Basel III Norm in India Bank

Basel III is an evolution rather than a revolution in the area of banking regulation. Drawing
largely from the already existing Basel II framework, Basel III aims to build robust capital base
for banks and ensure sound liquidity and leverage ratios in order to weather away any banking
crises in the future and thereby ensure financial stability
Figure-4.1: Evolution of Basel II to Basel III
Basel - III
Basel - II

Pillar I

Pillar I

Pillar II

Pillar III

Minimum
Capital
Requirements

Supervisory
Review
Process

Disclosure
& Market
Discipline

Enhanced Minimum
Capital & Liquidity
Requirements

Pillar II

Pillar III

Enhanced
Supervisory
Review

Enhanced
Risk
Disclosure

Process for
Firm-wide Risk
Management
and Capital
Planning

&Market
Discipline

Source: A public document of Moodys Analytics

Basel III documents (Basel III: A global regulatory framework for more resilient banks and
banking systems29 and Basel III: International framework for liquidity risk measurement,
standards, and monitoring30) present the Basel Committees reforms to strengthen global capital
and liquidity rules with the goal of promoting a more resilient banking sector. The objective of
the reforms is to improve the banking sectors ability to absorb shocks arising from financial and
economic stress (whatever is the source), thus reducing the risk of spillover from the financial
sector to the real economy. This document sets out the rules text and timelines to implement the
Basel III framework.

1 CAPITAL STANDARDS
Firstly, objective of the standard: Raising Capital Base is ensuring quality, consistency in

definition across. Jurisdictions and transparency in disclosure of capital base. Measures

suggested in this regard include: (a) Tier 1 capital predominantly held as common shares and
retained earnings; (b) Remainder of Tier 1 capital comprising of subordinated instruments with
fully discretionary non-cumulative dividends and with no maturity date or incentive to redeem;
(c) Innovative hybrid instruments with an incentive to redeem would be phased out.
Secondly, the objective of the capital standard: Enhancing Risk Coverage is aimed at
strengthening risk coverage of capital framework especially for on-and off-balance sheet items
and derivative exposures. Measures proposed towards this objective include: (i) Introduction of
stressed Value-at-Risk (VaR) capital requirement based on a continuous 12-month period of
significant financial stress; (ii) Higher capital require-ments for re-securi-tisation in banking and
trading book; (iii) Introduction of capital charge for potential mark-to-market losses related to
credit valuation adjustment risks associated with deterioration in creditworthiness of
counterparty (iv) Strengthening standards for collateral management. Banks with large illiquid
derivative position to a counterparty would have to apply longer margining periods for
determining regulatory capital requirements.
BaselIII recommends raising the quality, consistency, and transparency of banks regulatory
capital base. The primary intention is to declare common equity and retained earnings as the
predominant form of Tier 1 capital31. The previous capital regulation did not require banks to
hold a defined level of common equity and set limits only on total Tier I capital and total
capital32. Basel II stated that banks have to maintain 8 percent of capital base consisting of atleast
50 percent Tier I capital. Banks could have held as little as 2 percent of assets in common equity
without breaking regulatory standards. As such, banks could hold high capital ratios but with
majority of capital in preferred stock or supplementary capital. The best quality of capital is the
common equity as it is subordinate to all other types of funding that can absorb losses and has no
maturity date. Accordingly, any assets included in Tier I capital apart from common equity must
be able to absorb effectively. The ability to immediately counteract losses characterizes an
assets capacity for absorption of uncertain losses.