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BASEL III

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BASEL III Introduction

BASEL 1BASEL 2

BASEL 3

Objectives

Key Outcomes

Building Blocks Of BASEL 3

Impact of BASEL 3

BASEL 3 ProposalsBCBS Awaiting Proposals

Major Recommendations.

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BASEL 1 Introduced in 1988

Amendment in 1996.

Incorporate capital charge for market risk via,(1) Standardized Measurement Method (SMM).(2) Internal Models Approach (IMA).

Market risk capital framework includes,(1) Capital charge for general market risk.(2) Capital charge for credit risk.

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The Basel 2 amendment on 2004.

The main aim behind the proposal are as follows,

(a) Enhanced risk coverage

(1) Credit Risk(2) Market Risk(3) Operational Risk.

(b) Standardized to model based with

increasing complexity.

(c)Three pillar approach.

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The 3 Pillars of BASEL 3 are,

(1) Minimum Capital Requirement

(2) Supervisory review Process(3) Market Discipline

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The Basel 2 of 2004 copied and pasted the

capital charge for market risk of Basel 1amendment of 1996 as a result,

(1) Not keeping pace with newmarket developments and practices.

(2) Capital charge for market risk much

lower compared to banking bookpositions on the assumption thatmarkets are liquid and positions canbe hedged quickly.

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Capital charge for credit risk in trading bookwas lower than capital charge for credit riskin banking book.

Lower capital charge for trading book led toscope for capital arbitrage.

Capital charge for counterparty credit risk forderivative positions covered the default riskand migration risk was not captured.

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Global financial crisis happen in the areas of(1) Trading book(2) Off balance sheet derivatives(3) Market risk

(4) Inadequate liquidity risk management.

Banks suffered heavy losses in their tradingbook.

Banks did not have adequate capital to coverthe losses.

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Heavy reliance on short term wholesalefunding.

Unsustainable maturity mismatch.

Insufficient liquidity assets to raise financeduring stressed period.

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Global regulatory standard on bank capital

adequacy, stress testing and market liquidityrisk as per the Basel Committee on BankingSupervision in 2010-11.

Strengthens bank capital requirements

Introduces new regulatory requirements onbank liquidity and bank leverage.

Banks hold 4.5% of common equity and 6% ofTier I capital of Risk-Weighted Assets (RWA).

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Basel III introduces additional capital buffers,

(i) a mandatory capital conservation bufferof 2.5%.

(ii) a discretionary countercyclical buffer,which allows national regulators to requireup to another 2.5% of capital duringperiods of high credit growth.

Basel III introduces a minimum 3% leverageratio and two required liquidity ratios.

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Fundamental restructuring approach to riskand regulation in the financial sector.

Enhanced level of dynamism, complexity andinterdependency within the global regulatorylandscape.

G20 Summit in Seoul on November 2010endorsed the BCBS agreements on capital

and liquidity.

Long transitional periods needed for theimplementation of the Basel 3 proposals.

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Improving banking sectors ability to absorb

shocks.

Reducing risk spill over to the real economy.

Fundamental reforms proposed in the areas of

(1) Micro prudential regulation at individual

bank level(2) Macro prudential regulation at system

wide basis

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Increase in common equity tier1 ratio from 2% to7%.

Less than policy makers hoped.

For business the proposal is challenging.

Many banks already have ratios above 7% basedon Basel 2.

The changes add up and well capitalised banks in

Europe and the US could find it demanding.

The result was reduced credit availability orincreased cost of credit.

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Introduces Additional Capital Buffers

(*) Mandatory capital conservation bufferof 2.5%.

(*) Discretionary countercyclical buffer,

which allows national regulators torequire up to another 2.5% of capitalduring periods of high credit growth.

Introduces minimum 3% leverage ratio and

2 required liquidity ratios.

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Impact on profitability.

Strengthens bank capital requirements

Introduces new regulatory requirements onbank liquidity and bank leverage.

Banks has to hold 4.5% of common equity

and 6% of Tier I capital of RWA.

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It is a risk based capital regime.

Banks should keep in mind that regulatorswill continue to focus on risk managementand governance in underpinning a robust

financial sector.

Basel 3 is the solution for the outstanding

issues left by Basel 1 and 2 .

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Raising quality level, consistency andtransparency of capital base.

Improving/enhancing risk coverage on

account of counterparty credit risk.

Supplementing risk based capital requirementwith leverage ratio.

Addressing systemic risk andinterconnectedness.

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Reducing pro-cyclicality and introducingcountercyclical capital buffers.

Minimum liquidity standards

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Impact on Individual BanksWeaker banks crowded out.

Significant pressure on profitability andReturn On Equity.

Change in demand from short term to

long term funding.

Legal entity reorganisation.

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Impact on the Financial System Reduced risk of a systemic banking crisis.

Reduced lending capacity.

Reduced investor appetite for bank debt andequity.

Inconsistent implementation of the Basel 3proposals leading to international arbitrage.

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Impact on Economy IIF study loss of output of 3% in G3 on full

implementation during 2011-15

Impact of 0.2% on GDP for each year for 4 yearsfor 1% increase in TCE

For 25% increase in liquid assets, half the impact

of 1% increase in TCE

Long term gains will be immense

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Global banks have a gap of liquid assets of

1,730 billion to be met in 4 years.

Global big banks have a capital shortfall of577 billion to meet 7% common equity normto be met in 8 years.

Tier 1 capital ratio falls to 5.7% from 11.1%

under the adjustment of capital and increasein risk coverage.

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Impact on Indian Banks High capital ratios at 14.4% falls to 11.7%.

Tier 1 capital fall from 10% to 9%

Common equity from 8.5% to 7.4%

Most of deductions are mandated by RBI.

Most of our banks are not trading banks, sonot much increase in enhanced risk coveragefor counterparty credit risk

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Indian banks are not as highly leveraged as

their global counterparts.

The leverage ratio of Indian banks would becomfortable.

Banks having a huge trading book and offbalance sheet derivative exposures

Its impacted due to increased risk coverageon account of counterparty credit risk

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Banks having huge off balance sheetexposures, derivatives and others haveimpact on account of leverage ratio.

Banks depending heavily on wholesale fundshave impact on the new liquidity standards.

SIBs have implications for capital and liquidity

surcharges and activity restrictions

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New capital requirements

Effect of proposals on hybrid capital

Capital conservation ratio

Countercyclical buffer

Leverage ratio

Liquidity ratios

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Common equity to 4.5% of RWA phased in 2013 &

2014.

Tier 1 capital raised to 6% phased in 2013 & 2014.

Minimum total capital requirement remains at 8%.

New capital conservation buffer of 2.5% phased in2016, 2017 and 2018.

New countercyclical buffer in the range of 0% to2.5%

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Tier 1 capital:

(1) common equity

(2) non-common equity instrumentsmeeting specific criteria

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Common Equity Tier 1

Banks common shares meeting criteria

Stock surplus/share premium on Common Equity

Tier 1 instruments

Retained earnings and other disclosed reserves

Common shares issued by banks consolidatedsubsidiaries and held by third parties forinclusion in Common Equity Tier 1 afterregulatory adjustments .

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Claim in liquidation of the bank

Claim on the residual assets that isproportional with its share of issued capital,

after repaying all claims in liquidation

Principal is perpetual and never repaidoutside of liquidation

No circumstances under which thedistributions are obligatory

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Distributions paid after all legal/contractual

obligations have been met.

No preferential distribution.

Paid in amount is recognised as equity capitalfor determining balance sheet insolvency andin Accounting Standards.

Directly issued and paid in and the bank cannot directly or indirectly have funded thepurchase of the instrument

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Goodwill/other intangibles, except mortgageservicing rights

Deferred tax assets whose realisation

depends on the banks future profitability

Treasury stock

Certain specified portions of investments notconsolidated for regulatory purposes

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Cash flow hedge reserves relating to hedgingof items

Any increase in equity capital resulting fromsecuritisation transactions

Unrealised gains and losses resulting from

changes in banks own credit risk on fairvalued liabilities

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Tier 1 capital

Subordinated to all depositors creditors

Not secured or guaranteed

No incentives to redeem & no investor put option

Fully discretionary non cumulative coupons

Callable by bank only after 5 years

Return of capital only with prior supervisoryauthorisation

Principal loss absorption on a going concern basis

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Tier 2 capital criteria:

(1) Elimination of distinction between upper andlower tier 2

Minimum Tier 2 criteria:

(1) Original maturity at least 5 years with noincentive to redeem

(2) Callable only by the issuer

(3) Dividends/coupons may not have a credit-sensitive dividend feature

(4) subordinated to all non subordinated creditors

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To comprise common equity

Restraints on dividends and discretionarybonuses if buffer falls below 2.5%

Capital Conservation Ratio to commence in2016 at 0.625% and increase to 1.25% in2017, 1.875% in 2018 and 2.5% in 2019

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Protect banking sector from periods of excesscredit growth

Aim is to build-up phase of economic cycle

Each jurisdiction to be given discretion to setcountercyclical buffer:

(1) Minimum buffer range underconservation buffer

(2) Decisions should be preannounced by12 months

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Special rules for internationally active banks

Banks should calculate the buffer with at leastthe same frequency as their minimum capitalrequirements

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Tier 1 leverage ratio at 3% during parallel run

period between 2013 and 2017

Bank level disclosure of leverage ratio andcomponents to start in January 2015

Supervisory monitoring period to commenceon 1 January 2011

Leverage ratio not to become binding untilearly 2018

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Current proposals is to base leverage ratio onbanks capital compared to their Exposure onnew definition of tier 1 capital.

Exposure should follow accounting standards

High quality liquid assets include cash and cash-like instruments in the measure of Exposure

Securitisation exposures will be counted in amanner generally consistent with accountingtreatment

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Two proposed liquidity ratios:

(1) Short term Liquidity Cover Ratio (LCR)(2) Long term Net Stable Funding Ratio

(NSFR)

Liquidity cover ratio:

High quality liquid assets to cover net cashoutflows over 30 day period

Builds on traditional internal methodologies usedby banks to assess exposure to contingentliability events

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Certain high quality liquid assets to be

included on asset side on an unlimitedundiscounted basis

Level 2 assets must comprise no more than

40% of the overall stock and must have aminimum 15% haircut

Observation period for liquidity cover ratiocommences in 2011 and ratio to beintroduced at start of 2015

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Going-concern proposals

Systemically important banks

Trading book review

Credit ratings and securitisations

Cross-border bank resolution

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Increased quality of capital.

Increased quantity of capital.

Reduced leverage through introduction ofbackstop leverage ratio.

Increased short term liquidity coverage.

Increased stable long term balance sheet funding.

Strengthen risk capture notably counterparty risk.

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