Capital charge for market risk to be implemented in 2 yrs

RBI ANNUAL POLICY 2004-05/ MARKET MEASURES

The Reserve Bank of India has proposed phase-wise implementation of capital charge for market risk over two years.

The objective is to ensure smooth transition of the Indian banking system to Basle II norms.

The norms outline various risk management processes needed to conform to international standards.

The Basle Committee on Banking Supervision (BCBS) would be issuing the New Capital Accord, called Basle II, by June 2004 end. It is expected to be implemented by the end of 2006.

Capital charge on market risk refers to a system whereby banks will have to provide capital in proportion to the risk level of activities. At present, a flat 2.5 per cent risk weightage is provided across banking activities, irrespective of the risk assessment.

Under the new norms, banks will have to allocate capital in proportion to the risk assessment. In the first phase, banks will have to maintain capital charge for market risk in respect of their trading book exposure (including derivatives) by March 31, 2005.

The book contains instruments used by banks for day to day trading activity in the financial market.

In the second phase, banks would be required to maintain a capital charge for market risk on securities included in the "available for sale" (AFS) category by March 31, 2006.

AFS is not meant for day to day trading, but could be used if an opportunity for profit presents itself.

The move will amount to larger capital provisioning for banks that have inadequate risk management practices, the well-equipped banks could use this opportunity to diversify which at present is restricted owing to prudential limits.

This is because, for banks that have good risk management, the risk weightage will come down for many activities.