The Reserve Bank of India (RBI) has put out a draft amendment to its earlier directions on prudential norms for the capital adequacy of commercial banks. It deals with Pillar 3 (disclosure requirements) of the Basel III framework, adopted by RBI in 2013.
The rationale, according to the central bank, is to ensure greater consistency with that framework, as prescribed by the Bank for International Settlements, the global collective of central banks. Its three pillars cover minimum capital ratios, supervisory review processes and market discipline.
The third pillar aims to keep markets informed about the financial status of banks through a regulatory mandate to disclose vital information that has no legitimate claim to secrecy.
The draft circular hits the nail on its head by stating that the provision of “meaningful information about common key risk metrics to market participants is a fundamental tenet of a sound banking system” as it “reduces information asymmetry and helps promote comparability of a bank’s risk profile within and across jurisdictions.”
The business of banking is, by definition, characterized by a certain degree of opacity, thanks to its underlying principle of customer confidentiality. Information asymmetry—where one side knows more than the other—is almost a given.
This is where Pillar 3 hopes to make a difference. By stipulating what exactly a bank must disclose, it enables market participants to access key information on a bank’s risk exposure and capital cushion designed to absorb any losses that may arise from operations.
The broad idea is to increase transparency and confidence in a bank’s ability to withstand financial blows.
However, the adequacy of regulatory capital per se and good supervision are no guarantee against bank failure. A lender with more than the mandated level of capital as a fraction of its risk-weighted assets may still falter.
After all, banking is not only about taking risks on credit and interest rate exposure, to mention just two; at its core, it is “accepting for the purpose of lending or investment of deposits of money from the public,” as Section 5 of the Banking Regulation Act of 1949 states. Note the words “from the public.” It is people at large who have the most at stake in ensuring bank resilience.
For the public to watch out for itself, people must have access to information that is typically the preserve of the sector’s supervisor—RBI, in our case. Regulation must strike an appropriate balance between what must be kept confidential and what’s placed in the public domain.
The draft circular is right to say disclosures must be clear, comprehensive, regular, meaningful to users, consistent over time, comparable across banks, etc. By extending these norms even to banks that are not listed on stock exchanges, it ends the differential treatment of widely held and unlisted banks.
This is wise.
What’s less so is an exclusion granted to what RBI terms “exceptional cases,” where disclosing some items required by Pillar 3 may reveal the position of a bank or contravene its legal obligations on proprietary or confidential data. In such cases, general information and an explanation of what is being withheld and why would suffice.
This relaxation seems both inexplicable and unwarranted, as it is precisely such cases that may call for greater transparency. In fact, a key step in improving bank transparency would be for RBI to make its inspection reports public, a move that it has steadfastly resisted.