PROJECT REPORT ON

BASEL-3 AN OVERVIEW
COMMERCIAL BANK MANAGEMENT

Submitted to:
Prof. Prakash Singh
Indian Institute of Management, Lucknow

Submitted by
CBM Sec-A Group-4
Ankita Prayag Singh
Kislay Upadhyay
Pamu Sai Jayachandra Rao
Priyank Agarwal
Sonu Sharma
Yash Gupta

PGP30184
PGP30202
PGP30213
PGP30217
PGP30228
PGP30238

Contents
1.

History of the BASEL Norms ........................................................................................................................... 3

1.1 BASEL I .......................................................................................................................................................... 3
1.2 BASEL II Accord ............................................................................................................................................. 4
1.3 Towards BASEL III ......................................................................................................................................... 6

2.

BASEL 3: Framework ...................................................................................................................................... 6

2.1 Capital Standards ......................................................................................................................................... 6
2.2 Leverage Ratio .............................................................................................................................................. 7
2.3 Counter Cyclical Capital Buffers ................................................................................................................... 7
2.4 Measures against Counterparty Risk ............................................................................................................ 7
2.5 Liquidity Standards ....................................................................................................................................... 8

3.

BASEL III Implementation Timeline ................................................................................................................ 8

4.

Indian Banking System (Overview) ................................................................................................................ 9

4.1 Reserve Bank of India ................................................................................................................................... 9
4.2. Scheduled Commercial Banks ..................................................................................................................... 9
4.3. Regional Rural Bank ................................................................................................................................... 10
4.4. Co-operative Banks ................................................................................................................................... 10
4.5 Unscheduled Banks .................................................................................................................................... 10

5.

Comparative Analysis of Basel I, Basel II and Basel III: ................................................................................. 11

6. Difference between the RBI Regulations and the BASEL 3 Norms ................................................................... 12
7. Impact Of Basel 3 On Indian Banking System: Modelling The Loan Demand In India And The Impact Of These
Regulations Of The Indian Economy ..................................................................................................................... 13
7.1. BASEL III Capital Requirements: RBI .......................................................................................................... 13
7.2. Impact of BASEL III on Indian Banking ....................................................................................................... 13
8. Current Status of BASEL III Implementation in India ........................................................................................ 16
8.1. Banks Own Proactive Internal Approaches for Capital Adequacy Ratios .................................................. 16
9. References ........................................................................................................................................................ 17

1. History of the BASEL Norms

After the breakdown of the Bretton Woods system of managed exchange rates in 1973, many
banks incurred large foreign currency losses resulting in the financial market turmoil. Due to
weakening of banking systems in a number of industrial countries, the need for harmonizing
bank regulation was felt by the central bankers from around the world. As a result, the central
bank governors of the G10 countries established a Committee on Banking Regulations and
Supervisory Practices at the end of 1974, which had been renamed later as the Basel
Committee on Banking Supervision. The committee was designed as a forum for regular
cooperation with the aim to enhance financial stability by improving supervisory knowhow
and its quality worldwide. To achieve its aims, the committee initiated the development of
"rules of the game" for the capital adequacy assessment of internationally-active banks.
Following this, a capital measurement system commonly referred to as the Basel Capital
Accord (1988 Accord) was approved by the G10 Governors and released to banks in July 1988.
The accord was ratified by G10 banks to be implemented by the end of 1992 and ultimately,
this framework was introduced in virtually all other countries with active international banks.
The main reason for international regulation:

To enhance safety by reducing the likelihood of individual failures that could spread
the adverse effects across national boundaries
To provide for a level playing field, so that banks in different countries would not
benefit from any competitive advantages due to subsidies from their governments,
such as lower capital ratios or other government support.

1.1 BASEL I
Basel I norms were introduced only in 1992, and that too in a phased manner over a period
of four years, however, RBI had introduced measures for managing liquidity risk, forex risk
and credit risk (through the Health Code Systems 1985-86) in the Indian banking system.
The Health Code system, inter alia, provided information regarding the health of individual
advances, the quality of the credit portfolio and the extent of advances causing concern in
relation to total advances. It was considered that this accord, Banks obliged to comply with
a minimum "risk asset ratio (RAR) requirement of 8%. A bank's RAR is derived by expressing
its (adjusted) regulatory capital, comprising so-called "Tier 1" and "Tier 2" capital, as a
percentage of risk-adjusted, on- and off-balance-sheet activities.
Thus, the accord was primarily focused on credit risk and appropriate risk-weighting of
assets. Later, The Committee refined the framework to address risks other than credit risk
and issued the so-called Market Risk Amendment to the Capital Accord (or Market Risk
Amendment), to take effect at the end of 1997. This was designed to incorporate within the
Accord a capital requirement for the market risks arising from banks exposures to foreign
exchange, traded debt securities, equities, commodities and options. An important aspect of

the Market Risk Amendment was that banks were, for the first time, allowed to use internal
models (value-at-risk models) rather than the standardized RAR approach as a basis for
measuring their market risk capital requirements, subject to strict quantitative and qualitative
standards.
Since Jan1998, RAR (%) = ACB / [TOWRA+ (12.5 * Market Risk Capital Charge)], subject to a
minimum of 8%.
Advantages of Basel I
Substantial increases in capital adequacy ratios of internationally active banks;
Relatively simple structure;
Worldwide adoption;
Increased competitive equality among internationally active banks;
Greater discipline in managing capital;
A benchmark for assessment by market participants.
Weaknesses of Basel I
Capital adequacy depends on credit risk, while other risks (e.g. market and
operational) are excluded from the analysis;
In credit risk assessment there is no difference between debtors of different credit
quality and rating;
Emphasis is on book values and not market values;
Inadequate assessment of risks and effects of the use of new financial instruments, as
well as risk mitigation techniques
1.2 BASEL II Accord
Market Discipline by effective disclosure to encourage safe and sound banking
Practices. In response of flaws and weakness of Basel I assessment regime and to
accommodate market developments and industry practices in the field of risk management,
the Committee issued a proposal for a new capital adequacy framework in 1999 to replace
Basel I. This led to the release of the Revised Capital Framework in June 2004, known as Basel
II.
Concerns with Basel I:
The voluntary nature of the agreement
The flawed methodology inherent in the "standardized" assessment approach;
The market distortions and concomitant induced resource misallocation; and
The potential danger of exacerbating global or regional "credit crunches".
Under Basel II, the revised framework comprised three mutually-reinforcing pillars, namely:
1) Minimum capital requirements, (with amendment in the standardized approach of
Basel I Accord);
2) Supervisory review of an institutions capital adequacy and internal assessment
process; and
3) Effective use of disclosure as a lever to strengthen market discipline and encourage
sound banking practices.

1.2.1 First Pillar:

This deals with maintenance of regulatory capital of 8% calculated for three major
components of risk that a bank faces: credit risk, operational risk, and market risk. Other
risks are not considered fully quantifiable at this stage.

The credit risk component can be calculated in three different ways of varying degree
of sophistication, namely standardized approach, Foundation IRB, Advanced IRB.
For operational risk, there are three different approaches basic indicator approach
or BIA, standardized approach or STA, and the advanced measurement approach or
AMA.
For market risk the two approaches are Standardized approach and internal models
like VaR (value at risk).

1.2.2 Second Pillar

This includes four key principles of supervisory review and extensive supervisory
guidance.

Banks should have a process for assessing their overall capital adequacy in relation to
their risk profile and a strategy for maintaining their capital levels.
Supervisors should review and evaluate banks' internal capital adequacy assessments
and strategies, as well as their ability to monitor and ensure their compliance with
regulatory capital ratios.
Supervisors should expect banks to operate above the minimum regulatory capital
levels and should have the ability to require banks to hold capital in excess of the
minimum.
Supervisors should seek to intervene at an early stage to prevent capital from falling
below the minimum levels required to support the risk characteristics of a particular
bank, and should require rapid remedial action if capital is not maintained or restored.

Third Pillar:
This includes a set of specific qualitative and quantitative disclosures in four key areas:
Scope of application
Composition of capital
Risk exposure assessment and management processes
Capital adequacy
It even distinguishes between disclosure requirements (defined as core and supplementary
disclosure requirements), and strong recommendations. Core disclosures are defined as
those which convey vital information for all institutions and are important to the basic
operation of the market discipline; while supplementary disclosures are important for some,
but not all, institutions depending on the nature of their risk exposure, capital adequacy and
methods adopted to calculate the capital requirements.
Thus, the new framework was designed to improve the way regulatory capital requirements
reflect underlying risks and to better address the financial innovation that had occurred in
contemporary years. The changes aimed at rewarding and encouraging continued
improvements in risk measurement and control.

1.3 Towards BASEL III

Even before Lehman Brothers collapsed in Sep 2008, the need for a fundamental
strengthening of the Basel II framework had become apparent. The banking sector had
entered the financial crisis with too much leverage and inadequate liquidity buffers. These
defects were accompanied by poor governance and risk management, as well as
inappropriate incentive structures. The dangerous combination of these factors was
demonstrated by the mispricing of credit and liquidity risk, and excess credit growth.
Responding to these risk factors, the Basel Committee issued Principles for sound liquidity
risk management and supervision in the same month that Lehman Brothers failed. In July
2009, the Committee issued a further package of documents to strengthen the Basel II capital
framework, notably with regard to the treatment of certain complex securitization positions,
off-balance sheet vehicles and trading book exposures. In Sep 2010, the Committee
announced higher global minimum capital standards for commercial banks. This was followed
by a new capital and liquidity standards, now referred to as Basel III, that were agreed at
Dec 2010 Basel Committee meeting. The standards were set out in Basel III: International
framework for liquidity risk measurement, standards and monitoring and Basel III: A global
regulatory framework for more resilient banks and banking systems. The enhanced Basel
framework revised and strengthen the three pillars established by Basel II. It also extended
the framework with several innovations.

2. BASEL 3: Framework
Basel III aims to build robust capital base for financial institutions and ensure liquidity and
leverage ratios to withstand any future banking crises, thus ensuring financial stability.
The main pillars of the norms are explained below:
2.1 Capital Standards
The 4 different capital standards are:
1. Raising Capital Base: To ensure quality, consistency in definition across
jurisdictions and transparency in disclosure of capital base. Measures
suggested in this regard are:
a. Tier 1 Capital
b. Reminder of Tier 1 Capital
c. Innovative Hybrid Instruments
2. Enhancing Risk Coverage: To strengthen the risk coverage of capital framework.
Measures suggested in this regard are:
a. Introduction of stressed VaR capital requirement
b. Re-securitization in banking and trading books requiring higher capital
requirements
c. Additional Capital charge for mark-to-market losses related to credit valuation
adjustment risks
d. Strengthening standards for collateral management
3. Supplement Risk-Based Capital requirements with Leverage Measure: To

mitigate risk associated with deleveraging by containing leverage in the

banking sector
4. Reduce Pro-Cyclicality: Reduce effects of pro-cyclical movements in the banking
sector. Measures suggested in this regard are:
a. Incorporation of capital buffers above the capital requirements
b. Adoption of the Expected Loss (EL) approach instead of the Incurred Loss (IL)
approach
The following table gives the capital requirements as per the norms:
Minimum Capital
Conservation Buffer
Minimum Capital +
Conservation Buffer
Counter Cyclical Buffer

Common Equity Tier 1

4.5%
2.5%
7.0%
(0-2.5)%

Tier 1 Capital
6.0%

8.5%

Total Capital
8.0%

10.5%

Although banks can use up their buffer capital, they are expected to immediately replenish the
same using their earnings in the following manner:
Common Equity Tier 1 (%)
4.5-5.125
5.125-5.75
5.75-6.375
6.375-7.00
>7.00

Minimum Capital Conservation Ratio (% of earnings)

100
80
60
40
0

2.2 Leverage Ratio

This ratio was devised to protect banks against the model risks inherent in their risk
management processes as well as the measurement errors. The numerator of this ratio
consists of high quality capital while the denominator consists of on-balance sheet as well as
off-balance sheet assets. This ratio is used to reduce risk mitigation by banks by rapid
deleveraging. The minimum leverage ratio proposed is 3%.
2.3 Counter Cyclical Capital Buffers
This is an additional capital requirement over and above the above mentioned capital
requirements to ensure that the banks can transfer some of the capital built-up during the
periods of boom to the periods of stress.
Currently, this buffer is stipulated to be 2.5%.
2.4 Measures against Counterparty Risk
In the Basel II norms, banks were not expected to hold enough capital to limit counterparty
risk. Traditionally, the calculation of volatility used historical data. However, periods of high
economic stress were excluded from the calculations. This was amended in the Basel III norms.
As per the Basel III norms, banks should include at least 1 period of high stress in their volatility
calculations. Moreover, the correlation factors between economys asset values and the
financial firms asset values should be scaled up during the volatility calculations. This
increases the minimum capital requirements for the banks. The observed correlation between

the asset values of financial institutions is also high. Therefore, the norms stipulate a scaling
up of the correlation factors while estimating volatility of asset values. This has also increased
the capital requirements.
2.5 Liquidity Standards
The liquidity framework aims to increase the resilience of banks to liquidity problems in the
market. 2 ratios have been proposed to monitor the long-term and short-term liquidities.

1.

Liquidity Coverage Ratio:

Liquidity Coverage Ratio (LCR) = (Stock of High Quality Assets)/(Total Net Cash flows
over the next month)
This ratios value should be at least 100. It monitors the short-term liquidity situation.
The norms also stipulate that the banks define a stress scenario and test their
solvency.

2.

Net Stable Funding Ratio:

Net Stable Funding Ratio (NSFR) = (Available amount of stable funding)/(Required
amount of stable funding)
This ratios value should be at least 100. Stable funding is defined as those funds that
can be expected to remain stable over the next one-year period under conditions of
extreme stress.

3. BASEL III Implementation Timeline

2011

Leverage Ratio
Minimum Common Equity
Capital Ratio
Capital
Conservation
Buffer
Minimum Common Equity
Capital Ratio
+ Capital Conservation
Buffer
Minimum Tier 1 Capital
Minimum Total Capital
Minimum Total Capital
+ Capital Conservation
Buffer
Phase out of non-core

2012

Supervisory
Monitoring

2013 2014 2015

2016 2017 2018 2019
Parallel run Jan 2013-Jan
2017
Disclosure starts
Jan 2015
3.50
4.50
%
4.00% 4.50% %
4.50% 4.50% 4.50%
0.62
5% 1.25% 1.875% 2.50%
3.50
%
4.00% 4.50%

5.13
%
5.75% 6.38% 7.00%

4.50
%
5.50% 6.00%
8.00
%
8.00% 8.00%
8.00
%
8.00% 8.00%

6.00
%
6.00% 6.00% 6.00%
8.00
%
8.00% 8.00% 8.00%
8.63
10.50
%
9.25% 9.88% %

Phase-out over 10-year horizon

Tier-1 Capital
or Tier-2 Capital

starting from 2013

Observa
tion

Introdu
ce
Minimu
m
Standar
d

Liquidity Coverage Ratio Period

Begins
Observati
on
Net Stable Funding Ratio

Period
Begins

Introdu
ce
Minimu
m
Standar
d

4. Indian Banking System (Overview)

An outline of the Indian Banking structure may be presented as follows:1. Reserve banks of India
2. Indian Scheduled Commercial Banks
3. Regional Rural banks
4. Non-scheduled banks
5. Co-operative banks
4.1 Reserve Bank of India
The central bank was established in April 1, 1935 in accordance with the provisions of reserve
bank of India act 1934. Though originally the reserve bank of India was privately owned, since
nationalization in 1949, RBI is fully owned by GoI. The bank was constituted with objective as
- To regulate the issues of banknotes.
- To maintain reserves with a view to securing monetary stability
- To operate the credit and currency system of the country to its advantage.
4.2. Scheduled Commercial Banks
Scheduled Banks in India constitute the banks which have been included in the second
schedule of RBI act 1934.This includes:
a) State Bank of India and its associate banks
b) Twenty nationalized banks
c) Private Sector Banks
d) Other scheduled commercial banks
For the purpose of assessment of performance of banks, RBI categories these banks as:
private sector, public sector, and foreign banks.
Number
of
Number of
% Share of Number of Market Share of
Type of Banks
Banks
Branches
Branches
Assets (%)

Public Sector
26 67,466
83
72.8
Private Sector
20 13,452
16.6
20.2
Foreign Banks
41 323
0.4
7
Total
87 81,241
100
100
Thus, public sector banks (PSB) continue to dominate with 73% of market share of assets and
83% of branches.
4.3. Regional Rural Bank
The banks provide credit to the weaker sections of the rural areas, particularly the small and
marginal farmers, agricultural laborers, and small entrepreneurs. There are several
concessions enjoyed by the RRBs by RBI such as lower interest rates and refinancing facilities
from NABARD. The RRBs are under the control of NABARD. NABARD has the responsibility of
laying down the policies for the RRBs, to oversee their operations, provide refinance facilities,
to monitor their performance and to attend their problems.
4.4. Co-operative Banks
The co-operative banks are small-sized units which operate both in urban and non-urban
centers. They finance small borrowers in industrial and trade sectors besides professional and
salary classes. Regulated by the Reserve Bank of India, they are governed by the Banking
Regulations Act 1949 and banking laws (co-operative societies) act, 1965. The co-operative
banking structure in India is divided into following 5 components:
Primary Co-operative Credit Society
Central co-operative banks
State co-operative banks
Land development banks
Urban Co-operative Banks
4.5 Unscheduled Banks
Unscheduled Bank means a banking company as defined in clause (c) of section 5 of the
Banking Regulation Act, 1949, which is not a scheduled bank.
Thus, the banking system is dominated by commercial banks. Rural and urban co-operatives
banks have a relatively small share in the banking system. However, given their geographic
and demographic outreach, they play a key role in providing access to financial services to
low and middle income households in both rural and urban areas. Similarly, RRBs play a key
role in promoting financial inclusion. The Government is pursuing branch expansion and
capital infusion plans for the RRBs.

5. Comparative Analysis of Basel I, Basel II and Basel III:

Types of
Risk
Covered

Main tools
of Risk
Manageme
nt

Basel 1
Credit Risk
Market Risk

Capital to Risk 1. CRAR

Weighted
2. Supervisory Review
Assets Ratio 3. Market Discipline
(CRAR)

Ways of
Simple but
Calculation
standard
of Risk
Weighted 4 major risk
Assets and
categories of
CRAR
assets and
risk weights
according to
it

Major
Contributio
n

Basel 2
Credit Risk,
Market Risk &
Operational Risk

From Simple to Complex & flexible

Approach
Lesser Risk
Weights in
Complex
Approaches
Type
Method 1
Method 2
Method 3
o
fCredit
Risk
Standardize Foundation Advanced
Risk
d Approach Internal
Internal
Rating
Rating
Based
Based
Market
Standardize Internal Model Approach
Risk
d Approach
Operation Basic
Standardize Advanced
d Approach Measurem
al
Indicator
ent
Approach Approach
Approach
First
1. Covered Operational risk apart from credit &
market risk
International
Measure
to 2. Recognized differentiation & brought flexibility
cover banking 3. Better asset quality helped banks to reduce
risk
Capital Requirements

Basel 3
Credit Risk
Market Risk
Operational Risk
Liquidity Risk
Counter Cycle Risk
1.CRAR
2.Supervisory Review
3.Market Discipline
4.Liquidity Coverage
Ratio
5.Counter
cycle
Buffer
6.Capital
Conservation
Buffer
7.Leverage Ratio
Same as Basel 2 but
additional capital for
Capital Conservation
& Contra Cyclical
Buffer

Liquidity
Risk
Management
Will help to build
capital during good
time, which can be
used in stressed
situation by Counter
Cycle Buffer
Introduction
of Capital
Conservation
Buffer

6. Difference between the RBI Regulations and the BASEL 3 Norms

The regulatory capital requirements stipulated as per the RBI under the BASEL III norms are
given below:
Sl. No. Regulatory Capital
1
Minimum Common Equity Tier 1 Ratio
2
Capital Conservation Buffer
Minimum Common Equity Tier 1 Ratio + Capital Conservation Buffer
3
[(1)+(2)]
4
Additional Tier 1 Capital
5
Minimum Tier 1 Capital Ratio [(1)+(4)]
6
Tier 2 Capital
7
Minimum Total Capital Ratio [(5)+(6)]
8
Minimum Total Capital Ratio + Capital Conservation Buffer [(2)+(7)]

% of RWAs
5.5
2.5
8.0
1.5
7.0
2.0
9.0
11.5

Monitoring of Liquidity Standards under Basel III: Banks have been advised to meet the
following regulatory limits to satisfy their liquidity standards under Basel III framework:
Inter-Bank Liability (IBL) Limit: Currently, the IBL of the bank should not exceed 200% of the net
worth as of 31 March of the previous year. However, banks having a CRAR above 11.5% are
allowed to have a higher limit of 300%.
Call Money Borrowing Limit: Currently, as per RBI norms, the borrowings on the call money
market should not exceed 100% of the banks capital funds. However, during a fortnight, banks
can borrow 125% of their capital funds.
Call Money Lending Limit: Currently, as per RBI norms, the lending on the call money market
should not exceed 25% of the banks capital funds.
However, during a fortnight, banks can lend 50% of their capital funds. Thus, it can be seen
that the following are the 2 major differences between the BASEL III norms and the RBI
implementation guidelines:
1. The guidelines require banks to maintain a Minimum Total Capital (MTC) of 9%
against 8% (international) prescribed by the Basel Committee of Total Risk Weighted
assets. This has been decided by Indian regulator as a matter of prudence.
2. The RBI has set the minimum leverage ratio required at 4.5% instead of the 3%
stipulated by the Basel III norms. Since, Indian banks do not have a large exposure to
large derivative activities, this is not expected to have a large impact.
3. In terms of the liquidity requirements, the RBI currently also has the SLR and CRR
requirements due to which the liquidity requirements under the Basel III norms can
be met easily.

7. Impact Of Basel 3 On Indian Banking System: Modelling The Loan

Demand In India And The Impact Of These Regulations Of The Indian
Economy
7.1. BASEL III Capital Requirements: RBI
As a response to the aftermath of the global financial crisis, with a view to improving the
quality and quantity of regulatory capital, RBI has stated that the predominant form of Tier I
capital must be common equity; as it is critical that banks risk exposures are backed by high
quality capital base. As a result, under Basel III guidelines total regulatory capital must be the
sum of following categories:1. Tier I Capital (going concern capital)
a. Common equity Tier I
b. Additional Tier I
2. Tier II Capital (gone concern capital)
Furthermore banks are also required to maintain a capital conservation buffer (CCB) of 2.5%
of RWAs in the form of common equity Tier I Capital.
7.2. Impact of BASEL III on Indian Banking
The BASEL III capital requirement will be a positive impact for banks as it raises the minimum
core capital stipulation, introduces counter cyclical measures, and enhances banks ability to
conserve core capital in the event of a stress through conservation capital buffer. The
prescribed liquidity requirements, on the other hand, would bring in uniformity in the liquidity
standards of India. This liquidity requirement will help Indian banks manage liquidity
pressures in a stress scenario in a better manner.
Impact on Weaker Banks:
As economic conditions deteriorate and regulatory capital requirements become more
stringent, the weaker banks will find it more challenging to raise the required capital and
funding for economic purposes. This can have a drastic effect on
them leading to the crowding out of the weaker banks in India. This will tilt the competition
in favor of the larger PSU banks and financial institutions like SBI, ICICI, etc.
Increased Supervisory Vigil:
Banking operations might experience a reduced pace as there would be an increased
supervisory vigil on the activities of the banks in terms of ensuring the capital standards,
liquidity ratios- LCR, NSFR among others.
Reorganization of Institutions:
The increased focus of the regulatory authorities on the organizational structure and capital
structure ability of the financial institutions, i.e., banks would lead the banks to reorganize
their legal identity by resorting to mergers & acquisitions and disposals of portfolios, entities
or parts of entities wherever possible.
International Arbitrage:

In case the implementation of BASEL III is not done properly there might be the existence of
arbitrage in the international markets. This could lead to disruption of global financial
stability.
Impact on Capital Standards in India:
Indian banks need to look for quality capital and also have to preserve the core capital as well
as use it to more efficiently in the backdrop of BASEL III requirements. Though Indian banks
are placed comfortably, they still need to phase out those instruments from their capital
which are disallowed under BASEL III. In view of the favorable economic conditions in the
coming years, a few of the banks can shore up their capital bases through issuance of equity,
but the non-performing banks may be required to raise additional equity capital to maintain
the required 7% requirements.
Impact on Loan Spreads
The purpose here is to find the impact of BASEL III norms on the loan spreads that can be
charged by Indian banks in the near term. The estimation supposes that the return on equity
(ROE) and the cost of debt, are unaffected with no change in other sources of income, and
with the same line of thought it is assumed that there is no reduction in operating expenses.
A raise in interest rate charged on bank loans is supposed to decrease the loan demand in the
country leading to a drop in investment and output.
2 approaches to study the impact of BASEL III norms on loan spreads have been carried out
be researchers. They are :a. Representative Bank Approach (Mervin King)
b. OECD Approach
The results of impact of increase capital ratio on the loan spread of SCBs is shown in the
following table:Increase in Capital Ratio

+1
+2
+3
+4
+5
+6

Under- representative Bank Model Under OECD Model

employed by BCBS
Assuming RWAs unchanged
31.4
45.2
59
72.8
86.6
100.4

15.63
31.26
46.89
62.52
78.15
93.78

Now, if we assume that there is a decrease in RWAs, then its impact is as follows:-

Increase in Capital Ratio

Under- representative Bank Model Under OECD Model

employed by BCBS
Assuming for decline in RWAs

+1
+2
+3
+4
+5
+6

22
32
42
50
59
68

15.01
30.02
45.03
60.02
75.05
90.06

Impact on Capital:
Under BASEL III Tier 1 capital will have to be the predominant form of regulatory capital. It
will be minimum 75% of the total capital of 8%. i.e. 50% of the total capital. Again, within Tier
1 capital, common equity will have to be the predominant form of capital. It will have to be
minimum 75% of the Tier 1 capital requirement of 6%, i.e. 4.5%, for the existing level of 2%.
It is evident that the meaning of predominant form of common equity in Tier 1 capital
portion in total capital as 50% under Basel 1 and 2 has undergone a change to 75% under
Basel 3, thus enhancing the overall level of high quality capital in the banks.
Furthermore, innovative features in non-equity capital instruments are no longer accepted in
BASEL III. As such, Tier 3 capital has been adequately brought to an end. The regulatory
adjustments or deductions from capital, which are currently applied at 50% to Tier 1 capital
and 50% to Tier 2 capital, will hence be 100% from the common equity Tier 1 Capital. Towards
improving market discipline, all elements of capital are supposed to be disclosed along with
a detailed reconciliation of reporting accounts. Thus the definition of capital in terms of
quality, quantity, consistency and transparency has improved under BASEL III. The average
Tier 1 capital ratio of Indian banks is around 10% with more than 85% comprising of common
equity. It is felt that Basel III regulations would affect the equity capital marginally.
Impact of Capital Standards:
Key Recommendations of BASEL
III
Possible Impact
Increased Quality of capital
Increased quantity of capital

Reduced leverage ratio

May lead to capital raising by banks besides retention of

profits and resorting to reduced dividends
Banks will face additional capital requirements and
hence would raise common equity or otherwise retain
dividends
This could lead to reduced lending apart from the
likelihood of banks reducing the financing of projects.
Banks may reduce credit exposure and hence potential
credit losses through stricter credit approval processes,
and potentially through lower limits, especially with
regard to bank exposures. Banks may focus on higher risk
and higher return lending. Pressure arises on banks to sell
low margins assets.

Fig: Impact of key factors of capital standards on equity tiers

Key Factors
1

Increase in credit
deployment
Introduction of
capital buffer
Increase in capital
requirements
Transition to upper
approaches of credit
risk

2
3
4

Impact on equity Impact on

capital
additional Tier 1
Increase
Increase

Impact on Tier 2
capital
Increase

Increase

Increase

Increase

Increase

Increase

Increase

Decrease

Decrease

Decrease

8. Current Status of BASEL III Implementation in India

All the banks started reporting CAR ratio calculated as per BASEL-III norms from 201314
Regulatory requirement for CAR as per BASEL-III norms is minimum of 9%. All banks
are maintaining this minimum of 9%
Regulatory requirement for Tier I CAR is a minimum of 6.5% as per BASEL-III norms.
All 5 banks are maintaining this minimum of 6.5%

8.1. Banks Own Proactive Internal Approaches for Capital Adequacy Ratios
All banks have developed their own policies, methods and assessment techniques for proper
mapping of credit, operational, marker etc...type of risks in relation to projected business
growth. This is helping banks meet the regulatory requirements for capital adequacy ratios
by default. This is also mainly helping banks in proper assignment of capital and planning
which paves the way for expected growth. Technology based risk management systems are
also coming very handy for these risk assessment purposes. Adequacy of capital under stress
has also become integral part of banks Internal Capital Adequacy Assessment process (ICAAP).
The horizon for projections are typically for 2 to 3 years.
Thus banks identify, assess and manage comprehensively all risks that they are exposed to
through sound governance and control practices, robust risk management framework and an
elaborate process for capital calculation and planning.
Following are some of the risks being considered by banks during internal assessment
processes
Credit Risk, including residual risks
Credit Concentration Risk
Market Risk
Business Risk
Operational Risk

Strategic Risk
Interest Rate Risk in the Banking Book
Compliance Risk
Liquidity Risk
Reputation Risk
Intraday risk
Technology Risk
Model Risk
Counterparty Credit Risk

9. References
1. INTERNATIONAL BANKING REGULATION by Maximilian J.B. Hall and George G.
Kaufman, Dec 2002
2. A brief history of the Basel Committee, report by Bank For International Settlements,
Oct 2014
3. Financial Stability Report(Including Trend and Progress of Banking in India), RBI, Dec
2014
4. Banking Structure in India- Looking Ahead by Looking Back by Duvvuri Subbarao
5. Annual reports of SBI, UBI, HDFC, ICICI and Axis Bank for the year 2013-14
6. RBI Guidelines for implementation of Basel 3 norms-An overview.
www.allbankingsolutions.com/Banking-Tutor/Basel-iiiimplementationguidelines-RBI.htm
7. Comparison
of
Basel
II
and
III
norms.
http://www.allbankingsolutions.com/banking-tutor/basel-iii-accord-basel3- norms.shtml
8. Basel III: Implications for Indian Banking, Dr. Vigneshwara Swamy, IBS Hyderabad
9. https://www.princeton.edu/~hsshin/www/nr.pdf
10. http://www.narendramodi.in/capital-requirement-of-public-sector-banksraising-capital-from-public-markets-by-broad- basing-shareholding/
11. http://businesstoday.intoday.in/story/reserve-bank-of-india-rbi-tightens-rulesfor-nbfc/1/212188.html
http://www.businessstandard.com/article/finance/capital-raising-from-markets-by-govt-banksremains-a-challenge-rbi- 114122901091_1.html