3 May 2012
Update
Financials
RBI releases final guidelines for BASEL III
Significant increase in equity capital requirement in a phased manner
Higher emphasis on common equity Tier I (CET1) capital - Requirement of minimum 10.5% (8% without counter cyclical
buffer) by end of FY18 (draft guideline mentioned till FY17) v/s current minimum requirement of 3.6%.
Introduction of capital conservation buffer (2.5% of CRAR) and counter cyclical capital buffer (up to 2.5% of CRAR) to be
fulfilled by CET1. RBI has extended the creation of the capital conservation buffer period to FY18 vs FY17 earlier.
Introduction of leverage ratio (3% proposed globally and may be at 4.5%+ (earlier proposed at 5%) for Indian banks, not
stated as yet) supplementing overall risk based capital requirement.
RBI has kept the option open for considering the higher CRAR for banks, depending upon the risk factor, internal capital
adequacy assessment and risk management practises.
Most of the banks in India are already above minimum CET1 of 5.5% and on aggregate basis at Tier I of 8% or above hence,
transition should not be an issue in the near term. Overall guidelines place more emphasis on CET1. Private Banks and PSU
Banks with higher RoA are better placed as compared to mid-small sized PSU banks.
RBI has released the final guidelines for BASEL III. RBI
had already released the draft guidelines based on BCBS
roadmap in December 2011, and based on suggestions
of various market participants it has released the final
guideline for Indian banks.
Key highlights are:
Higher emphasis on common equity; however
compliance extended by one year:
Under Basel III
guidelines are banks are required to maintain
minimum common Equity Tier I (CET1) capital of
10.5% (8% without counter cyclical buffer) by end of
FY18 (draft guideline mentioned till FY17) v/s current
minimum requirement of 3.6%. Further qualifying
criteria for the other capital instrument (hybrid and
Tier II) is also linked with CET1. Banks which do not
fulfil CET1 and capital conservation buffer criteria
and has higher AT1 and T2 will not be allowed to
categorise them as capital funds
Leverage ratio at 4.5% vs. 5% in draft guidelines;
supplementing risk based capital requirement:
Taking clues from global financial crisis RBI has
suggested banks to maintain leverage ratio at 4.5%
(draft guidelines suggested of 5% and 3% globally
under Basel III). Leverage ratio will include all assets
on balance sheet and off balance sheet items at credit
conversion factors.
Key deductions to be made from core equity as
against overall CAR earlier:
Shortfall of provisions to
reach expected loss levels under IRB approach to be
deducted from CET1. Indian banks have not yet
shifted to IRB approach thus, not applicable under
BASEL II. Shortfall under defined benefit pension
fund should be deducted from CET1 thus, banks will
have to take the hit of unamortised liability
(occurred on account of second pension option) in
FY13 itself (two years in advance). However, under
IFRS it was expected to be netted off from the net
worth from FY14 onwards.
Other highlights
Exposure limits are linked to capital funds
(CET1+AT1+T2) and it does not include capital
conservation buffer and CCB. For adjustments from
CET1, till FY17, remainder will continue to have
current regulatory treatment. AT1, which no longer
meets requirement of BASEL III, will be phased out
beginning CY13 till FY22.
RBI has extended the creation of the capital
conservation buffer of 0.625% of RWAs by one year
to FY15. Limits have been placed for distribution of
capital if CET1 falls in the range of CCB.
Our view:
Most of the banks in India are already above
minimum CET1 of 5.5% and on aggregate basis at Tier I
of 8% or above [BASEL III requirement of 7% (CET1 of
5.5% and AT1 of 1.5%) and current regulatory
requirement of 6%] and hence, transition should not be
an issue in the near term (b) Higher share of CET1 and
fall in leverage will lead to a fall in RoEs of select PSU
banks. Overall guidelines place more emphasis on CET1.
Private Banks and PSU Banks with higher RoA are better
placed as compared to mid-small sized PSU banks. We
like banks with strong liability franchise, superior
capitalization, and stability at the top management
level, specifically for PSU banks. Our preferred bets:
ICICIBC, SBIN and PNB.
Alpesh Mehta
(Alpesh.Mehta@MotilalOswal.com) + 91 22 3982 5415
Sohail Halai
(Sohail.Halai@MotilalOswal.com) /
Umang Shah
(Umang.Shah@MotilalOswal.com)

Financials | Update
Minimum Capital Requirements and Capital Conservation Buffer
Stringent core Equity
capital requirement
placed in Basel III
Banks will have to achieve Common Equity Tier I (CET1) of 8% of RWA, which includes
2.5% for capital conversation buffer (CCB), in a phased manner by the end of FY18.
Proposed requirement of CET1 (including CCB) is stringent for Indian banks as compared
to proposed global standards of 7% by end of CY18. Overall minimum Tier I capital (ex
CCB) stated is 7%, of which CET1 should be 5.5% and Additional Tier I (AT1) 1.5%.
Overall minimum CRAR should be 9%, thus Tier II (T2) in overall CRAR will be just 2%.
If one considers CCB (2.5%), then overall CRAR will be 11.5% with CET1 of 8%, AT1 of
1.5% and T2 of 2%. In addition to above, regulators will also introduce countercyclical
Capital buffer of 0-2.5% of CET1 in the normal periods to protect banking sector from
excessive aggregate credit growth.
Extension of timeline for implementation of BASEL III Guidelines by one year
DRAFT GUIDELINES
BASEL II
BASEL III
1-Jan 31-Mar 31-Mar 31-Mar 31-Mar 31-Mar
2013 2014 2015 2016 2017 2013
4.50
0.00
4.50
1.50
6.00
3.00
9.00
9.00
40
5.00
0.63
5.63
1.50
6.50
2.50
9.00
9.63
60
5.50
1.25
6.75
1.50
7.00
2.00
9.00
10.25
80
5.50
1.88
7.38
1.50
7.00
2.00
9.00
10.88
100
5.50
2.50
8.00
1.50
7.00
2.00
9.00
11.50
100
4.50
0.00
4.50
1.50
6.00
3.00
9.00
9.00
20
FINAL GUIDELINES
BASEL III
1-Jan 31-Mar 31-Mar 31-Mar 31-Mar
2014 2015 2016 2017 2018
5.00
0.00
5.00
1.50
6.50
2.50
9.00
9.00
40
5.50
0.63
6.13
1.50
7.00
2.00
9.00
9.63
60
5.50
5.50
5.50
1.25
1.88
2.50
6.75
7.38
8.00
1.50
1.50
1.50
7.00
7.00
7.00
2.00
2.00
2.00
9.00
9.00
9.00
10.25 10.88 11.50
80
100
100
Source: RBI/MOSL
Minimum Capital Ratio (% of RWA)
A Minimum CET1
3.60
B Capital conservation buffer (CCB)
N.A
C Minimum CET1 + CCB (A+B)
3.60
D AT1
2.40
E Minimum Tier I capital (A+D)
6.00
F Tier II
3.00
G Minimum Total Capital (E+F)
9.00
H Minimum Total Capital + CCB (G+B) N.A.
Phased in of all deduction from CET(%)
Dividend distribution restricted if CCB falls below prescribed level
CCB is designed to ensure that banks build up capital buffer during normal times
(outside the period of stress) and can be drawn down as losses incurred during stress
period. CCB can be drawn down only when bank faces a systemic or idiosyncratic
stress. Draw down from CCB will only be allowed when bank will have specific plan to
replenish the capital through internal capital accruals.
RBI has specifically mentioned that banks will attract strict penal actions, if in the
normal circumstances bank will reach within CCB level and distribute dividends (higher
than prescribed by RBI) and discretionary bonus payment to employees. Limited
flexibility given to banks for distribution of profits, if CET1 falls in the range of CCB.
However, they will be allowed to conduct the business as usual.
Restriction for banks to distribute earnings when CET1 falls in CCB range
CET1 Ratio
5.5% - 6.125%
6.125% - 6.75%
6.75% - 7.735%
7.735% - 8.0%
>8.0%
Retained earnings
100%
80%
60%
40%
0%
Dividend payout
0%
20%
40%
60%
100%
Source: RBI/MOSL
2
CCB can be drawn down
only when bank faces a
systemic or idiosyncratic
stress
3 May 2012

Financials | Update
Instruments eligible for AT1 and T2 — also linked to CET1
Current AT1 instruments like IPDI, PNCPS etc will continue to be qualified as AT1;
however such instruments with step up options will have to be phased out. RBI has
specifically mentioned that AT1 should not be issued to retail investors. Current T2
instruments will continue except for no separate category of upper Tier II and
subordinate debt instrument. Under BASEL II, banks are not allowed to issue more
than 50% of Tier I capital as subordinate debt instrument. Provisions for standard
assets, Floating (if not included in PCR), Counter cyclical, Country exposures etc will
be included in T2 subject to overall limit of 1.25% of RWA under standardised approach.
Banks which will follow IRB approach will be allowed to recognise (to the extent of
0.6% RWA) provisions over and above expected losses as Tier II capital
Hybrid and TierII capital
with step-up options will
be phased out
Current requirements under BASEL II for minimum capital requirement
Banks have to maintain total CRAR of 9% (in-line with proposed BASEL III draft
guideline). However, Tier I capital requirement is 6% (as against proposed 7% under
BASEL III), thus allowing Tier II capital of 3% (v/s 2% under BASEL III). BASEL II
guidelines allow banks to have 40% of outstanding Tier I in form of hybrid capital/
Additional Tier I capital. Under Hybrid capital comprises of (a) Perpetual Non-
cumulative preference share (PNCPS) with the maximum limit of 40% of o/s Tier I
capital (b) Innovative perpetual debt instruments (IPDI) with the maximum limit of
15% of the Previous year Tier I capital. Thus, one were to assume maximum hybrid
capital limit used by the banks then CET1 is 3.6% under BASEL II (v/s 5.5% in BASEL
III). BASEL II also does not require banks to maintain CCB and counter cyclical capital
buffer. Thus, in our view by end of FY18 minimum CET1 requirement will increase to
10.5% (if countercyclical capital buffer is introduced, other wise 8%) v/s current
minimum requirement of 3.6%.
Introduction of leverage ratio; supplementing risk based capital requirement
Overall leverage capped
at 22x of Tier I capital
(CET1 + AT1)
Taking clues from global financial crisis where banks’ balance sheets were aggressively
leveraged (including off balance sheet items), despite reporting strong risk based
CRAR, it has been proposed to introduce overall leverage (non risk based) of 3% on
Tier I capital under BASEL III. Leverage ratio will include all assets on balance sheet
and off balance sheet items at credit conversion factors. Leverage ratios will be
calculated on the average quarterly basis i.e. based on average of month end balances.
RBI suggested banks to maintain leverage ratio at 4.5% (draft guidelines suggested of
5%) or above and banks which do not comply as of now should strive to achieve it as
soon as possible. While bank level disclosures will begin from FY16, they will have to
report to RBI on a quarterly basis.
Proposed leverage ratio on the lower side
Proposed Leverage Ratio
Bank level disclosures to start from
Draft Guidelines
5.0%
1-Apr-15
Final Guidelines
4.5%
1-Apr-15
Source: RBI/MOSL
3 May 2012
3

Financials | Update
Key deductions from CET1 which are applied to Tier I or Tier II or combination
of both under BASEL II
Shortfall of provisions to reach expected loss levels under IRB approach to be
deducted from CET1. Indian banks have not yet shifted to IRB approach thus, not
applicable under BASEL II. However, based on discussion paper on dynamic
provisioning requirement and parallel run by bank on IRB approach it is expected
to be implemented sooner than later.
Shortfall under defined benefit pension fund should be deducted from CET1 thus,
banks will have to take the hit of unamortised liability (occurred on account of
second pension option) in FY13 itself (two years in advance). However, under
IFRS it was expected to be netted off from the net worth from FY14 onwards.
Certain regulatory deductions (currently netted off against capital funds) will
attract Risk weight age of 1250%. In case of any regulatory capital shortfall for
unconsolidated entity (for e.g. Insurance), it should be deducted from CET1.
Direct/Indirect investments into banks own equity shares or investment in
subsidiary banking financial intuition based on the instruments
Treatment for regulatory adjustments and deductions
BASEL II
Goodwill and other intangibles
Deferred Tax Assets
Defined benefit pension fund*
Investment in Subsidiaries
100% from T1
100% from T1
No Adjustments
50% from T1
50% from T2
BASEL III
100% from CET1
100% from CET1
100% from CET1
Depending upon Holding,
instrument deduction is
done from respective tiers
Source: RBI/MOSL
* more clarity is required on this
Treatment for securitisation transactions
Under BASEL II, credit enhancement amount provided by banks is 50% deducted from
Tier I capital and 50% from Tier II capital. However, under BASEL III based on the rating
of transaction, risk weights will be assigned to securitisation transactions.
Domestic Rating
AAA
AA
A
BBB
BB B or below
or unrated
1,111
1,111
1,111
1,111
1,111
1,111
Risk weights for Non CRE exposures
For originator
20
30
Other than originators
20
30
Risk weights for CRE exposures
For originator
100
100
Other than originators
100
100
Risk weights for Re Securitisation Non CRE exposures
For originator
40
60
Other than originators
40
60
Risk weights for Re Securitisation CRE exposures
For originator
200
200
Other than originators
200
200
50
50
100
100
100
100
200
200
100
100
150
150
200
200
400
400
350
400
650
1,111
1,111
Source: RBI/MOSL
3 May 2012
4

Financials | Update
Other highlights
Exposure limits are linked to capital funds (CET1+AT1+T2) and it does not include
capital conservation buffer and CCB. For adjustments from CET1, till FY17,
remainder will continue to have current regulatory treatment. AT1, which no
longer meets requirement of BASEL III, will be phased out beginning CY13 till
FY22.
During the financial year, current year profits are also included (not mentioned
under draft guidelines) however based on the condition of (a) NPA provisions in
any quarter of the previous year should be higher by 25% than average quarterly
profit of previous year and (b) provisions for dividend should also created on the
quarterly basis (based on the last three years average dividend).
Our view
Impact on sector:
(a) Most of the banks in India are already above minimum CET1 of
5.5% and on aggregate basis at Tier I of 8% or above [BASEL III requirement of 7%
(CET1 of 5.5% and AT1 of 1.5%) and current regulatory requirement of 6%] and hence,
transition should not be an issue in the near term (b) Higher share of CET1 and fall in
leverage will lead to a fall in RoEs of select PSU banks (c) Currently, RBI mandates
banks to keep the dividend payout ratio below 40% depending upon its CRAR of last
3 year and performance on NNPA front. Banks are given flexibility under BASEL III for
dividend payout and it can also be as high as 100% payout. This is positive in case of
ICICIBC and FB considering the release of capital from Insurance venture and excess
capitalisation.
Impact on Private sector banks:
All the private sector banks at the current levels fulfil
the minimum CET1 + CCB requirement. So far, major Private sector banks have worked
with higher Tier I ratio and have recapitalized balance sheet if Tier I ratio reached
~9%. Private Banks also earn superior ROA as compared to PSU counter parts and
hence, transition to BASEL III is a non-issue. Higher capital requirement will also force
PSU banks to focus on core parameters and calibrate growth. We expect private banks
to effectively capitalise the consolidation phase of PSU banks with rapid expansion
of branch and customer acquisition.
Capital Structure of Private banks (Based on descending order of CET1 of FY11)
CRAR
FB
ICICIBC
IIB
HDFCB
JKBK
AXSB
VYSB
YES
18.4
19.4
15.3
17.4
15.9
15.8
14.9
20.6
Tier I
16.9
14.4
9.7
13.3
12.8
11.2
10.1
12.8
FY10
CET1
16.9
13.5
9.7
13.2
12.8
10.9
9.6
11.8
AT1
0.0
0.9
0.0
0.1
0.0
0.3
0.5
1.0
T2
1.4
5.0
5.7
4.1
3.1
4.6
4.8
7.8
CRAR
16.8
19.5
15.9
16.2
13.7
12.7
12.9
16.5
FY11
Tier I
CET1
15.6
13.2
12.3
12.2
11.3
9.4
9.4
9.7
AT1
T2
15.6
0.0
1.2
12.4
0.8
6.3
12.3
0.0
3.6
12.1
0.1
4.0
11.3
0.0
2.4
9.2
0.2
3.2
8.9
0.4
3.6
8.5
1.1
6.8
Source: Company/MOSL
3 May 2012
5

Financials | Update
Impact on PSU banks:
GOI commitment to keep Tier I ratio at 8% and above and it’s
holding at 58%+ in PSU banks, should ensure smooth transition to BASEL III by banks in
the near term. However, considering the fiscal health of GOI, funding PSU banks on a
longer term basis is not a viable option. Thus, banks will have to improve core operating
profitability to fund its growth requirement.
In our view, banks with low RoA’s and structurally weakening balance sheet structure
will find it difficult to fulfil BASEL III requirement, resulting in loss of market share
and eventual consolidation. In our view, top 6 six PSU banks are better placed to fulfil
BASEL III requirement. Alternate measures that can be adopted by GOI to fulfil BASEL
III requirements in PSU banks in the short term include considering to convert its
PNCPS and IPDI holding into equity.
Capital Structure of PSU banks (Based on descending order of CET1 of FY11)
CRAR
OBC
CBK
ANDB
DB
BOB
ALBK
PJSB
UNBK
CRPBK
PNB
SBIN (Cons)
IOB
BOI
UNTDB
VJYBK
SNDB
CBOI
BOMH
IDBI
UCO
12.5
13.4
13.9
12.8
14.4
13.6
13.1
12.5
15.4
14.2
13.5
14.8
12.9
12.8
12.5
12.7
12.2
12.8
11.3
13.2
Tier I
9.3
8.5
8.2
8.2
9.2
8.1
7.7
7.9
9.3
9.1
9.3
8.7
8.5
8.2
7.7
8.2
6.8
6.4
6.2
7.1
FY10
CET1
8.6
8.0
7.8
7.3
8.4
7.7
6.5
7.1
8.2
8.0
8.6
7.7
7.4
6.8
6.5
7.2
4.7
5.7
4.3
4.9
AT1
0.7
0.6
0.4
0.8
0.8
0.4
1.2
0.8
1.1
1.1
0.7
1.0
1.0
1.3
1.2
1.1
2.1
0.7
1.9
2.2
T2
3.3
4.9
5.8
4.6
5.2
5.5
5.4
4.6
6.1
5.1
4.2
6.1
4.5
4.6
4.8
4.5
5.4
6.4
5.1
6.2
CRAR
14.2
15.4
14.4
13.4
14.5
13.0
13.6
13.0
14.1
12.4
12.3
14.6
12.2
13.1
13.9
11.5
13.8
13.4
13.6
13.7
FY11
Tier I
CET1
11.2
10.9
9.7
9.8
10.0
8.6
9.3
8.7
8.7
8.4
8.0
8.2
8.3
8.9
9.9
7.8
8.5
8.0
8.0
8.5
AT1
T2
10.3
0.9
3.0
10.0
0.9
4.5
9.4
0.3
4.7
9.1
0.7
3.6
9.1
0.9
4.5
8.2
0.3
4.4
8.2
1.0
4.3
7.9
0.8
4.3
7.9
0.8
5.4
7.6
0.8
4.0
7.4
0.6
4.2
7.4
0.7
6.4
7.3
1.0
3.8
7.3
1.6
4.2
7.2
2.7
4.3
7.0
0.8
3.6
6.6
1.9
5.3
6.2
1.9
5.3
6.1
1.9
5.6
5.8
2.7
5.2
Source: Company/MOSL
3 May 2012
6

Financials | Update
3 May 2012
7

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