Impact of Basel III norms on the Indian public sector banking industry

Abstract

Basel committee was formed in 1988 to set minimal capital requirements for banks. Basel I norm focused on credit risk. Assets of the banks were classified into five categories according to credit risk of asset. Over 100 countries adopted Basel I norm. The Basel II norm was aimed at creating a single international standard that would be useful in creating regulations on how much capital would be needed to put aside to guard against financial and operational risk. Basel II had three pillars namely capital adequacy ratio, supervisor review and market discipline. In Basel II different approaches have be identified to take care of market risk, credit risk and operational risk. Basel III was set up to fulfill the shortcomings of Basel II norms as identified during financial crises in 2008. Basic framework of Basel III was similar to Basel II, but the requirements in each pillar have been enhanced to provide effective coverage. It involves raising capital adequacy ratio, providing capital conservation ratio, introducing global liquidity standard, extending and re-weighting the risk coverage, introducing of leverage ratio and introducing measures to dampen the pro-cyclicality. Comparison of Basel III norms and currently prevailing RBI norms reveals that Indian banks have many such regulations already in their system. But more measures need to be taken to fully compliant to Basel III norms. There are many challenges will be faced by Indian banks to implement fully Basel III norms. More Tier 1 capital would be required. Leverage of the banks would reduce and it will lead to reduction in profits of the banks. The cost of equity will rise as return on equity is reduced due to reduction in leverage of the banks. Banks are required to raise Rs. 6, 00, 000 crore by 2019 to fully implement Basel III norms which is a big challenge. Collection of relevant data and analyzing it to predict liquidity crisis scenario with reasonable accuracy is a concern for banks. There seems to be some negative impact on GDP on the country if monetary expansion to some extent is carried out. Implementation of liquidity coverage ratio is also very challenging. Many recommendation has been given to raise Rs. 6, 00, 000 crore to fully implement Basel III by 2019. Government holdings can be reduced to some extent so that it would still be major stakeholder in banks. Banks can issue equity only with dividend rights, but not with voting rights. Also secondary bond market can be helpful to tackle the difficulty of raising funds. Securitization of loans can also be a option to raise funds.