05 March 2012

B Mahapatra: Implications of Basel III for capital, liquidity and profitability of banks

Mr B Mahapatra, Executive Director of the Reserve Bank of India, gave an address at the National Conference on Emerging Macro Environment, Regulatory Changes and Bank Competitiveness, organised by the National Institute of Bank Management.

Mr Mahapatra started with the context in which the Basel III was set up – the causes and consequences of the global financial, nay, economic crisis. Thereafter he discussed the immediate response to the crisis in enhancing Basel II or introducing Basel II.5 capital requirement for the trading book, which was the epicentre of the crisis and capital arbitrage. Moving from there, he went in detail into the objectives of Basel III and the micro-prudential and macro-prudential elements of Basel III in relation to its objectives.

He went on to describe how the definition of capital, its quality and quantity, and consistency and transparency, and risk coverage will improve micro-prudential regulation under Basel III. He also underscored that the new leverage and liquidity framework will not only enhance the risk absorbency of individual banks but also aid in stabilising financial systems during periods of extreme stress. The other macro-prudential elements of Basel III, such as capital conservation buffer, countercyclical capital buffer, and the too-big-to-fail problem, were also discussed.

Mr B Mahapatra analysed the macro-economic impact of Basel III and the various research that has observed that there could be some initial cost in implementation of Basel III, but the long-term benefits will be immense as it would reduce the probability of banking crises. The implications of Basel III on capital, liquidity and profitability of banks, particularly Indian banks, were discussed.

Mr Mahapatra mentioned that Basel III is just a part of the financial sector reforms agenda being pursued by the G20. While the immediate challenge is to ensure consistent implementation of Basel II and Basel III across banks and jurisdictions, other important issues such as: strengthening the corporate governance, compensation practices, and resolution regimes; enhancing the regulatory and supervisory framework for global and domestic Systemic Important Banks (SIBs); improving the OTC derivatives markets; and regulation of shadow banking system, have also been addressed or are engaging the attention of the FSB and Basel Committee. The macro-prudential framework under Basel III is still untested and would need continuous research, monitoring and experience-sharing among the regulators to ensure its effectiveness.

Full speech

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