The Reserve Bank of India has recently asked banks to make their own assessment of their various risk exposures through a welldefined internal processand maintain an adequate capital cushion for such risks.The RBI has issued detailed guidelines in this regard under Pillar II of Basel II framework.Pillar II deals with supervisory review process.{SRP]The objective of SRP is to ensure that banks have adequate capital to support all risks and also to encourage them to develop and use better risk management techniques for monitoring and managing risks.
Banks have to calculate regulatory capital requirement under Pillar I of Basel Framework.These guidelines must be implemented with effect from March 31,2009 by foreign banks nad Indian banks having foreign operations and from March 31,2010 by all commercial banks.
The Bank for International Settlements was for nearly two decades grappling with the issue of how much capital a bank must have in order to ensure its continued stability having regard to the environment in which it operates and on the basis of assessment of risks involved.The Bank for International Settlements[BIS]arrived at the minimum capital requirement at 8 per cent of risk weighted assets.The Basel I recommendations on minimum capital requirement were accepted by most countries for adoption by banks in their respective countries.
Basel I accord being quite simple adopted a straight ''one size fits all''approach which does not distinguish between differing risk profiles and risk management standards across banks.Basel I norms were mainly meant for ensuring adequacy of capital as a definite proportion of risk weighted assets.They consider and take into account risks in totality or in overall terms alone.
Efforts were on for several years to find ways of remedying the deficiencies of Basel I norms and Basel Commitee came out with new approach in June 2004.The final version of the accord titled ''International Convergence of Capital Management and Capital Standards -A Revised Framework'' was released by BIS.This is popularly known as New Basel Accord or simply Basel II.
Basel II seeks to rectify most of the defects of Basel I accord.The objectives of Basel II are the following-
1.To promote adequate capitalisation of banks.
2.To ensure better risk management.
3 To strengthen the stability of banking system.
Three Pillars-
Basel II rests on three mutually reinforcing pillars.The first Pillar is concerned with the closer alignment of bank capital with the range of perceived risks.Basel I categorised risks in respect of credit in broad terms without taking into account individaul creditworthiness or lack of it.In other words it does not consider risks involved in individual assets.Under Basel II the above defect is sought to be rectfied by stipulating higher capital for higher risks and vice versa.This Pillar of the approach seeks to bring about alignment of capital requirement to each bank's actual risk of economic loss.It takes in to account all types of risks including market risk and credit risk.It prescribes minimum capital requirement having due regard to risk profile of each bank.
Pillar II of the new capital framework recognises the necessity of undertaking effective supervisory review of banks'internal internal assessment of their overall risks.This is to ensure that bank managements exercise sound judgement in the matter and set aside sufficient capital for these risks.RBI has now issued detailed guidelines under this pillar.The RBI guidelines have listed some risks that banks are generally exposed to but which are not fully captured in the regulatory capital to risk assets ratio[CRAR]such as interest rate risk,credit concentration risk,liquidity risk,settlement risk,and reputation risk among others.Banks have to provide and set aside adequate capital after evaluating all these types of risks.RBI will undertake supervisory review and assess and see whether capital is adequate and if there is shortfall the RBI may direct a bank to set aside extra capital.
Pillar III is meant for imposing market discipline among banks to ensure prudent management.This is sought to be done by enhancing the degree of transparency and public disclosures in banks' public reporting.Banks may follow the standardised approach wherunder they can make use of external credit ratings to assess and evaluate risks.More sophisticated banks can make use of internal rating basrd approaches.This may however be subject to strict supervision by regulatory authorities.Apart from credit risk and market risk covered by Basel I Basel II also provides for operational risks such as losses caused by failure of systems lapses on the part of staff and also losses arising out of external events such as natural disasters like fllods,earth quakes,etc.
The RBI had earlier indicated that banks must come out with framework for migrating their standards of supervision accountability and best practice guidelines in line with the provisions of Basel II Accord.Moreover the framework adopted by banks must be adaptable to changes in business size market dynamics and introduction of new products in future.In order to ensure this banks must-
1.Make indepth analysis of the options available under Basel II.
2,Adopt standardised approach for credit risk.
3.Adopt basic indicator approach for operational risk
4.review the progress at quarterly intervals.
and
5Instal comprehensive and rigorous system to assess borrower risk.
The RBI may closely monitor the progress to be made by banks .The basel II norms set out details for adopting more risk sensitive minimum capital requirements for banks.The new framework reinforces these risk sensitive requirements by laying down principles for banks to assess the adequacy of their capital and for supervisors to review such assessments to ensure that banks have adequate capital to support their risks.It also seeks to strengthen market discipline by enhancing transparency in banks;financial reporting.In overall terms we can broadly classify the essentials of Basel II as under-
Capital Adequacy.
Basel II intends to replace the existing approach by a system that would use external credit assessments for determining risk weights.It is intended that such an approach will also apply either directly or indirectly and in varying degrees to the risk weighting of exposure of banks to corporates and securities firms.The result will be reduced risk weights for high quality corporate credits and introduction of more than 100 percent risk weight for low quality exposures.
Risk Based Supervision
This ensures that a bank's capital position is consistent with its overall risk profile and strategy thus encouraging early supervisory intervention.The new framework lays accent on bank managements developing internal assessment processes and setting targets for capital that are commensurate with bank's particular risk profile and control environment.This internal assessment then would be subjected to supervisory review and intervention by RBI.
Market Disclosures
The strategy of market disclosure will encourage high diclosure standards and enhance the role of market participants in encouraging banks to hold and maintain adequate capital.
Advantages
The advantages that may accrue by implementing Basel II norms are in the form of opportunities ,namely banking and non-banking opportunities.
Banking Opportunities
India is presently one of the fast growing economies in the world.A sound,vibrant,efficient and evolved banking system will act as a strong spur to the growth efforts of India.Indian banking system is no doubt stronger than its counterparts in Asia in terms of performance indices and range of products and services.When compared to many peer group countries still some better risk practices are required to be adopted by Indian banks.Many of the Indian banks have low levels of competence in risk management system.They are yet to develop expertise in the use of modern technology and tools when compared to thjeir western counterparts.Second stage economic reforms,higher market dynamics and incresed globalisation demand robust risk management system in Indain banks.Failure of some banks like Glogal Trust Bank,United Western bank etc have shown that the existing level of risk based supervision and market disclosures are not adequatein Indain banking system.Basel II will provide a new framework for improvement in this regard.
Banks which are Basel II compliant can project a better image and amass more business from the market.The public can choose banks on the basis of market disclosures for keeping their deposits and for their credit needs.Banks also will have incentive to select assets of better quality.As a result there will be stress on toning up credit appraisal in banks.There will emerge more professionalism in credit decisions and credit management.There will be shift of emphasis from adequacy of capital to capital efficiency.Basel II compliant banking system will further enhance the image of India in the world and India's country rating will go up .This will facilitate larger inflow of FDI and other capital inflows.With improved image Indian banks will be able to raise resources at cheaper rates in foreign countries.With higher networh and improved capital efficiency Indian banks can pursue the task of financial inclusion aggrressively and try to exploit business and intermediation opportunities available at the bottom of the pyramid with greater measure of success.
Non -Banking Opportunities
The major advantage of basel II for Indai is going to be in the area of servicesin general and IT nad manpower in particular.Banks all over the world have to make huge investments inorder to be Basel II compliant.These investments will be mainly in the area of information technology,systems training.etc.These will cover software tools,data base management businessintelligence,hardware etc.These are necessary to create risk infrastructure to address the three pillars of the framework.Lot of opportunities will arise here for for consultancy for IT companiesin India and abroad.Employment opportunities in It companies will increaseand grow.Nedd for experts in the field of risk management will increse.
Constraints and Hurdles
Implementation of Basel II is not easy for banks.The technology infrasrtucture in terms of computerisation is still in nascent stage in several Indian banks.Computerisation of all branches including rural branches will be a challenging task.Owing to late start in computerisation most banks lack robust data capture ,cleansing and mannagement practices.This will be great hurdle in the process of implementation of Basel II.
The implementation of Basel II promises significant gains for the economy.Risk based capital maintenance by banks will enhance financial stability.This will promote risk based pricing which will ultimately contribute to enhancement of shareholder value.Implementation of Basel II may trigger new developments including mergers and acquisitions.In the new scenario there will be increased accent on corporate governance and creation and enhancement of share holder value in banking institutions
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