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Presentation onPresentation onBasel Committee Norms as regards toBasel Committee Norms as regards to

Financial Sector Reforms In IndiaFinancial Sector Reforms In India

Submitted bySubmitted by--

Roll noRoll no-- 5555--Umang DwivediUmang Dwivedi

5656--Varsa LodhaVarsa Lodha5757--Vengatesh v.gVengatesh v.g

5858-- Venkatesh ThatrajuVenkatesh Thatraju

5959-- Vidha ShuklaVidha Shukla

6060-- Yogesh SirsatYogesh Sirsat

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IntroductionIntroduction

What?What?

For what?For what?

How?How?

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Evolution of Basel normsEvolution of Basel norms

In effect since 1988; very simple inIn effect since 1988; very simple in

applicationapplication

Easy to achieve significant capitalEasy to achieve significant capital

reduction with little or no risk transfer.reduction with little or no risk transfer.

Much more complex and risk sensitiveMuch more complex and risk sensitive

First PillarFirst Pillar Minimum capitalMinimum capital

Second PillarSecond Pillar Supervisory reviewSupervisory review

Third PillarThird Pillar Market disciplineMarket discipline

Treats banks very unequally depending onTreats banks very unequally depending on

sophistication of risk management systemssophistication of risk management systems

Basel I

Basel II

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Evolution of Basel normsEvolution of Basel norms

BASELBASEL-- II

Concentrates on single risk component.Concentrates on single risk component.

Arbitrary risk categories and risk weightsArbitrary risk categories and risk weights

BASELBASEL-- IIII

Concentrates credit risk, market risk & operational riskConcentrates credit risk, market risk & operational risk

Risk weights are linked to external ratingRisk weights are linked to external rating

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TerminologiesTerminologies

Tier 1 capital: also called the core capital. itTier 1 capital: also called the core capital. itincludes paid up equity share capital andincludes paid up equity share capital anddisclosed reserves such as: statutory, capital anddisclosed reserves such as: statutory, capital and

general reserve. Eg: common stock, preferredgeneral reserve. Eg: common stock, preferredstock etc.stock etc.

Tier 2 capital: also called the supplementaryTier 2 capital: also called the supplementary

capital. Measure of a banks financial strength.Itcapital. Measure of a banks financial strength.Itconsists of undisclosed reserves. Eg :revaluationconsists of undisclosed reserves. Eg :revaluation

reserves, general provisions, subordinated debt.reserves, general provisions, subordinated debt.

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TERMINOLOGIESTERMINOLOGIES

CRAR: Capital to Risk weighted Assets Ratio.CRAR: Capital to Risk weighted Assets Ratio.

Also known as capital adequacy ratio.Also known as capital adequacy ratio.

Indicates banks risk taking ability.Indicates banks risk taking ability. RBI uses this to track financial position of aRBI uses this to track financial position of a

bank.bank.

CRAR =

CRAR = Tier 1 + Tier2Tier 1 + Tier2

risk weighted assets.risk weighted assets.

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BCBSBCBS

Created by central bank Governors of the groupCreated by central bank Governors of the group

of 10 nations.of 10 nations.

Founded in 1974.Founded in 1974.

Meets regularly 4 times a year, at the BIS, Basel,Meets regularly 4 times a year, at the BIS, Basel,

Switzerland.Switzerland.

Formulates broad supervisory standards andFormulates broad supervisory standards and

guidelines and recommends best practice inguidelines and recommends best practice inbanking supervision.banking supervision.

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BCBSBCBS

PURPOSE & FUNCTION:PURPOSE & FUNCTION:

Encourage convergence towards commonEncourage convergence towards common

approaches and standards.approaches and standards. The BCBS is not a classical multilateral organization.

It has no founding treaty, and it does not issue binding

regulation. Rather, its main function is to act as an

informal forum to find policy solutions and to promulgate

standards."

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BASEL II NORMSBASEL II NORMS

Basel II is the international capital adequacy

framework to banks that prescribe capital

requirements for credit risk, market risk and

operational risk.

Basel II is the second of the Basel Accords

recommended on banking laws and regulations

issued by Basel Committee on Banking

Supervision.

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NEED FOR BASEL II NORMS INNEED FOR BASEL II NORMS IN

IND

IAN BANKSIND

IAN BANKS The purpose behind applying Basel II norms to Indian

banks is to help them comply with international

standards. These international standards can help

protect the international financial system fromproblems that may arise from the collapse of a major

bank.

Basel II is stated to set up rigorous risk and capital

management requirements to ensure that banks have

capital reserves appropriate to their risk profile.

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The outcome is that the greater the risk to whicha bank is exposed, greater is the amount ofcapital it will require to hold to protect its

solvency and overall stability. It will also force banks to enhance disclosures,

which will help create more transparency and

trust in the banking system itself. We believe transparency in financial reporting

will improve.

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PILLARS OF BASEL II NORMSPILLARS OF BASEL II NORMS

Pillar 1 Minimum Capital Requirements

Pillar 2 Supervisory ReviewProcess

Pillar 3 Market Discipline

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PILLAR 1PILLAR 1

Includes 3 risks now, operational risk + credit risk +market risk.

Keeping in view RBI's goal to have consistency and

harmony with international standards, it has beendecided that all commercial banks in India shall adoptStandardized Approach (SA) for credit risk and BasicIndicator Approach (BIA) for operational risk.

Banks shall continue to apply the StandardizedDuration Approach (SDA) for computing capitalrequirement for market risks.

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DOMESTIC ANDDOMESTIC AND

INTERNATIONAL CREDITINTERNATIONAL CREDIT

RATING AGENCIESRATING AGENCIES The RBI decided that banks may use the ratings of the

following domestic credit rating agencies for the

purposes of risk weighting their claims for capital

adequacy purposes: a) Credit Analysis and ResearchLtd. b) CRISIL Ltd. c) FITCH Ltd. and d) ICRA Ltd.

Banks may use the ratings of the following international

credit rating agencies for the purposes of risk weighting

their claims for capital adequacy purposes a) Fitch; b)Moody's; and c) Standard & Poor's.

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Banks must disclose the names of the credit rating

agencies that they use for the risk weighting of their

assets, the risk weights associated with the particular

rating grades as determined by RBI for each eligiblecredit rating agency as well as the aggregated risk

weighted assets.

For instance recently, Induslnd bank entered MOU

with CRISIL and Allahabad bank entered MOU with

CARE for rating facility as required under Basel II.

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PILLAR 2PILLAR 2

Its requirements give supervisors, i.e., the RBI,

the discretion to increase regulatory capital

requirements.

The RBI can administer and enforce minimum

capital requirements from bank even higher than

the level specified in Basel II, based on risk

management skills of the bank.

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RBI will consider prescribing a higher level ofminimum capital ratio for each bank under thePillar 2 framework on the basis of their

respective risk profiles and their riskmanagement systems.

Further, in terms of the Pillar 2 requirements of

the NewC

apital Adequacy Framework, banksare expected to operate at a level well above theminimum requirement.

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PILLAR 3PILLAR 3

It demands comprehensive disclosure

requirements from banks.

For such comprehensive disclosure,IT structuremust be in place for supporting data collection

and generating MIS which is compatible with

Pillar 3 requirements.

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In short, compliance is a win-win situation for

all concerned. Banks will have to continuously

improve the quality of their internal loss data,

with Basel II requiring them to have at least five

years of data, including a downturn.

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Impact of Basel II in terms of borrowersImpact of Basel II in terms of borrowers

Efficient borrower

Higher rates

Less favorable terms

Lower amountRisky borrower

Lower rates

Favorable terms

Large amount

Concept of

Basel norms

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risk

Liquidity

RiskMarket

Operational

credit

Legal &

regulatory Human factor

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Banking risksBanking risks

Banking Activities are exposed to a host of risks.Banking Activities are exposed to a host of risks.

Based on the origin & their nature, they areBased on the origin & their nature, they are

classified into various categoriesclassified into various categories

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ADVANTAGES OF BASEL IIADVANTAGES OF BASEL II

BASEL IBASEL I

Focus on a single riskFocus on a single riskmeasure, primarily on creditmeasure, primarily on creditrisk.risk.

Does not cover operationalDoes not cover operationalrisk.risk.

One size fits all.One size fits all.

Broad structure.Broad structure.

Uses arbitrary risk categoriesUses arbitrary risk categories

and risk weights.and risk weights.

BASEL IIBASEL II

More emphasis on banksMore emphasis on banksown internal methodologies,own internal methodologies,supervisory review andsupervisory review and

market discipline.market discipline. Flexibility, menu ofFlexibility, menu of

approaches, incentives forapproaches, incentives forbetter risk management.better risk management.

More risk sensitivity.More risk sensitivity.

Risk weight linked to externalRisk weight linked to externalratings assigned byIRB byratings assigned byIRB bybank.bank.