Banking beyond Basel

India must continue to remain a step ahead

The Reserve Bank of India (RBI) has every reason to pat itself on the back as far as its policy on prudential and capital adequacy norms for banks is concerned. The new Basel- III norms, agreed upon by central bankers from the major economies of the world and to be considered by heads of government at the next Group of 20 summit, will only be catching up with already existing norms in India as far as capital adequacy goes. While Basel III requirement is that Tier 1 (equity capital and disclosed reserves) capital ratio be 6 per cent, in India it is already well above this. As RBI governor Duvvuri Subbarao said last week, as on June 30 the capital adequacy ratio of the banking system stood at 13.4 per cent, of which Tier-I capital accounted for 9.3 per cent. The new Basel-III norms introduce a new concept called capital conservation buffer (CCB). This will be an additional 2.5 per cent on top of the new Tier-1 capital. Any bank whose capital ratio fails to stay above the buffer faces restrictions by supervisors on payouts such as dividends, share buybacks and bonuses. The new CCB will include equity, after deductions like deferred taxes. This new buffer is proposed to be phased in from January 2016 and will be fully effective in January 2019. In addition, it has also been proposed that there would be a counter-cyclical capital buffer, amounting to between 0 and 2.5 per cent of equity or other full loss-absorbing capital. It is aimed at forcing banks to build up an extra buffer when banks see excessive credit in the system that may pose a threat to bank bottom lines. Banks would then be able to tap this buffer to offset any potential losses without having to raise fresh capital immediately. No timeline has been yet fixed for this new concept to be introduced.

Other ideas proposed include new definitions of capital aimed at improving both the quantity and quality of bank capital. It is reiterated that the predominant form of Tier-1 capital must be equity and retained earnings. To this, banks can include deferred tax assets, mortgage-servicing rights and investments in financial institutions to an amount no more than 15 per cent of the common equity component. The new norms also impose a ceiling on build-up of leverage in the banking sector. It is hoped that this would reduce the risk of destabilisation from deleveraging. There are also new liquidity norms aimed at ensuring that banks have enough liquid assets to tide over short-term shocks and medium to longer-term pressures. These and other proposals pertaining to risk are aimed at ensuring that the banking sector is better protected from the macroeconomic and financial consequences of excess credit and leverage. It is surprising, however, that the timetable laid out for adherence to Basel III is far too stretched out. There is good reason to insist on a shorter time span and early implementation of these norms. One reason why banking stocks have done so well on Monday could be that western banks feel less intimidated by this liberal timetable.