The Reserve Bank of India (RBI) has worked out the roadmap for the Indian banks to graduate from the simpler approaches of the Basel II framework to more advanced ones.
Basel II is the second among Basel Accords, which are primarily, recommendations on banking laws and regulations issued by the Basel committee on banking supervision.
It sets up rigorous risk and capital management requirements aimed at ensuring that a bank holds capital reserves appropriate to the risk it exposes itself to through its lending and investment practices.
Since March 2008, foreign banks operating in India and Indian banks having presence outside the country have migrated to simpler approaches under Basel II framework. Other commercial banks are required to migrate to these norms by March 31, 2009.
These include standardised approach for credit risk which arising from default by borrowers, basic indicator approach for operational risk (arising from day to operations of the banks such robbery or power failure) and standardised duration approach for market risk (arising from fluctuations in interest rate and share prices) which affects the investment and market portfolio of the banks.
In the framework, the RBI had earlier specified the date by which banks may file application for approvals and the the likely date by which approvals can be obtained from the central bank.
While banks have the discretion to adopt the advanced approaches, they need to seek prior approval.
Under market risk, banks may apply to RBI for graduating to more advanced method of internal models approach (IMA) by April 1, 2010 and then, RBI may approve it by March 31, 2011. IMA sets out a framework for applying capital charges to the market risks (both on balance sheet and off-balance sheet) incurred by banks by an internal model. The current standardised duration approach specifies a specific average duration of the banks at large, which the banks follow and make it a basis for applying capital charges to only open positions.
Similarly, for operational risk, banks may graduate to standardised approach by April 1, 2010 and RBI can approve the plan by September 30, 2010. After that, they can graduate to advanced measurement approach for operational risk by April 1, 2011 and get RBI approval by March 31, 2013.
While advanced measurement approach (AMA) sets the framework for banks to develop their own empirical model to quantify required capital for operational risk, it can be used after they get regulatory clearances.
Under the standardised approach, a bank's activities are divided into eight business lines: corporate finance, trading and sales, retail banking, commercial banking , payment and settlement, agency services, asset management and retail brokerage. Within each business line, gross income is a broad indicator for the scale of business operations and so, the scale of operational risk exposure within each of these business lines. The capital charge for each business line is calculated by multiplying gross income by a factor .
Currently, banks are using the basic indicator approach as per which they must hold capital for operational risk equal to the average over the previous three years of a fixed percentage of positive annual gross income.
For credit risk, banks can use internal ratings-based approach which allows them to develop their own model to estimate the probability of default for individual clients or groups of clients. Currently, banks use standardised approach where they are required to use ratings from external credit rating agencies to quantify the required capital for credit risk.
