BASEL III

RISK MANAGEMENT IN BANKING

INTRODUCTION
Basel presents the Basel Committees reforms to

strengthen global capital and liquidity rules of the

country with the goal of promoting a more resilient
banking sector.
The economic and financial crisis, started in 2007
became so severe because the banking sectors of
many countries had built up excessive on and offbalance sheet leverage.
Objective is to:
improve the banking sectors ability to absorb shocks
reduce the risk of overflow from the financial sector to

the real economy.

FAILURE OF BASEL II
Criticism

Critique

Its Risk Sensitivity made it

Criticism only partly valid

blatantly pro-cyclical
Failed to promote modeling

frameworks for accurate

measurement of risk and to
demand sufficient loss
absorbing capital to mitigate that
risk
Did not have any explicit

regulation governing leverage excessive leverage of banks was

one of the prime causes of the
crisis
Seen to be guilty of focusing

exclusively on individual
financial institutions, ignoring
the systemic risk arising from
the interconnectedness across

To claim that the risk sensitivity of

Basel II caused the crisis would

be extreme
Basel III does not negate Basel II;
but builds on the essence of Basel
II - the link between the risk
profiles and capital requirements
of individual banks
Basel III is not a negation, but an
enhancement of Basel II

augmentation in the level and

quality of capital
introduction of liquidity
standards;
modifications in provisioning
norms
better and more comprehensive
disclosures

BASEL II AND BASEL III

COMPARATIVE ANALYSIS
Capital Requirements

Liquidity Standards

Disclosure Requirements
One of the lessons of the crisis and the failure of Basel

Provisioning Norms
Less Cyclical than current incurred loss

approach

II to prevent or at least contain the same is that the

disclosures made by banks on their risky exposures
and on regulatory capital were neither appropriate nor
sufficiently transparent to afford any comparative
analysis
Basel III requires banks to disclose all relevant details,

including any regulatory adjustments, as regards the

composition of the regulatory capital of the bank

FRAMEWORK OFBASEL III

Reform measures, by BCBS to strengthen the regulation,
supervision and risk management of banking sector
Building Blocks
Improving Quality, Consistency &Transparency of Capital
o To ensure that banks are better able to absorb losses
o The Tier I capital to mainly consist of common equity to be
raised to 7% of RWA by March 31st, 2015
o Most of the adjustments to be from CET1 capital(phased
manner)
o all elements of capital to be disclosed with reconciliation to
the published accounts
o Tier 1 ratio of 6.0% for scheduled commercial banks in India
maintained
o Stricter norms for deductions from capital (accumulated
losses, deferred tax assets net of deferred tax liabilities,
investments in financial institutions, good will)

BUILDING BLOCKS
Promoting the buildup of capital buffers in good

times
o Capital conservation buffer that can be used to absorb
losses during periods of financial and economic stress
Capital conservation buffer of 2.5% to be phased in
over a period of time .
o Countercyclical buffer for broader macro-prudential goal
of protecting the banking sector from periods of excess
aggregate credit growth .
To be warranted where credit growth perceived
aggressive & leading to the system-wide buildup of
risk .
Within a range of 0 2.5% of RWAs in the form of
Common Equity will be implemented according to

BUILDING BLOCKS
Introducing internationally harmonized leverage

ratio
o Risk-based capital measure
o To contain the build-up of excessive leverage in the
system .
o Leverage Ratio minimum 4.5% Tier I Capital of Total
Exposure, (both On Balance Sheet & Off Balance
Sheet exposure)
o Increasing the risk coverage of the capital
framework( for trading , securitizations, exposures
to off-balance sheet vehicles and counterparty credit
exposures arising from derivatives )

BUILDING BLOCKS
Introducing minimum global liquidity standards
o LCR to ensure that banks to have sufficient high-

quality liquid assets to withstand a stressed funding

scenario

o Net stable funding ratio (NSFR) is a longer-term

ratio to address liquidity mismatches .

o It covers the entire balance sheet and provides
incentives for banks to use stable sources( types
and amounts of equity and liability financing
expected to be reliable sources of funds over a
one-year time horizon under conditions of extended

BUILDING BLOCKS
Raising

standards for supervisory review

process & disclosures
o Valuation practices
o Stress testing:
o Sound compensation practices and incentives to
better manage risk and return
o Corporate governance
o Supervisory colleges
o Firm-wide governance and risk management.
o Capturing the risk of off-balance sheet exposures
and securitization activities.
o Managing risk concentrations.

BUILDING BLOCKS
Market Discipline
o Banks disclose all elements of the regulatory

capital base, the deductions applied & full

reconciliation to financial accounts .
o Banks to disclose clear, comprehensive and
timely information about remuneration practices
Macro Prudentil Requirements
o Pro-cyclicality: from incurred losses model to
expected losses model of provisioning
o Systemic
Risk
and
Interconnectedness:
Systemically important banks to have loss
absorbing capacity beyond the minimum
standards

TRANSFORMATION ROADMAP

BASEL III IMPLEMENTATION

Preparation for
Migration

Requirement
Higher Common Equity
Non Common Equity to be loss

absorbing
Limits on AT1 and Tier 2 Capital

Risk Data Infrastructure

Ability to extract, compute, analyze

Capital Conservation Buffer

Countercyclical Buffer
SIFI Charge

Leverage Ratio

Liquidity Ratios

data
RWA Optimization
Remove data gaps, Refine
methodology, Diversification benefits
Managing ROE
Better pricing of risks, Fee based
income, Risk adjusted returns
Capital Optimization
Retention of profits, Full utilization of
Non Common Equity limits
Risk Management
Better risk governance, stress
testing, risk culture

BASEL III IMPLEMENTATION

Capital Management under Basel III

Sustainable Management of Risk

and Capital

IMPLICATIONS OF BASEL III

Increased quality of capital
Increased quantity of capital
Reduced leverage through introduction of backstop

leverage ratio
Increased short term liquidity coverage
Increased stable long-term balance sheet funding
Strengthened risk capture, notably counterparty risk

EMERGENCE OF BASEL IV
Changes from Basel III to Basel
IV
Higher minimum

leverage ratio
Internal Models: risk
weightings generated by
banks
Revised approach to the
Liquidity Coverage Ratio
(LCR)
Pillar 2 capital add-ons:
capital conservation and
counter-cyclical capital
buffers
Greater disclosure by
banks

POSSIBLE IMPLICATIONS FOR

BANKS
Significant higher capital requirements

combination of higher minimum leverage ratio

restrictions on internal models based calculations
imposing stress test
Pillar 2 cushion above minimum capital requirements

Capital Management Requirements by banks

Less risk-sensitive approach to both capital
ratios and internal modeling
banks to re-examine the balance between lower and higher
risk businesses

Transitional Arrangements in
India:
Basel III implementation will begin on April 1, 2013 and
will be fully phased in on March 31, 2018 as indicated
below in % terms:

CONCLUSION
It is natural to fear the unknown

We require good, uniform

Despite Basel III's shortcomings,

we are yet to hear of a better

solution than combining RWAs
with a good strong, leverage
ratio
RWAs can help bank examiners
identify exactly what risk exposures
banks have, and they can then
spend more time focusing on the
riskier areas of a bank
The use of RWAs can also provide
a fair basis for a level playing
field for banks in different banking
structures
The risk-weighted approach is also
good for the banks in that it helps
them determine what businesses
are riskier and not sufficiently
rewarded

guidelines for banks to follow

and inputs need to be disclosed to
the public
In most guidelines, the Basel
Committee has been reiterating the
need for transparency
The need is for market discipline
and to force banks to comply with
its disclosure requirements
We already have all the major the
tools to reform banks, we just have
to use them
If we use the tools to reform the
banks judiciously and
transparently, we must hope that
banks in particular, will be better
prepared against any major
financial crisis in future

RECOMMENDATIONS
The new Basel III package affords the

financial industry more clarity on the

regulatory front
Countercyclical capital buffer would be
activated by national authorities
Multiplicity of regulatory reforms under way
the more and more of everything approach to
regulation
Banks need to consider the combined impact
of Basel III and of moves towards Basel IV

THANK YOU