DR.

RAM MANOHAR LOHIYA NATIONAL LAW UNIVERSITY,

LUCKNOW

Final Draft

BANKING AND INSURANCE LAW

Comparative analysis of International Banking and Indian Banking

Submitted to:

Dr Aparna Singh

Assistant Professor (Law)

RMLNLU

Submitted by:

Shobhit Kumar Shukla

Enrolment ID-190101138

6th Semester

Section B

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 ACKNOWLEDGEMENT

I specially owe my gratitude to Dr. Aparna Singh (Faculty: Banking Law), for providing me
this opportunity to work on the project “COMPARATIVE ANALYSIS OF
INTERNATIONAL BANKING AND INDIAN BANKING”, and who was kind enough to
give me academic support and advice from time to time.

I am highly indebted to my family members for giving me their full cooperation, mental
support and their love and affection.

Lastly, I would like to express my deep sense of appreciation to everybody directly or

indirectly involved in this project work, all through the making of it.

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 TABLE OF CONTENTS

INTRODUCTION ................................................................................................................ 4
English Banking: Bank of England .................................................................................... 4
Core Purpose ..................................................................................................................... 5
Memorandum of Understanding ........................................................................................ 6
History of Banks ................................................................................................................ 7
Analysis of banking Systems Of International and Indian Banking ........................................ 8
BASEL AGREEMENT II.................................................................................................. 8
Containment of Financial Leverage of Banks Impact on Indian Banks ............................. 10
Reducing the Pro-cyclicality of Financial Sector Regulation: BCBS Proposals ................ 11
Liquidity Risk Management: BCBS Proposals ................................................................. 12
Dealing with Systemically Important Financial Institutions (SIFIs) : BCBS Proposals ..... 13
Containment of Systemic Risk: Indian Perspective .......................................................... 13
Regulation of Compensation Practices of Banks: BCBS Proposals .................................. 14
Regulation of Compensation Practices of Banks: Indian Perspective ................................ 14
International Financial Reporting Standards (IFRS): Reform Proposals ........................... 15
International Financial Reporting Standards (IFRS) Indian Perspective ........................... 15
Macroeconomic Impact of the proposed BCBS Reforms ................................................. 16
Implementation of Basel III in India .................................................................................... 18
CONCLUSION................................................................................................................... 19
BIBLIOGRAPHY ............................................................................................................... 20
BOOKS: .......................................................................................................................... 20
WEBSITES ..................................................................................................................... 20

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 INTRODUCTION

A bank is a financial institution and a financial intermediary that accepts deposits and
channels those deposits into lending activities, either directly or through capital markets. A
bank connects customers that have capital deficits to customers with capital surpluses. The
business of banking is in many English common law countries not defined by statute but by
common law, the definition above. In other English common law jurisdictions there are
statutory definitions of the business of banking or banking business. When looking at these
definitions it is important to keep in mind that they are defining the business of banking for
the purposes of the legislation, and not necessarily in general. In particular, most of the
definitions are from legislation that has the purposes of entry regulating and supervising
banks rather than regulating the actual business of banking. However, in many cases the
statutory definition closely mirrors the common law one. Examples of statutory definitions:

"banking business" means the business of receiving money on current or deposit account,
paying and collecting cheques drawn by or paid in by customers, the making of advances to
customers, and includes such other business as the Authority may prescribe for the purposes
of this Act; (Banking Act (Singapore), Section 2, Interpretation).

"banking business" means the business of either or both of the following:

receiving from the general public money on current, deposit, savings or other similar account
repayable on demand or within less than [3 months] ... or with a period of call or notice of
less than that period; paying or collecting checks drawn by or paid in by customers.

Since the advent of EFTPOS (Electronic Funds Transfer at Point Of Sale), direct credit, direct
debit and internet banking, the cheque has lost its primacy in most banking systems as a
payment instrument. This has led legal theorists to suggest that the cheque based definition
should be broadened to include financial institutions that conduct current accounts for
customers and enable customers to pay and be paid by third parties, even if they do not pay
and collect cheques. 1

English Banking: Bank of England

The Bank of England is the central bank of the United Kingdom. Sometimes known as the
'Old Lady' of Threadneedle Street, the Bank was founded in 1694, nationalised on 1 March

1
e.g. Tyree's Banking Law in New Zealand, A L Tyree, LexisNexis 2003, page 70 .

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1946, and gained independence in 1997. Standing at the centre of the UK's financial system,
the Bank is committed to promoting and maintaining monetary and financial stability as its
contribution to a healthy economy.

The Bank's roles and functions have evolved and changed over its three-hundred year history.
Since its foundation, it has been the Government's banker and, since the late 18th century, it
has been banker to the banking system more generally - the bankers' bank. As well as
providing banking services to its customers, the Bank of England manages the UK's foreign
exchange and gold reserves.

The Bank has two core purposes - monetary stability and financial stability. The Bank is
perhaps most visible to the general public through its banknotes and, more recently, its
interest rate decisions. The Bank has had a monopoly on the issue of banknotes in England
and Wales since the early 20th century. But it is only since 1997 that the Bank has had
statutory responsibility for setting the UK's official interest [Link] rate decisions are
taken by the Bank's Monetary Policy Committee. The MPC has to judge what interest rate is
necessary to meet a target for overall inflation in the economy. The inflation target is set each
year by the Chancellor of the Exchequer. The Bank implements its interest rate decisions
through its financial market operations - it sets the interest rate at which the Bank lends to
banks and other financial institutions. The Bank has close links with financial markets and
institutions. This contact informs a gr 88

eat deal of its work, including its financial stability role and the collation and publication of
monetary and banking statistics.

The Bank of England is committed to increasing awareness and understanding of its activities
and responsibilities, across both general and specialist audiences alike. It produces a large
number of regular and ad hoc publications on key aspects of its work and offers a range of
educational materials. The Bank offers technical assistance and advice to other central banks
through its Centre for Central Banking Studies, and has a museum at its premises in
Threadneedle Street in the City of London, open to members of the public free of charge.

Core Purpose

In pursuing its goal of maintaining a stable and efficient monetary and financial framework as
its contribution to a healthy economy, the Bank has two core purposes; achieving them
depends on the work of the Bank as whole. This part of the website describes and explains

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each core purpose and some of the work that is undertaken to achieve them. This material
adds to that provided on the 'About the Bank' main page. Other parts of the website provide
more information about each of the Bank's activities.

 Price stability and monetary policy

The first objective of any central bank is to safeguard the value of the currency in terms of
what it will purchase at home and in terms of other currencies. Monetary policy is directed to
achieving this objective and to providing a framework for non-inflationary economic growth.
As in most other developed countries, monetary policy operates in the UK mainly through
influencing the price at which money is lent, in other words the interest [Link] Bank's price
stability objective is made explicit in the present monetary policy framework. It has two main
elements: an annual inflation target set each year by the Government and a commitment to an
open and accountable policy-making regime.

 Financial Stability

The Bank of England has played a key role in maintaining the stability of the United
Kingdom's financial system for 300 years and it is now a core function of most central banks.
A sound and stable financial system is important in its own right and vital to the efficient
conduct of monetary policy.

Since 1997, the Bank of England has had responsibility for the stability of the financial
system as a whole, while the Financial Services Authority (FSA) supervises individual banks
and other financial organisations including recognised financial exchanges such as the
London Stock Exchange.

Memorandum of Understanding

In October 1997, a Memorandum of Understanding between the Bank, Her Majesty's

Treasury and the FSA was agreed. This formalised the allocation of responsibilities for
regulation and financial stability in the UK. It made provisions for the establishment of a high
level Standing Committee to provide a forum in which the three organisations could develop
a common position on any problems which may emerge. An updated Memorandum was
issued in 2006

The Bank's contribution to the Standing Committee on financial stability issues is informed
by the operations of the Bank's Financial Stability Executive Board - a high-level internal

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body providing guidance on priorities and the direction of work in the Financial Stability
area. The Board is chaired by the Bank's Deputy Governor for Financial Stability and
generally meets on a monthly basis.

History of Banks

The Bank of England was founded in 1694 to act as the Government's banker and debt-
manager. Since then its role has developed and evolved, centred on the management of the
nation's currency and its position at the centre of the UK's financial [Link] history of the
Bank is naturally one of interest, but also of continuing relevance to the Bank today. Events
and circumstances over the past three hundred or so years have shaped and influenced the
role and responsibilities of the Bank. They have moulded the culture and traditions, as well as
the expertise, of the Bank which are relevant to its reputation and effectiveness as a central
bank in the early years of the 21st century. At the same time, much of the history of the Bank
runs parallel to the economic and financial history, and often the political history, of the
United Kingdom more generally.

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 ANALYSIS OF BANKING SYSTEMS OF INTERNATIONAL AND INDIAN
BANKING

BASELAGREEMENT II

The role of Basel II, both before and after the global financial crisis, has been discussed
widely. While some argue that the crisis demonstrated weaknesses in the framework, others
have criticized it for actually increasing the effect of the crisis. In response to the financial
crisis, the Basel Committee on Banking Supervision published revised global standards,
popularly known as Basel III. The Committee claimed that the new standards would lead to a
better quality of capital, increased coverage of risk for capital market activities and better
liquidity standards among other benefits.

Nout Wellink, former Chairman of the BCBS, wrote an article in September 2009 outlining
some of the strategic responses which the Committee should take as response to the crisis. He
proposed a stronger regulatory framework which comprises five key components: (a) better
quality of regulatory capital, (b) better liquidity management and supervision, (c) better risk
management and supervision including enhanced Pillar 2 guidelines, (d) enhanced Pillar 3
disclosures related to securitization, off-balance sheet exposures and trading activities which
would promote transparency, and (e) cross-border supervisory cooperation. Given one of the
major factors which drove the crisis was the evaporation of liquidity in the financial markets,
the BCBS also published principles for better liquidity management and supervision in
September 2008.

A recent OECD study suggest that bank regulation based on the Basel accords encourage
unconventional business practices and contributed to or even reinforced adverse systemic
shocks that materialised during the financial crisis. According to the study, capital regulation
based on risk-weighted assets encourages innovation designed to circumvent regulatory
requirements and shifts banks’ focus away from their core economic functions. Tighter
capital requirements based on risk-weighted assets, introduced in the Basel III, may further
contribute to these skewed incentives. New liquidity regulation, notwithstanding its good
intentions, is another likely candidate to increase bank incentives to exploit regulation.

Think-tanks such as the World Pensions Council have also argued that European legislators
have pushed dogmatically and naively for the adoption of the Basel II recommendations,
adopted in 2005, transposed in European Union law through the Capital Requirements

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Directive (CRD), effective since 2008. In essence, they forced private banks, central banks,
and bank regulators to rely more on assessments of credit risk by private rating agencies.
Thus, part of the regulatory authority was abdicated in favor of private rating agencies. The
whole subject of international banking regulation, and in particular the topic of capital
standards for large banks, may seem a bit untimely just now, what with Europe’s banks at the
brink of collapse even though regulators declared them amply capitalized just weeks ago.
Given that recent history, it’s tempting to write off the debate over capital standards as not
only eye-glazing but fundamentally irrelevant.

But manipulable and difficult to enforce as they may be, capital standards are one of the best
regulatory tools for promoting financial stability, because holding substantial capital is one of
the few things banks can do that actually helps them withstand panics. Regulators can, and
should, design deposit insurance schemes and resolution mechanisms to deal with bank
failures; a firm capital base, though, protects banks from failing in the first place.

A collection of cartoons about international news. Indeed, Europe’s current plight merely
reinforces the point. And the job of devising better capital standards on a global scale falls to
the international negotiation process known as “Basel III .” The latest Basel III agreement is
due for submission to world leaders Thursday at the Group of 20 summit conference in
Cannes, France. The good news is that Basel III produced a consensus in favor of stronger
capital requirements; by 2019, banks will have to hold at least 7 percent of their assets in
common equity and retained earnings. Controversy still rages, however, about a proposal to
make two dozen or so giant global banks, known as “systemically important financial
institutions,” hold even more capital than that. The idea is that this capital “surcharge” helps
protect against the risk that the downfall of a huge and widely interconnected institution
could bring the world financial system down with it. Not only that, but the surcharge will be
adjusted (within a range) depending on how globally risky regulators judge a particular bank
to be. This is a disincentive to bigness as such — one of the rule’s advantages, according to
Federal Reserve Chairman Ben S. Bernanke.

Not surprisingly, bankers are pushing back, led by Jamie Dimon of JPMorgan Chase, who
argues that the proposed surcharge is not only unnecessary but discriminatory against U.S.
banks, in part because, as recent experience shows, European regulators are more lenient
about capital than their U.S. counterparts.

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The bankers have a point: There is an inherent tradeoff between tighter bank regulation and
the availability of credit. Higher capital requirements function, economically, as a tax. To the
extent banks must keep more of their resources in reserve, they are less able to lend to job-
creating businesses, so they are probably right to point to various studies suggesting that
higher capital standards would retard growth to some [Link]’s harder to calculate, of
course, are the risk of crisis that may go along with “too much” lending and the value of
preventing crises. But we know one big lesson of the financial crisis is that everything is
riskier than it seems, or at least it might [Link] are wise to err on the side of caution,
and to add a capital surcharge to systemically important institutions. Yes, it’s hard to define
such institutions precisely, as Mr. Dimon and others protest — but not impossible. A tougher
question is whether the surcharge should be a flat percentage applied to all systemically
important institutions or whether, as proposed, regulators should graduate it according to
more refined criteria. The regulators’ argument is that they do not want to create a sharp
difference in policy toward two banks that present almost the same risk profile. But line-
drawing problems come up no matter how you attempt to make distinctions.

As Basel III moves from the drawing board to full implementation by member countries, the
authorities will have to show that it is truly adding safety and soundness, and not just more
[Link] crisis has exposed several flaws in the quantitative risk management models
used by banks. One of the flaws is the inability of the models to capture the market risk in
their trading book positions, particularly under stressed conditions. This is sought to be
corrected by requiring that the capital calculations be made on parameters calibrated to
stressed conditions.

The last decade witnessed a quantum jump in the derivatives activities of banks leading to a
phenomenal rise in counterparty credit risk. One of the shortcomings of the prevailing Basel
II framework is that it does not fully capture the unexpected rise in counterparty exposures
under stressed conditions. Besides, during the crisis we saw the financial condition of
counterparties worsen at the same time when they suffered losses on their derivatives
transactions, leading to the so called ‘wrong way risk’. The counterparty credit risk
framework of Basel II is being revised to address these concerns.

Containment of Financial Leverage of Banks Impact on Indian Banks

Estimates show that the leverage in the Indian banking system is quite moderate. In the
BCBS deliberations, we argued that the SLR portfolio of our banks, which is a regulatory

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mandate, should be excluded from the calculation of the leverage ratio as this carries only a
moderate risk (i.e. no credit risk and only market risk). However, BCBS took an in-principle
position that no assets, inlcuding cash which obviously has the least risk, should be excluded
from the measurment of the leverage ratio. Nevertheless, since the Tier 1 capital of many
Indian banks is comfortable (more than 8%) and their derivatives activities are also not very
large, we do not expect the leverage ratio to be a binding constraint for Indian banks.

Reducing the Pro-cyclicality of Financial Sector Regulation: BCBS Proposals

Critics contend that a major flaw of the Basel II capital regulations is their inherent
procyclicality. The procyclicality debate came into sharp focus during the crisis. Banks found
themselves constrained in lending by already shrunk capital ratios owing to losses when more
lending would, in fact, have helped in containing the downturn. To minimise the procyclical
effects, BCBS has proposed to: (a) base the calculation of capital on more conservative
estimates of default probabilities, (b) promote more forward looking provisions, (c) conserve
capital to build capital buffers at individual banks and the banking sector that can be used
under stress, and (d) manage system-wide risk by containing excess credit [Link]
concept of making countercyclical provisions and establishing capital buffers simply implies
that banks should build up higher levels of provision and capital in good times which could
be run down in times of economic contraction consistent with safety and soundness
considerations. This will be done by defining buffer ranges above the regulatory minimum
capital requirement. The concept has an intuitive appeal. Operationalizing it though is a
complex task and poses many challenges. The first and foremost challenge is the difficulty of
identifying the inflection point in an economic cycle based on objective and observable
criteria which would indicate when to begin building up a capital buffer and when to start
using it. Second, what economic indicator do we use? It is difficult to identify a single
macroeconomic variable that can be a reliable indicator of both good and bad times. For
instance, credit growth could be a good indicator of the build up phase but credit contraction
is usually a lagging indicator of emerging strains in the system. Third, any approach to
creating a capital buffer whose size varies with the economic cycle poses the challenge of
defining an economic cycle in a global setting as economic cycles are not globally
synchronised. Fourth, experience shows that vulnerabilities build up gradually, often over
several years, but distress emerges quite rapidly. Hence, the capital buffer may have to be
released rather abruptly. Fifth, determining the right size of a capital buffer is both a difficult
task and also a contentious issue; it will need to be large enough to absorb losses in a

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downturn and still enable banks to continue lending but not so large as to make the insurance
against failure too expensive. Finally, any scheme of capital buffers needs to be simple and
transparent, entail low implementation costs and be as rule-based as possible. Can we design
a framework for reducing procyclicality that meets all these requirements?

BCBS is working on addressing all these issues. It must be recognised though that, given the
different structures and stages of development of financial systems across countries, it will be
absolutely essential to allow national discretion in applying the ‘framework’.

Liquidity Risk Management: BCBS Proposals

The financial turmoil highlighted the feedback loops through which institutional liquidity
constraints cascade into systemic solvency crises because of interconnectedness. A typical
chain reaction runs as follows. An institution gets into a liquidity problem, is unable to tide
over that because of a hostile funding environment, indulges in fire sale of its assets to
generate liquidity, incurs losses in the process which makes raising funding even more
difficult and is then forced into further fire sales. This leads to a sharp drop in asset prices and
the pressures transmit rapidly, and then explosively, to other banks and financial institutions
pulling the whole system into a ‘death spiral’. The BCBS proposals involve two regulatory
standards for managing liquidity risk: (i) a Liquidity Coverage Ratio to ensure resilience over
the short term; and (ii) a Net Stable Funding Ratio to promote resilience over the longer term.
Reckoning that there is wide diversity in the measures used by supervisors for monitoring the
liquidity risk, the new proposals also include a set of common liquidity-risk monitoring tools.
Liquidity Risk Management: Indian Perspective. The major challenge for banks in India in
implementing the liquidity standards is to develop the capability to collect the relevant data
accurately and granularly, and to formulate and predict the liquidity stress scenarios with
reasonable accuracy and consistent with their own situation. Since our financial markets have
not experienced the levels of stress that advanced country markets have, predicting the
appropriate stress scenario is going to be a complex judgement call. On the positive side,
most of our banks follow a retail business model and also have a substantial amount of liquid
assets which should enable them to meet the new standards. There is an issue about the
extent to which statutory holdings of SLR are counted towards the proposed liquidity ratios.
An argument could be made that they should not be counted at all as they are supposed to be
maintained on an ongoing basis. However, it would be reasonable to treat at least a part of

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the SLR holdings in calculating the liquidity ratio under stressed conditions, particularly as
these are government bonds against which RBI provides liquidity.

Dealing with Systemically Important Financial Institutions (SIFIs) : BCBS Proposals

BCBS is engaged in evolving an appropriate framework for dealing with systemically

important banks and financial institutions in the international context. This involves a host of
tasks: development of indicators of systemic risk, identification of systemically important
financial institutions (SIFIs), differential systems for SIFIs by way of capital and liquidity
surcharge and enhanced supervision, improving the capacity to resolve SIFIs without
recourse to taxpayer money, reducing the probability and impact of a SIFI failure,
strengthening the core financial market infrastructure to reduce contagion risks if failure
occurs and improving the oversight of SIFIs. Even if we accept that SIFIs should be subject
to some additional regulation on top of the base level regulations, there are several issues that
need to be addressed in fleshing out the necessary framework. The first issue is of evolving
objective criteria for identifying systemically important institutions. Second, how do we
apply the criteria since the systemic importance of an institution is likely to be time-varying
and state-dependent as per the economic environment? Finally, drawing a sharp distinction
between a SIFI and a non-SIFI requires considerable judgement and has a moral hazard
downside.

Containment of Systemic Risk: Indian Perspective

The framework for identification of SIFIs that will evolve is expected to be applicable
uniformly to all countries. India will also need to adopt that. The identification under the
BCBS framework will happen from an international perspective, and we need to do a
supplementary exercise to identify SIFIs in the domestic context even if they are not in the
international list. In either case, if the proposal for levying systemic risk capital and liquidity
charge is eventually agreed upon, a few Indian banks may be called upon to maintain
additional capital and liquidity charges. Then there is the issue of resolution of SIFIs in the
event of failure. We also need to promote structures which make such resolutions smooth and
orderly. The recent Reserve Bank initiative to constitute a working group to examine the
suitability of financial holding companies in India is a step in this direction. RBI has also
been constantly upgrading the regulatory and supervisory framework for financial
conglomerates. Efforts are also under way to bring a larger number of financial transactions
within the ambit of multilateral settlement through central counterparties.

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Regulation of Compensation Practices of Banks: BCBS Proposals

It is now widely acknowledged that the flawed incentive framework underlying the
compensation structures in the advanced country banking sectors fuelled the crisis. The
performance-based compensation of bank executives is typically justified on the ground that
banks need to acquire and retain talent. We now know, with the benefit of hindsight, that the
compensation framework overlooked the perverse incentives it would engender. Bank
executives focused too much on short-term profits and compromised long term interests with
disastrous consequences. The Financial Stability Board has since evolved a set of principles
to govern compensation practices and the Basel Committee has developed a methodology for
assessing compliance with these principles. The proposed framework involves increasing the
proportion of variable pay, aligning it with long-term value creation and instituting deferral
and claw-back clauses to offset future losses caused by the executives.

Regulation of Compensation Practices of Banks: Indian Perspective

Since 70 per cent of our banking sector is accounted for by public sector banks where
compensation is determined by the government, and where the variable component is very
limited, the proposed reform to compensation structures is relevant in India only to the
remaining 30 per cent of the non-public sector industry segment. Private, foreign and local
area banks in India are statutorily required to obtain RBI’s regulatory approval for the
remuneration of their wholetime directors and chief executive officers. In evaluating these
proposals in respect of Indian banks, Reserve Bank has historically ensured that the
compensation is not excessive, is consistent with industry norms, is aligned to the size of the
bank’s business and that the variable pay component is limited. In respect of foreign banks,
the Reserve Bank has largely gone by the recommendation of the bank’s head office.
However, reflecting the spirit of the global initiative on compensation structures, we
determined that there is need for reform in India too towards aligning compensation
structures to FSB principles. Accordingly, in July 2010, RBI issued draft guidelines on
Compensation of Whole Time Directors/Chief Executive Officers /Risk Takers and Control
Staff inviting public comments. The intent behind the guidelines is to encourage banks to
ensure effective governance of compensation, align the compensation with prudent risk
taking, improve supervisory oversight of compensation and facilitate constructive
engagement by all stakeholders. The guidelines require banks’ boards to formulate and adopt
a comprehensive compensation policy covering all employees (risk takers and

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control/compliance staff). We have advised that variable pay should be risk aligned, but we
have not proposed any limit on the variable components. As regards foreign banks, we will
require them to submit an annual declaration that their compensation structure in India is in
conformity with FSB principles and standards.

As I have said earlier, the remuneration and incentive structure of public sector bank
executives are determined by the Government. The executive compensation in the public
sector, as is well known, is lower than that in the private sector. Notwithstanding the
historical reasons for this, there is perhaps a good reason to revisit this. If public sector banks
are required to compete with private banks on a level playing field, there is a good case for
compensating them too on a competitive base. There is also the risk that if the public sector
bank compensation is not improved, the public sector may lose talent to the private sector.

International Financial Reporting Standards (IFRS): Reform Proposals

In the wake of the crisis, fair value accounting has come in for criticism for its inadequacy to
deal with the typical features of a financial crisis: illiquid markets and distress sale of assets.
It is argued that fair value accounting, no matter that it has logical appeal, is too rigid for a
crisis situation and that it, in fact, fuels a downturn. The G-20 Working Group on Enhancing
Sound Regulation and Strengthening Transparency recommended that the accounting
standards setters and prudential supervisors should work together to identify solutions that are
consistent with the complementary objectives of promoting the stability of the financial
sector and improving the transparency of results in the financial reports. Accordingly, the
IASB has initiated appropriate modifications to the relevant accounting standards.

International Financial Reporting Standards (IFRS) Indian Perspective

For banks in India, the Accounting Standards issued by the Institute of Chartered
Accountants of India (ICAI) together with the prudential regulations of the Reserve Bank
constitute the framework of the ‘Indian GAAP’ (Generally Accepted Accounting Principles).
Given India’s growing global integration, the ICAI recognized the need for Indian companies
to converge to global standards in presenting their financial results. The Core Group
appointed by the Ministry of Corporate Affairs (MCA) has since put out phased road maps
for convergence of Indian corporates and banks with IFRSs. Accordingly, scheduled
commercial banks in India will have to adopt the converged Indian Accounting Standards for
preparing their opening balance sheets as at April 1, 2013. In moving towards convergence

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with the IFRSs, there will be challenges for Indian banks. First, the Accounting Standard
IFRS 9 relating to financial instruments, which is the crucial standard for banks, is itself still
evolving and thus convergence with IFRS becomes a moving target. Second, the IT systems
of banks which are programmed to producing financial results as per Indian GAAP will need
to be modified. Third, as for any other new venture, banks will need to build capacity for
making a seamless transition to the new standards and for the adoption of the expected-loss
approach to loan loss provisioning. The Reserve Bank has constituted a Working Group to
address the implementation issues and to formulate operational guidelines to facilitate the
convergence of the Indian banking system with the IFRS. The members of the Group include
representatives from the Indian Banks' Association (IBA), the Institute of Chartered
Accountants of India (ICAI) and various regulatory and market related departments of the
Reserve Bank. Besides, professionals with core competence, expertise and experience in
IFRS implementation have been drafted in as special invitees.

Macroeconomic Impact of the proposed BCBS Reforms

The benefits of the reform package arise from reducing the frequency, severity and public
costs of financial crises and minimizing the consequent output losses. The costs arise by way
of possible higher lending rates and lower overall lending. Will the benefits of more stringent
regulation and supervision outweigh the potential costs? Will the result be the same in the
short-run as well as in the long-run? These are the questions uppermost in everyone’s mind,
most of all in the minds of governments and regulators. Three recent studies have addressed
this question – two by the Bank for International Settlements (BIS) and the third by the
Institute for Industrial Finance (IIF), a Washington based private sector body which
articulates the banks’ point of view. The BIS studies report that if the new requirements are
phased in over four years, each percentage point increase in capital would reduce annual
growth by 0.04 to 0.05 percentage points during the implementation period or about 0.2 per
cent over the four year period. However, as the financial system makes the required
adjustment, these costs will dissipate and then reverse in the medium term, and the growth
path will revert to its original trajectory. To summarize, the cost-benefit calculus will
possibly be negative in the short-term, albeit modestly, but will be distinctly positive in the
medium to long term.

The IIF study estimates significantly higher sacrifice ratios. According to this study, the G3
(US, Euro Area and Japan) will, if they implement the reform package in full, lose growth of

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up to 0.6 percentage points over the five-year period 2011-15 and 0.3 percentage points over
the ten-year period 2011-20. The differences between the two sets of studies stem obviously
from differing assumptions. Notably, the IIF study assumes a much larger increase in lending
rates but does not take into account the putative benefits arising from improvements in
operational efficiency, a more resilient financial system and an executive incentive structure
aligned to sustainable profitability. Such significant differences in the projection of the
macroeconomic impact of the reform package should not be surprising given the weak
database as also the fact that many of the relationships are non-linear. What is significant
though is that notwithstanding the differences in projected outcomes, all studies agree that the
benefits of a stronger and healthier financial system will be there for years to [Link]
Reserve Bank has also made a preliminary assessment of the impact of increased capital
requirements on our GDP growth path. We will calibrate the phase in of the new standards to
ensure that the sacrifice ratio is within acceptable limits

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 IMPLEMENTATION OF BASEL III IN INDIA

Basel III reflects the lessons of the crisis, and I believe it is going to be quite game changing.
However, as I indicated, not all the reform measures are going to be binding constraints for
us. Nevertheless, we should not underestimate the challenge of implementing Basel III. It will
demand greater capacity on the part of both banks and the regulators. I urge this conference
to flesh out the specifics in this regard.

India’s prudential regulations are ownership neutral. They will be applicable uniformly to
public sector banks, private banks and foreign banks. The impact of the measures will of
course vary and will depend on the business model and risk profile of the banks and their
domestic and overseas balance sheets. The buffers built into the reform package are expected
to provide automatic stabilizers obviating the need for external support during a downturn.
Also, as the buffers will be built-up over time and during the upturn of the business cycle, the
system should not be unduly stretched.

In the case of public sector banks, Government, as the owner, will have to contribute to
building the capital buffers so as to maintain the floor of 51 per cent in the ownership. This is
unlikely to put undue pressure on the Government’s fiscal position as it will happen during
the cyclical upturn when banks’ profits and Government’s revenues would be buoyant.
Consequently, public sector banks should anticipate no problem in building the buffers
contemplated under Basel III.

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 CONCLUSION

My attempt in this address has been to highlight the important components of the global
reform package on bank supervision and regulation and to evaluate them from an Indian
perspective. I have also given an assessment of the estimates made at the global level of the
macroeconomic impact of these reform proposals. Several concerns persist – some immediate
and some long-term. By far the most pressing immediate concern is about the calibration of
the standards and their phasing in. The BCBS and the regulators are sensitive to these
concerns, and are mindful of the need to facilitate a smooth transition to the new norms, and
in particular, to ensure that the more stringent capital and liquidity requirements do not
impede as yet fragile recovery process.

Two features of the reform package warrant special mention because of the communication
effort they require. First, banks across the world are apprehensive that even as they incur the
cost of building the capital buffers they will not be able to use them during a downturn,
because ironically that is when markets would expect and demand higher capital. Second,
some components of the reform package may have a ‘comply or explain’ framework which
allows individual jurisdictions to deviate from any specific provision of the package by
explaining why it has made deviations. There is a risk though that even well reasoned and
perfectly justifiable deviations may be interpreted as wilful noncompliance, or worse still as
unwarranted regulatory forbearance, and markets may penalize such jurisdictions. What these
problems basically highlight is the need for effective and timely communication to explain
the rationale for opting for deviations. Central banks have traditionally attached considerable
importance to communication regarding monetary policy to guide market expectations. Now
regulators too need to hone their communication skills. There are many reasons cited for
India having moved up to a higher growth trajectory. Most of the reasons are familiar. But
one of the big unacknowledged drivers of India’s growth has been the impressive
improvement in the quality and quantum of financial intermediation over the last decade. The
Indian financial sector in general and Indian banks in particular, can be proud of this very
credible achievement. As you contemplate, during this conference and beyond, the challenge
of delivering on your promise over the next decade, I urge you to think global and act local.

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 BIBLIOGRAPHY

BOOKS:

1. Basel Committee on Banking Supervision, (2001), The New Basel Capital

Accord, Bank for International Settlements.
2. The Economist, (2001), 'Banks New Capital Standards', January 20-26, London.
3. Mayer, L., (2001), ';The New Basel Capital Proposal';, BIS Review, No.40.

WEBSITES:

1. [Link]
2. [Link]
3. [Link]
4. [Link]

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