Mumbai: Tougher global rules on how much capital banks will need to back every rupee they have lent out or invested will pinch foreign banks in India far more than nationalized banks and domestic private sector banks, according to a study by the Reserve Bank of India (RBI) published in October.
“(A) majority of the foreign sector banks reported higher CRAR under Basel 1 than that under Basel 2,” the central bank noted. In contrast, a majority of nationalized banks have reported better capital ratios under the new rules compared with the old rules. Private sector banks present a mixed picture.
CRAR is the acronym for capital to risk-weighted assets ratio, a standard metric to measure balance sheet strength of banks. Basel 1 and Basel 2 are global capital adequacy rules that prescribe a minimum amount of capital a bank has to hold given the size of its risk-weighted assets. The old rules mandated banks to back every Rs100 of commercial loans with Rs9 of capital irrespective of the nature of these loans.
The new rules are more nuanced: the amount of capital needed depends on the credit rating of the customer.
Two analysts Mint spoke to said that the capital ratio of a majority of foreign banks in India dropped under the new capital rules because of the nature of their business. Foreign banks have a higher exposure to segments such as retail loans and lending to companies that do not have top-notch credit ratings, besides the fact that they also do more high-risk business in off-balance sheet derivatives and foreign exchange trading.
Pawan Agarwal, director- corporate and government ratings, Crisil Ltd, a Standard and Poor’s company said, “The implementation of Basel II will improve the capital adequacy ratio of the banking system by 75 to 100 basis points. This is largely due to reduction on risk weight for highly rated corporates.’’
“This capital relief that banks would get on account of the composition of their asset book could get nullified and banks could see a dip in capital adequacy as they have to provide additional capital for operational risk,’’ added Agarwal.
However, he clarified that despite the marginal dip in capital adequacy under Basel II, there is no pressure on banks.
Public sector banks on an average have shown a 100 basis points improvement in capital adequacy under Basel II according to the RBI data. The improvement in CRAR among public sector banks or PSBs bankers say is largely because their corporate exposure is largely skewed towards highly rated companies thus the capital relief is higher.
Additionally, PSBs also have lower exposure to retail loans as compared with private and foreign banks.
“Foreign banks have a higher proportion of business with local subsidiaries of global relationships where often the local subsidiary may not have strong stand-alone balance sheets and ratings. They also have a higher proportion of foreign exchange and derivatives business in proportion to advances portfolio resulting in higher amount of unsecured/unrated exposure, which puts pressure on their capital adequacy,’’ said a Mumbai-based banking analyst with a global consultancy firm who did not wish to be named.
Citibank N.A’s CRAR that dipped to 13.2% at the end of March 2009 under Basel II as against 14.8% at the end of March 2009 under Basel I. DBS Bank Ltd’s CRAR dipped to 15.7% under Basel II at the end of March 2009 as against 18.4% under Basel I at the end of March 2009. DBS declined comment.
Abhijit Sen, chief financial officer, Citi South Asia said, “Citibank expects that the availability of corporate ratings will improve as we go ahead. More and more borrowers are expected to go for issuer ratings rather than issue or borrowing specific ratings. This should help to apply proxy rules and bring down the risk weighted assets... As we move to advanced approaches, significant capital relief should be available particularly in respect of operational risk. Our CRAR under Basel II is significantly over the threshold.’’