BASEL II

Concept &
Implication
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.

 Basel II includes recommendations on three

main areas: risks, supervisory review, and
market discipline.
 The Accord in operation

The 3 Pillar Approach

Minimum Capital Requirement

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 non-collateralized
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.

 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.
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.

 Experts say that dearth of risk management

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

 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