Current Level of Basel II

Implementation
 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 cross-border banking supervision
 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
Environment of Basel II
The Accord in operation
 Pillar 1 :Minimum Capital Requirements

Market Risk Credit Risk Operation Risk

• No changes from Basel • Significant change from • Not explicitly
Basel I
I covered in Basel I
• Three different
approaches to the • Three different
calculation of minimum approaches to the
capital requirements calculation of
• Capital incentives for minimum capital
banks to move to more requirements
sophisticated credit risk
management approaches • Adoption of each
based on internal ratings approach subject to
• Sophisticated compliance with
approaches have defined ‘qualifying
systems/controls and criteria’
data collection
requirements as well as
qualitative requirements
for risk management
 Pillar 2 :Supervisory Review
• Banks should have a process for assessing their overall capital
adequacy and strategy for maintaining capital levels

• Supervisors should review and evaluate banks’ internal capital

adequacy assessment and strategies

• Supervisors should expect banks to operate above the minimum

capital ratios and should have the ability to require banks to hold
capital in excess of the minimum

• Supervisors should seek to intervene at an early stage to prevent

capital from falling below minimum level
Pillar 3 :Market Discipline & Disclosure

• Market discipline reinforces efforts to promote safety and

soundness in banks

• Core disclosures (basic information) and supplementary disclosures

to make market discipline more effective
Basel II Project Management
Phase Approach
 Bank
Current Situation Effect of BASEL II Challenges Risk
• Use “one-size-fits- • Need to choose •Interpret new •Interpret new
all” regulatory credit and regulations and regulations and
capital approach operational risk understand effects on understand effects on
approaches (Pillar I) business business

•Need to gather, •Secure and maintain •Manage change to

store, and analyze board and senior risk culture
wide array of new management
data sponsorship •Secure and maintain
board and senior
•Need to embed •Face new management
new/enhanced expectations from sponsorship
practices across the regulators, rating
organization agencies, and •Face new
Customers expectations from
regulators, rating
•Need to consider agencies, and
whether to customers
target certain
customers/products
or eliminate others
 Customer
Current Situation Effect of BASEL II Challenges Risk

•Often unable to •Need •Face new costs •Reduced credit lines

generate sufficient external/internal resulting from need
internal cash flow to rating to obtain credit to provide lenders •Increased collateral
realize all necessary with new, timely Requirements
investments •Face increased information
transparency of •Fewer refinancing
•Depend on external account profitability •Improve lending opportunities
resources, which terms
could be debt or •Need to collect and •Higher interest an
equity disclose new •Improve general
Information connections with Costs
enders/investors
•Face possibility of through enhanced
reduced service, disclosures and
standardized structured debt
products, higher holder’s
interest rates Relationship
management
 Regulators
Current Situation Effect of BASEL II Challenges Risk

•Operate in a •Gain access to more •Need well-trained, •May create new

fragmented and timely educated costs for
Environment information through professionals to fill banks and ultimately
the new disclosures roles that are for
•Need enhanced Basel requires of traditionally not as Customers
information to be banks well paid as
able to anticipate comparable positions •Impose numerous
bank problems •Gain power to set within financial locally specific choices
(vs. respond in incentives, penalize institutions that diminish the
crisis/default) wrong-doers, and act effects
(not react)—thus •Create regulation of the levelled playing
contributing to that reflects the field that Basel II
increased financial linkages among risks seeks to create
stability and
transparency
 Rating Agency
Current Situation Effects of Basel II Challenges Risk

• Operate in an • Grow based on • Seek to improve •Face reduced

oligopolistic new need for reputation (national market share
environment ratings by banks agencies) because most banks
dominated by and capital • Obtain approval will likely
Standard & Poor’s, market participants (supervisory use IRB approaches
Moody’s, and Fitch • Compete with new, criteria) for banks to
(Europe); others smaller players use Standard •Fail to benefit from
face high barriers to allied in new Approach increased
entry associations • Maintain high competition if
designed to quality of ratings smaller agencies
improve their • Benefit from cannot surmount
competitiveness intermediation barriers to entry
and reputation Process
• Respond to
requirements for
greater
transparency in
rating components
 Capital Markets
Current Situation Effects of Basel II Challenges Risk

• Face trend toward • Securitization, and • Face reduced • Volatility in the

securitization, growth in customer base as debt market
including credit derivatives low-quality
derivatives markets corporations avoid • Reduced liquidity
debt capital markets
• “Risks” (e.g., in favor of stable • Corporations
corporate bonds) relationships with facing difficulties in
offered in smaller banks offering bonds
parcels
• Create investor • Companies running
• New growth of trust and reduce out of Capital
debt market volatility by
encouraging the
development of a
regulatory
framework, by
market
 Financial Institutions of Basel II
Current Situation Effects of Basel II Challenges Risk
• Not covered by • Do not need to • Face reduced • Volatility in the
financial regulation gather or disclose customer base as debt market
comparable to the the same low-quality
Basel regime information as corporations avoid • Reduced liquidity
Basel-compliant debt capital markets
institutions in favor of stable • Corporations facing
• Need to consider relationships with difficulties in
the extent to banks offering bonds
which “complying”
with Basel II is • Create investor • Companies running
strategically trust and reduce out of Capital
important to help volatility by
the institution encouraging the
remain competitive development of a
and to signal quality regulatory
framework, by
market
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.
 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.
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