BASEL II

Concept &
Implication

Concept Overview:
Basel History
About Basel I
About Basel II

Introduction
Definition
Three

Pillar Approach
Advantages & Drawbacks
Implementation progress
Basel I Vs Basel II

Challenges with Indian banking

industry.
Implication.

Basel History
Basel Committee was constituted by the Central

Bank Governors of the G-10 countries.

The Committee's Secretariat is located at the Bank

for International Settlements in Basel,

Switzerland.

Its objective is to enhance understanding of key

supervisory issues and quality improvement of

banking supervision worldwide.

This committee is best known for its international

standards on capital adequacy; the core principles

of banking supervision and the concordat on crossborder banking supervision.

Basel

Basel I is the round of deliberations by

central bankers from around the world,

and in 1988, the Basel committee
(BCBS) in Basel, Switzerland, published
a set of minimal capital requirements
for banks.

It primarily focused on credit risk .

Basel I is now widely viewed as

outmoded, and a more comprehensive

set of guidelines, known as Basel II are
in the process of implementation by
several countries.

Basel II
Basel II is a type of recommendations on

banking laws and regulations issued by

the Basel Committee on Banking
Supervision that was initially published in
June 2004.

The objective of Basel II is to create an

international standard that banking

regulators can use when creating
regulations about how much capital banks
need to put aside to guard against the
types of financial and operational risks
banks face.

Basel II includes recommendations on

three main areas: risks, supervisory

review, and market discipline.

The Accord in operation

The 3 Pillar Approach

Minimum Capital Requirement

Supervisory Review

Market Discipline & Disclosure

The First Pillar..

The first pillar deals with

maintenance of regulatory capital
calculated for three major
components of risk that a bank
faces: credit risk, operational risk
and market risk. Other risks are
not considered fully quantifiable
at this stage.

The Second Pillar..

The second pillar deals with the

regulatory response to the first pillar,
giving regulators much improved 'tools'
over those available to them under Basel
I.

It also provides a framework for dealing

with all the other risks a bank may face,
such as systemic risk, pension risk,
concentration risk, strategic risk,
reputation risk, liquidity risk and legal
risk, which the accord combines under the
title of residual risk. It gives bank a power
to review their risk management system.

The Third Pillar..

The third pillar greatly increases

the disclosures that the bank must
make. This is designed to allow
the market to have a better
picture of the overall risk position
of the bank and to allow the
counterparties of the bank to
price and deal appropriately.

Advantages..
Takes global aspect into consideration for more

rational decision making, improving the decision

matrix for banks.
Makes better business standards.
Reduces losses to the banks.
Improving overall efficiency of banking and finance
systems.
Allowing capital allocation based on ratings of the
borrower making capital more risk-sensitive.
Provides range of alternatives to choose from.
Incorporates sensitivity to banks.
Encouraging mergers and acquisitions and more
collaboration on the part of the banks, this ultimately
leads to proper control over their capital and assets.

Drawbacks

Dealing with diversity.

Lack of data on internal ratings and modeling.

Credit risk reduction.

Cyclical fluctuations in bank lending.

Competition among banks.

Financial innovations.

Basel I VS Basel II

Basel I is very simplistic in its

approach towards credit risks. It

does not distinguish between
collateralized and non-collateralized
loans, while Basel II tries to ensure
that the anomalies existed in Basel I
are corrected.

Challenges with Indian Banking

Industry..
With the feature of additional capital requirements,

the overall capital level of the banks will see an

increase. But, the banks that will not be able to make
it as per the norms may be left out of the global
system.

Another biggest challenge is re-structuring the

assets of some of the banks would be a tedious

process, since most of the banks have poor asset
quality leading to significant proportion of NPA. This
also may lead to Mergers & Acquisitions, which itself
would be loss of capital to entire system.

The new norms seem to favor the large banks

that have better risk management and

measurement expertise, who also have better
capital adequacy ratios and geographically
diversified portfolios.

Conti

Challenges with Indian Banking

Industry..
Implementation of the Basel II will require huge

investments in technology. According to estimates,

Indian banks, especially those with a sizeable branch
network, will need to spend well over $ 50-70 Million on
this.

Experts say that dearth of risk management

expertise in the Asia Pacific region will serve as a

hindrance in laying down guidelines for a basic
framework for the new capital accord.

The technology infrastructure in terms of

computerization is still in a nascent stage in most

Indian banks. Computerization of branches, especially
for those banks, which have their network spread out in
far-flung areas, will be a daunting task.

Implications..

The Basel Committee on Banking Supervision is a Guideline

for Computing Capital for Incremental Risk.

It is a new way of managing risk and asset-liability

mismatches, like asset securitization, which unlocks
resources and spreads risk, are likely to be increasingly used.

The major challenge the country's financial system faces

today is to bring informal loans into the formal financial
system. By implementing Basel II norms, our formal banking
system can learn many lessons from money-lenders.

This was designed for the big banks in the BCBS member
countries, not for smaller or less developed economies.

Implications..

Keeping in view the cost of compliance for both banks and

supervisors, the regulatory challenge would be to migrate
to Basel II in a non-disruptive manner.

India is one of the early countries which subjected itself

voluntarily to the FSAP of the IMF, and our system was
assessed to be in high compliance with the relevant
principles.

With the gradual and purposeful implementation of the

banking sector reforms over the past decade, the Indian
banking system has shown significant improvement on
various parameters, has become robust and displayed
ample resilience to shocks in the economy.

There is, therefore, ample evidence of the capacity of the

Indian banking system to migrate smoothly to Basel II.

Thank you