Development Banks – 08
Bureau of International Settlement BIS fosters co-operation among central banks with a common goal of financial stability and common standards of banking regulations. Basel guidelines refer to broad supervisory standards formulated by this group of central banks- called the Basel Committee on Banking Supervision (BCBS). The set of agreement by the BCBS, which mainly focuses on risks to banks and the financial system are called Basel accord. The purpose of the accord is to ensure that financial institutions have enough capital on account to meet obligations and absorb unexpected losses. India has accepted Basel accords for the banking system.
In 1988, BCBS introduced capital measurement system called Basel capital accord, also called as Basel 1. It focused almost entirely on credit risk. It defined capital and structure of risk weights for banks. Naturally if the capital with the banks is adequate to cover the risks ( e.g. a power plant) they have invested in, then the bank is safe. The minimum capital requirement was fixed at 8% of risk weighted assets (RWA). RWA means assets with different risk profiles.
In 2004, Basel II guidelines were published by BCBS, which were considered to be the refined and reformed versions of Basel I accord. The guidelines were based on three parameters.
- Banks should maintain a minimum capital adequacy requirement of 8% of risk assets,
- Banks were needed to develop and use better risk management techniques in monitoring and managing all the three types of risks that is credit and increased disclosure requirements.
- Banks need to mandatorily disclose their risk exposure, etc to the central bank.
- 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.
The capital requirement (as weighed for risky assets) for Banks was more than doubled.
Leverage: Leverage basically means buying assets with borrowed money to multiply the gain. The underlying belief is that the asset will return the investor more than the interest he has to pay on the loan.
Funding and liquidity Banks can be subjected to a lot of risk if all depositors come and ask all their money at the same time. This is a hypothetical situation but it has happened in real with Lehman Brothers – the bank whose collapse gave us the 2008 recession. So, Basel III puts a requirement for the banks to maintain some liquid assets all the time. Liquid assets are those which can be easily converted to cash.
D-SIB: Domestic Systematic Important Banks
RBI identifies banks that ‘too big to fail’ (if they fail, it’ll severely hurt the economy)’ and labels them as Domestic Systematic Important Banks (D-SIB), & orders them keep additional equity capital against their Risk Weight Assets (RWA). Presently, 3 D-SIBs in India ICICI, HDFC, SBI
The government of India, in order to resolve the issues faced by the Public Sector Banks launched a 7 pronged plan called “Mission Indhradhanush. Indhradhanush for PSBs mission aims at revamping the functioning of the Public Sector Banks in order to enable them to compete with the Private Sector Banks. It seeks to revive economic growth by means of reduction of political interference in the functioning of PSBs and improving credit.
Components of Mission Indradhanush
- Appointments: Besides induction of talent from the Private Sector into the public banks, separation of the posts of Chief Executive Officer and the Managing Director, in order to check the excessive concentration of power and smooth functioning of the banks.
- Bank Boards Bureau: The appointments Board of the Public Sector Banks would be replaced by the Bank Boards Bureau (BBB). Advice would be rendered to the banks in the matters of raising funds, mergers and acquisitions etc by the BBB. It would also hold the bad assets of the Public Sector Banks. The BBB separates the functioning of the PSBs from the government by acting as a middleman.
- Capitalisation: Due to the high NPAs and the need to meet the provisions of the Basel III norms, capitalization of banks by inducing Rs. 70000 crore was planned.
- De-stressing: Solving issues arising in the infrastructure sector in order to check the stressed assets in the banks by strengthening the asset reconstruction companies. Development of a vibrant debt market for PSBs.
- Empowerment: Providing greater flexibility and autonomy to PSBs in hiring manpower.
- Framework of Accountability: The assessment of the banks would be based on a few key performance indicators.
Bank Board Bureau (BBB), 2016
Banks Board Bureau (BBB) is an autonomous body of the Government of India tasked to improve the governance of Public Sector Banks, recommend selection of chiefs of government owned banks and financial institutions and to help banks in developing strategies and capital raising plans.
The BBB works as step towards governance reforms in Public Sector Banks (PSBs) as recommended by P.J. Nayak Committee. It was part of the Indhradhanush plan.