Thursday, June 18, 2015

A setback for RBI?

RBI is one of the few central banks which ensure scrupulous compliance with various norms pronounced by Bank for International Settlements (BIS). BIS is an international organization that fosters global monetary and financial cooperation and serves as a bank for central banks. RBI is legitimately proud of its record of complying with the requirements of BIS even unmindful of being ridiculed as being holier than the Pope.

RBI, therefore, was not pleased when the Basel Committee on Banking Supervision (BCBS) recently released an assessment on Basel III implementation by India and South Africa, on behalf of BIS. India has been assessed only as “largely compliant” regarding implementation of the Liquidity Coverage Ratio (LCR) standard whereas South Africa has been assessed as compliant. Assessment grades are 1) compliant (L), 2) largely compliant (LC), 3) materially non-compliant (MNC !, exclamation intended) and 4)non-compliant (NC).

Earlier, BCBS had assessed the implementation of Hong Kong and Mexico as compliant for LCR standard. LCR is defined as the proportion of High Quality Liquid Assets (HQLA) to total net cash outflows over the next 30 calendar days under defined conditions of stress, expressed as a percentage. LCR came into effect on 1st January, 2015. The minimum requirement for banks is 60% now, progressively increasing by 10% every year. Thus, LCR has to be 100% by 1st January, 2019. It is worth noting that Basel III gives more prominence to liquidity and thereby corrects an unintended mistake that occurred in earlier Basel documents, a mistake that was realized only when quite a few banks started going bankrupt during the 2008 global crisis despite the apparent promise of adequate capital.

To qualify as HQLA, assets need to be unencumbered in addition to being easily and immediately convertible into cash without loss of value. Hence these assets satisfy the criteria of low risk, ease & certainty of valuation, low correlation with risky assets, listing in developed & recognized exchange, active & sizable market and low volatility.

The reason as to why India is not assessed as (fully) compliant in relation to LCR is that RBI treats State Government Bonds as HQLA whereas BCBS gives this status only to Central Government Bonds. RBI has taken up with BCBS that State Government Bonds in India satisfy the requirements of HQLA and as such must be treated as high quality liquid assets. BCBS is not yet fully convinced. It appears that the view of BCBS is not without merit. RBI may take consolation from the fact that banks’ investment in State Government Bonds is much less when compared with Central Government Bonds. Nevertheless, it is not a pleasant situation for RBI which jealously guards its reputation as a fully compliant constituent of BIS, to be told that some other central bank is implementing a part of Basel III in a better way. It will be interesting to watch if RBI would modify its position on State Government Bonds.

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