Basel Norms & Indian Banking System

Amidst globalisation Banking System in India
has attained vital importance.
Day by day there has been increasing
banking complexities in banking transactions,
capital requirements, liquidity, credit and risks associated with them.

The World Trade Organisation (WTO), of which India is a member nation,
requires the countries like India to get their banking systems at par with the
global standards in terms of financial health, safety and transparency,
by implementing the Basel II Norms by 2009.

BASEL COMMITTEE:

The Basel Committee on Banking Supervision provides a forum for regular
cooperation on banking supervisory matters. Its objective is to enhance
understanding of key supervisory issues and improve the quality of banking
supervision worldwide. It seeks to do so by exchanging information on national
supervisory issues, approaches and techniques, with a view to promoting common
understanding. The Committee’s Secretariat is located
at the Bank for International Settlements (BIS) in Basel, Switzerland.

NEED FOR SUCH NORMS:

The first accord by the name .Basel Accord I. was established in 1988
and was implemented by 1992. It was the very first attempt to introduce
the concept of minimum standards of capital adequacy.
Then the second accord by the name Basel Accord II was established
in 1999 with a final directive in 2003 for implementation by 2006 as Basel II Norms.
Unfortunately, India could not fully implement this but, is now gearing
up under the guidance from the Reserve Bank of India to implement it from 1 April, 2009.

Basel II Norms have been introduced to overcome the drawbacks of Basel I Accord.
For Indian Banks, its the need of the hour to buckle-up and practice banking
business at par with global standards and make the banking system in India
more reliable, transparent and safe. These Norms are necessary since India
is and will witness increased capital flows from foreign countries and there
is increasing cross-border economic & financial transactions.

FEATURES OF BASEL II NORMS:

Basel II Norms are considered as the reformed & refined form of Basel I Accord.
The Basel II Norms primarily stress on 3 factors, viz. Capital Adequacy,
Supervisory Review and Market discipline. The Basel Committee calls these
factors as the Three Pillars to manage risks.

Pillar I: Capital Adequacy Requirements:

Under the Basel II Norms, banks should maintain a minimum capital adequacy
requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated
maintaining of 9% minimum capital adequacy requirement. This requirement is
popularly called as Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).

Pillar II: Supervisory Review:

Banks majorly encounter with 3 Risks, viz. Credit, Operational & Market Risks.

Basel II Norms under this Pillar wants to ensure that not only banks have adequate
capital to support all the risks, but also to encourage them to develop and use better
risk management techniques in monitoring and managing their risks.
The process has four key principles:

a) Banks should have a process for assessing their overall capital adequacy
in relation to their risk profile and a strategy for monitoring their capital levels.

b) Supervisors should review and evaluate bank’s internal capital adequacy assessment
and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios.

c) Supervisors should expect banks to operate above the minimum regulatory
capital ratios and should have the ability to require banks to hold capital in excess of the minimum.

d) Supervisors should seek to intervene at an early stage to prevent capital from
falling below minimum level and should require rapid remedial action if capital
is not mentioned or restored.

Pillar III: Market Discipline:

Market discipline imposes banks to conduct their banking business in a safe, sound
and effective manner. Mandatory disclosure requirements on capital, risk exposure
(semiannually or more frequently, if appropriate) are required to be made so that market
participants can assess a bank’s capital adequacy. Qualitative disclosures such as risk
management objectives and policies, definitions etc. may be also published.

CONCLUSION:

Basel II Norms offers a variety of options in addition to the standard
approach to measuring risk. Paves the way for financial institutions to
proactively control risk in their own interest and keep capital requirement low.

But . . .

Requires strategizing risk management for the entire enterprise, building huge
data warehouses, crunching numbers and performing complex calculations
and poses great challenges of compliance for banks and financial institutions.

Increasingly, banks and securities firms
world over are getting their act together.


By: Anand Wadadekar,
M.A Economics, MBA Finance & Banking,
AMFI, DIT, GCIPR