Introduction to Basel Norms BCBS –Committee of Central bankers from across the world Tier 1 Capital and Tier 2 capital Risk Weighted Assets

Basel I  Basel II Minimum capital requirement of 8% Assets were risk-weighted according to the identity of the borrower Basel II - Risk-weighted according to the credit ratings

Basel II  Basel III No change in overall capital requirement TIER 1 Capital – 4 % to 6 % Common Equity - 2 % to 4.5% Capital conservation buffer – 2.5 %

Areas Main Basel III components Capital ratios and targets Capital definition Countercyclical buffers Leverage ratio Minimum capital standards Systemic risk RWA requirementsCounterparty risk Trading book and securitisation (also known as Basel II.5) Liquidity standardsLiquidity coverage ratio Net stable funding ratio Key Basel III components

Basel II minimum (2.0%) 1.TTC adjustments. 2. Basel III RWAs Basel III minimum (4.5%) 6. Systemic buffer (tbc) Basel III 3. Definition change 10. Impact of future accounting changes 7.Economic growth buffer 8. Market buffer 5. Countercyclical buffer (0.0% - 2.5%) 11.Volatility buffer 4.Conservation buffer (2.5%) Target CT1 ratio 9. Management buffer Basel III and other regulatory changes Additional considerations in setting target CT1 ratio 5 The approach to buffers

Capital buffers - Capital Conservation Buffer Purpose - to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions. Capital Conservation Buffer of 2.5 percent, on top of Tier 1 capital, will be met with common equity, after the application of deductions. Banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. Capital Conservation Buffer of 2.5 percent, on top of Tier 1 capital, will be met with common equity, after the application of deductions. 6

Capital buffers - Countercyclical Capital Buffer A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss absorbing capital will be implemented according to national circumstances. Banks that have a capital ratio that is less than 2.5%, will face restrictions on payouts of dividends, share buybacks and bonuses. The buffer will be phased in from January 2016 and will be fully effective in January Countercyclical Capital Buffer before 2016 = 0%, 1st January 2016 = 0.625%, 1st January 2017 = 1.25%, 1st January 2018 = 1.875%, 1st January 2019 = 2.5% 7

Regulatory Capital Ratio Total Regulatory Capital Ratio = [Tier 1 Capital Ratio] + [Capital Conservation Buffer] + [Countercyclical Capital Buffer] + [Capital for Systemically Important Banks] 8

Why so much importance for more capital??? To sustain any losses incurred by the bank To manage any financially stressful situation when the bank loses its credibility. Above all, as a response to the economics of moral hazard - discourages banks from involving in riskier activities like issuing CDS/Mortgage backed loans to unworthy borrowers, which happened in case of sub-prime crisis. 9

Leverage ratio IssuesBasel III proposals Observations during crisis situations Build up of excessive leverage – e.g. Current debt of European banks & nations Pre-crisis build up of excessive leverage in the banking system Crisis market pressure to reduce leverage, amplified downward pressure on asset prices Capture Off-Balance Sheet (OBS) items Constrain build-up of leverage in the banking sector Mitigate destabilising deleveraging which damages financial system and economy Reinforce risk-based requirements with a simple, non-risk-based backstop measure based on gross exposure Limiting excessive credit growth 10

Liquidity Coverage Ratio (LCR) The ratio is intended to ensure that a bank maintains adequate levels of unencumbered high quality assets to meet its liquidity needs. Measured as the ratio of the bank’s high quality liquid assets (numerator), divided by its net cash outflows over a 30-day period (denominator) The high quality assets included in the numerator include only Cash, central bank reserves that can be accessed during times of stress, marketable securities meeting certain criteria, and government or central bank debt The denominator will be calculated by taking into account certain “run-off factors” 11 LCR = High-quality liquid assets Net Cash Outflow (30 days)

Net Stable Funding Ratio (NSFR) To promote medium to long term structural funding of assets and activities “Stable funding” – the portion of those types and amounts of equity and liability financing expected to be reliable sources of funds over a one-year time horizon under conditions of extended stress Defined as Available amount of stable funding / Required amount of stable funding > 100% 12

Basel III : Transitional Arrangements

Impact on Indian Banks 14 Regulatory Capital Adequacy Levels Proposed Basel III Norm Existing RBI Norm Common equity (after deductions)4.5%3.6% (9.2%) Conservation Buffer2.5%Nil Countercyclical Buffer0-2.5%Nil Common equity + Conservation buffer + Countercyclical buffer 7-9.5%3.6% (9.2%) Tier I(including the buffer)8.5-11%6% (10%) Total capital (including the buffers) %9% (14.5%)

Basel III impact on Public Sector Banks 15