Basel III Compliance: Challenges for PSBs in India

Basel III norms are supposed to be implemented in India starting next year in 2013 and will be completed by 2018. In the aftermath of the financial crisis of 2008-09, the Basel Committee on Banking Supervision in 2010-11 came up with the new stringent capital adequacy requirement along with the new counter-cyclical capital buffers. The stringent capital requirement for Basel III stipulates that banks will have to hold 6% of the Risk Weighted Assets as Tier I capital with 4.5% of this being Common Equity up from 2% in Basel II norms. Private Banks in India may be able to get other players onboard but for Public Sector Banks this will be a major challenge.

With the Indian market growth story still intact, the banks will have scope for growth in assets. But increase in asset base will mean the government will have to recapitalize public sector banks with an estimated Rs 900 billion or be ready to reduce their equity stake in banks below 50% for them to comply with Basel III norms of 4.5% common equity. The Indian Government stated policy on stake dilution has been to maintain the majority stake in public sector entities. With the subsidy bill of the government snow-balling and social schemes like the MGNREGA escalating the Fiscal Deficit, it has left hardly any funds for recapitalization of the public sector banks. So what is the way out of this impending logjam?

Possible Solutions

There are a couple of possible solutions to this problem of compliance to Basel III norms for Public Sector Banks. The first would be to introduce the concept of golden share for Indian banks as Margaret Thatcher the then Prime Minister of Britain did it in the 1980’s for privatizing public sector entities. As a concept golden share means, reducing the stake in a company below 50% but retaining the majority voting rights. It basically delinks voting rights from ownership. So, as a solution the government can take up golden share to retail the voting rights but bring in funds from private players and reduce their stake below 50% in public sector banks.

An alternative to this is to create a banking sector holding company in which the Government will hold the majority stake, and the holding company in turn will hold majority stake in public sector banks. This was briefly outlined by the Finance Minister of India in his Union budget speech in March 2012. The Government can raise capital for the banking holding company through various means including a public offering. The modalities of the same are not clear as of now and will have to be closely watched for this to be a success. If implemented successfully this could be the biggest structural change in the Indian banking sector since nationalization in 1969 and 1980.

Looking Ahead

The way in which the Government and public sector banks in India are able to cope with this puzzle will largely shape the banking industry in India in the next five years. As the Banks in India and across the world move to Basel III compliance, the demand for Out of the Box Banking solutions for regulatory reporting and aligning their operations to meet the stringent Basel III norms will grow manifold.

And the players that are ahead of the curve will be able to capture the market!