The Hindu Business Line : Pillars of Basel II

FROM time to time, the Bank for International Settlements (BIS), located in Basel, Switzerland, puts together esoteric edicts under exotic titles prepared by a few financial wizards of G-10 cloistered within its catacombs. They may fly over the heads of worldly-wise intelligentsia, but, obviously, they do serve their purpose of keeping the international financial order on an even keel, for otherwise the BIS will not be there in the first place.

Its prescriptions are supposed to enhance the health of the banking sector and keep it in fine fettle. Governments, financial institutions, capital markets and regulatory bodies of industrial countries insist on compliance by their counterparts all over the world with the standard operating procedures to which the BIS attaches a lot of importance. Indeed, it has become a brand in its own right to the extent of its pronouncements going by the name of Basel series.

Let me digest and disseminate for the good of the bankers in India the latest launch of the Basel Committee on Banking Supervision. It is a revised framework, called Basel II, for international convergence of capital measurement and capital standards. It improves upon the Basel Capital Accord of 1988 which was based on broad classes of exposure without distinguishing between the relative degrees of creditworthiness among individual borrowers and without taking note of the need for more advanced risk measurement techniques, and the increasing use of sophisticated risk management practices such as securitisation. Basel II makes good this omission.

It rests on three "pillars", aimed at the safety, soundness and stability of the financial system and the banking sector's ability to serve as a source for sustainable economic growth. The first aligns the minimum capital requirements more closely to each bank's actual risk of economic loss. The second lays down the manner of exercising effective supervisory review of banks' internal assessments of their overall risks to ensure that bank management has set aside adequate capital for these risks. The third sets out the norms of prudent management, and the public disclosures that banks must make regarding adequacy of their capitalisation.

Any banker who wants to be on the right side of Basel II is welcome to visit www.bis.org.

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