Sunday, September 18, 2011

Basel III: Corporate borrowers spared

First, the good news! Basel III will not have any major impact on the corporate borrowers from banks, unlike Basel II. The Reserve Bank of India, while implementing Basel II, almost mandatorily imposed external credit rating requirements for any borrower having loans in excess of Rs 10 crore. No such new requirement is envisaged in Basel III.
Basel III is aimed at strengthening the global financial system by stipulating new rules for capital and liquidity requirements of banks and financial institutions, which have been singed by the financial crisis in the last few years. Specifically, Basel III aims to plug serious loopholes in regulatory oversight on the banking sector in developed economies. Many of these entities functioned almost like a bank, and also funded by banks, but were out of the purview of the banking regulators. Basel III will restrict exposure of banking system to such entities. Here again, Basel III implementation in India will not have a major impact largely because India does not have such a large shadow banking system.


The immediate impact of Basel III in India is that it will close the tap on an emerging source of capital for banks viz. Tier I Perpetual Bonds. This is a new class of capital market instrument that was allowed by the RBI in 2008-09, as a supplementary source of capital for banks. As of March 31, 2011, less than 1 per cent of the capital adequacy level reported by the Indian banking system was funded through such instruments, out of the overall capital adequacy of more than 13 per cent. The new norms, which prohibit “step up” coupon clause if the instrument isn't called back by the issuer, is a serious dampener as most investors in such instruments perceived this ‘step up' date as the maturity date by default. Similarly, other hybrid instruments, such as Tier 2 Perpetual Bonds, Tier 3 capital, etc., are likely to face the axe as some of these will no longer be treated as capital; others require such stringent norms that it is unlikely to attract any investor interest. However, healthy capital adequacy norms of most banks, demonstrated support by the government through capital infusion in public sector banks and benign credit growth outlook imply that there is no immediate pressure on the banking system because of Basel III. In the long term, however, the increase in capital requirements of banks (estimated at almost 10-20 per cent higher than the current levels) is likely to depress the ROE of banks, which the equity markets may not view favourably. But then, that is a small price to pay for a much more stable financial system!

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