Basel III overlooks our growth needs

The Reserve Bank fulfilled its promise of releasing by 2011 the draft guidelines outlining proposed implementation of Basel III capital regulation in India. The guidelines require achievement by March 2017, of minimum capital requirements to risk weighted assets (RWA) by commercial banks (CBs), with a transitional arrangement: 5.5 per cent of common equity tier capital; total tier I of 7 per cent; and total capital including tier II of 9 per cent. There will be an additional capital conservation buffer of 2.5 per cent, taking the total minimum capital requirement to 11.5 per cent.

Of the three additional features, some prescriptions on leverage have been added. RBI may await further work pertaining to liquidity standards and the counter-cyclical buffer. While as one of the 27 members of the Basel Committee, India is committed to implement Basel III, two conservative deviations in the RBI guidelines are worth noting. First, the time schedule is tighter, compressing the implementation period by two years from 2019 to 2017. Secondly, the overall requirement of capital is more stringent at least by one percentage point.

These deviations are apparently based on the present level of over-compliance by banks which provide the confidence to reach the goals earlier and at an elevated level. No other country seems to have adopted this approach. A more conservative approach has several advantages: First, it reduces the adverse incentive of slippage; second, it raises the level of prudential expectations as the markets get liberalised (including the possibility of an open capital account), grow, diversify and become more sophisticated and converge to global practices; third, the new banks that are in the licensing pipeline will start with an initial hurdle of additional buffer; and last, but not the least, it compels the government to augment capital or dilute the ownership status of public sector banks if they are to grow and be competitive in the coming years. But, there are serious development concerns.

Development Concerns

While the current debate centres around capital-raising concerns, in the Indian situation, public policy should not fail to address concerns about growth ambitions.

Strangely, the Basel III implementation period coincides with the period of Twelfth Five Year Plan, which targets a growth rate of 9 per cent. Now, it is certain that the initial two years of the Plan will end with below target growth rates, which would need to be compensated in the later three years by a larger than average growth rate, when the Basel III demands on the banking system also will be the maximum.

Unlike advanced countries, the linkage between growth and bank credit in India is much deeper, given the dominance of bank intermediation and less sophisticated development of markets. Furthermore, industry and infrastructure and social sector will place very large demands on the banking system, apart from the needs arising out of inclusive growth. The available data show that the growth in credit to priority and, in particular, to farm and MSME sectors has dwindled, coinciding with lower growth rate of the economy. The Basel approach is commented upon as linear to credit risk and does not take into account the composition risk. A portfolio of larger retail and real estate loans and leveraged derivatives by itself may carry additional risks.

The RBI has established additional prudential standards in terms of risk weights and provisioning. Banks also have in general a safer portfolio in the form of liquid and safe securities. Institutionally, all are not alike. In the Indian case, public sector banks carry by and large an additional load of socio-economic targets, and they enjoy implicit sovereign guarantee.

TOO STRINGENT

The non-consideration of the countercyclical capital buffer at this stage (0 – 2.5 per cent) is perhaps to allow the normal credit cycle to operate, given the Indian circumstance. However, it may also be interpreted that the additional one percentage of capital requirement is to take care of this cyclical factor.

Basel III is an outcome of crisis in advanced economies where several banks failed and many of them had to be bailed out at huge fiscal costs. No bank had failed for a long time in India, and development priorities require non-disruptive bank credit growth. In this light, while international commitment requires compliance with Basel III, the compression of time frame for implementation and elevated levels of compliance do not seem warranted.

If the perceived overall systemic risk is high, it would be worth considering discriminatory treatment of public sector banks vis-à-vis the rest of the banking system. It is reported that these banks will be required to adjust the unamortised portion of pension and gratuity liabilities in April 2013.

As far as liquidity is concerned, India is protected from high levels of cash and liquidity reserve requirements. When liquidity standards come into force, the high level of SLR should be viewed as a cushion in times of liquidity stress.

(The author is Director, EPW Research Foundation. These are his personal views.)

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