Wednesday, May 13, 2015

Implementation of Basel III Capital Regulations in India – Capital Planning

Basel III Transitional Arrangements
1.1 In terms of Basel III Capital Regulations issued by the Reserve Bank of India, the Capital Conservation Buffer
(CCB) is scheduled to be implemented from March 31, 2015 in phases and would be fully implemented as on March 31, 2018. It has been decided that the implementation of CCB will begin as on March 31, 2016. Consequently, Basel III
Capital Regulations will be fully implemented as on March 31, 2019.
Loss Absorption Features of Non-Equity Capital Instruments
2.1 The criteria for Additional Tier 1 (AT1) capital instruments inter alia require that these instruments should have principal loss absorption through either (i) conversion into common shares or (ii) a write-down mechanism which allocates losses to the instruments at an objective pre- specified trigger point. The pre-specified trigger is set at Common Equity Tier 1 (CET1) of 6.125% of risk weighted
assets (RWAs). It has now been decided that all Basel III compliant AT1 instruments issued before March 31, 2019 i.e., before the full implementation of Basel III, will have two pre-specified triggers. A lower pre specified trigger at
CET1 of 5.5% of RWAs will apply and remain effective before March 31, 2019, after which this trigger would be raised to
CET1 of 6.125% of RWAs for all such instruments. AT1 instruments issued on or after March 31, 2019 will, however, have pre-specified trigger at CET1 of 6.125% of RWAs only.
2.2 Presently, in addition to conversion feature, both the temporary and permanent write-down features have been permitted at the pre-specified trigger point for AT1 capital instruments. On a review, it has been decided that banks may issue AT1 capital instruments with conversion / permanent write-down features only. Similarly, with regard
to write-off feature at Point of Non-Viability (PONV) trigger, all non-equity capital instruments will have permanent
write-off feature only, even in cases where there is no public sector injection of funds. Further, it is clarified that
Basel III compliant capital instruments issued with temporary write-off feature till the date of this circular will continue to be recognised as eligible regulatory capital
2.3 Accordingly, Annex 16 of the Basel III Master Circular has been revised as indicated in the Appendix.
3. Dividend/Coupon Discretion on Capital Instruments
3.1 As regards ‘distributable items’, it is clarified that:
The dividend on common shares and perpetual non- cumulative preference shares (PNCPS) will be paid out of
current year’s profit only. If the payment of coupons on perpetual debt instrument
(PDI) is likely to result in losses in the current year, their declaration should be precluded to that extent. Moreover,
coupons on perpetual debt instruments should not be paid out of retained earnings / reserves. In other words, payment of coupons should not have the effect of reducing retained earnings / reserves.
4. Dividend Payment by Banks
4.1 Currently, dividend payment by banks is governed by the provisions of circular
DBOD.No.BP.BC.88/21.02.067/2004-05 dated May 04, 2005 on ‘Declaration of Dividends by Banks’. Further, Basel
III framework also imposes certain constraints on distributions (i.e. payment of dividend or bonuses in any form etc.) in case the capital level of banks falls within the stipulated range as prescribed by the capital buffers framework (i.e. capital conservation and countercyclical
buffers, etc.). It is clarified that the dividend payment by banks would be governed by the interaction of both these
guidelines, once the capital buffer framework has kicked-in.
4.2 Incidentally, the reference to Basel II capital requirements under paragraph 5(d) on ‘Board Oversight’ of the above circular should be read as the prevailing capital adequacy framework implemented by the Reserve Bank of India and applicable to scheduled commercial banks operating in India.
5. Optionality of Capital Instruments
One of the essential criteria with regard to the optionality of Basel III compliant capital instruments is that a bank must
not do anything which creates an expectation that the call will be exercised. For example, to preclude such expectation of the instrument being called, the dividend / coupon reset date need not be co-terminus with the call
date. Banks may, at their discretion, consider having an appropriate gap between dividend / coupon reset date and
call date.