The Hindu Business Line : Basel II- The challenge for risk managers

Rather than getting enamoured with the different methodologies for computing capital for credit and operational risk, if one starts addressing the qualitative factors for better risk management, it can take an organisation to greater heights.

Every one of us strives for change from our routine work & life. But when a change is at our doorsteps, due to external factors, for our benefit, the initial response is criticism and resistance. I hardly see any difference with the approach banking industry, across the globe, has displayed for adopting the guidelines Basel II Accord.

Over the past two decades the financial services industry has dramatically changed. Cut throat competition and customer focus have led to increasing customer demands and have forced banks to introduce structured and unique products in a complex technology environment. Today, the general belief is that plain vanilla products are no longer sufficient for survival.

Issues such as "one size fits all", ever increasing business complexities and dependence on technology have led the Basel committee to rethink on the capital adequacy framework. After a relatively stretched period and considerable inputs from the banking industry, across the globe, the committee came up with the new framework for capital adequacy in June 2004.

Hot topic

Basel II Accord has become a hot topic for the bankers and a hot selling cake for the rating agencies, consultants and software vendors. The hype generated by vendors is reminiscent of the Y2K fever. Banks have started pulling their socks and are finding ways to adapt to these new guidelines. Instead of treating this accord as a regulatory compliance measure, one needs to get deeply into the underlying concepts and treat the norms as the catalyst for alignment of business objectives with risk levels and thereby resulting ineffective utilisation of bank's resources and increase in shareholders' wealth.

In the Indian scenario, in addition to gearing up for the required knowledge and computational skills, significant efforts are required to change the way business dealings are done, the organisation structure, corporate culture & risk management practice.

Risk management

My take on risk management, not necessarily from Basel II perspective, is to get good people; you can trust, pay them well and back their judgment. Good people are far more valuable than good systems. "One should prefer a C-rated model with weaknesses and have people with experience and intuition to run risk management than an A-rated model with C-rated people who don't understand the model and are therefore unable to question the numbers that the system churns out." I would never have a fancy risk management system that takes care of the risks for an organisation and thereby relieves people the need to stay alert.

I doubt if I adopt VaR and associated systems just because my competitors are doing so. We got to resist the temptation to behave like a lemming. Don't adopt systems just because we have some vague idea that they will help us steal a march on the competition.

Understand the limitations of our risk management systems. Ask what could go wrong, ask your self if the results seem right, and so forth. Always ask risk management people where are they vulnerable. Keep in mind that no system ever gives guaranteed results.

Never think that you have some foolproof system that allows you to go to sleep. Avoid being complacent.

If one is tempted to regard risk management as expensive, believe me absence of risk management is more expensive. Organisation that has regarded risk management as a drain on profits has been drained.

I am sure identifying and categorising risk is also a challenge, what might look like a credit or trading loss may actually be an operational risk issue.

Though covered in Basel II guidelines, in brief one should always undertake regular stress testing and contingency planning exercises, since these events are of low frequency but have high impact.

The author is Deputy Vice-President, Risk Management at Kotak Mahindra Bank Ltd.

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