Basel Accords, Banking Regulation & PCA Framework

Key Principles

Capital Requirements

• Since 2015, a minimum Common Equity Tier 1 (CET1) ratio of 4.5% must be maintained at all times by the bank

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Leverage Ratio

• It means, buying assets with borrowed money to multiply the gain.
• The banks are expected to maintain a leverage ratio in excess of 3%

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Liquidity Requirements

• Banks can be subjected to a lot of risk if all depositors come and ask all their money at the same time.
• This is a hypothetical situation but it has happened in real with Lehman Brothers – the bank whose collapse gave us the 2008 recession.
• It was issued in December 2010 which presented the details of global regulatory standards on liquidity.
• Two minimum standards
  • Liquidity Coverage Ratio (LCR)
  • Net Stable Funding Ratio (NSFR)

Liquidity Coverage Ratio

• It promotes short-term resilience of banks to potential liquidity
• Need to ensure with high quality liquid assets (HQLAs) to survive an acute stress scenario lasting for 30 days.

Net Stable Funding Ratio

• It promotes resilience over longer term time horizons by requiring banks to fund their activities with more stable sources of funding on an ongoing basis.

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Basel III Norms in India

• BI has postponed the implementation of these norms to 2019
• Banks need to maintain min CRAR
  • Schedule Banks – 9%
  • Differential Banks – 15%
• Way to collect capital
  • Issue share, bond in capital market
  • Govt. will give 70k Cr. through Indradhanush Plan

Risk-Weighted Asset (RWA)

• It is a bank’s assets or off-balance-sheet exposures, weighted according to risk.
• This sort of asset calculation is used to determine capital requirement
• Different classes of assets have different risk weights associated with them.
• Corporate loan, Debentures are assigned a higher risk than cash or government securities

Capital to Risk (Weighted) Assets Ratio (CRAR)

• It also known as Capital Adequacy Ratio (CAR)
• Itis the ratio of a bank’s capital to its risk
• RBI track a bank’s CRAR to ensure that it can absorb a reasonable amount of loss
• Capital adequacy ratio is the ratio which determines the bank’s capacity to meet the time liabilities and other risks such as credit risk, operational risk etc.
• There are 2 types of CRAR
  • Tire1 – common shares, preferential shares
  • Tire2 – debt, hybrid instruments

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CCCB

• It is aimed to protect the banking sector against losses from changes in economic conditions.
• Banks may face difficulties in phases like recession when the loan amount doesn’t return.
• Banks should have own additional capital to keep flowing the economy
• This is an important theme of the Basel III norms.
• Its not using now, when needed RBI need to notify 4 quarters ahead
• Max 2.5% of RWA as common shares

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Prompt Corrective Action (PCA) framework

• Its a mechanism to ensure that banks don’t go bust.
• RBI has put some points to assess, monitor, control and take corrective actions on banks which are weak and troubled.
• It was introduced by Bimal Jalal in 2002 in India and was tightened by RBI governor Urjit Patel in April 2017.
• There are some parameter to measure the Banks risk situation
  1. NPA
  2. CRAR
  3. Profitability
  4. Leverage
• Maximum tolerance limit, sets at
  • net NPA over 12%
  • negative return on assets for 4 consecutive years
• 2 type of restrictions is there
  • Mandatory – Restrictions on dividend, branch expansion, directors compensation
  • Discretionary – Restrictions on lending and deposit
• It’s a Direct action by RBI under qualitative tools.
• It imposed only on Scheduled Commercial Banks except RRB.
• Banks are not allowed to re-new or access costly deposits or increase their fee-based income.
• Banks will also have to launch a special drive to reduce the stock of NPAs.
• They will also not be allowed to enter into new lines of business and borrow from interbank market.

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Society for Worldwide Interbank Financial Telecommunication (SWIFT)

• Provides a network to financial institutions worldwide to send and receive information about financial transactions.
• It is popularly known as “SWIFT codes“.
• Established in 1973.
• Now operates in 210 countries, linking more than 10,000 financial institutions.
• Each financial organization has a unique code of 8 or 11 characters.
• The code is interchangeably called the Bank identifier code (BIC), SWIFT code, SWIFT ID, or ISO 9362 code.
• Users of SWIFT are -Banks, money brokers, security broker dealers, clearing systems, corporates, NBFCs and more.
• SWIFT network doesn’t actually transfer funds.
• It sends payment orders between institutions’ accounts, using SWIFT codes.
• SWIFT transaction will need to go through intermediary banks, each of them levy their own fee.