Flexible approach to Basel II

Hinting that the implementation of Basel II norms by Indian commercial banks may go a little beyond March 2007, RBI Governor YV Reddy today strongly favoured a tailor-made approach, both in terms of timing and prioritisation in adopting prescribed standards.

Addressing a seminar on the challenges and implications of Basel II norms for Asia, on the opening day of the ADB annual general meeting, the RBI governor said it would be advantageous if central banks and banking regulators were allowed to implement the Basel II framework at their own pace and in a manner appropriate to their economies, banking systems and supervisory mechanisms.

Given the differential "risk appetite" across banks and their business philosophies, it was likely that the banks would select their own approach, which in turn, might engender a stabilising influence on the system as a whole, Reddy said.

On the fast track, commercial banks are required to maintain capital for both credit and market risks according to the Basel I framework.

Cooperative banks, on the second track, are required to maintain capital for credit risk according to the Basel I framework and through surrogates for market risk.

Regional rural banks, on the third track, have a minimum capital requirement, which is, however, not on par with the Basel I framework, said Reddy.

"Even after commercial banks begin implementing the Basel II framework in March 2007, we may witness a scenario where Basel II, Basel I and non-Basel entities would operate simultaneously," he added.

He cited inherent deficiencies in the post-Basel I scenario in terms of risk management, consolidated supervision and corrective action for undercapitalised institutions as one of the reasons for the need for different levels of approaching the adoption of Basel II norms.

Implementation of Basel II would require more capital for banks in India because the operational risk is not captured under Basel I and the capital charge for market risk was not prescribed until recently.

Karl Cordewener, deputy secretary general of the Basel Committee on Banking Supervision, said Basel II was more a journey than a destination.

While maintaining that Basel II was about better risk management, where good bankers would become better bankers by adopting global standards, he acknowledged other aspects involving the impact on weak banks.

Citing the US example where the Federal government wanted to implement Basel II standards in large international banks only, he suggested the banks and countries be given a choice to implement some parameters like minimum capital requirement at a later period.

Robert Bestani, director-general of the private sector operations department of ADB, said the implementation of Basel II standards would bring both good and bad news.

The cost of banking operations would increase owing to competition and tougher regulations. "While strong institutions will get stronger, the weak will become weaker," he said.