Head of the Post Graduate Programme
Banks are an important financial intermediary institution in an economy that helps to attain economic growth in a sustainable manner. With the advent of rising capital markets, however, the market risk exposure of banks has increased. This is evident from the post-financial crisis, which resulted from an underestimation of risk and deteriorating quality of capital. Since there were too many spillovers in the supervision of investments coupled with poor transparency, a crisis happened.
The crisis highlighted the criticality of the links between various liquidity, credit risk, and operational and market risk. Also, the build-up of excessive off-balance-sheet leverage led to a gradual erosion of the capital base. These events triggered a debate on the banking model and the rationale behind the existing regulations. It helped the policymakers and leaders of the G-10 countries to identify the loopholes in the existing framework, leading to the setting up of the BASEL Committee on Banking Supervision (BCBS) at the end of 1974.
Unlike anything the banking sector has witnessed before, “The International Convergence of Capital Measurements and Capital Standards” (1988) called as Basel accord tenets’, aim at making the banks robust enough to withstand economic/financial stress/shocks, reduce the risk spill-over to real economy and improvement of transparency in the system.
The Big Question of Trade-off between Growth and Capital Needs
The Indian banking sector, though initially thought to be insulated from the effects of the global financial crisis, is at an important junction between growth and capital needs. On a positive note, many of our banks do not depend much on short-term funding and maintain a substantial amount of liquidity to meet the RBI guidelines both in the corporate as well as retail banking segments. However, since our financial markets have not undergone a stress scenario, the relevant prediction of stress scenarios with utmost accuracy and consistency is a complex task. Many banks are still struggling to meet the capital requirements as per BASEL norms.
BASEL III Accord of Market Risk
Foreseeing the issues in the COVID pandemic, BIS countries have deferred the implementation of the Basel III accord in the totality of market risk also till January 1, 2023. The accompanying floors have also been extended till 1st January 2028. The Indian banks are raising the Tier-1 capital through Debt Bonds example – the State Bank of India in September 2021 raised the lowest pricing of AT1 – unsecured, perpetual debt bonds of Rs 4000 crore at a coupon rate of 7.72%. The call option will be September 3, 2026. Also, Axis and HDFC banks have also tapped such Bonds. As per SEBI norms the residual maturity of such Basel III compliant bonds will be 10 years up to March 2022, then 20 years from October 2022 up to March 2023, and then 100 years from the date of issuance of the bond.
The changing regulations may lead to the reorientation of the business models. The most prominent catalysts for this change are – limits on leverage, increasing price transparency, and greater supervisory scrutiny of proprietary trading. These changes will make it difficult to translate the narrow returns to high equity returns. These changes will push the banks to improve their efficiency, get rid of the less/unprofitable business arms, raise prices, and increase focus on stable and steady income generating avenues. This may lead to an increased focus on retail banking as compared to corporate banking because firstly, retail banking has a lower risk weight than corporate banking clients (except for some A-rated clients). So, an increase in capital allocation will have a lower impact on retail banking. Secondly, the probability of default on a short-term loan is lesser. This further advocates a preference for short-term retail loans over longer-term corporate loans. Hence, the business mix of banks may undergo a drastic change in the coming years.
Conclusion
Because of the increased level of risk perception among banks, credit risk and the difficulties linked with it can be cause for more concern. With various facets of credit creation, evaluation, and borrowings vis-a-vis qualities and business situations, Basel III is an uphill task. Furthermore, banks are likely to recover their losses from earnings but then the unexpected losses outweigh the circumstances at times. When a borrower fails to honor a financial obligation by the due date or on loan maturity, the bank faces a loss that might lead to bankruptcy and may take recourse to a legal forum. The number of risks faced by the Banks in the realm of lending for the primary source of revenues and if not managed properly would erode the capital where the company is endangered recoveries.
Head of the Post Graduate Programme
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