Amidst globalisation Banking System in India has attained vital

importance. Day by day there has been increasing banking complexities in banking transactions, capital requirements, liquidity, credit and risks

associated with them.

The World Trade Organisation (WTO), of which India is a member nation, requires the countries like India to get their banking systems at par with

the global standards in terms of financial health, safety and transparency, by implementing the Basel II Norms by 2009.

BASEL COMMITTEE:

The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance

understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging

information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. The Committee's

Secretariat is located at the Bank for International Settlements (BIS) in

Basel, Switzerland.

NEED FOR SUCH NORMS:

The first accord by the name .Basel Accord I. was established in 1988 and was implemented by 1992. It was the very first attempt to introduce the

concept of minimum standards of capital adequacy. Then the second

accord by the name Basel Accord II was established in 1999 with a final directive in 2003 for implementation by 2006 as Basel II Norms.

Unfortunately, India could not fully implement this but, is now gearing up under the guidance from the Reserve Bank of India to implement it from

1 April, 2009.

Basel II Norms have been introduced to overcome the drawbacks of Basel I Accord. For Indian Banks, its the need of the hour to buckle-up and

practice banking business at par with global standards and make the banking system in India more reliable, transparent and safe. These Norms

are necessary since India is and will witness increased capital flows from

foreign countries and there is increasing cross-border economic & financial transactions.

FEATURES OF BASEL II NORMS:

Basel II Norms are considered as the reformed & refined form of Basel I

Accord. The Basel II Norms primarily stress on 3 factors, viz. Capital

Adequacy, Supervisory Review and Market discipline. The Basel Committee calls these factors as the Three Pillars to manage risks.

Pillar I: Capital Adequacy Requirements:

Under the Basel II Norms, banks should maintain a minimum capital

adequacy requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated maintaining of 9% minimum capital adequacy

requirement. This requirement is popularly called as Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).

Pillar II: Supervisory Review:

Banks majorly encounter with 3 Risks, viz. Credit, Operational & Market Risks.

Basel II Norms under this Pillar wants to ensure that not only banks have adequate capital to support all the risks, but also to encourage them to

develop and use better risk management techniques in monitoring and managing their risks. The process has four key principles:

a) Banks should have a process for assessing their overall capital

adequacy in relation to their risk profile and a strategy for monitoring their capital levels.

b) Supervisors should review and evaluate bank's internal capital adequacy assessment and strategies, as well as their ability to monitor

and ensure their compliance with regulatory capital ratios.

c) Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to

hold capital in excess of the minimum.

d) Supervisors should seek to intervene at an early stage to prevent

capital from falling below minimum level and should require rapid remedial action if capital is not mentioned or restored.

Pillar III: Market Discipline:

Market discipline imposes banks to conduct their banking business in a safe, sound and effective manner. Mandatory disclosure requirements on

capital, risk exposure (semiannually or more frequently, if appropriate) are required to be made so that market participants can assess a bank's

capital adequacy. Qualitative disclosures such as risk management objectives and policies, definitions etc. may be also published.

CONCLUSION:

Basel II Norms offers a variety of options in addition to the standard approach to measuring risk. Paves the way for financial institutions to

proactively control risk in their own interest and keep capital requirement low.

But . . .

Requires strategizing risk management for the entire enterprise, building

huge data warehouses, crunching numbers and performing complex calculations and poses great challenges of compliance for banks and

financial institutions.

Increasingly, banks and securities firms world over are getting their act together.

The process of implementing Basel II norms in India is being carried out in phases. Phase I has been carried out for foreign banks operating in India and Indian banks having operational presence outside India with effect from March 31,2008. In phase II, all other scheduled commercial banks (except Local Area Banks and RRBs) will have to adhere to Basel II guidelines by March 31, 2009. With the deadline of March 31, 2009 for full implementation of Basel II norms fast approaching, banks are looking to maintain a cushion in their respective capital reserves. The minimum capital to risk-weighted asset ratio (CRAR) in India is placed at 9%, one percentage point above the Basel II requirement. All the banks have their Capital to Risk Weighted Assets Ratio (CRAR) above the stipulated requirement of Basel guidelines (8%) and RBI guidelines (9%). As per Basel II norms, Indian banks should maintain tier I capital of at least 6%. The Government of India has emphasized that public sector banks should maintain CRAR of 12%. For this, it announced measures to re-capitalize most of the public sector banks, as these banks cannot dilute stake further, as the Government is required to maintain a stake of minimum 51% in these banks. We carried out a study to evaluate the compliance levels of Indian banks with Basel II /RBI /Government of India norms. The scope of this report is to understand - which Indian banks comply with Basel II tier I capital norm of 6% - the cushion enjoyed by Indian banks which have CRAR above the Basel II norm of 8% and RBI norm of 9% - which public sector banks currently have CRAR below the Government recommended norm of 12% - which public sector banks with Government stake of 51 % may get Government recapitalization This report contains details of our study and analysis. Summary - Indian banking companies are required to ensure full implementation of Basel II

guidelines by March 31, 2009. The first phase of Basel II was implemented in India with foreign banks operating in India and Indian banks having operational presence outside India complying with the same effective end of March 2008. With Basel II norms coming into force in 2009, maintaining adequate capital reserves will become a priority for banks. Basel II mandates Capital to Risk Weighted Assets Ratio (CRAR) of 8% and Tier I capital of 6%. The RBI has stated that Indian banks must have a CRAR of minimum 9%, effective March 31, 2009. All private sector banks are already in compliance with the Basel II guidelines as regards their CRAR as well as Tier I capital. Further, the Government of India has stated that public sector banks must have a capital cushion with a CRAR of at least 12%, higher than the threshold of 9% prescribed by the RBI. - We carried out a study to understand which Indian banks meet the tier I capital norm of 6%. There are 4 banks viz. Bank of Maharashtra, Central Bank, UCO Bank and Vijaya Bank, whose tier I capital as on March 31, 2008 was below the stipulated norm of 6%. - Failure to adhere to Basel II can attract RBI action including restricting lending and investment activities. Since fund raising has been difficult in the recent turbulent times, the question was whether the full implementation of Basel II norms would be deferred. However, the implementation is unlikely to be deferred with the Government taking steps to recapitalize some public sector banks. The Government announced 1st round of recapitalization for 3 banks, viz., Central Bank, UCO Bank and Vijaya Bank. - Further for public sector banks, the Government prescribed CRAR of at least 12%. There are 5 banks which have CRAR less than 12% as of December 31, 2008, viz., Bank of Maharashtra, Central Bank, Dena Bank, IDBI Bank and Vijaya Bank. Since the Government's stake in public sector bank cannot be allowed to go below 51 %, these banks cannot take recourse to equity funding for Tier I capital. Of these banks, government holding in Dena Bank is very close to 51%; it is therefore not possible for it to raise further equity capital (without diluting the Government's stake to below 51 %). - The Government, in the Interim Budget, embarked approx. Rs200bn for re-capitalizing public sector banks whose CRAR is less than 12%, as well as for other public sector banks for future business growth. The first round of recapitalization has already been announced, via a Rs38bn recapitalization package for 3 banks, viz., Central Bank, UCO bank and Vijaya Bank whose tier I capital was less than 6%. - The Government has announced that there will be 2nd round of recapitalization. We believe Bank of Maharashtra will have to be recapitalized soon with detailed plan, since its Tier I capital is below 6%. Its government stake is 76%, which is much above the needed 51 %, indicating scope for an equity dilution. However, the current market conditions may render an equity issue difficult. - In such times, recapitalization by the Government is the only recourse for public sector banks since: (i) Primary market dried out, FPO and private placements too are difficult

(ii) Internal sources of funding remains a problem, as increasing provisions are hitting bottom lines - The recapitalization move by the Government seems to be a precautionary measure to avoid any kind of risk during the times of a global financial turmoil. We believe the recapitalization will increase the Government's stakes in the public sector banks, so that they will be able to opt for fund raising in the future, when credit off-take picks up momentum.

The Terminology Capital to Risk Weighted Assets Ratio (CRAR) is also known as Capital Adequacy Ratio which indicates a bank's risk-taking ability. The RBI uses CRAR to track whether a bank is meeting its statutory capital requirements and is capable of absorbing a reasonable amount of loss. CRAR = (Tier I capital + Tier II capital) / Risk-Weighted Assets Capital funds are broadly classified as Tier 1 and Tier 2 capital. Two types of capital are measured: Tier one capital, which absorbs losses without a bank being required to cease trading, and Tier two capital, which absorbs losses in the event of winding-up and so provides a lesser degree of protection to depositors. Tier I capital (core capital) is the most reliable form of capital. The major components of Tier I capital are paid up equity share capital and disclosed reserves viz. statutory reserves, general reserves, capital reserves (other than revaluation reserves) and any other type of instrument notified by the RBI as and when for inclusion in Tier I capital. Examples of Tier 1 capital are common stock, preferred stock that is irredeemable and non-cumulative, and retained earnings. Tier II capital (supplementary capital) is a measure of a bank's financial strength with regard to the second most reliable forms of financial capital. It consists mainly of undisclosed reserves, revaluation reserves, general provisions, subordinated debt, and hybrid instruments. This capital is less permanent in nature. The reason for holding capital is that it should provide protection against unexpected losses. This is different from expected losses for which provisions are made. What are Basel I and Basel II norms? While Basel I framework was confined to the prescription of only minimum capital requirements for banks, the Basel II framework expands this approach not only to capture certain additional risks in the minimum capital ratio but also includes two additional areas, viz. Supervisory Review Process and Market Discipline through increased disclosure requirements for banks. Thus, Basel II framework rests on the following three mutually- reinforcing pillars: Pillar 1: Minimum Capital Requirements — prescribes a risk-sensitive calculation of

capital requirements that, for the first time, explicitly includes operational risk along with market and credit risk. Pillar 2: Supervisory Review Process (SRP) — envisages the establishment of suitable risk management systems in banks and their review by the supervisory authority. Pillar 3: Market Discipline — seeks to achieve increased transparency through expanded disclosure requirements tor banks. Basel Committee - The Basel Committee on Banking Supervision was established in 1974, by the Bank ot International Settlements (BIS), an international organization founded in Basel, Switzerland in 1930 to serve as a bank for central banks. - Basel Committee on Banking Supervision is a committee of bank supervisors consisting of members from each of the G10 countries. It is represented by central bank governors of each of the G10 countries. The Committee's members are from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, UK and US. The present Chairman of the Committee is Mr. NoutWellink, President of the Netherlands Bank. - The Committee is a forum for discussion on handling of specific supervisory problems. It coordinates the sharing of supervisory responsibilities among national authorities in respect of banks' foreign establishments with the aim of ensuring effective supervision of banks' activities worldwide. It meets regularly 4 times a year. With a view to adopt Basel Committee on Banking Supervision (BCBS) framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off-balance sheet business and to strengthen the capital base of banks, RBI decided in April 1992 to introduce a risk asset ratio system for banks in India as a capital adequacy measure. Essentially, under the above system the balance sheet assets and other off-balance sheet exposures are assigned prescribed risk weights and banks have to maintain minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. Basel I The first accord was the Basel I. It was issued in 1988 and focused mainly on credit risk by creating a bank asset classification system. The Basel Capital Accord is an Agreement concluded among country representatives in 1988 to develop standardized risk-based capital requirements for banks across countries. The Accord was replaced with a New capital adequacy

framework (Basel II), published in June 2004.

Basel II It is the second accord which focuses on operational risk along with market risk and credit risk. Basel II tries to ensure that the anomalies existed in Basel I are corrected. Basel II is based on 3 pillars that allow banks and supervisors to evaluate properly the various risks that banks face. These three pillars are: (i) Minimum capital requirements, (ii) Supervisory review of an institution's capital adequacy and internal assessment process; (iii) Market discipline through effective disclosure to encourage safe and sound banking practices. Computation of Total CRAR and Tier I capital under Basel II Basel II Tier I CRAR = Tier I capital / (Credit Risk RWA + Operational Risk RWA + Market Risk RWA) Basel II Total CRAR = Total capital / (Credit Risk RWA + Operational Risk RWA + Market Risk RWA) RWA - risk weighted assets

Global Scenario on Basel II Banking regulators in around the world are planning to implement Basel II, but with varying timelines and use ot the varying methodologies being restricted. European banks already report their capital adequacy ratios according to the new system. European banks implemented Basel II at the start ot 2008 whereas Japanese banks implemented in 2007. Australia implemented the Basel II Framework in 2008. US banks are scheduled to switch over in 2009. Basel II Norms - Basel II is the international capital adequacy framework tor banks that prescribes capital requirements for credit risk, market risk and operational risk. Basel II is the second of the Basel Accords recommended on banking laws and regulations issued by Basel Committee on Banking Supervision.

- The purpose behind applying Basel II norms to Indian banks is to help them comply with international standards. These international standards can help protect the international financial system from problems that may arise from the collapse of a major bank. - Basel II is stated to set up rigorous risk and capital management requirements to ensure that banks have capital reserves appropriate to their risk profile. - The outcome is that the greater the risk to which a bank is exposed, greater is the amount of capital it will require to hold to protect its solvency and overall stability. It will also force banks to enhance disclosures, which will help create more transparency and trust in the banking system itself. We believe transparency in financial reporting will improve. - Total CRAR and Tier I capital is expected to expand with implementation of Basel II norms. 3 Pillars of Basel II

Pillar 1 includes 3 risks now, operational risk + credit risk + market risk. Keeping in view RBI's goal to have consistency and harmony with international standards, it has been decided that all commercial banks in India shall adopt Standardized Approach (SA) for credit risk and Basic Indicator Approach (BIA) for operational risk. Banks shall continue to apply the Standardized Duration Approach (SDA) for computing capital requirement for market risks. Under the Standardized Approach, the rating assigned by the eligible external credit rating agencies will largely support the measure of credit risk. RBI has identified external credit rating agencies that meet the eligibility criteria specified under the revised Framework. Banks may rely upon the ratings assigned by the external credit rating agencies chosen by the RBI for assigning risk weights for capital adequacy purposes. The RBI decided that banks may use the ratings of the following domestic credit rating agencies for the purposes of risk weighting their claims for capital adequacy purposes: a) Credit Analysis and Research Ltd. b) CRISIL Ltd. c) FITCH Ltd. and d) ICRA Ltd. Banks may use the ratings of the following international credit rating agencies for the purposes of risk weighting their claims for capital adequacy purposes a) Fitch; b) Moody's; and c) Standard & Poor's. Banks should use the chosen credit rating agencies and their ratings consistently for each type of claim, for both risk weighting and risk management purposes. Banks

will not be allowed to "cherry pick" the assessments provided by different credit rating agencies. Banks must disclose the names of the credit rating agencies that they use for the risk weighting of their assets, the risk weights associated with the particular rating grades as determined by RBI for each eligible credit rating agency as well as the aggregated risk weighted assets. For instance recently, Induslnd bank entered into MOU with CRISIL and Allahabad bank entered into MOU with CARE for rating facility as required under Basel II. Pillar 2 requirements give supervisors, i.e., the RBI, the discretion to increase regulatory capital requirements. The RBI can administer and enforce minimum capital requirements from bank even higher than the level specified in Basel II, based on risk management skills of the bank. RBI will consider prescribing a higher level of minimum capital ratio for each bank under the Pillar 2 framework on the basis of their respective risk profiles and their risk management systems. Further, in terms of the Pillar 2 requirements of the New Capital Adequacy Framework, banks are expected to operate at a level well above the minimum requirement. Pillar 3 demands comprehensive disclosure requirements from banks. For such comprehensive disclosure, IT structure must be in place for supporting data collection and generating MIS which is compatible with Pillar 3 requirements. While Basel I was useful, as it brought into focus the need to bridge gap between capital requirements and risk profiles of commercial banks, Basel II is a step forward by forcing banks to recognize the need to distinguish between credit quality of individual borrowers. Basel II will help promote increased transparency and better reporting systems. In short, compliance is a win-win situation for all concerned. Banks will have to continuously improve the quality of their internal loss data, with Basel II requiring them to have at least five years of data, including a downturn. Impact of Basel II implementation on the Indian Banking Industry Changes in Capital Risk Weighted Assets Ratio (CRAR) Most of the banks are already adhering to the Basel II guidelines. However, the Government has indicated that a cushion should be maintained by the public sector banks and therefore their CRAR should be above 12%. Basel I focused largely on credit risk, whereas Basel II has 3 risks to be considered, viz., credit risk, operational risk and market risks. As Basel II considers all these 3 risks, there are chances of a decline in the Capital Adequacy Ratio. However, on the basis of data we collated, we observe that following public sector banks' CRAR as at December 31, 2008, as per Basel I, increased as computed under Basel II norms, primarily on account of reduction in the risk weights. Table 1: CRAR as per Basel I and Basel II

High costs for up-gradation of technology

Full implementation of the Basel II framework would require up-gradation of the

bank-wide information systems through better branch-connectivity, which would

entail huge costs and may raise IT-security issues. The implementation of Basel II

can also raise issues relating to development of HR skills and database

management. Small and medium sized banks may have to incur enormous costs to

acquire required technology, as well as to train staff in terms of the risk management

activities. There will be a need for technological upgradation and access to

information like historical data etc.

Rating risks

Problems embedded in Basel II norms include rating of risks by rating agencies.

Whether the country has adequate number of rating agencies to discharge the

functions in a Basel II compliant banking system, is a question for consideration.

Further, to what extent the rating agencies can be relied upon was also a matter of

debate, in the light of the recent US experience.

Entry norms for recognition of rating agencies should be stricter. Only firms with

international experience or background in ratings business should be allowed to

enter. This is necessary given that the Indian ratings industry is in its growth phase,

especially with the implementation ot new Basel II capital norms that encourage

companies to get rated.

Basel Study

- We observed the ratios ot 16 listed private sector banks and 19 listed public sector

banks to ascertain whether they comply with Basel II norms.

- We carried out a study to identity the cushion levels in the CRAR ot listed private

sector banks as well as public sector banks.

- We used the Tier I capital ratios ot banks as on March 31, 2008 to see whether the

respective bank meets the Tier I capital limit ot 6%. The data tor Tier I capital ratio ot

banks as on December 31, 2008 is not in the public domain.

- We observed the CRAR tor March 2008 as well as December 2008 to identity

whether there is an increase / decline in the CRAR between these two dates.

Compliance with Basel II (Tier I capital norm of 6%)

Table 2: Listed Private sector banks

Table 3: Listed Public sector banks

- Basel II mandates banks to have tier 1 capital of at least 6%. Data on Tier I capital

of all banks as on December 31, 2008 was not readily available. We therefore

examined the Tier I capital ratios of banks as on March 31, 2008.

- We identified 4 listed public sector banks, viz., Bank of Maharashtra, Central Bank

of India, UCO Bank and Vijaya Bank, which had their Tier I capital ratios below 6%,

as on March 31, 2008.

- Central Bank of India's tier I capital fell further as on December 31,2008 to 5.33%,

which is below the stipulated norm under Basel II.

- As on December 31, 2008, the tier I capital for UCO bank stood at 5.44%.

Extension of Tier I capital norm of 6%

Even if the banks are not able to meet the tier 1 capital limit of 6% by March 31,

2009, there are no issues in purview of the new guidelines. As per the revised Basel

II guidelines, banks which would not be able to meet the minimum Tier I capital

adequacy of 6% from the date of implementation of Basel II, will be provided time till

March 31, 2010.

Compliance with Basel II - CRAR norm of 9%

On an average, (as on December 31, 2008), private sector banks had a higher

CRAR ot 14.15%, vis-a-vis 12.60% tor public sector banks.

Table 4: Listed Private sector banks

Observations - The table above shows that private banks are well placed with their respective CRAR well above 9%, which is the stipulated CRAR norm under Basel II. - On an average, the CRAR for private sector banks increased from 13.53% on March 31, 2008 to 14.15% on December 31, 2008. - Since the Government of India has mandated public sector banks to have CRAR of at least 12% for meeting the capital requirement as well as business growth, we observe that among private sector banks, Bank of Rajasthan and ING Vysya Bank have their CRAR below 12%. In case of ING Vysya bank, its CRAR grew by 52bps from March to December 2008, yet it is still below 12%. We believe these banks could require funding in the future for growth prospects. Table 5: Listed Public sector banks

Observations - The reported CRAR for Allahabad Bank, Bank of Baroda, Bank of India, Indian Bank, Indian Overseas Bank, Punjab National Bank, State Bank of India, Syndicate Bank and UCO Bank are as per Basel II guidelines. - On an average, the CRAR for public sector banks increased from 11.94% on March 31, 2008 to 12.60% on December 31, 2008. - Government of India issued a directive to public sector banks to maintain CRAR of at least 12%. As on December 31, 2008, 5 public sector banks, viz., Bank of Maharashtra, Central Bank, Dena Bank, IDBI Bank and Vijaya Bank reported CRAR below 12%, the government stipulated directive. - Under 1é round of re-capitalization package, goverment accounced a sum of Rs3800Cr for Central Bank, UCO bank and Vijaya Bank. - 2nd round of re-capitalization is also being considered. Dena Bank and Bank of Maharashtra are likely to be funded. Table 6: Public sector banks with government stake of 51% may get government recapitalization

As on December 31, 2008, the Government's stake in Andhra Bank, Dena Bank and Oriental Bank of Commerce is close to 51 % each. These banks cannot raise money through the primary market as the Government shareholding is just a tad above the statutory level of 51%. Therefore further equity dilution is all but ruled out. We feel Dena bank with CRAR of 11.79% and Government stake of 51.19% may need funding. The Government of India stated that it would provide funds to all public sector banks whose CRAR is between 10% and 12%. Dena Bank will get Government aid in the 2nd round of re-capitalization. Andhra Bank's CRAR as of December 31, 2008 is 13.43%, much above the required norm. Its CRAR increased 182bps y-o-y basis. Yet, for future funding and knowing that its government stake is 51.55%, must be eligible for recapitalization. Oriental Bank of Commerce's CRAR is 12.01 %, just meeting the norm but the government may still infuse capital in these banks so that their CRAR doesn't fall after business expansion. It is more likely to get recapitalized as its government stake is 51.09%. Dena Bank, Oriental Bank of Commerce and Andhra Bank could benefit from the 2nd capital infusion plan, since the government's holding in these three banks is very close to the maximum permissible limit of 51%. Modes of Fund Raising Earlier, public sector banks ploughed back profits in order to finance capital requirements for Tier I capital, while increase in Tier II capital was done via subordinated debt. Private sector banks ploughed back profits as well as did

aggressive equity and bond issues. To meet funding requirements for Basel II, a few banks earlier went public/made follow-on public offers. ICICI bank raised Rs100.63bn via a follow-on public offer in June 2007. Central Bank of India raised Rs816Cr through an IPO in July 2007. In case of a few banks, Basel II implementation will release capital as they lend to rated borrowers. But, a few other banks may need capital infusion. Banks also intend to raise funds in anticipation of credit off-take picking up. High-growth and high-risk-taking banks too need capital to support their growth. Options to raise funds and its feasibility in the current scenario Fund raising difficult via IPOs / private placements Banks could use the capital markets to meet capital requirements and go for IPOs or private placements to garner capital. However, this option seems unviable in the current scenario. Internal sources have dried out A significant proportion of funds could be met via internal resources of the banks, such as growth in reserves and surplus through efficient operations in the coming years. However, downturn in the economy is likely to affect the asset quality which may result in higher NPAs. Therefore provisioning can see an increase, going forward. Higher provisions are likely to affect bottom lines; therefore ploughing back of profits may be difficult. Re-capitalization of Public Sector Banks - a boon The Prime Minister announced that public sector banks with CRAR less than 12%, well above the Basel II norm of 8%, and RBI stipulated norm of 9%, will be recapitalized by the Government. Public sector banks are helped by the state and central government which can infuse funds in form of recapitalization to fulfill their capital adequacy. Capitalization by the Government will be via debt instruments such as tier-ll bonds or preference shares, which will issued by the banks and subscribed to by the Government. As part of the second stimulus package, the Government had announced plans to recapitalize public sector banks to the extent of Rs 200bn in two years. The Government is working out the capital that each public sector bank would require till 2011 in order to maintain a CRAR of 12%. Banks may require capital infusion if their businesses keep growing at the current pace or even faster. However, the Government initially plans to infuse capital only in banks which did not have enough headroom to raise resources on their own. The Government would look for both ways of capital enhancement, through direct cash infusion and through conversion of equity into perpetual bonds.

First round of re-capitalization: Rs38bn for Central Bank of India, UCO Bank and Vijaya Bank Central Bank of India, UCO Bank and Vijaya Bank needed re-capitalization, as their respective Tier I capital was below 6%, stipulated Basel II norm as stated in Table 3. Government annouced first round of recapitalization for these three banks.

The above CRARs of the respective banks are as per Basel I. The fund infusion would increase the banks' CRARs to more than the desired level of 12% and achieve tier I capital above 6% norm Central Bank of India The CRAR for Central Bank is 10.02% and Tier 1 capital is 5.33%, which are both below the stipulated norms. The headroom to raise capital under Tier I and Tier II capital is approx. Rs5bn. CBILwas negotiating with the Government for aid in the form of hard cash to meet its capital adequacy. Recently, it announced plans to raise capital in the form of tier II bonds to the tune of Rs2.7bn. UCO Bank UCO Bank had CRAR of 10.68% as per Basel I, and 12.53% as per Basel II, higher than the Government guidelines. In spite of this, it received the first line of re-capitalization package. This is as the Tier I capital of UCO bank is 5.44% as on December 31, 2008, below the stipulated norm. The Government injected Rs450Cr last month and balance Rs750Cr would be infused in FY10. The Government will infuse capital in phases by subscribing to LJCO's non-convertible preference shares, which qualify for tier I capital. UCO bank will pay interest @ 6.5% p.a. to the Government on the instrument. It plans not to enter the bond market before March 31, 2009. With the improvement in UCO Bank's tier I capital, the bank will have additional headroom of Rs12bn for raising tier II capital. Vijaya Bank Vijaya Bank would get Rs5bn in the first tranche under the recapitalization package. The recapitalization would continue till 2011 and would aid in raising tier-ll capital. 2nd round of re-capitalization: Dena Bank and Bank of Maharashtra likely to benefit It is likely that Dena Bank and Bank of Maharashtra will get recapitalized in the second round of recapitalization as government stake is close to 51% and tier I capital is below 6% respectively. These two banks are expected to be recapitalized in FY10.

More re-capitalizations to come Almost all public sector banks, barring a handful such as Punjab National Bank, Bank of India and Canara Bank, are in line to get recapitalization finance from the government over the next 24 months. World Bank funding The Government is also in talks with the World Bank for getting financial assistance of about $4bn for the recapitalization of over a dozen public sector banks over the next two years. Tapping bond markets a feasible option for tier II capital Since inflation and interest rates were higher in the first 2 quarters of 2009, there were not many bond issuances. With easing of yields, there has been a series of Tier-ll and perpetual debt issuances by banks to raise capital. Most banks will be required to enhance capital, as they are likely to expand credit growth this fiscal. Therefore, the period of December 2008 - January 2009 saw hectic activity in the bond market as banks rushed to raise funds. Banks which came out with bond issues in January 2009 to raise tier II capital include Allahabad bank, Bank of Baroda, Bank of India, Canara Bank, Oriental Bank of Commerce, Punjab National bank etc. Currently there is only a 1 -month window before the end of the fiscal and demand for bond issues may pick up further. To sum up - Indian banking companies are required to ensure full implementation of Basel II guidelines by March 31, 2009. With Basel II norms coming into force in 2009, maintaining adequate capital reserves will become a priority for banks. - Basel II mandates Capital to Risk Weighted Assets Ratio (CRAR) of 8% and Tier I capital of 6%. The RBI has stated that Indian banks must have a CRAR of minimum 9%, effective March 31, 2009. All private sector banks are already in compliance with the Basel II guidelines as regards their CRAR as well as Tier I capital. Further, the Government of India has stated that public sector banks must have a capital cushion with a CRAR of at least 12%, higher than the threshold of 9% prescribed by the RBI. - There are 4 banks viz. Bank of Maharashtra, Central Bank, UCO Bank and Vijaya Bank, whose tier I capital as on March 31, 2008 was below the stipulated norm of 6%. - Failure to adhere to Basel II can attract RBI action including restricting lending and investment activities. However, private sector banks as well as public sector banks are likely to comply with Basel II norms by March 31, 2009. The Government announced 1st round of recapitalization for 3 banks, viz., Central Bank, UCO Bank

and Vijaya Bank (whose tier I capital was less than 6%) for an aggregate sum of Rs38bn. - Further for public sector banks, the Government has prescribed CRAR of at least 12%. There are 5 banks which have CRAR less than 12% as of December 31, 2008, viz., Bank of Maharashtra, Central Bank, Dena Bank, IDBI Bank and Vijaya Bank. Since the Government's stake in public sector bank cannot be allowed to go below 51 %, these banks cannot take recourse to equity funding for Tier I capital. Of these banks, government holding in Dena Bank is very close to 51%; it is therefore not possible for it to raise further equity capital (without diluting the Government's stake to below 51 %). - The Government, in the Interim Budget, embarked approx. Rs200bn for re-capitalizing public sector banks whose CRAR is less than 12%, as well as for other public sector banks for future business growth. - The Government has announced that there will be 2nd round of recapitalization. We believe Bank of Maharashtra will have to be recapitalized soon with detailed plan, since its Tier I capital is below 6%. Its government stake is 76%, which is much above the needed 51 %, indicating scope for an equity dilution. However, the current market conditions may render an equity issue difficult. - The recapitalization move by the Government seems to be a precautionary measure to avoid any kind of risk during the times of a global financial turmoil and would improve market confidence in the banking system. We believe the recapitalization will increase the Government's stakes in public sector banks, so that they will be able to opt for fund raising in the future, when credit off-take picks up momentum.