Page 217 - DMGT303_BANKING_AND_INSURANCE

Banking and Insurance

Notes bank capital requirements and introduces new regulatory requirements on bank liquidity and
bank leverage. For instance, the change in the calculation of loan risk in Basel II which some
consider a causal factor in the credit bubble prior to the 2007-8 collapse: in Basel II one of the
principal factors of financial risk management was out-sourced to companies that were not
subject to supervision, credit rating agencies. Ratings of creditworthiness and of bonds, financial
bundles and various other financial instruments were conducted without supervision by official
agencies, leading to AAA ratings on mortgage-backed securities, credit default swaps, and other
instruments that proved in practice to be extremely bad credit risks. In Basel III, a more formal
scenario analysis is applied (three official scenarios from regulators, with ratings agencies and
firms urged to apply more extreme ones).
The OECD estimates that the implementation of Basel III will decrease annual GDP growth by
0.05-0.15%. Outside the banking industry itself, criticism was muted. Bank directors would be
required to know market liquidity conditions for major asset holdings to strengthen
accountability for any major losses.
Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of
Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). Basel III also introduces
additional capital buffers, (i) a mandatory capital conservation buffer of 2.5% and (ii) a
discretionary countercyclical buffer, which allows national regulators to require up to another
2.5% of capital during periods of high credit growth. In addition, Basel III introduces a minimum
3% leverage ratio and two required liquidity ratios. The Liquidity Coverage Ratio requires a
bank to hold sufficient high-quality liquid assets to cover its total net cash outflows over 30
days; the Net Stable Funding Ratio requires the available amount of stable funding to exceed the
required amount of stable funding over a one-year period of extended stress.

10.9 Summary

A commercial bank can serve society and help economy to develop only when it operates
successfully. Generation of adequate operational surpluses by banks is necessary to provide
cushion to support their credit risks and also to supplement the finances of the government.
Thus, a bank in order to survive successfully in the long run has to give due importance to profit
as well as social goals. There should not be problem for a banker to strike satisfactory balance of
the two goals if funds are properly managed and there is a conscious and deliberate planning of
the bank's income, expenditure and overall productivity of human resources. Thus, profit
constitutes the base of growth and contributes to inner strength.

Indian banking sector is having a serious problem of non-performing assets. The earning capacity
and profitability of the banks are highly affected due to this.

The level of non-performing assets (NPAs) of the banking system in India has shown a decline
in recent years, but it is still too high. Part of the problem is the carry-over of old NPAs in certain
declining sectors of industry. The problem has been further complicated by the fact that there
are a few banks, which are fundamentally weak and where the potential for return to
profitability, without substantial restructuring, is doubtful.
Narasimham Committee was appointed to examine the effectiveness of the existing financial
system of the country and suggest reforms.
Capital Adequacy relates to the firm's overall use of financial leverage. It also measures the
relationship between firm's market value of assets and liabilities and the corresponding book
value. Not all source of capital show up on the firm's balance sheet.

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