BASEL Norms & Implication on Indian Banks

Presented by :
Kumar Ramchandani Diploma Banking Batch No: 14

BIRTH OF BASEL NORMS

The failure of the German Bank Herstatt in 1974. The 1970s saw banks operating on waferthin capital base. International banks, especially Japanese,tried to get short-term competitive advantage. The definition of regulatory capital differed in every country.

BIRTH OF BASEL NORMS

The central banks of the G-10 countries addressed the issue of under-capitalized banks and non-standardized banking regulations. Basel Committee on Banking Supervision was formed under the Bank of International Settlements (BIS) in 1974. In July 1988, the Basel Committee came out with a set of recommendations popularly known as Basel I norms.

BASEL I NORMS

Maintain capital of at least 8 per cent of their risk-weighted loan exposures. Exposures to Govt. 0% Banks 20% Corporate-100% Capital was categorized as Tier I capital - The permanent capital like equity. Tier II capital- Supplementary capital like
subordinate debt.

WEAKNESS OF BASEL-I NORMS

The one-size-fits-all approach Did not consider capital requirement to take care of operational risk Did not distinguish between high and low quality assets in the same class. Not compatible with developing services like derivatives and securitisation, as they could as manipulative tools.

BASEL II NORMS

(JUNE 2004)

These norms are based on the three pillars Capital Requirement Supervisory Review Market Discipline

PILLAR I provide banks with guidelines to measure the various types of risks - credit, market and operational risks.

PILLAR I CREDIT RISK

Standardized Approach

Based on ext. credit rating(CRISIL/ICRA)

Expected Loss (EL) on a loan = Exposure at default (EAD) * Loss given default (LGD) * Probability of Default (PD) LGD and EAD provided by Regulator Independent group within bank MIN 7 Rating Grades Data on previous 5 years of PD estimates

Foundation Internal Rating Based Approach

Advanced IRB Approach

PILLAR I MARKET RISK

Risk arising from market investments (SLR Requirements)

PILLAR I OPERATIONAL RISK

Failure of internal systems, human errors, fraud

Basic Indicator Approach 15% Standardized Approach Diff for each busi. Internal Measurement Approach int. data

PILLAR II SUPERVISORY REVIEW

Employ better risk mgmt practices Principle 1: Assessing Capital Adequacy(CA) visa-vis their risk profile

Principle 2: Review and evaluate banks' internal CA

and strategies, ensure compliance with regulatory capital ratios. Take appropriate supervisory action

Principle 3: Expect banks to operate above the

minimum regulatory capital ratios. stage.

Principle 4: Take fast remedial steps at an early

PILLAR III MARKET DISCIPLINE

Suggests greater transparency -adequate disclosures to supervisors, bank's customers, rating agencies, depositors and investors. Provides a comprehensive menu of public and regulatory disclosures

Capital structure (core and supplementary capital) Capital adequacy Risk assessment Risk management processes

KEY ISSUES FOR BANKS IN INDIA

Credit Risk Standardized Approach

Portion of unrated assets have no rating Unrated Assets attracts 100% Risk

Credit Risk Foundation IRB Approach

5 years PD data not available Mismatch due to diff in classifying NPA LGD is tough to compute
Tough to get LGD,EAD Diversification benefits are not considered

Credit Risk Advanced IRB Approach

KEY ISSUES FOR BANKS IN INDIA

Operational Risk

Overall increase in Capital requirement Indian Banks are not ready Markets are not mature enough to respond the disclosure 1.6% decline in capital adequacy

Market Discipline

CRISIL estimation