms?
Just like for international banks, Basel III norms will affect the profitability and return ratios of Indian banks as well. Something which is admitted by the RBI.
Basel III requires higher and better quality capital. Admittedly, the cost of equity capital is high. The average Return on Equity (RoE) of the Indian banking system for the last three years has been approximately 15%. Implementation of Basel III is expected to result in a decline in Indian banks' RoE in the short-term.
Q: How much extra capital will Indian banks need for Basel III?
According to RBI’s estimates, Indian banks will require a capital of Rs 5 lakh crore over the next five years, of which Rs 1.75 lakh crore will have to be equity capital. Within the Rs 1.75 lakh crore, anywhere between Rs 70,000-1,00,000 crore will have to raised through the market, depending on to what extent the government will infuse capital in state-owned banks.
Q: Indian banks are much better off than global banks that caused the financial crisis. Why then should Indian banks then comply with Basel III norms?
The RBI said: India should transit to Basel III because of several reasons. By far the most important reason is that as India integrates with the rest of the world, as increasingly Indian banks go abroad and foreign banks come on to our shores, we cannot afford to have a regulatory deviation from global standards. Any deviation will hurt us both by way of perception and also in actual practice. Also, it is important that Indian banks have the cushion afforded by improved risk management systems to withstand shocks from external systems, especially as they deepen their links with the global financial system going forward.