The Hindu Business Line : How ready is RBI for Basel-II transition?

GOING through the RBI papers (2004) in public domain, one re-read a piece styled: `Implementation of Basel II: An Indian Perspective', detailing the issues which around 100 banks could face end-2006 when Basel II becomes an operational norm.

This paper was presented by the RBI Deputy Governor, Ms K.J. Udeshi, in Washington on June 2, 2004, at the fourth annual international seminar on policy changes for the financial sector - Basel II.

The paper states: "Basel II provides scope for the supervisor to prescribe higher than minimum capital levels for banks for, among others, interest rate risk in the banking book and concentration of risks/risk exposures. ... .The magnitude of this task to be completed by December 2006, when we in India have as many as 100 banks, is daunting."

The RBI has been taking advance action and at a minimum all banks in India, to begin with, will adopt the Standardised Approach for credit risk and Basic Indicator Approach for operational risk. After adequate skills are developed, both in banks and at supervisory levels, some banks may be allowed to migrate to the Internal Ratings Based Approach. This in itself could create two bank groups varying in quality.

Banks going for the IRB Approach will be much more risk-sensitive than those on Standardised Approach as a "small change in degree of risk might translate into a large impact on additional capital requirement for the IRB banks. Hence, IRB banks could avoid assuming high-risk exposures. Since banks adopting Standardised Approach are not equally risk-sensitive and since the relative capital requirement would be less for the same exposure, the banks on Standardised Approach could be inclined to assume exposures to high-risk clients, which were not financed by IRB banks.

As a result, high-risk assets could float towards banks on Standardised Approach which need to maintain lower capital on these assets than the banks on IRB Approach. Similarly, low-risk assets would tend to get concentrated with IRB banks which need to maintain lower capital on these assets than the Standardised Approach banks. Hence, system as a whole may maintain lower capital than warranted. Due to concentration of higher risks, Standardised Approach banks can become vulnerable at times of economic downturns."

If this be, so what happens to directed lending norms, like the 40 per cent for priority sector, with bankers unwilling to touch farmers? The RBI is also worried over the influence of large and complex financial conglomerates (SBI and ICICI groups are examples) and believes supervisory policies are in order to handle "systemic risks" flowing from their dominance. But is this feasible?

Then there is the rating issue. Currently, three rating agencies examine issues and not issuers, which could be a tough task. Further, what happens to the moribund rural credit delivery system comprising co-operative banks, regional rural banks and rural branches of government banks?

The paper admits "the private sector banks, especially the new ones, are world-class" which is surprising as a few of them have gone under while others face ownership and corporate governance queries.

Foreign banks will throw up fresh problems like, "whether the internal models approved by their head offices and home country supervisor adopted by the Indian branches of foreign banks need to be validated again by the RBI or whether the validation by the home country supervisor would be considered adequate?"

Though Basel I had prescribed minimum capital adequacy of 8 per cent, the Indian banking system had gone for a 9 per cent norm though this does not apply to rural credit institutions. Yet, Indian banks have still to opt for capital charge for market risk though since 1998 there are several copycats like a 5 per cent Investment Fluctuation Reserve plus a 2.5 per cent risk weight on the entire investment portfolio.

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