Basel III is meant to address the excesses of Western banks. It will hike borrowing costs in India and choke growth.
Basel I, Basel II, Basel II.5 and now, Basel III! Even as the global economy grapples with the problems of a persistent downturn and India's GDP is down for the eighth straight quarter, Indian banks may well have to gear themselves up for the implementation of the latest round of the Basel package.
The Reserve Bank of India has already circulated the draft guidelines for the implementation of Basel III norms, proposing a tighter timeline and higher capital adequacy norms than those adopted by the Basel Committee on Banking Supervision (BCBS) in December, 2010. The Indian standards are going to be stricter with respect to both the stipulated capital and leverage ratios and, the implementation period.
While the stipulated capital is higher by 1 per cent, and the leverage ratio by 2 per cent, the time-span for adoption has been shortened by two years. Will it be a case of ‘too much, too soon', an instance of being more loyal than the king? Should it be made applicable to all scheduled commercial banks? Will it stifle growth?
First, let us look at the context for the adoption of the Basel III reforms. It follows Basel II.5 which, for the first time, charged banks extra capital for the credit risk of what they hold in their trading portfolio.
The Basel III package seeks to address the lessons of the financial crisis in a post-2008 scenario, and aims at enhancing the banking sector's ability to absorb shocks arising from financial and economic stress. The background, obviously, is the sub-prime crisis in the US and the resultant fallout, which led to the collapse of leviathans like the Lehman's and the balance-sheet stress of Citi, Bank of America, RBS, et al.
Asia stood up quite resiliently to these developments. Like their counterparts in China, Japan, Hong Kong and Singapore, Indian banks too were largely unscathed, thanks to forward-looking counter-cyclical, macro-prudential national regulations, pioneered by the RBI under Dr. Y. V. Reddy. In fact, while liquidity dried up for Western banks then, it was a problem of plenty for Indian banks, with SBI itself receiving inflows of almost Rs 1000 crore daily during January-February of 2009, in a flight to safety of NRI money. State Bank of India was seen globally as the “Safe” Bank of India!
It is widely known that the problems arose in the West because of the widespread use of financial weapons of mass-destruction — Mortgage Backed Securities, Collateralised Debt Obligations and Credit Default Swaps. The bipartisan Levin-Coburn report of the US Senate, running into 629 pages, authored by Senator Carl Levin (Democrat) and Tom Coburn (Republican), April, 2011, has documented in detail the use of complex derivatives by US banks, and made 19 recommendations to prevent such crises in future.
A close reading of these19 recommendations of the report, titled Wall Street and the Financial Crisis: Anatomy of a Financial Collapse, makes it clear that the crisis had very little to do with Basel norms or their inadequacies. The investigation found that the crisis was “the result of high risk, complex financial products, undisclosed conflicts of interest, and the failure of regulators to rein in the excesses of Wall Street”.
Complex financial products, which nobody understood, and light-touch regulation were the main reasons why Western banks were shaken to their foundations by the impact of the crisis. Regulators were asleep at the switch. In the UK, for instance, an audit by the Financial Services Authority would typically be done in less than an hour, according to colleagues who worked in the London offices of Indian banks.
The RBI is a more thorough-going regulator, and its CAMELS-based supervision of Indian banks has been largely effective in making sure that they function in a safe and sound manner. A typical Annual Financial Inspection (AFI) of an Indian bank would take approximately 45 to 60 days, being detailed both in its scope and coverage.
Also, Indian banks have been traditionally dealing in plain-vanilla loans and advances, mainly the ubiquitous cash-credit and term loans. They don't deal in any of the derivatives that are the staple of the Western banks. Even in terms of operations at the branch level, what do Indian bank branches do? Mainly, direct housing loans, vehicle loans, cash-credits to industry, trade and business and term loans. Where is the complexity in all this?
Even the international operations of Indian banks are insignificant. Out of the 26 public sector banks in India, only three — SBI, Bank of Baroda and Bank of India — have any international operations worth the name. None of the foreign offices of Indian banks dabble in any derivatives/complex instruments. In foreign centres, the assets portfolio of Indian banks consists of mostly statutory investments, India-related trade credit (Buyers Credits and Suppliers' Credits or Bills discounted under LCs of Indian banks) and ECB loans of Indian corporates.
The systemic importance of Indian banks is another important parameter to be kept in mind while making Basel III applicable to them. The US Federal Reserve Board, for instance, in its proposal released in December, 2011, has announced that its new risk-based capital, leverage and liquidity requirements would be applicable only to banks with consolidated assets of US$ 50 billion (Rs 250,000 crores) or more. It is noteworthy that the Federal Reserve hasn't proposed adoption of the Basel III package in its entirety, even though it is a member of the BCBS).
Out of 48 Indian public and private sector banks, only seven had assets in excess of Rs 250,000 crore, as at March, 2011; 23 had asset sizes of less than Rs 75,000 crores ($ 15 billion). The Basel committee's move is to make the new Basel III rules applicable even to banks like Tamilnad Mercantile Bank (Assets of Rs 16,117 crore), Lakshmi Vilas Bank (Rs 13,301 crore) and Catholic Syrian Bank (Rs 9829 crore).
How perverse would it be to impose international norms drawn up in the aftermath of the “excesses” of the Western monoliths on small Indian banks engaged in straightforward, traditional banking? If New York Governor Arnold Schwarzenegger has migraine, should Mayor Sharadamma in Bangalore take any analgesic?
There are studies by the Organisation for Economic Co-operation and Development and the Institute of International Finance (the global bankers' body) which indicate that Basel III norms will lead to increase in borrowing costs and choke growth.
CRISIL has estimated that the Basel III norms would necessitate Indian banks raising Rs 2,70,000 crore in capital during the next 5 years. That is an average of Rs 55,000 crore every year. It is the public sector banks that would require most of the capital. It is a moot point how the Union Government will find the resources to fund this requirement of capital.
There definitely is a case for a very selective adoption of the Basel III norms by Indian banks, based on their asset size, systemic importance, complexity of operations and international linkages or similar parameters, looking to our own growth/stability needs. One size won't fit all. And Mumbai needn't sneeze each time New York catches a cold.