Banks o

develop
function
operatio
governm
frauds a
Regulato
reputatio
Regulati
unhealth
Regulato
quality,
encount
practices
essentia
in financ
where b
Regulato
from the
be attrib
erosion


operating in
ment of regi
ing in a reg
ons through c
ment impleme
and bank failu
ory support f
on. It also
ion of banks
hy competitio
ory intervent
earnings qu
ter financial
s in an econ
al for effectiv
cial crisis wh
ig banks hav
ory framewo
e impact of g
buted to abs
and absence
an economy
ons and ine
gulation free
creative acc
ents many o
ures world ov
for banks en
reduces exc
s focuses on
on, health of
tion aims at
uality and p
crisis. Mere
nomy. Vigilan
ve regulation
here even b
ve been allow
ork in India is
global financi
sence of su
e of mistrust
Nee
y where imp
quality of inc
e environmen
ounting. The
of its develop
ver brought o
nables vulne
cessive risk
n ownership
banks and d
maintaining
rotecting the
e presence
nce and adap
. Even in de
big banks we
wed to surviv
s time tested
ial crisis. So
ubprime lend
among bank
d for Regula
perfect mark
come are pr
nt tend to i
erefore bank
pment progr
out lessons f
rable banks
k taking and
structure, o
disclosure of
g capital ade
e banks liq
of regulator
pting to chan
eveloped eco
ere forced to
ve despite hu
d and effecti
me of the re
ding, non-ex
ks.
ation
ket condition
evalent need
ntroduce ris
king regulatio
ams through
for effective r
to manage f
d unwanted
operational c
information.
equacy of ba
uidity. If ba
ry framewor
nging environ
onomies slac
o close thei
uge losses th
ive enough t
easons for th
otic derivativ
s prevail an
ds regulatory
sky products
on has beco
h the suppor
regulation of
financial cris
innovations
control, custo

anks, asset q
nk protectio
rk will not a
nment and c
ckness in reg
r business.
hrough Gove
to isolate ba
is effectiven
ve products
nd imbalance
y interventio
s and cover
me a neces
rt of banks.
f banks.
sis and main
s in banking
omer protect
quality, man
n is minima
assure healt
constant mon
gulation has
There are i
ernment inter
anking sector
ess in regula
, absence o

es in the
n. Banks
up their
ssity. The
Financial
tain their
g sector.
tion, and
agement
al, banks
thy bank
nitoring is
resulted
nstances
rvention.
r in India
ation can
of capital


Liberaliz
opportun
changing
brings w
these ris
Product
improvin
the step
To bring
national
in rural
society a
play a do
In 1991,
also ope
advanta
has forc
environm
In view
regulato
based a
authority
products
Banks w
and high
Rising e
banks m
To cove
zation, rising
nities for the
g, imposing
with it severa
sks and show
innovation,
ng operationa
s taken by b
g into focus
ized in 1969
areas and n
and to smal
ominant role
, the liberaliz
ening the d
ge of techno
ced traditiona
ment also bro
of these ris
ory authoritie
assets. Bank
y of an indep
s such as fin
which have ig
h levels of NP
expectations
many times t
er up these la
g competitio
banking sec
new standa
al risks for b
w better perfo
improving s
al efficiency,
anks through
the social r
9 and subseq
non-banked
l and mediu
e in the imple
zed economi
doors for for
ology and pr
al well establ
ought with it
sks banks a
es also focus
ks have inco
pendent cen
ancial deriva
gnored risk m
PAs necessit
of customer
o adopt risky
apses, banks
Banking R
on and tech
ctor. In view
ards and be
banking oper
ormance.
service qual
bringing in t
h regulation
role of bank
quently in 19
regions. Cre
m entrepren
ementation of
c policies br
reign banks
roduct innova
lished banks
several risks
are forced to
sed their atte
orporated ris
tralized func
atives to man
managemen
tating depen
rs and press
y practices r
s have also
Risks and R
hnological ad
of these cha
enchmarks f
rations. Bank
lity and inno
transparency
to sustain in
ks and their
980. This has
edit facilities
neurs through
f developme
rought along
and for pr
ation brough
s also to cha
s to the bank
o adopt risk
ention on he
sk managem
ction. New to
nage risk hav
nt practices h
ndence on ce
sure of bette
resulting in o
resorted to w
Regulation
dvancement
anges, the re
for performa
ks need to i
ovations, red
y and good g
the changin
developmen
s resulted in
s have been
h priority sec
ntal program
with it subst
ivate sector
ht stiff compe
nge their bu
ks.
k manageme
ealthy practi
ment practic
ools and tech
ve been intro
have been b
entral bank a
er performan
operational la
window dress
s are posin
egulatory req
ance. The d
ncorporate s
ducing cost
governance p
g banking en
ntal function
expansion o
n extended t
ctor lending.
ms of the gov
tantial chang
r banks. The
etition in the
siness strate
ent practices
ces and pro
ces at differe
hniques of ri
oduced.
urdened with
ssistance at
nce from sta
apses and s
sing financia
ng new thre
quirements a
dynamic env
strategies to
of transacti
practices are
nvironment.

s, banks ha
of banking op
to weaker se
Public sect
vernment.
ges in bankin
e new bank
banking sec
egies. The lib
s and strateg
oper valuatio
ent levels u
isk assessm
h poor qualit
times of cris
keholders co
slackness in
al statements
eats and
also keep
vironment
manage
ions and
e some of
ave been
perations
ectors of
or banks
ng sector
ks taking
ctor. This
beralized
gies and
on of risk
nder the
ment, new
ty assets
sis.
ompelled
controls.
s through
creative accounting. To prevent these undesirable practices regulatory authorities have brought in
new norms of disclosures and reporting practices.

Basel Recommendations
To strengthen banking sector practices across the countries and to improve their risk management
practices central bank authorities of all countries came together to set up a committee known as
BASEL committee in 1974. After reviewing bank practices and the various crisis and failures in
different countries the committee came out with a series of recommendations to the regulatory
authorities to improve banking operations in their respective countries. These recommendations are
followed up with improved norms and standards in subsequent reports namely Basel II and Basel III
norms.
In Basel I recommendations the primary focus is on capital adequacy of banks. The committee
recommended a minimum of 8% capital adequacy. The capital adequacy should include 4% of Tier I
capital and 4% of Tier II capital.
Considering the currency crisis in South-East Asian countries, the Basel II norms were announced in
1999. The focus of Basel II norms is on risk management practices. New standards and approaches
for risk measurement have been suggested. Banks are given flexibility to adopt their own approaches
for risk management. Regulators have been given freedom to fix new norms for capital adequacy
based on their own country perspective. This resulted in increased capital adequacy norms in some
countries. In India capital adequacy had been increased to 9% and subsequently to 11%.
To measure credit and market risks, banks are given a choice of standardized approach or internal
ratings based approach. For operational risk measurement they have a choice between three
approaches namely basic indicator approach, standardized approach and advanced measurement
approach. The standardized approach is a generalized approach whereas internal rating based
approach gives flexibility to the banks to arrive at realistic standards based on their own business,
priorities and compulsions. Advanced measurement approach is a complex method of setting
standards based on enormous data from the historical records of banks and the forecasts.
There are three bases on which operational risk can be measured. On the basis of causes of such
risk they can be people oriented, process oriented, technology oriented and external. Based on the
effects, operational risk can be measured in terms of legal liability, regulatory penalties and loss of
damage to assets. Another basis for measurement of operational risk is the events leading to the risk
such as internal fraud, external fraud, employment practices, business practices, system failures and
execution and delivery management.
Basel norms focus on the three regulatory review processes of supervisory, minimum capital and
market discipline.

Disclosure Requirements
Basel norms and consequent guidelines from regulatory authorities required banks to show improved
disclosures and financial reporting practices. These disclosures are necessarily quantitative in nature.
Quantitative disclosure requirements mainly deal with capital adequacy, credit and market risk and
operational risk measurements. These disclosures should cover capital adequacy computations, the
basis and the actual as on the reporting date.
Capital adequacy is to be disclosed under Tier I and Tier II capital requirements. Further capital
requirements for credit risk coverage, market risk coverage and operational risk coverage are to be
disclosed along with method of computation.
Credit risk disclosures include reporting on aggregate credit outstanding and its classification on the
basis of industry, region and maturity duration. Gross and net NPAs and their percentage on
outstanding credit are to be disclosed.
Market risk disclosure includes exposure to interest rate fluctuations, exchange rate fluctuations and
equity market fluctuations. Sensitivity of bank asset values towards market risk variations are to be
computed and disclosed. Its impact on earnings of the bank is to be assessed.
Operational risk computation and its impact on earnings are to be disclosed.
Interest rate risk on the basis of duration gap approach and sensitivity of assets and liabilities for rate
variations and the impact on equity valuation are to be assessed and disclosed by the banks.

Questions
1. Liberalization requires low level of regulation whereas occurrence of financial crisis demands
a high level of regulation. How do you think a central bank needs to balance these extremes?
2. How does regulation help banks in managing risk?
3. What are the new norms and standards arising out of Basel committee recommendations?
4. What are the recommendations of Basel II committee on managing operational risk?
5. What are the three pillars of supervision?
6. What are the measures initiated by Reserve bank of India to improve and strengthen banks
risk bearing capacity?
7. Discuss disclosure requirements of banks.
8. What are the changes in the financial reporting of banks on account of Basel committee
recommendations?
9. Differentiate Tier I and Tier II capital.
10. Explain the computation of capital adequacy as per Basel II norms.