This refers to the article "Why India should focus on leverage not just capital adequacy" (May 8). Rohit Lamba and Arvind Subramanian's recommendation that India should desist from focusing exclusively on refined measures of capital adequacy is in line with current thinking. Even the Basel Committee, while recommending post-crisis Basel-III version of capital regulations, has also suggested simultaneous monitoring of the leverage ratio as banks adopt these more stringent capital standards by March 2019 in a phased manner. It is, however, somewhat surprising that the learned authors seemingly lump all versions of Basel regulations together in their criticism. The evolution of Basel norms, spread over several years, was aimed at making capital computation more comprehensive (inclusion of market and operational risks) and risk insensitive. The financial crisis also highlighted the importance of maintaining liquidity, which prompted the Basel Committee to introduce liquidity standards along with higher capital requirements.
While it is debatable whether American shadow banks were governed by Basel standards, the evolution and refinement of risk measurement was indeed motivated by lowering of banks' capital requirements. What level of bank capital is adequate would always be debatable, but the notion that capital adequacy should be risk-sensitive cannot be altogether thrashed. Stipulation of lower capital for sovereign exposure and high-rated corporate exposures was required to incentivise banks to optimise their risk-taking.
The advanced version of Basel-II standards, which allows banks to develop their own risk-measurement models for the computation of regulatory capital, may be introduced by respective bank management at their discretion after successful demonstration of their ability to develop and run their own risk models to bank regulators To the best of my knowledge, no Indian Bank has started using advanced measures of Basel II.
Post-financial crisis, some analysts have, in fact, suggested to snap the link between assets and bank capital by stipulating a measure similar to debt equity ratio commonly used for non-finance entities. It must be mentioned that while the Reserve Bank of India (RBI) has stipulated various Basel standards in line with international agreements, it has been more conservative. The RBI has stipulated minimum capital ratio of 9 per cent (as against 8 per cent Basel stipulation) under Basel-II. The same cautious approach is reflected in Basel-III as well; the RBI has stipulated leverage ratio of 4.5 per cent as against the 3 per cent stipulated by Basel.
M K Datar Mumbai
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