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ufficient provisions from their profits so as to bring down the net NPAs level t
o 3 percent of their advances.
NPAs are the primary indicators of credit risk. Capital Adequacy Ratio (CAR) is
another measure of credit risk. CAR is supposed to act as a buffer against credi
t loss, which is
1 ICRA Limited, (2004), Report 1 : Global Benchmarking , IBA Bulletin, special issu
e, January 2004, pp. 30 2 ICRA Limited, (2004), Op.cit. pp.36 3 Parasmal Jain, (
2004), Basel II Accord : Issues and Suggestions , IBA Bulletin, June 2004, pp.9-10.
4
set at 9 percent under the RBI stipulation4. With a view to moving towards Inte
rnational best practices and to ensure greater transparency, it has been decided
to adopt the 90 days
over due norm for identification of NPAs from the year ending
March 31, 2004.
The New Basel Capital Accord is scheduled to be implemented by the end of 2006.
All the banking supervisors may have to join the Accord. Even the domestic banks
in addition to internationally active banks may have to conform to the Accord p
rinciples in the coming decades. The RBI as the regulator of the Indian banking
industry has shown keen interest in strengthening the system, and the individua
l banks have responded in good measure in orienting themselves towards global be
st practices.
1.3 Credit Risk Management(CRM) dynamics:
The world over, credit risk has proved to be the most critical of all risks face
d by a banking institution. A study of bank failures in New England found that,
of the 62 banks in existence before 1984, which failed from 1989 to 1992, in 58
cases it was observed that loans and advances were not being repaid in time 5 .
This signifies the role of credit risk management and therefore it forms the b
asis of present research analysis.
Researchers and risk management practitioners have constantly tried to improve o
n current techniques and in recent years, enormous strides have been made in the
art and science of credit risk measurement and management6. Much of the progre
ss in this field has resulted form the limitations of traditional approaches to
credit risk management and with the current Bank for International Settlement (BI
S) regulatory model. Even in banks which regularly fine-tune credit policies an
d streamline credit processes, it is a real challenge for credit risk managers t
o correctly identify pockets of risk concentration, quantify extent of risk carr
ied, identify opportunities for diversification and balance the risk-return trad
e-off in their credit portfolio.
The two distinct dimensions of credit risk management can readily be identified
as preventive measures and curative measures. Preventive measures include risk
assessment, risk measurement and risk pricing, early warning system to pick earl
y signals of future defaults and better credit portfolio diversification. The c
urative measures, on the other hand, aim at minimizing post-sanction loan losses
through such steps as securitization, derivative trading, risk sharing, legal e
nforcement etc. It is widely believed that an ounce of prevention is worth a pou
nd of cure. Therefore, the focus of the study is on preventive measures in tune
with the norms prescribed by New Basel Capital Accord.
The study also intends to throw some light on the two most significant developme
nts impacting the fundamentals of credit risk management practices of banking in
dustry New Basel Capital Accord and Risk Based Supervision. Apart from highligh
ting the salient features of credit risk management prescriptions under New Base
l Accord, attempts are made to codify the response of Indian banking professiona
ls to various proposals under the accord. Similarly, RBI proposed Risk Based Sup
ervision (RBS) is examined to capture its direction and implementation problems.
4 Information Bureau, (2004), The Economic Times, 4th August 2004, pp.7
5 Prahlad Sabrani,
Risk Management by Banks in India , IBA Bulletin, July 2002. 6
Ravi Mohan R., Credit Risk Management in Bank , The Chartered Accountant, March 200
1.
5
1.4 Objectives of the research: The present study attempts to achieve the follow
ing objectives: 1. Analysis of trends in Non-Performing Assets of commercial ban
Year / Banks Public Sector Banks Private Sector Banks Gross NPAs Net NPAs Gross
NPAs Net NPAs
1993-94 24.80 14.5 6.23 3.36
1994-95 19.50 10.7 6.47 4.10
1995-96 18.00 8.9 7.45 4.34
1996-97 17.84 9.18 8.49 5.37
1997-98 16.02 8.15 8.67 5.26
1998-99 15.89 8.13 10.44 6.92
1999-00 13.98 7.42 8.17 5.14
2000-01 12.37 6.74 8.37 5.44
2001-02 11.09 5.82 9.64 5.73
2002-03 9.36 4.54 8.08 4.95
9 Pricewaterhouse Coopers, (2004), Management of Non Performing Assets by Indian
Banks , IBA Bulletin, Special Issue, January, 2004, pp.61.
10 Tamal Bandyopadhya, (2002), Debt Wish for ARCs? , Business Standard, July 4, 200
2.
7
Source : Report on Trend and Progress of Banking in India from 1994-2003. Reser
ve Bank of India.
Graph 2.1 : Gross NPAs as percentage of advances of Public and Private Sector B
anks : 1994-2003
0.00
5.00
10.00
15.00
20.00
25.00
30.00
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Year
(in %)
Public Sector Banks Private Sector Banks
2.3 International comparison of NPA levles:
Comparison of the problem loan levels in the Indian banking system vis--vis those
in other countries, particularly those in developed economies, is often made, m
ore so in the context of the opening up of our financial sector. The data in re
spect of NPAs level of banking system available for countries like USA, Japan, H
ong Kong, Korea, Taiwan & Malaysia reveal that it ranged from 1 percent to 8.1 p
ercent during 1993-94, 0.9 percent to 5.5 percent during 1994-95, 0.6 to 3.0 per
cent during 2000 as against 23.6 percent, 19.5 percent and 14 percent respective
ly for Indian banks during this year11.
The NPAs level in Japan, for example is at 3.3 percent of total loans, it is 3.1
percent in Hong Kong, 7.6 percent in Thailand, 11.2 percent in Indonesia, and 8
.2 percent in Malaysia during 94-95, whereas the corresponding figure for India
is very high at 19.5 percent12. According to Ernst & Young13, the actual level o
f NPAs of banks in India is around $40 billion, much higher than the government
own estimates of $16.7 billion14. This difference is largely due to the discrep
ancy in the accounting of NPAs followed by India and rest of the world. Accordi
ng to Ernst & Young, the accounting norms in India are less stringent than those
of the developed economies. Further more, Indian banks also have the tendency
to extend past due loans. Considering India s GDP of around $ 470 billion, NPAs w
ere around 8 percent of the GDP which was better than many Asian economic power
houses. In China, NPAs were around 45 percent of GDP, while equilent figure for
Japan was around
11 www.SomeAspectandIssuesRelatingToNPAsInCommercialBanks.htm, (2001), pp.2 12 K
aturi Nageswar Rao, (2000), NPAs Ground realities , Chartered Financial Analysts, A
pril 2000, pp. 46. 13 Banking Bureau, (2003), India and Non-Performing Assets , IBA
Bulletin, January 2003, pp.36 14 Banking Bureau, (2003), Op. cit. pp.36
8
28 percent and the level of NPAs for Malaysia was around 42 percent. On an aggr
egate level. Asia s NPAs have increased from $ 1.5 trillion in 2000 to $ 2 trillio
oan, banks need evaluate how much incremental risk they are adding, how much the
y need to be compensated for taking that risk. Many banks
19 John E. Mckinley & John R. Barrickman, (1994), Op. cit. pp. 3-8. 20 John E. M
ckinley & John R. Barrickman, (1994) Strategic Credit Risk Management , Robert Morri
s Associates, pp. 36
11
look at each credit inside than across the enterprise to understand the incremen
tal risk that the new loan is adding the loans. Portfolio theory applies equally
to collections of credit risks as to equity and other investments. The purpose
of having a portfolio of assets, instead of a single asset, is to reduce risk t
hrough diversification without sacrificing the rate of return21. An efficient p
ortfolio achieves a specified rate of return with the minimum possible risk for
specified level of risk of for the maximum possible rate of return. The princip
le, which underlines portfolio management, is diversification of risk22 . The objec
tive of this chapter is to present a general framework for quantification of con
centration risk followed by concentration risk profiling of public sector banks
vis--vis private sector banks; and to explore the relationship between concentrat
ion risk profile and NPAs level.
4.2 Concentration risk:
A new methodology adopted to evaluate the volatility in portfolio performance
predicated on the risk profile of the institution. The banking industry has rel
ied heavily on prior experience as a predictor of future credit performance. Con
centration risk23 is the aggregation of transaction and intrinsic risk within th
e portfolio and may result from loans to one borrower or one industry, geographi
c area, or line of business. Senior management must define acceptable portfolio
concentrations for each of these aggregations.
The most conservative banks manage borrower exposure through restrictive house l
imits and maximum exposure to industries and lines of business. Many banks also
have wisely sought to mitigate risk through geographic diversification. Aggres
sive banks have traditionally accepted hogs shares of individual borrower, lines o
f business, and industry exposures. Managing concentration limits will become a
high priority for these lenders in the future because of the lingering pain fro
m lessons leaned in commercial real estate, energy etc.
4.3 Concentration risk strategy: The bank does have an opportunity to reduce t
heir concentration in one line of business or industry. Outstanding would have
to be replaced with more lending focused on lower risk lines of business and bor
rowers. Banks must constantly monitor the risk profile to determine it future l
ending practices are consistent with the desired risk profile24. Selecting a Ris
k Strategy: Using the risk profile as a frame of reference, management should se
lect a risk strategy that will be consistent with long-term objectives for portf
olio quality and performance. The three variable risk strategies in order of ris
kiness are: Conservative, Managed and Aggressive. The selection of the appropria
te strategy depends on a bank s priorities and risk appetite. Most often, the cho
ice is not made as part of a formal process but evolves as the bank seeks its de
sired risk posture through its lending practices. Consequently,
21 Ravimohan R, (2001), A New Perspective CRM in Banks , The Chartered Accountant,
March 2001. 22 Joseph F. Sinkey, Jr., (1998), Commercial Bank Financial Managemen
t In the Financial Services Industry , Fifth Edition, Prentice-Hall International
Inc. New Jersey. pp. 403.
23 John E. Mckinley & John R. Barrickman, (1994) Op.cit. pp.41 24 John E. Mckinl
ey & John R. Barrickman, (1994), Op.cit. pp50
12
few banks have a clear picture of the risk profile that will emerge. A selectio
n of risk strategy with specific implementation plans provides a much better ide
a of the future risk profile. The following guidance should help in understandin
g, which strategy best serves managements intent; (i) Conservative : Accepts re
latively low levels of transaction, intrinsic and concentration risk. The strat
egy normally supports a values-driven culture. (ii) Managed: Accepts relatively
low levels of risk in two categories but high levels in one category. For exam
ple: a bank that takes conservative levels of concentration and transaction risk
but is more aggressive with intrinsic risk. The strategy normally promotes the
immediate performance culture. (iii) Aggressive: Accepts relatively low levels
of risk in one category, more aggressive risk in two categories. An example wou
ld be a bank that closely manages transaction risk but accepts higher levels of
intrinsic and concentration risk. This strategy is normally employed in a produ
ction driven culture. Obviously, credit volatility rises as the levels and categ
ories of risk are increased. The aggressive strategy requires more careful manag
ement because it operates closer to the danger zone. If risk in all three catego
ries reaches high levels, the bank s credit volatility becomes so great in a downt
urn that capital adequacy and survival could become real issues.
4.4 Impact of concentration risk on NPAs level:
The concentration risk is an important component of the credit risk and is promp
ted by the concentration of the credit portfolio in one or two occupations or in
dustries. It is desirable to achieve a diversified credit portfolio in order to
minimize the occupation-wise concentration risk as well as industry-wise concen
tration risk. It has been the experience of the commercial banks that higher NP
As level is generally associated with high degree of concentration risk-both occ
upation-wise and industry-wise. In order to analyse the observed relationship b
etween NPAs level and concentration risk, the relevant data is presented in this
section. The highest level of NPAs, i.e., 24.8 percent in the year 1994 corresp
onds to the maximum index value in the same year. Similarly, the minimum level
of NPAs, i.e., 9.36 percent in the year 2003 corresponds to the lowest index va
lue in the same year. Overall, the decrease in occupation-wise concentration ri
sk is matched by the corresponding decrease in NPAs level.
An attempt was made to quantify the relationship between concentration-index and
NPAs level by way of coefficient of correlation and the results found to be sat
isfactory in reinforcing our earlier observations. Table 4.1 lists the results.
Table 4.1 : Coefficient of correlation between Concentration-Index and NPAs for
the period 1994 2003 Public Sector Banks Private Sector Banks
(a) Occupation-wise concentration risk
Coefficient of correlation = r 0.80 0.
67
13
Coefficient of determination = r2 0.64 0.45
(b) Industry-wise concentration risk
Coefficient of correlation = r
Coefficient of determination = r2
0.89 0.78
-0.52 0.27
As observed earlier, there exists a strong positive relationship between occupat
ionwise concentration-index and NPAs level in case of both the public sector ban
ks and private sector banks with the coefficient of correlation value being 0.80
and 0.67 respectively. This is confirmed by the higher values of coefficient o
f determination of 0.64 and 0.45 for public sector banks and private sector bank
s respectively. Similarly, there exists a strong positive relationship between
industry-wise concentration-index and NPAs level in case of public sector banks
as confirmed by a very high value of r2 = 0.78. But this is not clearly pronoun
ced in the case of private sector banks as indicated by lower value of r2 = 0.27
.
4.5 Conclusion:
Concentration risk is a very significant component of overall credit risk profil
e of a banking institution. A prudent credit risk management is based on the pr
inciple of diversified portfolio to avoid concentrations in any one or couple of
occupations or industry. Trends in concentration risk profile of public sector
banks during the post-liberalization period clearly indicate a paradigm shift i
n the portfolio approach to credit risk management. The occupation-wise and ind
ustry-wise concentrations reduced significantly during the study period. On the
contrary, the trends in concentration risk profile of private sector banks sign
ify an opposite direction. The occupation-wise concentration risk increased sub
stantially from 37 percent in 1999 to 59 percent in 2003.
Both the approaches suggested for quantification of concentration risk yielded s
atisfactory results. Under the profile-score method, with a score of less than
10 for public sector banks, and more than 10 for private sector banks, it is con
cluded that public sector bank s risk profile is low while that of private sector
bank s risk is moderate. Similarly, under the concentration-index method it was f
ound that there exists strong relationship between occupation-wise concentration
risk profile and NPAs level with higher values of coefficient of determination
of 0.64 and 0.45 for public sector banks and private sector banks respectively.
Similarly, strong positive relationship between industry-wise concentration ris
k and NPAs level in case of public sector banks, as confirmed by high value of r
2=0.78. But same is not pronounced in case of private sector banks.
Based on these results it can be concluded that
1. The declining trends in Non-Performing Assets (NPAs) in public sector banks du
ring the post-liberalization period is an outcome mainly caused by the improved
credit portfolio diversification .
2. The concentration risk profile of credit portfolio of private sector banks is
higher than that of public sector banks impacting adversely the NPAs level of pr
ivate sector banks vis--vis public sector banks .
14
5. CREDIT RISK MANAGEMENT PRACTICES IN COMMERCIAL BANKS - AN EVALUATION
5.1 Introduction:
The objective of this chapter is to evaluate the credit risk management pract
ices in public sector banks vis--vis private sector banks based on primary data.
Primary data have been collected from the credit department executives serving i
n public and private sector banks at head office level and regional office level
in Karnataka with the help of predesigned questionnaires. In this case, direct
interview method has been followed for data accuracy and to get first-hand info
rmation from respondents about credit risk management practices.
5.2 Sample data:
The study has analyzed the credit portfolio risk management policies and practic
es of 21 Banks of which 12 are public sector banks and 9 private sector banks.
Though it was originally aimed to cover 20 percent of over 800 credit department
executives in the selected banks, it was possible to get the response of only a
bout 10 percent of the number. Credit department executives were not easily acce
ssible. They were found either closeted in a meeting or busy otherwise. Theref
ore, the generalizations formulated here are based on the opinions of this small
number.
5.3 Analysis of CRM practices:
This section is devoted for analysis of CRM practices in public sector banks vis
--vis private sector banks. For this purpose, various issues covered include sco
pe for NPAs reduction, credit risk measurement, credit evaluation processes, cre
dit rating system and training in credit risk assessment.
CRM perform index Public and Private sector banks:
The questionnaire was designed with a focus on standards of CRM practices envisa
ged under the New Basel Capital Accord.
The important parameters of performan
ce standards considered for analysis included the following table.
Table 5.1 CRM Performance Index Public and Private sector banks Performance Inde
x ( % )
Sl. No.
Performance Evaluation Public Sector Banks
Private Sector Banks 1 Project appraisal procedures 58 49 2 Availability of comp
rehensive data 46 39 3 Risk based loan pricing 48 40 4 Deployment of information
technology 46 57 5 Efficacy of Internal credit rating system 54 50 6 Sharing ex
perience with other lenders over problem loans 40 36 7 Practice of fine-tuning l
oan policies 55 46 8 Internal audit of CRM procedures 42 49 9 Bank credit standa
rds 51 48 10 Credit decision: merit v/s extraneous considerations 60 46 11 Frequ
ency of credit portfolio reviews 61 58
15
12 Renewal of borrowers limits 34 42 13 Periodical review of customer credit rat
ings 33 57 Total 632 617 Performance Index 49 47
Overall CRM performance is at below the satisfactory level for both the public a
nd private sector banks. Furthermore, with performance index score of 49 percen
t and 47 percent for public sector banks and private sector banks respectively,
there is no significant difference between public sector banks and private secto
r banks as regards CRM performance.
5.4 Conclusion:
The analysis of the primary data revealed some interesting aspects about the cre
dit risk management practices of commercial banks in India. The important among
them are listed below: (1) More popular credit evaluation techniques like Altma
n s Z score model, J.P. Morgan credit matrix, Zeta analysis do not find a place in
the credit evaluation tool kit of the commercial banks in India. (2) Employees
are not given enough training to enhance their conceptual understanding of credi
t risk and improving their skills in handling it. (3) The leverage provided by i
nformation technology for efficient credit risk administration is not satisfacto
rily harnessed by commercial banks in India, particularly in public sector banks
. (4) The availability of comprehensive data for credit evaluation is far from s
atisfactory in commercial banks in India. (5) Overall CRM performance of commerc
ial banks in India as against the standard set out under New Basel Capital Accor
d is not satisfactory. (6) With CRM performance Index of 49 percent in public se
ctor banks and 47 percent in private sector banks respectively, the performance
of public sector banks is at par with the performance of private sector banks. B
ased on these findings it can be concluded that;
1. Credit risk management practices of commercial banks in India do not meet the
standards set out under the New Basel Capital Accord .
2. There exists no marked difference between public sector banks and private sec
tor banks as regards their credit risk management performance .
6. RISK BASED SUPERVISION PROBLEMS AND PROSPECTS
Changes over the past ten years in the banking system have been dramatic. Advanc
es in technology, closer interrelations among economies, liberalization and dere
gulation etc. have made the world of banking a far more complex place. The syst
em of annual inspection of banks by RBI may soon be a thing of the past. The ce
ntral bank is expected to follow a system of random and more frequent inspection
s based on the risk profile of individual banks. RBI insisted that all commerci
al banks move towards the system
16
of Risk- Based Supervision (RBS) by January 1st 200325, its inspections would b
e more focused on areas of potential risk such as credit risk, market risk and o
perational risk. Based on the guidelines to be drafted by the RBI all banks ha
ve to submit information to the central bank periodically. With this informatio
n, bankers believe that the RBI will always be in the know as how particular ban
k is operating and can monitor its performance almost on a day-today basis. RBI
inspections, both on-site and off-site can be conducted as and when the central
bank deems necessary and could be as often as possible based on RBI s risk percept
ion of a bank.
After the recent scams, the RBI wants to tighten norms so that th
e central bank is informed well in advance about any irregularity26 . The Basel Co
mmittee on Banking Supervision had advocated Risk- Based Supervision of banks an
d this has been put to practice in various countries. Now RBI has come with a d
iscussion paper on Move towards Risk Based Supervision of Banks in Aug 2001 and RB
I roll out the process and implemented from the financial year April 200427. Thi
s chapter describes the main features of proposed RBS and analyses the responses
of executives to the modalities of implementing it.
In moving towards a Risk Based Supervision of banks the goal of Reserve Bank of
India and the concern of banks converge in a common point: we want strong, healt
hy institutions that offer loans to worthy borrowers who in turn repay the loan
interest, so that the bank can build its capital base and provide a reasonable r
eturn to its shareholders. If the goal can be achieved, the public, including b
oth borrowers and depositors, will be better served through a network of safe an
d sound financial institutions that properly identify, measure, monitor and cont
rol their risks. The risk based supervision project would lead to prioritizatio
n of selection and determining frequency and length of supervisory cycle, target
ed appraisals, and allocation of supervisory resources in accordance with the ri
sk perception of the supervised institutions. The RBS will also facilitate the
implementation of the supervisory review pillar of the New Basel Capital Accord,
which requires that national supervisors set capital ratios for banks based on
their risk profile.
Private sector banks executives are not in-favour for implementation of RBS as v
indicated by the sample data according to which 94 percent (an average) of them
are against the various proposals of RBS. This negative response reflect the re
servations hosted by the private sector banks in general about the various propo
sals coming from a Central Bank leading to more interfere in their internal affa
irs. On the other hand, the public sector banks show a different scenario as th
ey have almost balanced opinion in favour of RBS.
7. NEW BASEL CAPITAL ACCORD - IMPLICATIONS FOR CRM PRACTICES OF COMMERCIAL BANKS
IN INDIA
7.1 Introduction:
One of the most crucial methods of risk control in banks and financial instituti
ons around the world is regulatory capital requirement, which is vital in reduci
ng the risk of bank insolvency and the potential cost of a bank s failure for its
customers.
25 Rajalakshmi Menon, (2002), RBI may shift to risk-based supervision of banks , Bu
siness Line, July 3, 2002, pp.10. 26 Rajalakshmi Menon, (2002), Op.cit. pp.10 27
Pathrose P.P. (2002), Op.cit pp.21
17
The Basel Committee of the Bank for International Settlements (The Committee) th
at sets the capital adequacy requirements for banks and other financial institut
ions drew up Basel Accord-I in 198828. This Accord recommends a method of relat
ing the capital requirement of banks to their assets, using a simple system of r
isk weights and minimum capital ratio of 8 percent. This Accord provides a stand
ard approach to measuring credit, market risk of the banks to arrive at the mini
mum capital requirement.
Basel-I have served the banking world for over 10 years. The business of bankin
g, risk management practices, supervisory approaches and financial markets have
seen a sea change over the years. In 1996, the initial Accord was extended to i
nclude market risk that banks incur in their trading account. The BCBS (Basel C
ommittee on Banking Supervision) brought out a consultative paper on New Capital
Adequacy framework in June 1999, followed by second and third consultative pack
age in January 2001 and April 200329. Implementation is expected to take effect
in member countries by 2006. Banks in India will not meet a 2006 deadline for
implementing the revised Basel Capital Accord and will need at least two additio
nal years to comply with the new international banking rules30. The Basel II Ac
cord will put further pressure on banks requiring them to also hold capital to o
ffset operational risk that the Committee expects on an average to constitute ap
proximately 20 percent of the overall capital requirement.
Recognising the importance of Basel-II and the need for a reasonable timeframe t
o switch over, the RBI has already initiated discussions in several areas well i
n time. The adoption and implementation of the new capital accord by all banks
in India may further result in the improvement in our country rating which, in t
urn, will increase our competency to adopt the new accord.
7.2 The New Basel Capital Accord(Basel -II):
The New Accord is being proposed to introduce greater risk sensitivity. The New
Accord provides a spectrum of approaches from simple to advance methodologies f
or the advancement of both credit and operational risks in determining capital l
evels.
The new accord is built around the THREE Pillars as shown in Figure 7.131: (1)
Pillar-I : Minimum Capital Requirement (2) Pillar-II : Supervisory Review (3) Pi
llar-III : Market Discipline
7.3 New Basel Accord Issues in the Indian context: The Accord, aims at boostin
g the safety of the world banking system. Regulators in both India and China are
anxious to nudge their banks on to the proposed risk-based capital regime, to e
nsure that they are competitive and managed to the highest standards32. True,
28 Geetha Bellu, (2003), Discloures in the forefront , Decan Herald, Monday, Octobe
r 6, 2003, pp.1 . 29 Geetha Bellu, (2003), Op.cit. pp.1 30 Gautam Chakravorthy,
(2003), Indian banks not ready for capital rule deadline , International Herald Tri
bune, Wednesday, Septermber 24, 2003. 31 BIS, (2003), An overview of the New Base
l Capital Accord , IBA Bulletin, September 2003, pp.33-34
32 Melvyn Westlake, (2003), India, China still undecided on adopting new accord , G
ulf News, September, 2003, pp. 1.
18
banks in these two Asian giants may not all be ready to adopt the full rigorous
of the accord dubbed Basel II from the outset, at the end of 2006. The RBI agre
es with committee s view that the focus of the New Accord may be primarily on Inte
rnationally Active Banks, that is, those with 20% of the business from foreign o
perations. SBI s Chairman Mr. A.K. Purwar says that SBI s International operations
(India s largest bank) contribute about 6% of its business33. So the new accord
feared by many central banks, including the RBI. In this regard, RBI is of the v
iew that all banks with cross border business exceeding 20% of the total busines
s may be defined as Internationally Active banks and Significant banks may be define
d as those banks with complex structures and whose market share in the total ass
ets of the domestic banking system exceed 1 percent34.
The Basel II accord is a challenge to Indian banks. Indian Banks are conceptuall
y and academically ready to adopt the new norms. It would involve shift in direc
t supervisory focus away to the implementation issue and also there are lot of d
ifficulties and issues in its implementation in the Indian Context35. These dif
ficulties like availability of historical data, higher risk wrights for sovereig
n, cost factor, technological up-gradation, diversified products, legal and regu
latory guidelines, higher risk weight to small and medium enterprises, credit ra
ting etc.
7.4 Conclusion:
The response to Basel Accord II reforms world over is not uniform and spontaneou
s. Basel-II is known for complicated risk management models and complex data req
uirements. Big international banks, as those in the US, prefer this new version,
as they perceive that their superior technology and systems would make them Bas
el compliant and provide an edge in the competitive environment, in the form of
lower regulatory capital.
Indian banks do not perceive any immediate value in the new norms as they are gl
obally insignificant players with simple and straight forward balance-sheet stru
ctures. This is clearly vindicated by the sample study according to which 57 pe
r cent of the executives of public sector banks are sceptical about Basel Accord
II norms, particularly in respect of investment cost and the complexity of prop
osed internal rating system. As against this, the private sector banks with sup
posedly more investment in technology related infrastructure are in favour of th
e proposals under New Basel Capital Accord as vindicated by the sample study acc
ording to which 67 percent of executives of private sector banks are in-favour f
or New Basel Capital Accord.
However, putting Basel II in place is going to be far more challenging than Base
l I. The adoption of Basel II will boost good Risk Management practices and good
corporate governance in banks. However, the cost of putting in place robust sys
tem today is viewed in an increasingly number of countries as a price worth payi
ng to prevent such crisis. Assuming that the banks can get over the technologica
l and operational hurdles, switching over to Basel II norms can no doubt turn th
e Indian banks, mainly the public sector banks, more efficient and competitive g
lobally. This, in turn, will help strengthen the financial sector to undertake
further reforms including capital account convertibility more confidently.
33 Information Bureau, (2003), SBI to be Basel-II compliant: Purwar , The Hindu Bus
iness Line, September 2003. 34 Information Bureau, (2003), Testing waters: RBI to
meet bank CEOs on Basel II soon , The Economic Times, September 19, 2003. 35 Para
smal Jain, (2004), Op.cit. pp.8-10
19
8. FINDINGS, SUGGESTIONS & CONCLUSION:
8.1 SUMMARY OF FINDINGS:
The trends in NPAs level, CRM practices of commercial banks and the response to
reforms under Basel Accord II and Risk Based Supervision were examined and compa
red between public sector banks and private sector banks in this study. The ana
lysis of secondary and primary data resulted in satisfactory results, a summary
of which is presented in the following paragraphs.
(1) While NPAs level of public sector banks did register a clear decreasing tren
d during the post-liberalization period, NPAs level of private sector banks rema
ined constant during this period. (2) The concentration risk profile of private
sector banks is found to be higher than that of public sector banks. (3) In ca
se of public sector banks, there exists a strong relationship between NPAs level
and credit portfolio diversification as vindicated by higher co-efficient of co
rrelation values. The decrease in NPAs level is caused by reduction in concentra
tion risk. This relationship is however, not clearly pronounced in case of pri
vate sector banks. (4) Credit risk management performance of commercial banks in
India is not satisfactory. (5) There exists no marked difference between public
sector banks and private sector banks as regards their credit risk management p
erformance: (6) Though the private sector banks executives are not in-favour of
implementation of Risk Based Supervision, yet they are receptive to the proposa
ls under New Basel Capital Accord. This is vindicated by sample data according
to which only 6 percent of respondents have expressed their concurrence with RBS
and the remaining 94 percent of them opposing it. In contrast, 67 percent of t
he respondents expressed their concurrence to the proposals under NBCA and remai
ning 33 percent of respondents opposing it. (7) The executives of public sector
banks have almost balanced their opinions in-favour of RBS and New Accord. Whil
e 54 percent of them expressed their concurrence to the proposals under RBS, 43
percent of them agree with the proposed reforms under NBCA.
8.2 SUGGESTIONS: (1) Achieving a better portfolio equilibrium: Commercial ban
ks need to diversify further to achieve a better credit portfolio equilibrium.
The share of transport operations and finance occupations in case of public sect
or banks was very minimal i.e., 1.21 percent and 6.53 percent respectively as on
March 31, 2003. Similarly, in case of private sector banks, the share of occup
ations like transport and finance was very minimal at 1.52 percent and 6.46 perc
ent respectively as on March 31, 2003.
(a) In India now the services sector (including transportation, financial servic
es etc.,) is playing an important role and in fact it accounts for about one hal
f of India s GDP and this sector is also generating more income and more employmen
t opportunities. Banks will, therefore, have to sharpen their credit assessment
skills by providing better training to enhance their conceptual understanding of
credit risk and improving their skills in handling it which lay more emphasis i
n providing finance to the wide range of activities in the services sector. (b)
Retail loans are also a relatively small fraction of the Indian banking system s t
otal loans and advances. In India retail loans constitute about 5 percent of ag
gregate GDP compared to an average of around 30 percent for other Asian economie
s. The implication of all this data is that the retail market is relatively unde
r-penetrated and has significant potential for growth both for public and private
sector banks.
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(c) Retail products help banks in diversifying their risk by spreading credit to
widely dispersed set of individual customers. Retail loans offers banks the opp
ortunity to cross sell various other value added services and retail products li
ke insurance and mutual fund to the depositors.
(2) Establishing Risk Management Information System (RMIS): The effectiveness o
f risk management depends on efficient information system, computerization and n
etworking of the branch activities. An objective and reliable database has to b
e built up for which bank has to analyse its own past performance data relating
to loan defaults, operational losses etc. (a) Added to IT expenditure is the cos
t and effort of training and redeployment of manpower. Besides training in the h
ard aspects of understanding risk and using software, it is also need for buildin
g in a risk orientation in individual officers at the operating level, to create
awareness about credit assessment skills and risk mitigation processes is neede
d. (b) Public sector banks need to set up modern IT infrastructure in place with
in one to two years in line with foreign and new generation private banks. There