FIN 6002 – Session 21 - 22

Pradeepta Sethi
TAPMI
Thicker • Capital Conservation Buffer
(CCB)
Cushions
• Counter Cyclical Capital Buffer
(CCCB)

• Common Equity Tier 1 (CET1)

 ¢ The intention behind the capital conservation
buffer is to make certain that banks
B accumulate capital buffers in times of low
financial stress.
A
¢ Such a buffer is handy when banks are hit by
S losses and aims to prevent violations of
E Capital
minimum capital requirements.

L Conservation ¢ When the buffer is utilized (say, in a period of

Buffer financial stress), banks need to recreate it by
pruning their discretionary distribution of
earnings.
I
I ¢ Banks facing reduced capital buffers must
certainly not signal their financial strength by
I way of distributing earnings.

¢ The other option available here is to raise

fresh capital from the private sector.
 ¢ The capital conservation buffer can be drawn
down only when a bank faces a systemic
B stress.

A ¢ Basel III incorporates a capital conservation

buffer of 2.5% above the minimum capital
S requirement.
E Capital ¢ This buffer is built out of CET1 only after the
L Conservation minimum CET1 of 5.5% has been achieved
and 9% total capital requirements have been
Buffer
fulfilled.

I ¢ Banks in India are now at 1.875% level,

implementation of the last tranche of 0.625%
I is differed till September 30, 2020.
I ¢ While the bank’s operations remain
unaffected when its capital falls short of the
2.5% threshold, the accord enforces
constraints on distribution of earnings.
B
Minimum Capital
A Common Equity Tier 1 Ratio after Conservation Ratio
including the current periods
S retained earnings
(expressed as a % of
earnings)
E Capital 5.5 - 6.125 % 100
L Conservation >6.125 - 6.75 % 80
Buffer
>6.75 - 7.375 % 60
I >7.375 – 8.0 % 40
I > 8.0 % 0
I
Source: Master Circular – Basel III Capital Regulations
 ¢ The underlying premise of the countercyclical
buffer is that capital requirements in the banking
sector must take into consideration the
B macroeconomic environment in which banks
operate.
A
¢ It requires banks to build up a buffer of capital in
S good times which may be used to maintain flow of
credit to the real sector in difficult times.
E Counter ¢ Restricting the banking sector from indiscriminate
L Cyclical lending in the periods of excess credit growth that
Capital have often been associated with the building up of
system-wide risk
Buffer
I ¢ The countercyclical buffer will be enacted by
national authorities, when they believe that the
I excess credit growth potentially implies a threat of
financial distress.
I ¢ The buffer for internationally-active banks is
computed as a weighted average of the buffers for
all jurisdictions where the bank bears a credit
exposure.
 ¢ Banks would be subject to a countercyclical buffer
between zero and 2.5% of their total risk-weighted
assets.
B
¢ The countercyclical buffer mandated for a bank
A “will extend the size of the capital conservation
buffer” as per the accord.
S
¢ Banks failing to maintain the required
E Counter countercyclical buffer would face restrictions on
distributions.
L Cyclical
Capital ¢ Banks should mandatorily calculate (and disclose)
Buffer their countercyclical buffer requirements with
minimally the same frequency as their minimum
I capital requirements.
I ¢ The credit-to-GDP gap is the main indicator in the
I counter cyclical buffer framework in India.

¢ Credit-to-GDP gap is the difference between credit-

to-GDP ratio and the long-term trend value of
credit-to-GDP ratio at any point in time.
 ¢ The credit-to-GDP gap will be used in conjunction
with other supplementary indicators, viz., the
B Credit-Deposit (C-D) ratio for a moving period of
three years, industrial outlook (IO) assessment
A index, and interest coverage ratio.
S
¢ The lower threshold (L) of the credit-to-GDP gap
E Counter where the CCCB is activated shall be set at 3
percentage points and upper threshold (H) where
L Cyclical the CCCB reaches its maximum shall be kept at 15
Capital percentage points of the credit-to-GDP gap. CCCB
shall increase gradually from 0 to 2.5 per cent of
Buffer the RWA of the bank.
I
I ¢ CCCB would be activated as and when the
circumstances warranted, and the decision would
I normally be pre-announced with a lead time of four
quarters.

¢ Implementation has been deferred.

B
A Minimum Capital
Common Equity Tier 1 Conservation Ratio
S Ratio (expressed as a
E Counter
percentage of earnings)
>5.5 - 6.75 % 100
L Cyclical
Capital >6.75 - 8.0 % 80
Buffer >8.0 – 9.25 % 60
I >9.25 – 10.50 % 40
I > 10.50 % 0

I
Source: Juan Ramiraz (2017), Handbook of Basel III capital
 • Basel III seeks to identify global systemically
important banks (G-SIBs) and mandating them
to maintain a higher level of capital dependent
on their level of systemic importance.
G-SIBs & D- • Adequate loss-absorbing capacity for G-SIBs by
SIBs setting a new minimum requirement for total
loss-absorbing capacity (TLAC).

• The list of G-SIBs is to be reviewed annually.

Currently, no Indian bank appears in the list of
G–SIBs.

• Domestic systemically important banks (D-

SIBs) - State Bank of India, ICICI Bank & HDFC
Bank.

• ICICI, HDFC - 0.2% & SBI – 0.6% - additional

CET1 in addition to the CCB.
 Tier 1 Capital (going-concern capital)

• Common Equity Tier 1 (CET1)

• Additional Tier 1 (AT1)

Tier 2 Capital (gone-concern capital)

Total regulatory capital

 Raising the quality of capital - To ensure
B ¢
banks are better able to absorb losses on
A both a going concern (Tier I capital) and a
gone concern (Tier II capital) basis.
S
Going-concern capital is the capital which can
E Capital
¢
absorb losses without triggering bankruptcy of
L the bank.

¢ Gone-concern capital is the capital which will

absorb losses only in a situation of liquidation
I of the bank.
I
¢ Greater focus on common equity - the
I highest quality component of a bank’s capital.
 Common Equity Tier 1 capital

• Common shares (paid-up equity capital),

• Stock surplus (share premium),
• Statutory reserves,
• Capital reserves,
• Other disclosed free reserves, if any;

Tier 1 • Balance in Profit & Loss Account at the end of

the previous financial year;

Capital Additional Tier 1 capital

• Perpetual Non-Cumulative Preference Shares

(PNCPS),
• Stock surplus (share premium) from issue of
instruments in AT1
• Debt capital
• Any other type of instrument
 Tier 2 capital

• General Provisions and Loss

Reserves

Tier 2 • Debt Capital Instruments issued by

the banks
Capital • Preference Share Capital
Instruments
• Stock surplus (share premium)
• Revaluation reserves at a discount
of 55%
 Regulatory Capital As % to
RWAs
Minimum Common Equity Tier 1 Ratio 5.5

Capital Conservation Buffer (comprised 2.5

of Common Equity)

Minimum Common Equity Tier 1 Ratio 8.0

plus Capital Conservation Buffer
Capital
requirements Additional Tier 1 Capital 1.5

Minimum Tier 1 Capital Ratio 7.0

Tier 2 Capital 2.0

Minimum Total Capital Ratio (MTC) 9.0

Minimum Total Capital Ratio plus 11.5

Capital Conservation Buffer
 Basel III: Capital ratios

¢ Common Equity Tier 1 Capital ratio =

!"##"$ %&'()* +(,- . !/0()/1
!-,2() 3(45 36789/-5,) 3(45 3678:0,-/)("$/1 3(45 367

%1(;(<1, +(,- . !/0()/1

¢ Tier 1 Capital ratio =
!-,2() 3(45 36789/-5,) 3(45 3678:0,-/)("$/1 3(45 367

%1(;(<1, +")/1 !/0()/1

¢ Total Capital (CRAR) =
!-,2() 3(45 36789/-5,) 3(45 3678:0,-/)("$/1 3(45 367
 Transitional arrangements - SCBs

Minimum capital April 1 March 31 March 31 March 31 March March March 31

ratios 2013 2014 2015 2016 31 2017 31 2018 2019
Minimum
4.5 5 5.5
Common Equity 5.5 5.5 5.5 5.5
(3.5) (4) (4.5)
Tier 1 (CET1)
Capital 2.5
conservation - - - 0.625 1.25 1.875 (Sept 20)
buffer (CCB) (1.875)
Minimum CET1+
4.5 5 5.5 6.125 6.75 7.375 8
CCB
Minimum Tier 1 6 6.5 7
7 7 7 7
capital (4.5) (5.5) (6)
Minimum Total 9 9 9
9 9 9 9
capital (8) (8) (8)
Minimum Total
9 9 9 9.625 10.25 10.875 11.5
Capital +CCB
Source: Financial Stability Report (July 2020) – Reserve Bank of India
 ¢ Output floor places a limit on the regulatory capital
benefits that a bank using internal models can derive
relative to the standardized approaches.
B
¢ In effect, the output floor provides a risk-based
A backstop that limits the extent to which banks can
lower their capital requirements relative to the
S standardized approaches.
E Output Floor
¢ This helps to maintain a level playing field between
L banks using internal models and those on the
standardized approaches.

Under the revised output floor, banks’ risk-weighted

I
¢
assets must be calculated as the higher of:
I a) total risk-weighted assets calculated using the
I approaches approved by the regulator for the bank
&

b) 72.5% of the total risk-weighted assets calculated

using only the standardized approaches.