Adoption of the Basel III

There has been significant progress towards implementation of Basel III risk-based capital standards, the liquidity standards, the standards for global and domestic systemically important banks (SIBs), the leverage ratio, the large exposure framework and the interest rate risk in the banking book (IRRBB). Basel III Capital Regulations will be fully phased in for Indian banks by March 31, 2019, i.e., close to the internationally agreed date of January 1, 2019.

Basel III

In 2010, Basel III guidelines were released. These guidelines were introduced in response to the financial crisis of 2008. A need was felt to further strengthen the system as banks in the developed economies were under-capitalized, over-leveraged and had a greater reliance on short-term funding. Too much short-term funding makes the banks prone to risks. Banks generally rely on short-term funding because it is profitable.

Also, the quantity and quality of capital under Basel II were deemed insufficient to contain any further risk. This was because the banking system was growing. The world economy was growing too. Hence, what is sufficient earlier was not sufficient now.

Basel III norms aim at making most banking activities such as their trading book activities more capital-intensive. The guidelines aim to promote a more resilient banking system by focusing on four vital banking parameters viz. capital, leverage, funding and liquidity.

Steps Taken by RBI to Deal with NPA Problems

The 5/25 Refinancing of Infrastructure Scheme

  • This scheme offered a larger window for revival of stressed assets in the infrastructure sectors and eight core industry sectors.
  • Under this scheme lenders were allowed to extend amortisation periods to 25 years with interest rates adjusted every 5 years, so as to match the funding period with the long gestation and productive life of these projects.
  • The scheme thus aimed to improve the credit profile and liquidity position of borrowers, while allowing banks to treat these loans as standard in their balance sheets, reducing provisioning costs.
  • However, with amortisation spread out over a longer period, this arrangement also meant that the companies faced a higher interest burden, which they found difficult to repay, forcing banks to extend additional loans (‘evergreening’). This in turn has aggravated the initial problem.

Private Asset Reconstruction Companies (ARCs)

  • ARCs were introduced to India under the SARFAESI Act (2002), with the notion that as specialists in the task of resolving problem loans, they could relieve banks of this burden.
  • However, ARCs have found it difficult to resolve the assets they have purchased, so they are only willing to purchase loans at low prices. As a result, banks have been unwilling to sell them loans on a large scale.
  • Then, in 2014 the fee structure of the ARCs was modified, requiring ARCs to pay a greater proportion of the purchase price up-front in cash.
  • Since then, sales have slowed to a trickle: only about 5 percent of total NPAs at book value were sold over 2014-15 and 2015-16.

Strategic Debt Restructuring (SDR)

  • The RBI came up with the SDR scheme in June 2015 to provide an opportunity to banks to convert debt of companies (whose stressed assets were restructured but which could not finally fulfil the conditions attached to such restructuring) to 51% equity and sell them to the highest bidders, subject to authorization by existing shareholders.
  • An 18-month period was envisaged for these transactions, during which the loans could be classified as performing.
  • But as of end-December 2016, only two sales had materialized, in part because many firms remained financially unviable, since only a small portion of their debt had been converted to equity.

Asset Quality Review (AQR)

  • Resolution of the problem of bad assets requires sound recognition of such assets.
  • Therefore, the RBI emphasized AQR, to verify that banks were assessing loans in line with RBI loan classification rules.
  • Any deviations from such rules were to be rectified by March 2016.

Sustainable Structuring of Stressed Assets (S4A)

  • Under this arrangement, introduced in June 2016, an independent agency hired by the banks will decide on how much of the stressed debt of a company is ‘sustainable’.
  • The rest (‘unsustainable’) will be converted into equity and preference shares. Unlike the SDR arrangement, this involves no change in the ownership of the company.

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