The Hindu Business Line : Basel II norms

INDIAN banks and RBI have the whole of 2005-06 to gear up for meeting Basel II norms which click in by by end of 2006. Basel II norms will put pressure on bank boards to assess the need for risk capital and will be replacing the minimum 9 per cent capital adequacy norm under Basel I.

Unlike now when there is nothing to set apart one bank from another, the Basel II guidelines will make banks different. Critically, banks will have to evaluate themselves and any laxity will hurt. In a way, bank chairmen will have to refrain from making tall, if not spurious, claims.

The RBI Bulletin (January 2005) carries a detailed study: Review of the Recommendations of the Advisory Groups Constituted by the Standing Committee on International Financial Standards and Codes: Report on the Progress and Agenda Ahead. The revised Basel II is cut up into four parts. The first provides scope of application and details on the manner capital requirements are to be applied within a banking group. Calculation of the minimum capital requirements for credit risk and operational risk as well as certain trading book issues form the second. The third and fourth outline expectations concerning supervisory review and market discipline, respectively.

Basel II, the Report says, "provides for a greater use of assessment of risk by banks' internal systems as inputs to capital calculations. It also details a set of minimum requirements designed to ensure the integrity of these internal risk assessments. It provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and their financial market infrastructure.

The framework also suggests establishment of minimum levels of capital for internationally active banks. The revised framework is more risk-sensitive than the 1988 Accord, but provides for countries to consider if banks should be required to hold additional capital over and above the Basel minimum.

This is particularly the case with the more broad-based standardised approach but even in the case of the internal ratings-based (IRB) approach, the risk of major loss events may be higher than allowed for in this framework."

The Basel Committee on Banking Supervision (BCBS) is keen on supervisory review (second pillar) and market discipline (third pillar).

Sitting on a tripod is never easy and Indian banks could find the experience unsettling. Some changes have been proposed in the treatment of expected losses, unexpected losses and securitisation exposures.

The BCBS wants banks using IRB approach to weave in the effects of economic downturns into their loss-given-default (LGD) parameters. Indian banks have yet to capture elements of risk-like probability of default, loss given default and exposure at the time of default.

RBI has been following a standardised approach under Basel II and there is a feeling that at present "these are not very relevant for most of the banks. However, banks could consider the process of building up necessary MIS in this regard for future purposes."

Also RBI will have to move towards setting up bank-specific ratios based on individual risk profiles under the standardised approach.

"A quality change based on advanced mathematical models and economic know-how is on and one is not sure if the personnel manning the Indian banking system are well-equipped," says a banker.

Banks will have to rework capital requirements, implying a need for more capital. Government banks have little scope today as New Delhi wants to hold 51 per cent majority. By 2006, New Delhi will have to be less rigid if Basel II has to make sense.

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