What Basel-III norms mandate

One of the sardonic comments on the last published balance sheet of Lehman Brothers was that whatever was on the left-hand side (liabilities) was not right and whatever was on the right-hand side (assets) was not left.

The question whether the Government should have bailed out Lehman will be debated for many summers. The Basel Committee on Banking Supervision has been quick to learn the lessons from Lehman and has brought out Basel-III norms which focus on protecting the common equity of a banking entity. Lehman got into a financial logjam when they realised that their collateralised debt agreements were worth a fraction of their book value and they had a miniscule capital to tap into. The Reserve Bank of India (RBI) has responded with their version of what Basel-III norms should be in India.

One of the fundamental assumptions of accounting is the concept of going concern. Basel-III norms as issued by the RBI should raise a few eyebrows when they refer to tier-2 capital as gone-concern capital in their guidelines, though it is apparent that this is only to distinguish it from tier-1 going-concern capital. As percentages to risk-weighted assets, the guidelines stipulate 5.5 as tier-1 common equity, a capital conservation buffer of 2.5, and additional tier-1 capital of 1.5 and tier-2 capital of 2.

The total minimum capital ratio will have to be 9 per cent without the capital conservation buffer and 11.5 per cent with it. However, the present Basel norms as well as the new one stipulate a number of deductions from capital. With its overriding principle of conserving the common equity, Basel-III norms do away with the option available now to divide the deductions equally over tier-1 and tier-2 capital. Most deductions are from common equity, which will force banks with borderline tier-1 capital to beef it up.

Accounting standards

The RBI may have missed a trick by referring to Indian accounting standards while calculating the deductions from common equity. Goodwill and other intangible assets are one of the deductions to be made from common equity. Typically, these assets result from acquisitions. While the present Indian accounting standard, AS-14, talks of amalgamations, Ind-AS 103 specifies recognition and measurement norms for goodwill and a whole lot of other intangible assets after an acquisition.

Some banks in the US stunned the world by reporting profits when the credit crisis was supposedly at its peak. A look into their income statements showed that they had recognised revenue on own credit risk. IFRS (International Financial Reporting Standards) norms specify that own credit risk should be reflected under ‘other comprehensive income' and cannot form a part of normal income.

The Institute of Chartered Accountants of India goes a step further and has opted for a carve-out by prohibiting recognising revenue on own credit risk even under that head. The RBI guidelines state that the amount of any cash-flow-hedging reserve which relates to the hedging of any items that are not fair-valued on the balance sheet date should be derecognised in the calculation of common equity.

With the trilogy of accounting standards on financial instruments in India yet to find traction in application, it is only banking companies that follow either IFRS or Ind-AS norms that would recognise a cash-flow-hedging reserve. However, the chances of not valuing them fairly will be sporadic. Basel-III norms mandate knocking off treasury stock from the banks' capital as the RBI is of the opinion that it is tantamount to repayment of capital. Present Indian accounting standards are silent about treatment of treasury stock. The RBI Basel-III guidelines mandate the removal of the stock of provisions to expected losses from the common equity. There could be a significant difference in the stock of these provisions as measured by IFRS norms vis-a-vis the prudential norms of the RBI.

Ind-AS norms

It appears that Ind-AS norms complement the Basel-III norms better than the present Indian accounting standards. However, with these standards now comatose, there could be challenges in implementing Basel-III norms as the RBI is looking at triggering these norms with effect from January 1 next year in phases. This could well be the spur the Ministry of Corporate Affairs needed to bring Ind-AS back to life. The RBI is expected to pronounce their own set of IFRS-compliant standards specific to the banking industry, for which they will expect base standards from the Ministry. As most banking companies are listed and more banking licences being on the anvil and consolidation in the sector inevitable, announcing these base standards should brook no delay.

(The author is a Bangalore-based chartered accountant.)

COMMENT NOW