Banks going to gear up for Basel III norms

The Reserve Bank of India (RBI) this month released the final guidelines of the Basel III norms aimed at toughening up the banking system in the country to withstand all kinds of risk and financial shocks.

The guidelines framed by a committee of central banks of various countries, to which RBI is also a member, based in Basel, Switzerland, seek to fortify banking systems across the world after the massive banking crisis in 2008 and in 2009.

The existing norms stipulate that banks maintain Tier-I capital or core capital and Tier-II comprising instruments with debt-like features, whereas Basel III has introduced many elements of capital like a clearly defined common capital that measures core equity in relation to its total risk weighted assets. Simply put, they asses the bank’s financial strength and capital conservation buffers (CCB) at various levels.

The new norms will be made effective in a phased manner from January 1, 2013 and fully implemented by March 31, 2018. The key point is that banks need to achieve a minimum Core Equity Tier-I (CETI) capital adequacy of 5 per cent by FY’14 and then, in a staggered manner, increase it to 8 per cent by FY’18.  

Some experts aver that Basel III is not meant for Indian banks, but insist they are relevant in addressing problems which could arise as domestic banks transform into organisations similar to their global counterparts over the next decade. From an investor perspective, there would be no impact of Basel III on the share market investors’ perception in the valuation of Indian banks, says Crisil Ratings Senior Director Pawan Agrawal.  

He also explains that transition to Basel III will not be any challenge since most banks have a common equity capital ratio which is above the prescribed requirements of 4.5 per cent, stipulated under Basel III. Yet, the transition timeline (till 2018) should suffice for banks in raising the required amount of equity and prepare the market and the system to adjust.

By and large, bankers concede that the Indian banking system is already stable, far less complex and well-capitalised as compared to banks across the globe. Still, they believe that Basel III is a step in the right direction in terms of preparing the domestic banks to address or prevent some of those challenges faced by their global counterparts.
Macquarie Capital Securities in a report says, Basel III would be more an issue of growth than solvency for domestic banks, more so for public sector banks (PSBs) because they are at the mercy of the government with regard to their capital needs. “Frequent dilutions will be required to support growth and also simultaneously maintain capital adequacy ratio levels,” it adds.

Impact immediate

The immediate impact of the Basel III capital regime will be benign as the CETI ratio of many domestic banks is already close to 8 per cent or higher. However, the shortfall will be likely between FY’16 and FY’18, mostly for government banks with loan growth outpacing internal capital generation and the minimum capital ratios stepping up. The additional equity will be needed for business growth and for creating a buffer above the regulatory minimum.

Reports of many rating agencies suggest that banks in India will require Rs 3.9 to R5 trillion as capital over the next six years to comply with Basel III norms. Of this, CETI requirements will be Rs 1.3 to 2 trillion; Rs 1.9 trillion for additional tier-I; and Rs 1 trillion for tier-II, which is “achievable so long as banks can find investors for the riskier additional tier I capital,” says ICRA. This requirement can turn out to be higher (by another Rs 1.3 trillion) in case the investor appetite is low for non-equity tier-I capital instruments, adds Agrawal. PSBs will account for bulk (80 per cent) of the requirement and  need regular infusion from the government. The largest of them is the State Bank of India and its associate banks, reflecting their significant share in the banking system.

The new norms also ask banks to maintain a minimum of 5.5 per cent in common equity by March 31, 2015 as against the current 3.6 per cent, apart from creating a capital conservation buffer (CCB) consisting of common equity of 2.5 per cent by March 31, 2018. CCB is designed to ensure that banks build up capital buffers during normal times which can be drawn down as and when losses are incurred during a stressed period. However, RBI is yet to announce final guidelines on counter-cyclical capital buffer.

More for capital adequacy

Basel III also hiked the minimum overall capital adequacy to 11.5 per cent by March 31, 2018 as against the current 9 per cent. Over 80 per cent of common equity need relates to public sector banks (PSBs) and the government share would be Rs 0.3 to Rs 0.8 trillion in the total equity need of PSBs as per the government average stake in PSBs at around 58 per cent. “Incremental equity requirement appears manageable, considering past trends in capital mobilisation,” ICRA points out, adding, “Banks raised over Rs 1.0 trillion in equity during 2007-08 to 2011-12, of which around 54 per cent were mobilised by PSBs and 46 per cent by private banks.”

ICRA also warns that “if banks are unable to mop up the required additional tier-I and the gap is bridged by raising common equity, then the incremental equity requirement may go up to a high of Rs 3.2 to Rs 4.0 trillion over the next six years, of which the Centre’s share will be Rs 1.2 to Rs 1.7 trillion.” It would also be wrong to assume that the government won’t provide money for PSBs, counters Agrawal. In the last four years, the government has given a total of Rs 55,000 crore to PSBs, he says.

While the equity target may appear easy at first glance, it may not be so eventually as RBI has also introduced loss-absorption features in the additional tier-I capital instruments, say experts. These features can limit investor appetite to invest in banks’ instruments as profitability will be under cloud though ICRA thinks higher core capital will help improve credit ratings of banks in the long run.

When it comes to private players, most of them are already well-capitalised, so transition to Basel III may not impact their earnings significantly. “In fact, private banks’ competitive position can improve when PSBs raise their lending yields. But, at the same time, the upside potential for private banks can be limited by the higher minimum core capital requirement,” says ICRA.

Fitch Ratings, however, points out that domestic banks raised only about $2.5 billion of common equity from the markets in FY’11 and FY’12 combined. Unless planned, PSBs may face risks of a sudden shortfall in capital during FY’16, requiring additional support by from the government.

Enough time

Most public sector bankers are neither worried about the timeline as there is enough time to raise capital, if required. “If annual credit growth is around 15 per cent, then there will not be any problem, but if it is to be 20 per cent a year, then banks will be under some pressure. But, by and large, I don’t see any hassle in complying with the norms,” says IDBI Bank Executive Director R K Bansal.

CMDs of Union Bank of India and Indian Overseas Bank maintain that Basel III will force banks to plough back a larger chunk of their profit into the balance sheet. Banks may have to lower dividend payouts and retain more profit as capital, they said.

Although the total capital adequacy ratio (CAR) stipulated at 9 per cent under Basel III, unchanged from what the regulator prescribes in India currently, domestic banks will now need to raise more money than under the current Basel II norms because several capital instruments cannot be included under the new definition. Perpetual debt, for instance, now qualifies as a tier-I instrument which will be excluded under Basel III, forcing banks to raise more equity. So the challenge for banks is not in transitioning to Basel III, but in their capital-raising ability because at 20 to 25 per cent credit growth, they would need capital at a higher threshold, which could impact their return on equity, especially for PSBs.