Basel II adherence emphasised

ANNUAL POLICY 2005-06/ THE ROAD AHEAD

The RBI today asked banks to put in place strategies for augmenting capital to be able to meet the stringent Basel II capital adequacy norms.

It urged banks to undertake analyses of the impact of Basel II norms on their operations and accordingly focus on capacity building, as they have two year's lead-time to prepare.

"On the basis of the outcome of the impact studies, banks may put in place appropriate strategies and plans for raising fresh capital or augment capital through internal resources," the central bank said in its annual monetary policy statement.

The RBI further advised banks to even consider redefining business strategies with a view to altering their profile of risk exposures or adopt a combination of approaches to meet the capital requirements.

Banks are required to adopt standardised approach for credit risk and basic indicator approach for operational risk with effect from March 31, 2007. But banks wanting to adopt advanced approaches have been asked to make objective self-assessment of their fulfilment of the minimum criteria prescribed under Basel-II.

Banks may be allowed to migrate to internal rating based (IRB) approach after adequate skills both in banks and at supervisory levels are developed.

Basel II has prescribed a new capital adequacy framework requiring capital allocation for credit risk, market risk and operational risk. Under the standardised approach, banks would use ratings assigned by credit rating agencies identified by RBI.

The new framework also recognises the responsibility of bank management in developing an Internal Capital Adequacy Assessment Process (ICAAP) that is commensurate with bank's risk profile and control environment.

The apex bank, therefore, asked banks to focus on formalising and operationalising their ICAAP, which will serve as a useful benchmark while undertaking the parallel run with effect from April 1, 2006.

For implementation of Basel II norms, RBI will set up a steering committee, which in turn would have smaller focused sub-committees for each of the three pillars of Basel II with members representing interests of all stake holders.

The main benefit of Basle II will flow from the greater awareness of risk that it will instill in the banks. It also has in-built incentives for improved risk analysis, risk management systems, allocation of capital and pricing of risk, she added.

Achieving sophistication in risk management capabilities might enable banks to improve the quality of their asset portfolio.

The Basel II norms would compel a bank to first assess its own risk management capability, its technical expertise, its data warehousing and data mining readiness as also capacity to incur expenditure on advanced technology.

The new norms require a lot of disclosures of risks and the risk management practices by banks. Data sharing among banks is also a very crucial under the new norms.

The Basel II norms, whose implementation is to take effect in member countries by year-end 2006, imposes new regulatory methods of calculating capital that apply to both banking and non-banking subsidiaries of bank holding companies.

Compliance with Basel II will require increased capital commitments from all banks, as well as increased transparency and reporting to both regulators and the marketplace. To conform to these regulations, financial services firms are expected to rely heavily on new technology infrastructures.

The more successful banks are likely to secure considerable competitive advantage by reducing their regulatory capital requirements, thus increasing their capital.

By the same token, financial services providers that fail to create the necessary IT environments will operate at a significant competitive disadvantage. Basel II may herald a fundamental change in the way banking organisations view their data management needs and future investments in IT.