The Reserve Bank on Friday released draft guidelines for minimum capital requirements for market risk under the Basel III framework, in which it proposes several curbs on banks’ trading and banking books and a steep increase in penalties and provision ratios. .
The regulator said the move is part of the Reserve Bank’s efforts to align regulations with Basel III standards.
The final guidelines, after amendments following public and stakeholder suggestions, will be applicable to all commercial banks except local area banks, payments banks, regional rural banks, small finance banks and all types of co-operative banks – urban, state and central co-operative banks . Co-operative banks and will come into force from April 1, 2024.
The central bank has sought comments from both stakeholders and the public till April 15.
What is Basel III Framework?
The Basel III reforms are a response to the Basel Committee on Banking Supervision (BCBS) to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, thus spreading risks from the financial sector to the real economy. reduces ,
During the Pittsburgh summit in September 2009, G20 leaders committed to work together to strengthen the regulatory system and raise capital standards for banks and other financial firms, with the aim of ending those practices. Implement strong international compensation standards that lead to excessive risk-taking. Reforming the over-the-counter derivatives market and creating more powerful tools to hold large global firms accountable for the risks they take. For all these reforms, the leaders set for themselves a strict and precise timetable.
As a result, the Basel Committee on Banking Supervision (BCBS) issued a comprehensive reform package in December 2010 entitled “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (known as the Basel III Capital Regulations).
RBI’s latest draft guidelines for minimum capital requirements for market risk
The new norms clearly draw a boundary between the banking book and the trading book and list instruments that can be included in the trading book, subject to market risk capital requirements; And they are to be included in the banking book subject to credit risk capital requirements.
The capital requirement for both specific risk and general market risk would be 9 per cent of the bank’s core capital plus exposure to the specified instruments. These capital charges will also apply to all trading book exposures, which are exempted from the capital market exposure limits for direct investments.
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For the purpose of capital adequacy, the regulator defines a trading book as all instruments that meet the specifications of trading book instruments such as financial instruments and foreign exchange and all other instruments to be included in the banking book.
It also defines market risk as the risk of loss arising from fluctuations in market prices and in an off-balance-sheet position.
Since a financial obligation is a contractual obligation to deliver cash or other financial assets, banks will only include a financial instrument or foreign exchange instrument in the trading book when there are no legal barriers against selling or outright hedging.
The new norms also oblige banks to make a daily fair value on any trading book instrument and specify that any instrument held by a bank when it is first recognized on its books is treated as a trading book instrument. unless specifically provided for by a shorter term. resale, profiting from short-term price fluctuations; locking in arbitrage profits; or hedging risk arising from the meeting of the instruments.
The new guidelines specify unlisted equity and equity investments in subsidiaries/associates; designated equipment for securitization storage; securities with real estate as well as its derivatives; securities with retail and micro, MSME exposure as the underlying; Equity investment in funds in the banking book.
The new guidelines prohibit short positions on any instrument except derivatives and central government securities. Banks are permitted to engage in underwriting of issues of shares, debentures and bonds.
But banks will have the option to deviate from the projected list with prior approval from RBI and after approval of the Board. In cases where this approval is not given, the instrument will be designated in the trading book.
Subject to supervisory review, banks will have the option to exclude certain listed equities from the market risk framework. For example equity positions arising from deferred compensation plans, convertible debt securities, bank owned life insurance products and legislative programs.
The framework also obliges banks to lay down clearly defined policies, procedures and documented practices on which instruments can be included or excluded in the trading book for the purpose of computing regulatory capital, and the bank’s Risk management capabilities and practices may also be taken into account.
There is also a strict limit on the ability of banks to move instruments between the trading book and the banking book at their discretion after initial designation and any such transfer for regulatory arbitrage is strictly prohibited.
In practice, transfers should be rare and only permitted in exceptional circumstances, it added, adding transfers may be permitted if there is a major publicly announced event, such as a bank restructuring instrument. or requires the cessation of business activity applicable to the portfolio. or a change in accounting standards that allows an item to be fair valued through profit and loss accounts.
Market events, changes in the liquidity of a financial instrument, or simply a change in trading intent are not valid reasons for reassigning an instrument to a different ledger. While changing the status, banks should ensure that all the mandatory norms are being followed.
But transfer between books is possible if approved by the bank’s board and RBI after a fully documented process and determined by internal review in compliance with the bank’s policies and prior RBI.
Irrespective of the frequency of reporting, banks shall meet all capital requirements for market risk on an ongoing basis at the end of each business day. Banks should maintain a strict risk management system to monitor and control intraday exposure to market risks.
Banks must document the positions and amounts to be excluded from market risk capital requirements and make available for supervisory review. The foreign exchange risk capital requirement will not apply to positions relating to items that are deducted from a bank’s capital while computing its capital base.
(With PTI inputs)
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