New accord will cut Indian banks' capital ratios
MUMBAI - Indian banks are likely to experience some overall reduction in capital ratios when the new, risk-based Basel capital accord is implemented there from March 31, 2007.
However, this overall decline is "manageable" and can mostly be met through internal accruals and the raising of fresh capital, says CRISIL Ratings in a report published in late February.
Under the new capital adequacy framework being introduced in India, the overall capital ratio of Indian banks would have dropped by 1.6 percentage points, from 12.9% to 11.3%, if applied to the banks' portfolios at March 31,2004, the CRISIL report calculates.
The Reserve Bank of India (RBI) recently announced the timetable for the country's roughly 90 commercial banks to implement the new accord - Basel II. At a minimum, all the banks must adopt the simplest of the three approaches in calculating their credit and operational risks and capital requirement (that is, the standardised approach for credit risk measurement, and the basic indicator approach for operational risk). Along side the implementation of Basel II, India banks will also have to apply the provisions of the market risk amendment, which was added to Basel I in 1996, but not introduced in India at the time.
The 1.6% estimated decline in the overall capital ratio is the combined effect of falls of 1.2% and 1.1%, respectively, for market risk and operational risk, offset by a 0.7% rise under the new credit risk measurement, reckons CRISIL, the largest of the country's four credit rating agencies, in which Standard & Poor's has a stake (CRISIL could become a majority-owned S&P subsidiary under a current offer to shareholders).
Despite the likely drop in the overall capital ratio, CRISIL says the proposed capital framework will have a positive affect on the Indian banking sector. In the long-term, it will encourage banks to become more risk sensitive, leading to an improvement in their risk management systems.
A second assessment of the likely Basel II impact on Indian banks, published in March by ICRA Rating Services, another Indian rating agency, estimates that Indian banks will need additional capital of Rs.120 billion ($2.8 billion) to meet the operational risk capital requirement under the new accord. Most of this would be required by the 27 public sector banks (Rs. 90 billion or $2.07 billion), followed by the 7 so-called new generation private sector banks (Rs.11 billion or $253 million) and the old generation of private sector banks (Rs.7.5 billion or $172 million). Given the asset growth witnessed in the past and the expected growth trends, the op risk capital charge could rise by 15-20% annually over the next three years, which implies the banks will need to raise Rs.180-200 billion ($4.14 billion - $4.6 billion) over the medium term, says ICRA, which is partly owned by Moody's rating agency.
These sums are broadly the amounts required if banks are to maintain their Tier 1 (or core) capital ratio above 6%. Many banks would continue to maintain the Tier 1 ratio comfortably above 7% or 8%, and in some cases, significantly above 10%. At the same time, many of the public sector banks have announced plans to raise equity capital in the current financial year, including Punjab National Bank, Bank of India, Bank of Baroda and Dena Bank.
ICRA, like CRISIL expects that the adoption of Basel II will lead to a small reduction in the credit risk capital requirement of most of the banking sector. It also concludes that Basel II is likely to improve the risk management systems and practices of banks, and strengthen the overall financial system of the country over the longer term.
