RBI’s mandated 9% Capital Adequacy for Indian Commercial Banks as a Prudence against 8% Basel III norms

Last Updated on June 29, 2017 by Bharat Saini

Reserve Bank of India issued Guidelines based on the Basel III reforms on capital regulation on May 2, 2012, to the extent applicable to banks operating in India. The Basel III capital regulation has been implemented from April 1, 2013 in India in phases and it will be fully implemented as on March 31, 2019. Banks have to comply with the regulatory limits and minima as prescribed under Basel III capital regulations, on an ongoing basis. Banks are required to maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) of 9% on an on-going basis (other than capital conservation buffer and countercyclical capital buffer etc.). As a matter of prudence, it has been decided that scheduled commercial banks (excluding LABs and RRBs) operating in India shall maintain a minimum total capital (MTC) of 9% of total risk weighted assets (RWAs).

Basel Committee on Banking Supervision (BCBS) provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee’s Secretariat is located at the Bank of International Settlements (BIS) in Basel, Switzerland. However, the BIS and the Basel Committee remain two distinct entities.

Basel III is an international regulatory accord that introduced a comprehensive set of reform measures, developed by the BCBS, to strengthen the regulation, supervision and risk management of the banking sector. BCBS published the first version of Basel III in late 2009, giving banks approximately three years to satisfy all requirements. Largely in response to the credit crisis, banks are required to maintain proper leverage ratios and meet certain minimum capital requirements. A focus of Basel III is to foster greater resilience at the individual bank level in order to reduce the risk of system-wide shocks. The implementation of the Basel standards is monitored. Under Basel III, the minimum capital adequacy ratio that banks must maintain is 8%. The capital adequacy ratio measures a bank’s capital in relation to its risk-weighted assets. The capital to risk-weighted assets ratio promotes financial stability and efficiency in economic systems throughout the world.

The capital adequacy ratio is calculated by adding components of Capital Tier 1 Capital to Tier 2 Capital and dividing by risk-weighted assets.

• Tier 1 capital (going-concern capital) is the core capital of a bank, which includes equity capital and disclosed reserves. This type of capital absorbs losses without requiring the bank to cease its operations. This include:

(a) Common Equity Tier 1

(b) Additional Tier 1

• Tier 2 Capital (gone-concern capital) is used to absorb losses in the event of liquidation. Tier 2 capital consists of unsecured subordinated debt with an original maturity of at least five years.

 

Risk-weighted assets represent a bank’s assets weighted by coefficients of risk set forth by Basel III. The higher the credit risks of an asset, the higher its risk weight. Basel III uses credit ratings of certain assets to establish their risk coefficients

The Basel III capital regulations continue to be based on three-mutually reinforcing Pillars:

• Pillar 1: Minimum capital requirements
• Pillar 2: Supervisory review of capital adequacy
• Pillar 3: Market discipline of the Basel II capital adequacy framework

Under Pillar 1, the Basel III framework will continue to offer the three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk, albeit with certain modifications / enhancements. These options for credit and operational risks are based on increasing risk sensitivity and allow banks to select an approach that is most appropriate to the stage of development of bank’s operations.

The options available for computing capital for credit risk are:

• Standardised Approach,
• Foundation Internal Rating Based Approach
• Advanced Internal Rating Based Approach.

The options available for computing capital for operational risk are:

• Basic Indicator Approach (BIA),
• The Standardised Approach (TSA)

Advanced Measurement Approach (AMA)