What is CCB and why is implementation of final phase of it being delayed?

A major decision taken at the recent Reserve Bank of India board meeting was to push back the deadline for banks to set aside an additional 0.625 per cent as capital conservation buffer, required under the Basel III norms, by a year to enable them to lend more. Anup Roy explains the implications.

What is capital conservation buffer (CCB) and why is it important?

CCB is a relatively new concept, introduced under the international Basel III norms, which says that during good times, banks must build up a capital buffer that can be drawn from when there is stress. In simple terms, this is savings for the winter as this capital can be drawn when a bank is incurring losses. Since it is a buffer, or extra capital, banks’ minimum capital is not violated. 

In India, the minimum capital requirement is 9 per cent. The CCB would be 2.5 percentage points over and above the minimum capital requirement. The CCB is being implemented in a phased manner of 0.625 per cent per year from January 1, 2016.

The final phase is now delayed by a year, till March 31, 2020. 

Why was the CCB introduced?

India follows the international Basel III norms, and the CCB is an integral part of those norms. The concept gained currency after the credit crisis of 2008, when large banks witnessed their capital eroding at a fast clip. The CCB was aimed to cover for their losses on risky investments. The Basel Committee on Banking Supervision released its capital buffer norms wherein two kinds of structures were introduced — one, the CCB, and the other was countercyclical capital buffers. The Reserve Bank of India (RBI) has decided to implement both. 

Why is the implementation of the final phase of CCB being delayed?

At a time when banks are struggling to preserve their capital, and the government is finding it difficult to provide adequate funds, pushing back full implementation of CCB is understandable. By definition, CCB is something that is done when times are good. The Indian banking system has hardly been in a good state over the past few years. Delaying the CCB frees up capital for the banks, and allows the government to breathe easy. That apart, higher capital would also mean that banks will now be able to lend more. More the amount of capital with banks, the more they can leverage it and lend. According to estimates, the delay in implementing the final phase of CCB would free up as much as Rs 3 trillion in additional capital for Indian lenders till the end of the next financial year. The saving for the government on this count is expected to be around Rs 350 billion in the current financial year.

Will the delay harm the banking industry in any way?

Rating agency Moody’s says the move is credit negative for Indian banks, as the core capital for some banks would be lower in the next 12 months than what they are now. Some other experts say it would not cause any major harm to the system. The banking system has still not dipped into its past reserves after incurring losses due to rising bad debt. Sure, there were special bonds —the additional tier-1 bonds — that allowed banks to use past reserves to honour the obligations, but state-owned banks recalled them from the market. Besides, if the capital level dips below a critical level, the RBI will use its special restrictive rule for banks, called the prompt corrective action (PCA) framework. Under this, banks are required to shrink their balance sheet and stay away from risky lending in order to preserve capital. So, delaying the last phase of CCB does not pose any danger to Indian banks, looking at it from the risk perspective. 

What are the ways in which banks can rebuild such buffer given the overall stress in the system?

The CCB is largely driven by banking regulator RBI and banks will have to fulfil their CCB requirement by 2020. But that is not a problem for well capitalised banks, as they have capital at more than the regulatory minimum. Most private sector banks fall under this category. Hence, all they have to do is to make a book entry, putting some of the capital under the CCB head. But the problem lies with banks that are struggling to maintain even the basic minimum capital requirement. As rating agency Moody’s noted, these banks will likely see their capital base eroding further in the next 12 months. These public sector banks will have to likely ask the government for more capital, or aggressively sell non-core assets to generate own capital, since profitability of these banks have taken a hit due to bad debts. 

Is there a penalty if a country fails to implement CCB norms in its entirety?

No. Basel norms are a standard set of rules, and it is left to the individual country to implement the norms at a pace that is suitable to it. However, in a connected world, the sooner a bank become international norm compliant, the better it is poised to raise funds and expand operations overseas.