Basel II capital charge rule implementation on the cards

The implementation of the Basel II recommendation about capital charge on banks' investment portfolio may be made in the monetary & credit policy due on Tuesday.

The central bank is expected to make a mention of these guidelines in order to prepare the Indian banking sector with adequate risk management processes, which will bring them on a par with the international standards.

The Basel II recommendations affect the capital structure of banks that are not prepared for it, and will be a boon for those prepared for it.

It is understood that the proposed Reserve Bank of India (RBI) recommendation will reduce the risk-weightage on banks' investments in AAA-rated corporate bonds. This will help banks widen their exposure to the corporate sector, and at the same time help them negotiate better lending rates.

Currently, bank investments in corporate bonds have reduced after the RBI issued guidelines limiting banks' exposure to 10 per cent. Risk management will also help banks increase their exposure to infrastructure financing, which today is low priority due to the high risk factors attached to the projects.

CREDIT ENHANCEMENT: With infrastructure likely to be accorded priority sector status, the central bank might insist that states back banks' investment through credit enhancement for projects. The central bank is expected to prepare a detailed guideline in this respect.

In 2003, the RBI had issued a draft circular on the Basel II recommendations, requiring banks to put a capital charge on each and every kind of investment in their portfolio.

As per the current guidelines, banks have to uniformly provide capital at the rate of 2.5 per cent risk-weightage irrespective of the nature of the asset or risk associated with it. Under the proposed method, the specific risk of each security "" whether long or short "" has to be assessed.

Thereby, exposure to government bonds, foreign exchange-denominated investments and metals (like gold) will have to be assessed at the current market value.

Capital will have to be provided on the combined risk emerging out of it. This will not only reduce the capital adequacy of individual banks, but also bring down the profit to a large extent.

This is as some banks might need to provide for more capital than the current uniform requirement.

Under the new norm, banks' overall minimum capital requirement will be a combination of capital charge for credit risk on prudential norms on capital adequacy and capital charge for market risk of the portfolio.

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Into the global league

• The Basel II rules will affect the capital structure of banks that are not prepared for it, and will be a boon for those prepared for it.
• The rules will reduce the risk-weightage on banks' investments in AAA-rated corporate bonds.
• Currently, bank investments in corporate bonds have reduced after the central bank issued guidelines limiting banks' exposure to 10 per cent.