COVID-19, Basel III and the Current State of India's Banking System

In response to COVID-19, the Reserve Bank of India recently announced it would defer implementation of certain Basel III capital and funding provisions until April 2021. The intent is to give Indian banks more of an opportunity to build up capital buffers and draw them down as losses when faced with stressed environments.

The RBI's decision effectively pushes back by six months the deadline for Indian banks to meet Basel III's capital conservation buffer of 2.5%. As part of a staged approach to meet the full buffer (which offers an additional layer of capital against losses), Indian banks were expected to complete the final tranche (0.625%) of the CCB by the end of September 2020. But the RBI has extended the deadline for that tranche to April 1, 2021.

Likewise, the RBI has also delayed the deployment of Basel III's net stable funding ratio (NFSR) - a tool designed to help banks maintain a stable source of funding for their activities - to April 2021. Initially, the RBI expected banks to maintain 100% NSFR by April 1, 2020. But that deadline has been pushed back twice in response to the pandemic, including once in September.

In line with decisions made earlier this year by oversight body of the Basel Committee on Banking Supervision (BCBS), the RBI is also delaying deployment of the Basel III's market risk framework and Pillar 3 disclosure requirements, pushing each implementation back from January 1, 2022, to January 1, 2023.

Basel III guidelines focus on regulatory capital, leverage and funding and liquidity ratios designed to support a more resilient banking system. Despite the deadline extensions, the implementation of Basel III at India's public-sector banks (PSBs) - which offer a wider range of products and constitute a large segment of the country's financial system - continues to advance. The RBI and other regulators oversee these PSBs, which are owned and administered by the central government.

Evolution of Basel Standards in India

The RBI's decision to delay implementation deadlines for Basel III capital, funding and disclosure requirements aligns with its traditionally conservative approach to the adoption of global standards. For example, the RBI's minimum capital-to-RWA requirement of 9% for Indian commercial banks is one percent higher than the Basel III recommendation. What's more, RBI's leverage ratio of 4% for domestic systemically-important banks (D-SIBs), and 3.5% for all other banks, is higher than the Basel III threshold.

Currently, Indian banks operating under the supervision of the RBI must meet the following Basel III regulatory capital guidelines:

Historically, as part of a strategy that has reaped rewards for Indian banks, the RBI has always kept up with international capital standards set by the BCBS.

Prior to the central bank's adoption of Basel II (around 2008), credit risk managers at Indian banks relied heavily on market experience and judgement to estimate counterparty loan repayments and the recoverability of non-performing assets. A counterparty's ability to repay a loan, moreover, was not factored into income recognition, and the write-off and potential recovery of non-performing assets was accounted for only after a lengthy legal process.

Basel II implementation addressed these inefficiencies, resulting in modifications to income recognition and new standards for assessing and classifying asset performance. Basel III - which calls for stronger monitoring of technology risk and data management processes - should yield even more benefits for Indian banks.

Basel III's Impact on Credit Risk Management in India

PSBs in India support both retail and institutional lending needs. With credit extension a primary business driver, the allocation of regulatory capital is naturally skewed toward expected and unexpected credit-driven losses. On average, approximately 85% of regulatory capital at PSBs is consumed by credit-driven exposures, with the balance allocated to market and operational risk under Pillar I requirements.

Currently, unless local regulation requires an internal ratings-based approach, PSBs rely on standardized approaches to calculate risk capital for credit exposures. But Basel III implementation should further strengthen PSBs' capital provisions, while providing greater transparency and management of their funding and balance sheet risk.

Basel III aims, in part, to create stronger corporate risk governance through an emphasis on a top-down-approach that includes proper risk appetite frameworks and statements that align with organizational business models. Consequently, risk culture at PSBs should also be buoyed.

In effect, the adoption of Basel III guidelines also ensures standardization in the PSBs' Pillar III disclosures, providing transparency for shareholder risk assessment. What's more, it offers these banks a consistent approach for assessing and managing asset quality and potential impact on earnings.

Shashi Ramachandra is the former group chief risk officer of Canara Bank, one of the largest public-sector banks owned by the Government of India. She is currently a board member at a non-bank financial company in India.