Capital Planning Under Basel III

Sanjay Basu
NIBM, 2022
 Why Capital Planning under
Basel III?
• Basel III will result in less available capital to cover
higher RWA requirements and more stringent minimum
coverage for quantity and quality of bank capital
• More capital will be required to continue to operate
above higher minimum buffers, but then,
– Capital is scarce
– Capital is costly
– Capital is not continuously available
 Capital Planning Process
• Decide the planning horizon
– Short term – upto 1 year
– Medium Term – upto 3 years
– Over the Basel III transition horizon – 5 years
• Project the capital requirements forward
– Business growth projections – organic and acquired
– RWAs under Basel III
– Changes in risk profile
– Stress tests
• Project the capital resources forward
– Available capital under Basel III definitions and its projections subject
to Basel III deductions and phase outs
– RE growth projections (internal generation)
 Capital Planning Process
• Measure the key capital adequacy and buffer ratios and
compare with minimum regulatory requirements and
management targets which may be higher
– Measure shortfalls in each year to determine capital raising
strategies
• Choose optimal mix of capital
– Minimize the cost of capital subject to regulatory and market
constraints
• Allocate to businesses, products, customers
– Maximise RAROC
 Outcome - Example
Forecasting Year
1-Jan-13 31-Mar-14 31-Mar-15 31-Mar-16 31-Mar-17
CET 1 Ratio 4.50% 5.00% 5.50% 5.50% 5.50%
Minimum CCB Ratio 0.63% 1.25% 1.88% 2.50%
Regulatory Tier 1 Ratio 6.00% 6.50% 7.00% 7.00% 7.00%
Ratios CAR 9.00% 9.00% 9.00% 9.00% 9.00%
CAR + CCB 9.00% 9.63% 10.25% 10.88% 11.50%
Actual RWA 75000.00 90000.00 108000.00 129600.00 155520.00
CET 1 Ratio 10% 9.20% 8.30% 7.50% 6.00%
CCB Ratio 0% 0.63% 1.25% 1.88% 2.50%
Actual Ratios Tier 1 Ratio 12% 10.50% 9.50% 8.00% 6.50%
CAR 14.70% 12.00% 11.00% 10.50% 9.25%
CAR + CCB 14.70% 12.63% 12.25% 12.38% 11.75%
CET 1 Ratio 0 0 0 0 0
Deficiency
CCB Ratio 0 0 0 0 0
Below
Tier 1 Ratio 0 0 0 0 -778
Regulatory
CAR 0 0 0 0 0
Minimum
CAR + CCB 0 0 0 0 0
Deficiency CET 1 Ratio 0 0 0 0 -778
below Internal CCB Ratio 0 0 0 0 0
Targets of 1% Tier 1 Ratio 0 0 0 0 -2333
above CAR 0 0 0 0 -1166
Minimum
Regulatory CAR + CCB 0 0 0 0 -1166
 Key Considerations
• What is the response time and operational readiness for
each strategy?
• Which capital is deficient?
• Can it be organically increased or does it have to be
raised?
• What are the cost constraints and can the capital be
raised in a cost effective manner?
• How much capital is needed and timing?
• Stakeholder reactions?
 Business Impact
• Higher amounts of capital required
• Higher cost per unit of capital available to
support business growth
– May translate into a higher lending rates and
higher fees for non-fund based credit
– If bank doesn’t allocate on the higher cost of
capital through product pricing, it may be
subject to a lower NIM and therefore a lower
internal accrual of capital
 Strategies
• Maintain a balance between Minimum Ratios and ROE:
unduly high amounts of capital will subdue ROE and
affect future ability to raise capital
• Should it be a passive, reactive or proactive Strategy?
• Long Term Plan: Reduce Required Capital (↓ RWA)
– Suspend potential future expansion, mainly in portfolios where
regulatory capital needed is relatively high
– Downsize high risk portfolios actively
– Allocate capital more effectively by focussing on high RAROC
areas
– Increase returns by better management of NPAs
– Increase operational effectiveness
 Strategies
• Short Term Plan: Increase Available Capital Resources
– Support CET1 by issuing common stock. Constraints?
– Retain more profits by restricting dividends and share buy-back
– Support Tier 1 by issuing PNCPS, PDI. Constraints?
– Support Tier 2 by issuing eligible T2 instruments