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Laws & Practices of Banking & Bank Accounts (Course Code -3101)

Article on
Effects Of Implementation Of Basel II In Bangladesh

Department of Accounting & Information Systems University of Dhaka

Article on
Effects Of Implementation Of Basel II In Bangladesh
Submitted TO
IshterMahalShithee Lecturer Dept. of A&IS University OfDhaka

Submitted By:(Group-3)
1. Md. RezaulKarim (16113) 3. Fayez Ahmed (16134) 5. ZeniaAkter (16102) 7. BabuMarma (16171) 9. NeloyDevNath (16127) 2. Ibne Al JayedHossain (16133) 4. Iffad Mahmud (16098) 6.SikandarHossain (16152) 8. Saddam Hossain (16129)

Date of Submission: 07-07-2012

Acknowledgement

It is our refreshment stand to thankIshterMahalShithee, the adhering Lecturerof the Department of Accounting & Information Systems,and University of Dhaka for rendering us her expertise knowledge and giving the opportunity of practical exposure through this article.

Practical knowledge is deep-seated for the application of conjectural intelligence. Bearing this in mind, the course teacher introduced a program for the students of the courseLaws & Practices of Banking & Bank Accounts (Course Code-3101)to prepare an article. The goal of this article is to expose the students to learn about Basel II. We would like to thank the honorable teacher to provide us the opportunity to apply classroom learning in practice. There are always some differences between theories and practical. This article bridges the gaps between them.

Basel II is a new issue in the banking sector. All the banks are required to follow Basel II as it is to follow according to central banks guideline. By making article on this topic we have learned not only about Basel II but also many practical aspects. For this we would like to give special thanks to our madam IshterMahalShithee.

Table of Contents

Particulars

Page No. 5 5-6 6 6 7-8 9-18 19 17-18 18-20 21 22 22 23 25 25 26

Abstract Introduction
Objectives Methodology Literature Review Interpretation & Analysis Findings Recommendation TITLE VIISTUDIES AND REPORTS TITLE VIIICORPORATE AND CRIMINAL FRAUD ACCOUNTABILITY TITLE IXWHITE-COLLAR CRIME PENALTY ENHANCEMENTS TITLE XCORPORATE TAX RETURNS TITLE XICORPORATE FRAUD ACCOUNTABILITY

Literature Review Conclusions References

Abstract

This paper has made a study on the effects of implementation of Basel II in the banking sector especially in Bangladesh. Basel II is an emerging issue that must be followed by the banks mandatorily.For the purpose of preparing article we have selected 10 leading banks in Bangladesh. We have practically visited the 10 banks & talked with the executive officer of those banks. In our study we have found that Basel II has been being implemented by the banks. All the banks are strictly following Basel II requirement.

Under Basel II, all the banks are required to maintained its capital based on its risk (such as operational risk , market risk, financial risk etc.) and as a result not only the depositors interest are protected but also banks credibility has been increased.

Introduction
Basel II is a recommendatory framework for banking supervision which was issued by Basel committee in June 2004.The Basel II accord is a document that outlines the minimum capital requirements to which all large, internationally active banks in the G10 countries must adhere. It is published under the auspices of the Bank for International Settlements (BIS), specifically the Basel Committee on Banking Supervision, and is intended to be adopted in all of the G10 jurisdictions. It is also expected that many of the principles of the accord may also be adopted for internationally active banks in other jurisdictions, outside of the G10. The accord has three key pillars:

From Basel I to Basel II: Previously Basel I was to maintain by the bank. But Basel I was not so much effective. As a result Basel II has been initiated by the Basel committee. Basel II replaces Basel I. The objectives of the new Basel capital accordis to Enhance the sensitivity of capital requirements to the degree of risk involved in banks positions and activities Encourage banks to improve their risk measurement and management systems Increase the role of banking supervisors and the role of market discipline Constitute a more comprehensive approach to addressing risks the banks are exposed to Promote safety and soundness in the financial system as well as competitive equality Same objectives but more advanced tools

Objectives:
In performing our research we have set the following objectives 1. Whether the banks in Bangladesh are in compliance with Basel II? 2. What is the effect of implementation of Basel II? 3. What is the present condition of implementation of Basel II?

Methodology:
We have conducted our research based on both primary & secondary data.We have selected 10 leading banks in Bangladesh namely Eastern Bank Ltd, Al-ArafahIslami Bank Ltd, Prime Bank Ltd, South east Bank Ltd, Dhaka Bank Ltd, NCC Bank Ltd, Social Islami Bank Ltd, Dutch Bangla Bank Ltd , Mutual Trust Bank Ltd. & Standard Bank Ltd. We have practically visited those banks & collected information by questionnaire.

Literature Review:

Many researches have been done by different researcher & analyst on the implementation of Basel II& its effects. A research done by Richard J. Herring on The Rocky Road to Implementation of Basel II in the United States reveals that the implementation of Basel II would reduce compliance costs dramatically for both banks and regulators and limit the extent to which Basel II might reduce the average level of capital in the system. It would also reduce the risk of exacerbating business cycles and increase the transparency of capital charges and capital adequacy measures.

An article published by The Institute of International Finance Inc. on The Implementation of Basel II states that notwithstanding the continuingchallenges, the investments that both banks and supervisors aremaking in preparation for Basel II have already resulted in growth in the Sophistication and responsiveness of risk-management capabilities. The Institute continues to appreciate the openness of the BCBS, its working groups and subgroups, and their eagerness to work with the industry on refinements and relative details as well as fundamental issues. A report published by FINANSINSPEKTIONEN states thatthe minimum capital requirement for internationally active ban (Group 1 banks) decreases moderately and there is a clear incentive for banks to adopt more risk-sensitive and sophisticated measurement methods to calculate the capital coverage requirement.

A Whitepaper Prepared By MichleMcCormac, Managing Director, Adastra Corporation states that the New Basel Capital Accord, also known as Basel II, has sparked on-going discussion in the global financial institution sector on risk management, with volumes published on the formulae and risk modeling approaches that will be utilized to determine portfolio risk segments, operational risk levels, and the associated required capital allocation.

Another study by FREDERIK C. MUSCH on BASEL II IMPLEMENTATION IN THE MIDST OF TURBULENCE states that the positive aspects introduced by Basel II capital regulation namelyenhanced risk sensitivity and flexibility, the increased importanceattached to risk mitigation techniques and an emphasis onsupervisory review and market discipline are a step forward towards amodern and global banking regulatory framework. Having beenimplemented under severe financial market conditions, however, Basel IIsinherent

weaknesses were brought to the forefront, compellinginternational regulators to revisit several of its aspects that might not havebeen adequately addressed under more benign market circumstances

Another research by John C. DUGAN& Jennifer XI on US IMPLEMENTATION OF BASEL II states that much has been written about the Basel III agreement on capital and liquidity requirements for internationally active banks. Far less attention has been paid to the status of international efforts to implement Basel II. In particular, there have been many questions about the slow pace of Basel II implementation in the United States compared to countries in Europe and Asia. . There are many criticism of Basel II. KPMG calls it a `Risk Management Revolution disguised as Regulation.HariMisra on his special report on Basel II Framework and India: Compliance V/s Opportunity states that risk-based financial regulation is inherently pro-cyclic. procyclicality means that banks governed by Basel II (capital tied to risks) will loosen credit in `good times (when risk perceptions are low) and restrict it when times are bad (when risks rise again). If most banks act in this fashion, having adopted the accord, they would accentuate the crisis in bad times, jeopardizing stability. He also shows that Basel II requires heavy implementation cost & it creates complexity in banking operation.

Interpretation & Analysis:

Under Basel II all banks are required to maintain three pillars. In pillar I (Minimum capital requirement) all banks are required to maintain capital that must at least 10% of risk weighted asset. Under pillar II (Supervisory Review Process) all banks must have a supervisory review process that is solely responsible for identifying risk of a particular bank & making report to the Bangladesh Bank. Under pillar III (Market discipline) all banks are required to make proper disclosure on its maintaining minimum capital requirement & supervisory review process. Now we will go for detail analysis regarding Basel II of different banks..

Eastern Bank Ltd.

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It has a separate Basel II unit. The Bank complied with all the required conditions except condition 1.4 (e) for maintaining regulatory capital as stipulated in the revised RBCA guidelines by Bangladesh Bank as per following details: The amount of Tier 2 capital will be limited to 100% of the amount of Tier 1 capital: Status of Compliance: Complied. 50% of revaluation reserves for fixed assets and securities eligible for Tier 2capital: Status of Compliance: Complied. 10% of revaluation reserves for equity instruments eligible for Tier 2 capital: Status of Compliance: There was no unrealized gain from quoted equities as on the reporting date. Subordinated debt shall be limited to a maximum of 30% of the amount of Tier 1 capital: Status of Compliance: As on the reporting date there was no subordinated debt in the capital structure of EBL. Limitation of Tier 3: A minimum of about 28.5% of market risk needs to be supported by Tier 1 capital. Supporting of Market Risk from Tier 3 capital shall be limited up to maximum of 250% of a banks Tier 1 capital that is available after meeting credit risk capital requirement.Status of compliance: Capital required for meeting credit risks was BDT11,013.02 million against maintained tier i capital of BDT 10,244.07 million. Capital required for meeting 28.5% of market risks was BDT 273.31 million (BDT 958.99 X 28.5%) as on the reporting date. So, this condition is not met.

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Al-ArafahIslami Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit. Qualitative Disclosures:(as of 31stDecember, 2010) Figures in crore taka b) The total amount of Tier-I capital 958.28 Paid-up capital 467.73 Non- repayable share premium account Statutory Reserve 168.18 General Reserve Retained earnings 127.48 Minority interest in subsidiaries 194.89 Non-cumulative irredeemable preference shares Dividend equalization account c) The total amount of Tier-2 and Tier-3 capital 93.00 d) Other deductions from capital e) Total eligible capital

1051.28

C) Capital Adequacy:Byfollowing Standardized Approach for assessing and mitigating Credit Risk, Standardized Rule Based Approach for quantifying Market Risk and Basic Indicator Approach for Operational measurement. For the consolidated group: For stand alone CAR 12.56% CAR14.49%

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Prime Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit.
Quantitative disclosures: :(as of 31stDecember, 2010)
Taka in Million

Particulars The amount of Tier-1 capital (A) I. Fully Paid up capital II. Non repayable share premium account III. Statutory reserve

Solo

Consolidated

5,776.37
2,241.23

5,776.37
2,241.23

4,391.63 IV. General reserve

-

4,391.63
-

V. Retained earnings 2,691.26 VI. Minority interest in subsidiaries

-

3,383.90

VII. Non-cumulative irredeemable preference shares VIII. Dividend equalization account

Sub-Total (A)

15,100.49

15,793.13

The total amount of Tier 2 and Tier 3 capital (B) 5,671.61 5,691.71 Total eligible capital (A+B)

20,772.10

21,484.84

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consolidated capital adequacy ratio11.69%

South east Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit.
Quantitative disclosures:(as of 31stDecember, 2010)

The total amount of Tier-I capital 15159.20 Paid-up capital 831.7.00 Non- repayable share premium account Statutory Reserve 4519.30 General Reserve 247.70 Retained earnings 2067.60 Minority interest in subsidiaries 7.70 Non-cumulative irredeemable preference shares Dividend equalization account The total amount of Tier-2 and Tier-3 capital 3840.90 Other deductions from capital Total eligible capital19000.10 C) Capital Adequacy Ratio For the consolidated group:11.46% For stand alone11.50%

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Dhaka Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit. Quantitative Disclosure:For the year ended December 31, 2009 Tk. (Crore) Amount of Tier-1 capital Fully Paid-up Capital/Capital Deposited with BB 212.77 Statutory Reserve 197.02 General Reserve 0.34 Retained Earnings 53.23 Total Tier-1 Capital 463.36 Total amount of Tier-2 capital (net of deductions from Tier-2 capital) 100.00 Total eligible capital 563.36
CAPITAL ADEQUACY (Qualitative Disclosure): Dhaka Banks policy is to maintain 1-2% higher than the minimum required capital.

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NCC Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit. Capital adequacy position and Basel II

Basel II accord to be implemented from 2010 (parallel 2009), places heavy reliance on the internal risk assessment and management technique for the purpose of quantifying and allocating capital for credit, market and operational risks. To cope with this new change NCC has already formed a committee for implementation of Basel II Capital Accord NCCs total risk weighted assets (RWAs) and core capital stood BDT 41,848 and BDT 3,648 respectively as at 31 December 2008. The bank attained adequate capital level of 10.61% (regulatory requirement is 10%) as at 31 December 2008. This ratio was same in 2007 although the RWAs relatively less than RWAs of 2008.

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Social Islamic Bank Ltd

The Bank complied with all the required conditions for maintaining regulatory capital as stipulated in the RBCA guidelines by Bangladesh Bank for the year ended 31 December 2011 as per following details: The amount of Tier II capital will be limited to 100% of the amount of Tier I capital: It reported TierI capital for an amount of BDT 827.37 crore whereas TierII capital was BDT 126.08 crore as on 31 December 2011, which is only 15.24% of TierI capital: Status for compliance: Complied. Fifty percent (50%) of Assets Revaluation Reserves shall be eligible for Tier II or Supplementary Capital: Revaluation reserve for fixed assets was BDT 113.85 crore as on 31 December 2011 whereas only 50% or BDT 56.92 crore was accounted for as TierII capital: Status for compliance: Complied. A minimum of about 28.5% of market risk needs to be supported by Tier I capital. Supporting of Market Risk from Tier III capital shall be limited up to a maximum of 250% of a banks Tier I capital available after meeting credit risk capital requirements: Capital required for meeting credit risks was BDT 658.28 crore, so the core (Tier I) capital after meeting credit risk was BDT 169.09 crore. Capital required for meeting 28.5% of market risks was BDT 68.75 crore as on the reporting dates: Status for compliance: Complied. Up to 10% of revaluation reserves for equity instruments shall be eligible for TierII Capital: Page 2 of 16 No revaluation reserve for equity instrument maintained: Status for compliance: Complied. Subordinated Debt shall be limited to a maximum of 30% of the amount of Tier I capital: SIBL did not have any Subordinated Debt as on the reporting dates: Status for compliance: Complied.

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Dutch Bangla Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit. Quantitative Disclosures (for the year ended 31 December 2011) The amount of Tier 1 capital Paid up capital 2,000.0 Non-repayable share premium account 11.1 Statutory reserve 3,657.7 General reserve Retained earnings 2,047.9 Minority interest in subsidiaries Non-cumulative irredeemable preference shares Dividend equalization account 257.4 Total of Tier 1 capital 7,974.0 Total amount of Tier 2 and Tier 3 capital 3,011.8 Other deductions from capital [Deferred tax asset

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against the specific loan loss provision] * 451.0 Total eligible capital 10,534.9 Capital Adequacy Ratio: For the consolidated group For stand-alone 11.2% 11.2%

Mutual trust Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit. Capital Adequacy Mutual Trust Banks policy is to maintain 1-2% buffer capital i.e. higher than the minimum required capital. The Bank strictly follows the guidelines of Bangladesh Bank regarding capital adequacy. Bank has Capital Adequacy ratio of 11.96%as against the minimum regulatory requirement of 10%. Tier-1 capital adequacy ratio is 8.10% against the minimum regulatory requirement of 5%. The Bank policy is to manage and maintain its capital with the objective of maintaining strong capital ratio and high rating. Due to sustainable growth in all aspects including advance 4,700.55 Crore, deposit 5,905.08 Crore, total eligible capital of the Bank surplus by 113.27 Crore.

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Standard Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd. has been working in compliance with Basel II. It also has a separate Basel II unit.

Tier-2 (Supplementary Capital)

Total & Tier-1 Capital Ratio: Total CAR Tier-1 CAR Total CAR Tier-1 CAR 10.92% 9.85% 11.44% 10.33%

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Findings:
In our study we have found the followings 1. All the banks are strictly following Basel II as per Bangladesh Bank guideline. 2. All the banks have maintained their capital adequacy ratio at least 10% of total risk weighted asset that we have found in the Basel II disclosure made by the banks. 3. All the banks have separate Basel II unit & have supervisory review process that is solely responsible for identifying the risks based on which the banks must maintain its capital. 4. The supervisory review process is active for all the banks & they make reports to he Bangladesh Bank about the risk of the banks. 5. All the banks are in regulatory framework. As a result the depositors interests are protected as all the banks are maintaining their capital based on risk (credit risk, financial risk & operational risk). 6. Banks credibility has also been increased as one bank can compare their capital adequacy ratio (CAR) with other banks. 7. Banks liquidity problem has been reduced.

Recommendation:
Although Basel II is an important tool for bank but it has some limitation. Basel II has high implementation cost. Its pillar II & pillar III has yet to implement. Moreover Basel II only recognize credit risk, financial risk & operational risk but it does not provide any method & tools for calculating other risks such as liquidity risk, strategic risk, interest risk etc. As a result Basel III has been undertaken by the Basel committee & will be implemented from 2013.

Conclusion:
In fine we can say that besides some limitation, Basel II is an important tool for both the bank & its stakeholders. If it is implemented properly, it will create a new dimension in the banking sector. As banking sector plays a vital role in the context of Bangladesh, the proper implementation of Basel II in our country will contribute a large in our economy.

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Referrence
, L. R. Chowdhury (2009)

Basel II disclosure, Eastern Bank Ltd. 2011 Basel II disclosure, Al-ArafahIslami Bank Ltd. 2011 Basel II disclosure, Prime Bank Ltd. 2010 Basel II disclosure, South east Bank Ltd. 2011 Basel II disclosure, Dhaka Bank Ltd. 2009 Basel II disclosure, NCC Bank Ltd. 2010 Basel II disclosure, Social Islami Bank Ltd. 2011 Basel II disclosure, Mutual Trust Bank Ltd. 2011 Basel II disclosure Dutch Bangla Bank Ltd. 2011 Basel II disclosure, Standard Bank Ltd. 2011 Richard J. Herring on The Rocky Road to Implementation of Basel II in the United States (2007) The Institute of International Finance Inc. on The Implementation of Basel II ( November 2005) by FREDERIK C. MUSCH on BASEL II IMPLEMENTATION IN THE MIDST OF TURBULENCE (June 2008) John C. DUGAN & Jennifer XI on US IMPLEMENTATION OF BASEL II( October 2008) and Capital Standards, July 1988 (Basel I); available at http://www.bis.org/publ/bcbs04a.pdf.

and Capital Standards: A Revised Framework, June 2004, rev. June 2006 (Basel II); available at http://www.bis.org/publ/bcbs128.pdf.

More Resilient Banks and Banking Systems, December 2010, rev. June 2011 (Basel III); available at http://www.bis.org/publ/bcbs189.pdf.

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