What are Basel III guidelines?

New rules are expected to moderate the return on equity of public and private sector banks. Return on equity is the profit made by banks with respect to the equity.

Michael Perschke, head of Audi India, poses with the new A4 at its launch in Mumbai.
Michael Perschke, head of Audi India, poses with the new A4 at its launch in Mumbai.

Basel III guidelines are norms that the Reserve Bank of India has implemented to strengthen the regulation, supervision and risk management of the banking sector.

Here’s a quick guide:

1. Basel III is asset of guidelines agreed upon by the Basel Committee on Banking Supervision in 2010-11. The Basel committee was formed in 1974 by a group of central bank governors from 10 countries, and has now expanded to include members from nearly 30 countries, including India.

2. The Reserve Bank of India had released draft guidelines on its website on December 2011 for comments and feedback from various stakeholders.

3. According to the guidelines, which will be effective from January 1, 2013, banks will have to maintain their total capital ratio at 9%, higher than the minimum recommended requirement of 8% under the Basel III norms. Capital ratio is the percentage of a bank’s capital to its risk-weighted assets.

4. The norms also require banks to maintain Tier I capital at 7% of risk weighted assets. Tier I capital, or core capital, includes a bank’s equity capital and disclosed reserves.

5. Under the new norms, banks will have to maintain a capital conservation buffer of 2.5% of risk-weighted assets. A capital conservation buffer is a cushion that banks are required to build to withstand periods of stress.

6. Broadly, the Reserve Bank’s guidelines are tougher than global Basel III recommendations, meaning Indian banks will have to work that much harder. Banks with low return on assets will be badly hit, as they will have a harder time securing capital.

7. According to brokerage estimates, state-run banks will need up to Rs 2 trillion to meet the new norms.

8. State-run banks may also see a dilution of government stake, says brokerage Prabhudas Lilladhar.