impacted by the new capital rules. At the end of June 30, 2010, the aggregate capital to risk-weighted assets ratio of the Indian banking system stood at 13.4%, of which Tier-I capital constituted 9.3%. As such, RBI does not expect our banking system to be significantly stretched in meeting the proposed new capital rules, both in terms of the overall capital requirement and the quality of capital. There may be some negative impact arising from shifting some deductions from Tier-I and Tier-II capital to common equity. Indian banking system is moderately leveraged and PSU banks may not face problem in building buffer capital. The governor also says that PSU banks, Public Sector Banks should not be so much worried about meeting the capital requirements under the Basel III norms because the governor says that thegovernment will have to contribute to help public sector banks meet their capital requirements and also maintain their 51% ownership. Anand Sinha , Deputy Governor ,RBI has said that the Central Bank has already finalized certain portion of Basel III norms. As an impact of the previous crisis, two things have emerged ,including countercyclical capital and counter -cyclical provisioning .Our banks have already done it in the past.The adoption of Basel III norms significantly increases the regulatory capital requirement of Indian banks. Furthermore, within capital, the proportion of the more expensive core capital could increase. According to the proposed norms, the minimum core capital requirement is set to be raised to 4.5%. In addition, theintroduction of the conservation and countercyclical buffer means that the capital requirement would increase to between 7% and 9.5%. Indian banks, as per the current norms are required to maintain Tier I capital of at least 6%. However, since innovative perpetual debt and perpetual non cumulative preference shares cannot exceed 40% of the 6% Tier I capital, the minimum core capital is 3.6% (i.e., 60% of 6%). Given that most Indian banks are capitalized well beyond the stipulated norms, they may not need substantial capital to meet the new stricter norms. However, there are differences among various banks. While core capital in most of the private sector banks and foreign banks exceeds 9%, there are some public sector banks that fall short of this benchmark. These public sector banks, which account for more than 70% of the assets in the banking sector and are a major source of funding for the productive sectors, are likely to face some constraints due to the implementation of the Basel III norms. These banks are also unable to freely raise capital from the market as the government has a policy of maintaining at least 51% stake in these banks. Currently, there are only six banks where the government stake is higher than 70%. The other option is for the government to infuse capital to these banks to augment their core capital. Moreover, a rise in risk-weighted assets as well as the proposed disqualification of some non-common Tier I and Tier II capital instruments for inclusion under regulatory capital would increase the
requirement of additional capital. According to ICRA (2010), if risk-weighted assets were to grow at an annualized rate of 20%, there would be a requirement of additional capitalby the banking sector (excluding foreign banks) of about Rs 6000 billion as a whole over the next nine years, ending on 31 March 2019. Of this, public sector banks would require about 75-80% of this additional capital and private Indian banks accounting for the rest. While the concept of a
countercyclical buffer is intuitively appealing, operationalizing it has many
challenges. These include defining a business cycle in a global setting although business cycles are not globally synchronized, identifying an inflection point in the business cycle to indicate when to initiate building up the buffer, choosing the appropriate indicator that identifies both good and bad times, determining the right size of the buffer, etc. Given the different stages of financial sector development in different countries there will be a need to allow national discretion in applying the framework. In India there is also a concern about the variable (most likely the credit-to-GDP ratio) will be used to calibrate the countercyclical buffer. However, this may not be the most appropriate variable candidate for India ( Subbarao 2010). Unlike in advanced countries, in India and other developing economies, the credit-to-GDP ratio is a volatile variable and is likely to go up for structural reasons like enhanced financial intermediation owing to high growth or efforts of deeper financial inclusion. Moreover, while credit growth can be a good indicator of the build up phase, credit contraction tends to be a lagging indicator of emerging pressures in the system. The primary challenge for India will be to develop the capability to collect accurate and relevant data granularly. Given that Indian financial markets were not subject to the same stress level as markets in advanced countries, predicting the appropriate stress scenario will be a tough call. However, at the same time, most Indian banks follow a retail business model whereby there is limited dependence on short-term or overnight funding. Furthermore, Indian banks possess a large amount of liquid assets that will enable them to meet new standards. From the Indian point of view, a key issue is the extent to which SLR holdings should be considered in the estimation of the liquidity ratios. On the one hand, while there is a case for these to be excluded as they are expected to be maintained on a regular basis; however, it would also be reasonable to treat at least a part of the SLR holdings in calculating the liquidity ratio under stressed conditions, especially since these are government bonds against which the RBI provides liquidity. In India, more than 70% of the banking sector is dominated by public sector banks, where compensation is determined by the government with the variable component limited.Furthermore, private and foreign banks are statutorily required to obtain the RBI's regulatory approval for remuneration of their whole-time directors and chief executive officers. Recently, in a move to join the global initiative on compensation structures and align Indian compensation structures to Financial Stability Board (FSB) guidelines, RBI issued draft guidelines on compensation of high-level executives. These guidelines attempt to ensure effective governance of compensation, align compensation with prudent risk taking, and improve supervisory oversight of compensation. However, the Indian banking system is currently facing a different predicament. With the majority of the banking sector also a part of the public sector, ideally one would like to attract the best talent into this sector. However, there is a disparity between the compensation packages of public and private sector bank executives, the former receiving significantly less valuable packages. This
disparity should be rectified as it is leading to a loss of talent from the public sector to private sector. The outgoing deputy governor of the Reserve Bank of India, Shyamala Gopinath, is confident that Indian banks have the necessary capital cushion to absorb the additional requirements of Basel III. Fastforwarding to current developments, banks in India are well placed to cope with new banking regulation sweeping the global financial services industry, such as Basel III. "Banks in India are adequately capitalised and common equity of banks in India stood at 8.38% as of December 2010 and if we
take tier 1 capital, it was 8.60%,". To maintain the financial system, the RBI
has thrusted foreign banks to set up subsidiaries in India if they want to do substantial business in the country. To encourage banks to operate as
subsidiaries the RBI has offered a "less restrictive branch expansion policy".
Conclusion
Basel III is an opportunity as well as a challenge for banks. It can provide a solid foundation for the next developments in the banking sector, and it can ensure that past pitfalls are avoided. The primary objectives of the Basel reforms are to ensure the reduction of incidence, severity, and costs of financial crises and the associated output loss. As per the March 2010 dataset, the average common equity tier I capital of Public Sector Bank is 7.27 % and average CRAR is 13.21 %. The maximum and minimum of the core capital are 10.50 and 4.37 %.The CRAR of all the public sector bank is above 10.5 %. The average Common Equity Tier I Capital of Private Banks is 12.67 % and average CRAR is 14.91 %.The private banks are well cushioned above the Basel III defined Core (common equity tier I ) are 17.31 % and 9.62 %. The CRAR of all the private banks is above 10.5 %. The average Common Equity Tier I Capital of Foreign Banks is 13.78 % and average CRAR is 16.39 %.The Foreign Banks are well cushioned above the Basel III defined Core (common equity tier I) capital. The maximum and minimum of the core capital are 17.29 % and 6.72 %.The CRAR of all the foreign banks is above 10.5 %. Where banks have strengthened their capital over the last few years through retained earnings and capital raisings, the implementation of Basel III is likely to have less of an impact on the global economy. To the extent that banks try to comply more quickly with Basel III's capital and leverage requirements, this may lead to an increase in loan spreads, the tightening of loan terms or a cut-back in lending volumes.
