Basel III guidelines and its impact on banks: ICRA
ICRA has come out with its report on Basel III guidelines and its impact on banks.
ICRA has come out with its report on Basel III guidelines and its impact on banks.
Basel III not so onerous, provided Additional Tier I debt finds takersGuidelines on the implementation of BASEL III Capital Regulations were released by the Reserve Bank of India (RBI) on May 2, 2012. Implementation of these guidelines will begin January 1, 2013 and the process will be completed by March 31, 2018.Highlights- Banks required to maintain a minimum 5.5% in common equity (as against the current 3.6%) by March 31, 2015
- Banks to create a capital conservation buffer (consisting of common equity) of 2.5% by March 31, 2018
- Banks to maintain a minimum overall capital adequacy of 11.5% (against the current 9%) by March 31, 2018
- Conditions stipulated to increase the loss absorption capacity of banks’ Additional Tier I; Banks not to issue additional Tier I capital to retail investors
- Risk-based capital ratios to be supplemented with a leverage ratio of 4.5% during parallel run
- Banks allowed to add interim profits (subject to conditions) for computation of core capital adequacy
- Banks to deduct the entire amount of unamortised pension and gratuity liability from common equity Tier I capital for the purpose of capital adequacy ratios from January 1, 2013
Impact on Banks
Incremental equity requirements appear achievable so long as banks can find investors for the riskier Additional Tier I capital Indian banks would need Rs. 3.9–5 trillion capital over the next six years, out of which the requirements for common equity would be Rs. 1.3-2.0 trillion, for Additional Tier I Rs. 1.9 trillion, and for Tier II Rs. 1 trillion.A sizeable part (around 80%) of the common equity requirement relates to Public Sector Banks (PSBs). Of the PSBs’ total equity requirement, the Government of India’s (GOI’s) share would be Rs. 0.3 to 0.8 trillion (going by the Union Finance Ministry’s current stance of maintaining 58% shareholding in PSBs). The incremental equity requirement appears manageable, considering past trends in capital mobilisation. Indian banks raised over Rs. 1 trillion in equity during the period 2007-08 to 2011-12, of which around 54% was mobilised by PSBs and 46% by private banks. However, if one were to exclude 2007-08, when some large banks took advantage of the buoyancy in the capital markets to raise around Rs. 0.5 trillion, the equity raised by Indian banks over the four years from 2008-09 to 2001-12 was around Rs. 0.5 trillion; of this, around 60% was infused by the GoI/Life Insurance Corporation.While the equity target may appear easy at first glance, it may not prove to be so eventually, given that the RBI has also introduced loss-absorption features in Additional Tier I capital instruments. These features could well limit investor appetite for these instruments as it would be difficult to assess the probability of their conversion into equity or of a principal write-down in a stress scenario (and the extent of the resultant loss). In case banks are unable to mobilise the required Additional Tier I and the gap is bridged by raising common equity, the incremental equity requirement may go up to as high as Rs. 3.2–4 trillion over the next six years; in this, the GoI’s share could be a staggering Rs. 1.2-1.7 trillion.Increase of 25-30 bps in lending yields may help most banks protect their return on equity
As of December 31, 2011, around 15 PSBs have less than 8% core Tier I capital and of these eight have less than 7%. When banks with low core Tier I shore up their capital to around 9% (required 8% + 1% cushion), their return on equity (ROE) could drop by 1-4%, which they could seek to compensate by raising their lending yields (as long as competitive forces allow them to do so), increasing fee income, or rationalising costs. In ICRA’s view, since the largest bank would also need to shore up its capital and may therefore raise its lending yields to compensate for the ROE loss, the smaller banks may also have an opportunity to do the same. However, banks with relatively low core capital (less than 7%) would have to take a knock on their ROE. As for private banks, most of them being well capitalised already, the transition to Basel III may not impact their earnings significantly. In fact, their competitive position could improve when the PSBs raise their lending yields. However, at the same time, the upside potential for private banks could be limited by the higher minimum core capital requirement. Further, as the countercyclical buffer has to be set annually, when activated (in times of stress), the buffer requirement could introduce an element of variation in lending rates and/or the ROE of banks.Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.To read the full report click on the attachment 
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