Fin-o-mania: Case Study on PSBs in India

Team Name: Fin-atics

College: Symbiosis Institute of Management Studies, Pune

By:
Vivek Yadav
Virender Thakur

Introduction
In banking entity assets are created as a process of intermediation by accepting deposits; the
basic function of intermediation itself is a source of credit and liquidity risks for any banking
institution. Further, banks are exposed to various market and non-market risks in performing
their functions. These risks expose banks to events, both expected and unexpected, with the
potential to cause losses, putting depositors money at risk. Expected losses may be mitigated
by a combination of product pricing and accounting loss provisions, while capital funds are
expected to meet unexpected losses. Thus the primary role of capital in a banking institution
is to meet the unexpected losses arising out of portfolio choice of banks and to protect the
depositors money.

Basel III implementation: Effect on Indian banks

Basel Banking Accords
The Basel Banking Accords are norms issued by the Basel Committee on Banking
Supervision (BCBS), formed under the auspices of the Bank of International Settlements
(BIS), located in Basel, Switzerland. The committee formulates guidelines and makes
recommendations on best practices in the banking industry. The Basel Accords, which govern
capital adequacy norms of the banking sector, aim to ensure financial stability and thereby
increase the risk absorbing capability of the banks worldwide.
BASEL-1
It defined capital and structure of risk weights for banks. The minimum capital requirement
was fixed at 8% of risk weighted assets (RWA). RWA means assets with different risk
profiles. A portfolio approach was taken to the measure of risk, with assets classified into four
buckets (0%, 20%, 50% and 100%) according to the debtor category. For example, an asset
backed by collateral would carry lesser risks as compared to personal loans, which have no
collateral. India adopted Basel 1 guidelines in the year 1999.
BASEL-II
The objective of BASEL-II was to promote safety and soundness in the financial system;
enhance competitive equality; constitute a more comprehensive approach to addressing risks;
and to develop approaches to capital adequacy that are appropriately sensitive to the degree
of risk involved in a banks positions and activities.
The Basel II capital accord is a three-pillared framework consisting of Minimum Capital
Requirement, Supervisory Review Process and Market Discipline.
Features of BASL-III
The features of BASEL-III, which make it more stringent than BASEL-I and II are
as follows :

1. Basel III aims to introduce much stricter definition of capital. Better quality capital means
higher loss-absorbing capacity. This in turn will mean that banks will be stronger, allowing
them to better withstand periods of stress.
2. By introduction of Basel III, banks will be required to hold a capital conservation buffer of
2.5%. The aim of asking to build conservation buffer is to ensure that banks maintain a
cushion of capital that can be used to absorb losses during periods of financial and economic
stress.
3. The counter cyclical buffer has been introduced with the objective to increase capital
requirements in good times and decrease the same in bad times. The buffer will slow banking
activity when it overheats and will encourage lending when times are tough i.e. in bad times.
The buffer will range from 0% to 2.5%, consisting of common equity or other fully lossabsorbing capital.
4. The minimum requirement for common equity, the highest form of loss-absorbing capital,
has been raised under Basel III from 2% to 4.5% of total risk-weighted assets. The overall
Tier 1 capital requirement, consisting of not only common equity but also other qualifying
financial instruments, will also increase from the current minimum of 4% to 6%. Although
the minimum total capital requirement will remain at the current 8% level, yet the required
total capital will increase to 10.5% when combined with the conservation buffer.
5. Under Basel III, a framework for liquidity risk management will be created. A new
Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) are to be introduced
in 2015 and 2018, respectively.
Basel: Summary and Recommendation
The Basel norms, at some level, aim to create a global banking system that is fairly
homogenous. While this very aim purports to build a more robust financial system, it may
actually be its undoing.
The Basel norms also fail to consider national competencies. We have a global scenario
where individual countries vastly differ in their extent of development. In an age where
international banks are so prevalent, such differences across geographies can become tricky
to deal with.
The Basel accords need to incorporate, in some form, the element of national competencies
so as to create a level-playing field. While the Basel accords aim to bring along a host of
benefits, they inevitably imply high costs for the adopting nations. This is especially true
because there is no single set of dates corresponding to the implementation of a particular
Basel regulation worldwide.
This lack of synchronization in the adoption of the norms dilutes their efficacy. The proposal
of phases and timelines for implementation should be put forth in a manner that ensures a fair
amount of coordinated adoption.

Recommendations for solving the problem of NPA of Public Sector Banks

NPA is an asset, including a leased asset, becomes non-performing once it ceases to generate
income for the Bank. A non-performing asset is an asset in respect of which either the
principal or interest remains overdue for more than 90 days.
ICRA Report on NPA
P
e
r
c
e
n
t
a
g
e

ICRA report on NPA

4.80%
4.60%
4.40%
4.20%
Q1 (2014)

o
f

Q2(2014)

Q1 (2015)

Quarter

N
P
A

In the case study there are some predictions made by the ICRA on NPAs as shown in the
graph.
Basically two problems are given for high NPA in Public Sector Banks.
1. High NPA due to ineffective governance in PSU Banks
2. Weakness of the credit appraisal procedures followed by the banks
PROBLEM 1: High NPA due to ineffective governance in PSU Banks
MEASURES:
1. Bring down the government's control over banks: As per the various ET Reports NPA
of the bank are also increasing due to the high involvement of the government in the
form of cutting interest rates in spite of interest rates in the economy are good. So by
loosening the control over banks, they will be free to take independent decisions.
2.

Experienced directors are critical to good governance. An Audit Committee with

charter, members with requisite skill, oversight of a formal risk management program

3. By eliminating crony capitalism in the various public sector banks and have
Responsible decision making teams
4. Recognize legitimate interests of stakeholders, whether they are genuinely interested
in investing this money for their projects or not. These stakeholders are people to
whom we are giving the loan.
PROBLEM 2: Weakness of the credit appraisal procedures followed by the banks

MEASURES:
1.
2.

In depth analysis before giving credit.

Opening of certain specialized branches which would have proper policies in place
on how the appraisal would be done.
3. Recruitment and training of officers for credit appraisal and strengthening of internal
audit.
4. Take the help of credit rating agencies before issuing credit.
5. Unique ID scheme and proliferation of SHGs (self-help group) till the villages. It will
reduce the transaction cost between the borrower and the lender.
SOME OTHER TECHNIQUES TO CONTROL NPAs:
1.
2.
3.
4.
5.

Debt Recovery Tribunals (DRTs) & Lok Adalats

Asset Reconstruction Company (ARC)
Ensuring compliance with term and conditions of the bank
Credit assessment and monitoring
Compromise settlement schemes

CASE STUDY: HDFC BANK

NPA
GROSS NPA
2014
2013
2012

NET NPA

0.27%
0.20%
0.18%

0.98%
0.97%
1.02%

HDFC Bank is one of the Indian Banks which has been successfully able to keep the NPAs
least in the Banking Industry.
The reasons for its success to keep NPAs low are:

In order to avoid non-performing assets HDFC sends the names of the defaulters to
other banks and itself verifies from other banks.
HDFC recommends that there should be complete exposure of defaulters to all the
banks.
HDFC has a strong structure in place for minimizing the NPAs. Similarly, the
government should define and implement a strong legal structure regarding nonperforming accounts.

Willful defaulters constitute a very less percentage,

Recovery of Nonperforming assets is not much of a concern for HDFC as the
recovery rate is good.
Annexure & Exhibits:
Exhibit 1: Calibration of the Capital Framework in Basel III

Capital Requirement / Buffer

Common
Equity Tier
1

Minimum

4.5%

Conservation buffer

2.5%

Minimum plus conservation buffer 7.0%

Countercyclical buffer range

Tier 1

Total

Capital

Capital

6%

8%

8.5%

10.5%

0% - 2.5%

(Source: Basel III accord, 2011

Revision)

Exhibit 2: Time frame of phased implementation of Basel III

Phases

2013 2014 2015 2016

2017

2018

2019

Capital Ratio

Leverage ratio

Migration
to Pillar I

Minimum common equity

3.5% 4.0% 4.5%

4.5%

capital ratio

Capital conservation buffer

0.625%

1.25%

1.875%

2.5%

Minimum common equity

3.5% 4.0% 4.5% 5.125%

5.75%

6.375%

7.0%

80%

100%

100%

plus capital

conservation

buffer

Phase-in of deductions from

20%

40%

60%

CET1

Minimum Tier I Capital

4.5% 5.5% 6.0%

Minimum Total Capital

8.0%

Minimum total

8.0%

conservation buffer

capitaland

6.0%

8.0%

8.625%

9.25%

9.875%

10.5%

Capital instruments that

no

Phase out over 10 year horizon beginning 2013

longer qualify as non-core

Tier I or Tier II capital

Liquidity ratio

Liquidity coverage ratio

60%

70%

80%

90%

(minimum)

Net stable funding ratio

Introduce
minimum
standard

(Source: Basel III Phase-in arrangements, Basel Committee on Banking

Supervision)

100%