BASEL-III

Presented by:

Naushad ChaudharyPGDM-(Finance) Batch- 2012-14

KOHINOOR BUSINESS SCHOOL (MUMBAI)

(INDIA)

Table of Contents• Bank for international settlements (BSI)

– Introduction of BIS:– Subcommittees of BIS:– Functions and Objectives of (BIS):

• BACKGROWND OF BASEL COMMITTEE• Objective of the BCBS• HISTORY OF BASEL COMMITTIEES• WHY BASEL-III• OBJECTIVES OF BASEL-III• Three pillars of BASEL-II still standing in BASEL-III

– Pillar-1 (Capital Requirements)– Pillar-2: Supervisory Review– Pillar-3: Market Discipline

• Major Changes Proposed in Basel III over earlier Accords• RBI Guidelines for Implementation of Basel III• The Impact of Basel III

– Impact on economy:– Impact on Indian banks:

• Criticism of BASEL• CONCLUSION

Bank for international settlements (BSI)

Introduction of BIS

• Established in 1930• The BIS is located in Basel (A city in Switzerland)

• BIS is an international organization of central banks• BIS is a central bank for central banks• it is the oldest international financial organization• 60 central banks are the member BIS

Subcommittees of BIS:

The BIS carries out its work through its subcommittees

• Basel Committee, committee on global financial system (BCBS)

• Committee of payment and settlement system (CPSS)

• Irving Fisher Committee (IFC)

• Financial Stability Institute (FSI)

• Markets committee etc.

Functions and Objectives of (BIS):

• Functions:– Regulates capital adequacy– Encourages reserve transparency– Banking supervision (provide Basel Committee on Banking Supervision)– Provides banking services, but only to central banks– Acting as a prime counterparty for central banks in their financial

transactions

• Objectives:– To promote information sharing– To increase transparency in banking and financial system– To minimize the risk in banking and financial system– To enhance financial stability

BACKGROWND OF BASEL COMMITTEE

• The Basel Committee on Banking Supervision (BCBS) is a committee of Bank for International settlements (BIS)

• Established in 1974, by the central bank governors of the Group of Ten G-10 countries.

• The present Chairman of the Committee is Stefan Ingves, Governor of the central bank of Sweden (Sveriges Riksbank)

• The Committee's members as of September 2013: Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India,

Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom and United States

Why Basel committee was formed?

• Default of Herstatt Bank (German) - foreign exchange exposures was three times then its capital- (1974)

• Default of Franklin National Bank (New York) and- (1972)

• Disruptions in the international financial markets

Objective of the BCBS

• To enhance financial stability by improving the quality of banking supervision worldwide.

• To strengthening the Banks capital

• improving the quality of capital

• Strengthening the banks' transparency • Improving market discipline

• Improving banking sector’s ability to absorb shocks

HISTORY OF BASEL COMMITTIEES

• Basel I: the Basel Capital Accord, introduced in 1988 and focuses on

– Capital adequacy of financial institutions.

• Basel II: the New Capital Framework, issued in 2004, focuses on following three main pillars

– Minimum capital Standard [Minimum CAR or CRAR]– Supervisory review and [Review by central Bank RBI, on time to time]– Market discipline, [Review by market, stake holders, customer, share holder, gvt etc]

• Basel III: Basel III released in December, 2010, (implementation till March 31, 2018)"Basel III" is a comprehensive set of reform measures in, – regulation, – supervision &– risk management of the banking sector.

WHY BASEL-III ?

• Because of the global financial crisis which begin 2008 because of,– too much leverage – inadequate liquidity buffers (liquidity issues)– Mispricing of credit and – liquidity risk, and – Excess credit growth.

• Failures of Basel II being– Inability to strengthen financial stability– Insufficient capital reserve– Global financial crisis in spite of Basel I & Basel II– Liquidity issues in banking system– Inadequate comprehensive risk management approach

Responding to these risk factors, the Basel Committee did following major reforms in BASEL-III:

– Increase the quality and quantity capital – Introduce Leverage ratio – Improve liquidity rules – Introduce Countercyclical Buffer– Introduce Liquidity coverage Ratios

OBJECTIVES OF BASEL-III

• To improve quality of capital

• To improve liquidity of assets

• To bring further transparency and market discipline under Pillar III.

• To improve the banking sector's ability to deal with financial and economic stress,

• To enhancing the quantum of common equity;

• To improve risk management

• To strengthen the banks' transparency

• To Improving banking sector’s ability to absorb shocks (by creating capital buffer)

• To optimizing the leverage through Leverage Ratio

• To reduce risk spillover to the real economy

Three pillars of BASEL-II still standing in BASEL-III

• Pillar-1: Capital Requirement: Minimum capital required based on Risk Weighted Assets (RWAs).

• Pillar-2: Supervisory Review: Whether Bank is maintaining proper capital or not, that aspect will be reviewed

time to time by central bank (RBI) in India

• Pillar-3: Market Discipline: Pillar 3 is designed to increase the transparency in banking system

Pillar-1

Pillar-1: Capital Requirement

I. Capital adequacy

II. Risk Coverage

III. Leverage ratio

IV. Liquidity requirements

Pillar-1 (cont)

I. Capital adequacy: (The basic 8% minimum ratio of capital to RWA remain same under Basel III)

a. Quality and level of Capital:

o Tier1: Banks core capital = 6% paid up capital (common equity), Reserves Non-redeemable non-cumulative preferred stock

Common equity should be minimum 4.5% of RWAs

o Tier2:Supplementary capital =2% Undisclosed Reserves General Loss reserves hybrid debt capital

b. Capital Conservation Buffer: 2.5% of RWAs- (CET 1 capital)

c. Countercyclical buffer: 0-2.5% (depending on macroeconomic circumstances)- (CET 1 capital)

REGULATORY CAPITAL IN INDIA

Overall capital as % to risk weighted assets:

Pillar-1 (cont)

II. Risk Coverage:

• Higher capital requirements for trading and securitization activities.

• Capital requirements for certain counterparty credit risk exposures (arise from derivatives, and financial securities)s

• Market risk: Banks have to maintain additional capital to face market risk. Banks can use any of the following Model:

– Standardized Measurement Method (SMM) (central bank model)– Internal Models Approach (IMA) (banks own model)

Example of RWA

RWA in Basel-II & Basel-III

Pillar-1 (cont)

III. Leverage ratio: (capital to exposure)

• Leverage ratio should not exceed more then 3%.

• Higher capital for systemic derivatives

• Higher capital for inter-financial exposures

• Capital surcharge for systemic banks (maintaining Buffer capital above 10.5% )

Pillar-1 (cont)

IV. Liquidity requirements: BCBS introduce two standards for the liquidity of bank assets.

• Short term-Liquidity Coverage Ratio (LCR): – To ensure that banks have sufficient liquidity to deal with liquidity outflows during a 30-day period of

stress.– Asset should be highly liquid

• Long term-Net Stable Funding Ratio (NSFR): – To promote more medium and long-term funding activities of banking organizations.– To promote more stable funding of the banks– Stable funding in this context means capital, preferred stock and debt with maturities of more than

one year

Pillar-2

Pillar-2: Supervisory Review Whether Bank is maintaining proper capital or not, that aspect will be reviewed time to time by

central bank (RBI) in India

• Coverage in Pillar-2:

– Interest rate risk – Liquidity risk – Business risk – Credit concentration risk– Counterparty credit risk

Pillar-3

Pillar-3: Market Discipline

• Pillar 3 is designed to increase the transparency in banking system

• Increased in minimum public disclosure of banks risk information

• Improve disclosure of capital structure

• Improve disclosure of risk measurement and management practices

• Improve disclosure of capital adequacy

Major Changes Proposed in Basel III

• Capital adequacy: basic 8% including buffer 10.50%

• Capital Conservation Buffer:2.5% of RWAs (CCB is designed to ensure that banks build up capital buffers during normal times which can be used to absorb losses during

periods of financial and economic stress)

• Countercyclical Buffer: The countercyclical buffer has been introduced with the objective to increase capital requirements in good times and decrease the same in bad times”.

• Introduced Leverage Ratio: 3% leverage ratio will be tested till from Jan 2013- Jan 2017 before a mandatory leverage ratio is introduced under piller-1 in January 2018.

• Introduced Liquidity Ratios: Banks have to hold enough highly liquid assets to cover expected net outflows during a 30-day stress period.

• Reduce the overreliance of institutions and investors on external credit ratings,

Major Changes Proposed in Basel III over earlier Accords (Basel-II)

TIMELINE FOR IMPLIMENTION(International)

TIMELINE FOR IMPLIMENTION (In INDIA)

The Impact of Basel III

Impact on economy:

• IIF study: (IIF) calculated that the economies of G3 (US, Euro Area and Japan) would be 3% smaller after

implementation of Basel-III till 2015.

• Basel Committee study: 0.2% Impact on GDP each year for 4 years

Global banks could have a gap of liquid assets of € 1,730 billion in four years

Global big banks could have a capital shortfall of € 577 billion to meet 7% common equity norm

However, long term gains will be immense

Impact of Basel-III on Indian banks:

• India may need at least $30 billion to $40 billion (i.e. around Rs 1.6 trillion) as capital over the next six years to comply with the new norms.

• Capital for PSU Banks Would impose a huge financial burden on the government,

• RBI Deputy Governor, Mr. Anand Sinha viewed that the implementation of Basel III may have a negative impact on India's growth story.

• Banks depending heavily on wholesale funds may be impacted due to the new liquidity standards (75% RWA)

CONCLUSION

• Imposing economic loss and emotional pain on hundreds of millions and billions of people because of the crisis which arise due to improper regulation, deregulation, and lake of supervision,

• It is worthwhile to give up a little economic growth in the average year in order to avoid these major impacts,

References

• http://www.cml.org.uk/cml/policy/issues/748]• • http://rbi.org.in/scripts/NotificationUser.aspx?Id=7911&Mode=0• • • http://www.bis.org/publ/bcbs262.htm• • • http://www.bis.org/cbanks.htm• • http://www.brookings.edu/research/papers/2010/07/26-basel-elliott• • http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/basell-III-issues-implications.pdf• • • http://rbidocs.rbi.org.in/rdocs/notification/PDFs/70BIIIMC010713.pdf• • http://rbidocs.rbi.org.in/rdocs/content/pdfs/FBSEIII020512_I.pdf• • http://www.sullcrom.com/Basel_III_Counterparty_Credit_Risk/• • http://en.wikipedia.org/wiki/Basel_III• • http://www.driems.ac.in/mba/Download/5%20A%20CRITICAL%20REVIEW%20OF%20BASEL-III%20NORMS%20FOR%20INDIAN%20PSU%20BANKS.p

df• • http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture-Basel-III-Handbook.pdf• • http://rbidocs.rbi.org.in/rdocs/notification/PDFs/70BIIIMC010713.pdf• • http://rbidocs.rbi.org.in/rdocs/content/pdfs/FBSEIII020512_I.pdf