BASEL Norms Concept & Implication

Submitted By:

Awadhesh Kumar Patel & Manish Kumar Soni

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 cross-border banking supervision.

Basel I
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.
areas: risks, supervisory review, and market discipline.

Basel II includes recommendations on three main

The Accord in operation

The 3 Pillar Approach
Minimum Capital Requirements
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 noncollateralized 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.
better risk management and measurement expertise, who also have better capital adequacy ratios and geographically diversified portfolios.

The new norms seem to favor the large banks that have

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. Asia Pacific region will serve as a hindrance in laying down guidelines for a basic framework for the new capital accord.

Experts say that dearth of risk management expertise in the

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