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Outline
Introduction Enhancement to Basel II Building blocks of Basel III Elements of Basel III relevant for banks treasurers Implications of Basel III Impact on Indian banks Conclusion
Introduction
The Basel I 1988 capital charge for credit risk a simple broad-brush approach Amendment to Basel I 1996 to incorporate capital charge for market risk
Standardized Measurement Method (SMM) Internal Models Approach (IMA)
A menu of approaches standardized to model based with increasing complexity Three pillar approach
The Basel II of 2004 copied and pasted the capital charge for market risk of Basel I amendment of 1996
As a result, the capital charge framework for market risk did not keep pace with new market developments and practices Capital charge for market risk in trading book calibrated much lower compared to banking book positions on the assumption that markets are liquid and positions can be wound up or hedged quickly
Capital charge for specific risk (credit risk) in market risk framework (trading book) was lower than capital charge for credit risk in banking book Lower capital charge for trading book led to scope for capital arbitrage Capital charge for counterparty credit risk for derivative positions also covered only the default risk and migration risk was not captured
The global financial crisis mostly happened in the areas of trading book /off balance sheet derivatives / market risk and inadequate liquidity risk management Banks suffered heavy losses in their trading book Banks did not have adequate capital to cover the losses
There was heavy reliance on short term wholesale funding Unsustainable maturity mismatch Insufficient liquidity assets to raise finance during stressed period
Enhancement to Basel II
Post- crisis, global initiatives to strengthen the financial regulatory system July 2009 Enhancement to Basel II mostly in trading book
Pillar 2 guidance
firm wide governance and risk management; capturing risk of off balance sheet exposures and securitization activities; managing risk concentrations; managing reputation risk and liquidity risk; improving valuation practices; and implementing sound stress testing practices
Pillar 3
appropriate additional disclosures completing enhancements in Pillars 1 and 2
Securitization exposures in trading book Sponsorship of off balance sheet vehicles Re-securitization exposures; and Pipeline and warehousing risks with regard to securitization exposures
Objectives
Improving banking sectors ability to absorb shocks Reducing risk spillover to the real economy
Banks using standardized approach or IRB approach for credit risk in OTC derivatives, must add a capital charge to cover CVA (Credit Valuation Adjustment) risk to capture down gradation of counterparty before default in all approaches Capital charge for wrong way risk PD and EAD are positively correlated - in all approaches
Asset value correlation of 1.25 for financial firms of $ 100 billion assets and unregulated financial firms Strengthening collateral management and extend margining period of risk to 20 days for OTC derivatives Increasing incentives for use of CCPs compliant with CPSS/IOSCO norms, for OTC derivatives
Ratio 3% As a Pillar 2 measure to start with but will be integrated with Pillar 1 Leverage ratio will be tracked from January 1, 2011 to see the result of the above definition and parallel run from January 1, 2013 to 2017 and final adjustment in 2017 Disclosure from January 2015 As Pillar 1 ratio from January 1, 2018
Improving loss-absorbing capacity of SIBs/SIFIs - Contingent capital and bail-in-able debt Orderly unwinding of SIBs/SIFIs improving resolvability living wills
Key characteristic of the financial crisis was inaccurate and ineffective management of liquidity risk Two standards/ratios proposed
Liquidity Coverage Ratio (LCR) for short term (30 days) liquidity risk management under stress scenario Net Stable Funding Ratio (NSFR) for longer term structural liquidity mismatches
Market-related characteristics
Active and sizable market Presence of committed market makers Low market concentration Flight to quality
Global banks could have a gap of liquid assets of 1,730 billion - to be met in four years Global big banks could have a capital shortfall of 577 billion to meet 7% common equity norm to be met in eight years Tier 1 capital ratio falls to 5.7% from 11.1% under the new definition / adjustment of capital and increase in risk coverage (RWAs) Therefore, long phase-in arrangements (Annex1)
Banks mostly follow a retail business model and do not depend on wholesale funds Whether our SLR securities can be part of liquid assets? Whether our liquid assets will stand the scrutiny of fundamental characteristics and market-related characteristics?
Indian banks are generally not as highly leveraged as their global counterparts The leverage ratio of Indian banks would be comfortable
Banks having a huge trading book and off balance sheet derivative exposures may be impacted due to increased risk coverage (capital) on account of counterparty credit risk
Similarly, banks having huge off balance sheet exposures - derivatives and others - may be impacted on account of leverage ratio Banks depending heavily on wholesale funds may be impacted due to the new liquidity standards SIBs may have further implications for capital and liquidity surcharges and activity restrictions
Whether our banks can attract capital in the form of contingent capital and bail-in able debt at the point of non-viability or whether our capital market will support such instruments?
Conclusion
Basel Committee is undertaking a fundamental review of the trading book whether a particular position to be covered in trading book or banking book and capital requirement Not only sluggish growth, high unemployment and low returns, but also more resolution will be the New Normal
Thank You