Capital Adequacy Guidelines – Review of Trading Book
The regulatory landscape for capital adequacy in banks is undergoing significant changes, as outlined in recent updates to existing guidelines. This article provides an overview of the modifications made in light of the new Master Direction on Investment and their implications for commercial banks.
The foundation of the current regulatory framework can be traced back to the Master Circular – Basel III Capital Regulations dated May 12, 2023, and the Master Direction – Prudential Norms on Capital Adequacy for Local Area Banks (Directions), 2021 dated October 26, 2021. Together, these documents form the core of the capital adequacy guidelines, ensuring that banks maintain sufficient capital to cover their risks.
A major update to these guidelines was introduced with the Master Direction – Classification, Valuation, and Operation of Investment Portfolio of Commercial Banks (Directions), 2023, issued on September 12, 2023. This new directive introduces a clearly identifiable trading book under the ‘Held for Trading (HFT)’ accounting sub-classification. Additionally, it introduces an AFS-reserve, which will now be part of regulatory capital. These changes necessitated an amendment to the existing capital adequacy guidelines to align them with the new MD on Investment.
Consequently, the provisions of the Master Circular – Basel III Capital Regulations have been modified. The detailed modifications are provided in Annex 1 of the updated guidelines. One notable change is the revised definition of the trading book, which will now follow the criteria set out in Annex I of the MD on Investment.
Furthermore, the regulatory authorities released the ‘Draft Guidelines on Minimum Capital Requirements for Market Risk – under Basel III’ on February 17, 2023, for public comment. These draft guidelines cover the ‘Definition of trading book’ and the ‘Market Risk Capital Requirements – Simplified Standardised Approach’. While the final guidelines on the simplified standardised approach for market risk capital requirements will be issued separately at a later date, the revised definition of the trading book is already in effect.
To facilitate the transition to the new market risk capital requirements, intermediate scalers have been introduced. These scalers recalibrate the existing market risk capital requirements and should be considered by banks in their strategies and capital planning measures.
In addition to the changes for commercial banks, the Master Direction – Prudential Norms on Capital Adequacy for Local Area Banks (Directions), 2021, has also been updated, with the modifications outlined in Annex 2.
These updated instructions will be applicable from April 1, 2024, to all commercial banks, excluding Regional Rural Banks. The exclusion of Regional Rural Banks ensures that the guidelines are tailored to the specific needs and operations of different types of banking institutions.
Overall, these changes represent a significant shift in the regulatory environment, aimed at enhancing the robustness and transparency of the banking sector’s capital adequacy framework. Banks must closely review these updates and adjust their capital planning and risk management strategies accordingly to ensure compliance and maintain financial stability.
