Guidelines on Implementation of Basel III Capital Regulations in India

The Basel Committee on Banking Supervision (BCBS) issued a comprehensive reform package entitled Basel III: A global regulatory framework for more resilient banks and banking systems in December 2010 with the objective to improve the banking sectors ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. The reform package relating to capital regulation, together with the enhancements to Basel II framework and amendments to market risk framework issued by BCBS in July 2009, will amend certain provisions of the existing Basel II framework, in addition to introducing some new concepts and requirements. A summary of Basel III capital requirements is furnished below:

2. Summary of Basel III Capital Requirements

2.1 Improving the Quality, Consistency and Transparency of the Capital Base 2.1.2 Presently, a banks capital comprises Tier 1 and Tier 2 capital with a

restriction that Tier 2 capital cannot be more than 100% of Tier 1 capital. Within Tier 1 capital, innovative instruments are limited to 15% of Tier 1 capital. Further, Perpetual Non-Cumulative Preference Shares along with Innovative Tier 1 instruments should not exceed 40% of total Tier 1 capital at any point of time. Within Tier 2 capital, subordinated debt is limited to a maximum of 50% of Tier 1 capital. However, under Basel III, with a view to improving the quality of capital, the Tier 1 capital will predominantly consist of Common Equity. The qualifying criteria for instruments to be included in Additional Tier 1 capital outside the Common Equity element as well as Tier 2 capital will be strengthened. 2.1.3 At present, the regulatory adjustments (i.e. deductions and prudential filters) to capital vary across jurisdictions. These adjustments are currently a revised version of this document was issued in June 2011. Generally applied to total Tier 1 capital or to a combination of Tier 1 and Tier 2 capital. They are not generally applied to the Common Equity component of Tier 1 capital. With a view to improving the quality of Common Equity and also

consistency of regulatory adjustments across jurisdictions, most of the adjustments under Basel III will be made from Common Equity. The important modifications include the following: (i) deduction from capital in respect of shortfall in provisions to expected losses under Internal Ratings Based (IRB) approach for computing capital for credit risk should be made from Common Equity component of Tier 1 capital; (ii) cumulative unrealized gains or losses due to change in own credit risk on fair valued financial liabilities, if recognized, should be filtered out from Common Equity; (iii) shortfall in defined benefit pension fund should be deducted from Common Equity; (iv) certain regulatory adjustments which are currently required to be deducted 50% from Tier 1 and 50% from Tier 2 capital, instead will receive 1250% risk weight; and (v) limited recognition has been granted in regard to minority interest in banking subsidiaries and investments in capital of certain other financial entities.

2.1.4 The transparency of capital base has been improved, with all elements of capital required to be disclosed along with a detailed reconciliation to the published accounts. This requirement will improve the market discipline under Pillar 3 of the Basel II framework.