Basel II and International Banking Practices

PROJECT FOR THE SUBJECT

Banking Law

SUBMITTED BY

Mr. Aditya Chopra (Roll No. 07BAL006)

Semester – VII (B.A.LL.B.)

UNDER THE GUIDANCE OF

Prof. Asha Verma
Asst. Prof., ILNU

Submitted to

INSTITUTE OF LAW
 NIRMA UNIVERSITY, AHMEDABAD

ACADEMIC YEAR (2010-11)

DECLARATION

I Aditya Chopra declare the work entitled “Basel II and International Banking

Practices” being submitted to Nirma University for the project in the subject of

“Banking Law” is original and where the text is taken from the authenticated books,

articles or web articles, appropriate reference is given. It is true in my best of knowledge.

Date : Aditya Chopra

Roll No 07 BAL 006
VII Semester, (2010-11)
Institute of Law
Nirma University
CERTIFICATE

This is to certify that the Project entitled “Basel II and International Banking

Practices” – submitted by Mr. Aditya Chopra for the project work in the subject of

Banking Law embodies independent and original research work carried out by him

under my supervision and guidance.

To the best of my knowledge and belief, it is his original work submitted to fulfil

the project assignment for the Semester End Examination of seventh semester of

B.A.LL.B. Programme during the academic year 2010-11.

Date : Prof. Asha Verma

Asst. Professor in Law
Institute of Law,
Nirma University
Ahmedabad
ACKNOWLEDGEMENT

A successful accomplishment of research project signifies great contribution of

the Course Coordinator. In the present research project Prof. Asha Verma has
contributed significantly in the accomplishment of this research project.
Without his support and guidance this research project would have been an
unrealistic dream. Prof. Asha Verma has guided the researcher throughout the
preparation of project. Besides he also gave valuable inputs for the research
project. At this moment the researcher would like to heartily acknowledge
contribution of Prof. Asha Verma in the preparation of research project.

The researcher would acknowledge the contribution of library staff for

extending such support to the researcher. Last but not the least researcher
would like to thank Institute of Law for providing such opportunity in the form
of project whereby our knowledge is enhanced. Besides the researcher wish to
express gratitude to those who may have contributed to this wok even though
anonymously. The researcher extends his sincere thanks to all.

Date : Mr. Aditya Chopra

Table of Contents

DECLARATION.........................................................................................................................2
CERTIFICATE............................................................................................................................3
ACKNOWLEDGEMENT...........................................................................................................4
Table of Contents.........................................................................................................................5
LIST OF ABBREVIATIONS......................................................................................................6
INTRODUCTION.......................................................................................................................7
The Existing Framework.............................................................................................................8
Impact of the 1988 Accord..........................................................................................................9
The June 1999 proposal...............................................................................................................9
AIMS AND OBJECTIVE OF THE STUDY............................................................................10
HYPOTHESIS...........................................................................................................................11
NATURE AND SCOPE OF THE STUDY...............................................................................11
RESEARCH QUESTIONS.......................................................................................................12
RESEARCH METHODOLOGY..............................................................................................12
CHAPTER -2.............................................................................................................................13
Basel I........................................................................................................................................14
Loopholes of Basel I Accord.....................................................................................................14
Basel II.......................................................................................................................................14
What is Basel II.........................................................................................................................15
Objectives of the New Basel Accord.........................................................................................16
Reasons:.....................................................................................................................................16
Structure of the new Accord......................................................................................................18
BASEL II FRAMEWORK........................................................................................................20
CHAPTER-4..............................................................................................................................21
ISSUES AND CHALLENGES.................................................................................................21
BASEL II GUIDELINES..........................................................................................................24
CHAPTER-6..............................................................................................................................27
Conclusion:................................................................................................................................27
LIST OF ABBREVIATIONS 

1. AIG       Accord Implementation Group

2. AMA     Advanced Measurement Approach
3. BIS        Bank for International Settlements
4. IRB        Internal Ratings Based
5. USA      United States Of America
INTRODUCTION

The Basel Committee was formed in response to the messy liquidation of a Cologne-based bank
in 1974. On 26 June 1974, a number of banks had released Deutschmark to the Bank Herstatt in
exchange for dollar payments deliverable in New York. On account of differences in the time
zones, there was a lag in the dollar payment to the counter-party banks, and during this gap, and
before the dollar payments could be effected in New York, the Bank Herstatt was liquidated by
German regulators.

This incident prompted the G-10 nations to form towards the end of 1974, the Basel Committee
on Banking Supervision, under the auspices of the Bank of International Settlements (BIS)
located in Basel, Switzerland.

The major impetus for the 1988 Basel Capital Accord was the concern of the Governors of the
G10 central banks that the capital of the world's major banks had become dangerously low after
persistent erosion through competition. Capital is necessary for banks as a cushion against losses
and it provides an incentive for the owners of the business to manage it in a prudent manner.

The Existing Framework

The 1988 Accord requires internationally active banks in the G10 countries to hold capital equal
to at least 8% of a basket of assets measured in different ways according to their riskiness. The
definition of capital is set (broadly) in two tiers, Tier 1 being shareholders' equity and retained
earnings and Tier 2 being additional internal and external resources available to the bank. The
bank has to hold at least half of its measured capital in Tier 1 form.

A portfolio approach is taken to the measure of risk, with assets classified into four buckets (0%,
20%, 50% and 100%) according to the debtor category. This means that some assets (essentially
bank holdings of government assets such as Treasury Bills and bonds) have no capital
requirement, while claims on banks have a 20% weight, which translates into a capital charge of
1.6% of the value of the claim. However, virtually all claims on the non-bank private sector
receive the standard 8% capital requirement.
There is also a scale of charges for off-balance sheet exposures through guarantees,
commitments, forward claims, etc. This is the only complex section of the 1988 Accord and
requires a two-step approach whereby banks convert their off-balance-sheet positions into a
credit equivalent amount through a scale of conversion factors, which then are weighted
according to the counterparty's risk weighting.

The 1988 Accord has been supplemented a number of times, with most changes dealing with the
treatment of off-balance-sheet activities. A significant amendment was enacted in 1996, when
the Committee introduced a measure whereby trading positions in bonds, equities, foreign
exchange and commodities were removed from the credit risk framework and given explicit
capital charges related to the bank's open position in each instrument.

Impact of the 1988 Accord

The two principal purposes of the Accord were to ensure an adequate level of capital in the
international banking system and to create a "more level playing field" in competitive terms so
that banks could no longer build business volume without adequate capital backing. These two
objectives have been achieved. The merits of the Accord were widely recognized and during the
1990s the Accord became an accepted world standard, with well over 100 countries applying the
Basel framework to their banking system. However, there also have been some less positive
features. The regulatory capital requirement has been in conflict with increasingly sophisticated
internal measures of economic capital. The simple bucket approach with a flat 8% charge for
claims on the private sector has given banks an incentive to move high quality assets off the
balance sheet, thus reducing the average quality of bank loan portfolios. In addition, the 1988
Accord does not sufficiently recognize credit risk mitigation techniques, such as collateral and
guarantees. These are the principal reasons why the Basel Committee decided to propose a more
risk-sensitive framework in June 1999.
The June 1999 proposal
The initial consultative proposal had a strong conceptual content and was deliberately rather
vague on some details in order to solicit comment at a relatively early stage of the Basel
Committee’s thinking. It contained three fundamental innovations, each designed to introduce
greater risk sensitivity into the Accord. One was to supplement the current quantitative standard
with two additional “Pillars” dealing with supervisory review and market discipline. These were
intended to reduce the stress on the quantitative Pillar 1 by providing a more balanced approach
to the capital assessment process. The second innovation was that banks with advanced risk
management capabilities would be permitted to use their own internal systems for evaluating
credit risk, known as “internal ratings”, instead of standardized risk weights for each class of
asset. The third principal innovation was to allow banks to use the grading provided by approved
external credit assessment institutions (in most cases private rating agencies) to classify their
sovereign claims into five risk buckets and their claims on corporate and banks into three risk
buckets. In addition, there were a number of other proposals to refine the risk weightings and
introduce a capital charge for other risks. The basic definition of capital stayed the same. The
comments on the June 1999 paper were numerous and can be said to reflect the important impact
the 1988 Accord has had. Nearly all commenter’s welcomed the intention to refine the Accord
and supported the three Pillar approach, but there were many comments on the details of the
proposal. A widely-expressed comment from banks in particular was that the threshold for the
use of the IRB approach should not be set so high as to prevent well managed banks from using
their internal ratings. Intensive work has taken place in the eighteen months since June 1999.
Much of this has leveraged off work undertaken in parallel with industry representatives, whose
cooperation has been greatly appreciated by the Basel Committee and its Secretariat.
AIMS AND OBJECTIVE OF THE STUDY

The object behind carrying out this non-doctrinal research on the subject
matter of the provisions of Basel Convention on International Banking
Practices is to have thorough understanding of the reasons and objects
envisaged behind having such conventions.
In view of the foregoing discussion, the main purpose of the present work is to
understand the Basel thoroughly. Keeping in view this aim, the researcher has
analyzed the works of eminent and respected Jurists and Writers having strong
views regarding the subject.

Therefore this research work is intended to make an extensive doctrinaire

study of the research topic. In the backdrop of above, an attempt has been
made to review, understand and appreciate the views, opinions and theories of
several noted Jurists and Philosophers.

HYPOTHESIS

In order to conduct a research work, some important hypotheses are to be

formulated. The focal points and assumptions are normally available through
the formulation of hypothesis. The major hypotheses developed on the basis of
study of available literature and evaluation of primary as well as secondary
data and work done earlier including related studies is that:

 The researcher assumes that the object behind having Basel is to keep a
check on the International Banking Practices
NATURE AND SCOPE OF THE STUDY

The nature of the present research project is a doctrinal one. The subject
matter of the study being Basel II and International Banking Practices it
would have been impracticable to carry out a non-doctrinal research project.
Thus the researcher has opted for the doctrinal method of research.

The scope of the present research is very wide in the nature. As the topic
suggest this research project deals with Basel II And International Banking
Practices, the researcher will deal with the aspects of as when this Convention
is applicable. Looking at the vastness of the project the researcher had tried his
best to do justice to the topic. The researcher has tried cover all the aspects
connected with the said topic and explain them in an elaborative manner.

RESEARCH QUESTIONS

 To Study the Concept of Basel II

 Application in Indian Culture
 Suggestions to Come Out from Constraint to Apply

RESEARCH METHODOLOGY

The quality and value of research depends upon the proper and particular
methodology adopted for the completion of research work. Looking at the
vastness of the research topic, doctrinal legal research methodology has been
adopted. To make an authenticated study of the research topic ‘Basel II and
International Banking Practices’ enormous amount of study material is
required. The relevant information and data necessary for its completion has
been gathered from secondary sources available in the books, journals,
periodicals, research articles and proceedings of the books on Interpretation of
Statutes and websites.

Keeping in view the need of present research, various cases filed in the
Supreme Court as well as in the High Court on the issue of interpretation of
non obstante clauses and the judgments therein have also been used as a
source of information. The judgments pronounced in the cases have been
analysed in detail and included a means of diagnosis.

From the collected material and information, researcher proposes to critically

analyse the topic of the study and tries to reach the core aspects of the study.
CHAPTER -2

Basel I

It is the term which refers to a round of deliberations by central bankers

fromaround the world, and in 1988, the Basel Committee (BCBS) in Basel,
Switzerland, published a set of minimal capital requirements for banks. This is also
known as the 1988 Basel Accord, and was enforced by law in the Group of Ten
(G-10) countries in 1992, with Japanese banks permitted an extended transition
period. Basel I is now widely viewed as out modeled, and a more comprehensive
set of guidelines, known as Basel II are in the process of implementation by several
countries.

Loopholes of Basel I Accord

 After ten years of implementation and taking into consideration the rapid technological,
financial and institutional changes happened during the period many weaknesses started
appearing in Basel I accord.
 Because of a flat 8% charge for claims on the private sector, banks have an incentive to
move high quality assets off the balance sheet (capital arbitrage) through securitization.
Thus, reducing the average quality of bank loan portfolio
 It does not take into consideration the operational risks of banks, which become
increasingly important with the increase in the complexity of banks.
 Also, the 1988 Accord does not sufficiently recognize credit risk mitigation techniques,
such as collateral and guarantees.
 The regulatory Capital requirement has been in conflict with increasingly sophisticated
internal measures of economic Capital
 It was concentrating on only on credit risk.
Basel II
The new framework intends to provide approaches which are both more comprehensive and
more sensitive to risks than the 1988 Accord, while maintaining the overall level of regulatory
capital. Capital requirements that are more in line with underlying risks will allow banks to
manage their businesses more efficiently. The new framework is less prescriptive than the
original Accord. At its simplest, the framework is somewhat more complex than the old, but it
offers a range of approaches for banks capable of using more risk-sensitive analytical
methodologies. These inevitably require more detail in their application and hence a thicker rule
book. The Committee believes the benefits of a regime in which capital is aligned more closely
to risk significantly exceed the costs, with the result that the banking system should be safer,
sounder, and more efficient.

What is Basel II

Basel 2 is the new capital accord signed in June 2004 at Bank for International Settlement
located at Basel, Switzerland. It is an improvement over Basel 1 which had certain deficiencies
which have now been removed. Basel 2 is based on three pillars: capital adequacy, supervisory
review and market discipline. It is basically concerned with financial health of the banks
worldwide. The focus in Basel 2 is the risk determination and quantification of credit risk,
market risk and operational risk faced by banks. Reserve Bank of India has accepted the accord
and issued guidelines to ensure compliance with the norms by March 31, 2008. Other scheduled
commercial banks are required to implement Basel 2 by March 31, 2009.

Rationale for a new Accord: need for more flexibility and risk sensitivity

The existing Accord The proposed new Accord

Focus on a single risk measure More emphasis on banks’ own internal

methodologies, supervisory review, and
 market discipline

One size fits all Flexibility, menu of approaches, incentives

for better risk management

Broad brush structure

More risk sensitivity

Basel II is basically a Risk Management Exercise

 Doesn’t seek to change business models of the Bank.

 But requires to fine-tune/update Risk Management practices.

 Robust enough to capture all possible Risks the Bank is facing or likely to face.

 Initiate adequate and appropriate Risk Mitigation measures through effective Systems
and Procedures

Objectives of the New Basel Accord

Broadly speaking, the objectives of Basel II are to encourage better and more systematic risk
management practices, especially in the area of credit risk, and to provide improved measures of
capital adequacy for the benefit of supervisors and the marketplace more generally. At the outset
of the process of developing the new Accord, the Basel Committee developed the so-called three
pillars approach to capital adequacy involving
Reasons:

Safety and soundness in today’s dynamic and complex financial system can be attained only by
the combination of effective bank-level management, market discipline, and supervision. The
1988 Accord focused on the total amount of bank capital, which is vital in reducing the risk of
bank insolvency and the potential cost of a bank’s failure for depositors. Building on this, the
new framework intends to improve safety and soundness in the financial system by placing more
emphasis on banks’ own internal control and management, the supervisory review process, and
market discipline.

Although the new framework’s focus is primarily on internationally active banks, its underlying
principles are intended to be suitable for application to banks of varying levels of complexity and
sophistication. The Committee has consulted with supervisors worldwide in developing the new
framework and expects the New Accord to be adhered to by all significant banks within a certain
period of time.

The 1988 Accord provided essentially only one option for measuring the appropriate capital of
internationally active banks. The best way to measure, manage and mitigate risks, however,
differs from bank to bank. An Amendment was introduced in 1996 which focused on trading
risks and allowed some banks for the first time to use their own systems to measure their market
risks. The new framework provides a spectrum of approaches from simple to advanced
methodologies for the measurement of both credit risk and operational risk in determining capital
levels. It provides a flexible structure in which banks, subject to supervisory review, will adopt
approaches which best fit their level of sophistication and their risk profile. The framework also
deliberately builds in rewards for stronger and more accurate risk measurement.
Structure of the new Accord

Three pillars of the new Accord

 First pillar: minimum capital requirement
 Second pillar: supervisory review process
 Third pillar: market discipline

The new Accord consists of three mutually reinforcing pillars, which together should contribute
to safety and soundness in the financial system. The Committee stresses the need for rigorous
application of all three pillars and plans to work actively with fellow supervisors to achieve the
effective implementation of all aspects of the Accord It is hardly necessary to emphasize the
importance of banks and banking systems to financial and economic stability. The ability of a
sound and well-capitalized banking system to help cushion an economy from unforeseen shocks
is well known, as are the negative consequences of a banking system that itself becomes a source
of weakness and instability. A critical potential weakness of financial markets is that risks are in
many cases under-estimated and not fully recognized until too late, with a concomitant potential
for excessive consequences once they have been fully realized. This is why the Basel
Committee’s efforts to promote greater recognition of risks and more systematic attention to
them are vitally important.

The essence of Basel II is a focus on risk differentiation and the need for enhanced approaches to
assessing credit risk. Some critics have argued that it is preferable to downplay differences in
risk, and indeed forbearance can sometimes appear the most expedient strategy.

But experience has also shown that this will not work as an overall approach because ignoring
risks inevitably leads to larger problems down the road. Thus, one of the key messages of Basel
II is that bankers, supervisors, and other market participants must become better attuned to risk
and better able to act on those risk assessments at the appropriate time. Bank supervisors must
get better at addressing issues pre-emptively rather than in crisis mode.
Significant attention to risk management is one of the primary mechanisms available to help
banks and supervisors do that. Basel II seeks to provide incentives for greater awareness of
differences in risk through more risk-sensitive minimum capital requirements. The Pillar 1
capital requirements will, by necessity, be imperfect measures of risk as any rules-based
framework will be. The objective of the proposals is to increase the emphasis on assessments of
credit and operational risk throughout financial institutions and across markets.

Perhaps even more important in the long run is the second pillar of the new Accord. Pillar 2
requires banks to systematically assess risk relative to capital within their organization. The
review of these internal assessments by supervisors should provide discipline on bank
management to take the process seriously and will help supervisors to continually enhance their
understanding of risk at the institutions. The third pillar of Basel II provides another set of
necessary checks and balances by seeking to promote market discipline through enhanced
transparency. Greater disclosure of key elements of risk and capital will provide important
information to counterparties and investors who need such information to have an informed view
of a bank’s profile.
 BASEL II FRAMEWORK

THREE PILLARS OF BASEL

II

Supervisory
Minimum Market
Review
Capital Discipline
Requirement Process

Credit Risk Market Risk

Operational Risk

Standardized
Standardized IRBA
Duration
Internals
Approach
Approach
Model

Approach

Advanced
Basic Indicator Standardised
Measurement
Approach Approach
Approach
CHAPTER-4

ISSUES AND CHALLENGES

While there is no second opinion regarding the purpose, necessity and usefulness of the proposed
new accord – the techniques and methods suggested in the consultative document would pose
considerable implementation challenges for the banks especially in a developing country like
India.

Capital Requirement: The new norms will almost invariably increase capital requirement in all
banks across the board. Although capital requirement for credit risk may go down due to
adoption of more risk sensitive models – such advantage will be more than offset by additional
capital charge for operational risk and increased capital requirement for market risk. This partly
explains the current trend of consolidation in the banking industry.

Profitability: Competition among banks for highly rated corporates needing lower amount of
capital may exert pressure on already thinning interest spread. Further, huge implementation cost
may also impact profitability for smaller banks.

Risk Management Architecture: The new standards are an amalgam of international best
practices and calls for introduction of advanced risk management system with wider application
throughout the organization. It would be a daunting task to create the required level of
technological architecture and human skill across the institution.

Rating Requirement: Although there are a few credit rating agencies in India – the level of
rating penetration is very low. A study revealed that in 1999, out of 9640 borrowers enjoying
fund-based working capital facilities from banks – only 300 were rated by major agencies.
Further, rating is a lagging indicator of the credit risk and the agencies have poor track record in
this respect. There is a possibility of rating blackmail through unsolicited rating. Moreover rating
in India is restricted to issues and not issuers. Encouraging rating of issuers would be a
challenge.

Choice of Alternative Approaches:

The new framework provides for alternative approaches for Computation of capital requirement
of various risks. However, competitive advantage of IRB approach may lead to domination of
this approach among big banks. Banks adopting IRB approach will be more sensitive than those
adopting standardized approach. This may result in high-risk assets flowing to banks on
standardized approach - as they would require lesser capital for these assets than banks on IRB
approach. Hence, the system as a whole may maintain lower capital than warranted and become
more vulnerable. It is to be considered whether in our quest for perfect standards, we have lost
the only universally accepted standard. Absence of Historical Database: Computation of
probability of default, loss given default, migration mapping and supervisory validation require
creation of historical database, which is a time consuming process and may require initial
support from the supervisor. Incentive to Remain Unrated: In case of unrated sovereigns, banks
and corporates the prescribed risk weight is 100%, whereas in case of those entities with lowest
rating, the risk weight is 150%. This may create incentive for the category of counterparties,
which anticipate lower rating to remain unrated.

Supervisory Framework: Implementation of Basel II norms will prove a challenging task for
the bank supervisors as well. Given the paucity of supervisory resources there is a need to
reorient the resource deployment strategy. Supervisory cadre has to be properly trained for
understanding of critical issues for risk profiling of supervised entities and validating and
guiding development of complex IRB models.

Corporate Governance Issues:

Basel II proposals underscore the interaction between sound risk management practices and
corporate good governance. The bank’s board of directors has the responsibility for setting the
basic tolerance levels for various types of risk. It should also ensure that management establishes
a framework for assessing the risks, develop a system to relate risk to the bank’s capital levels
and establish a method for monitoring compliance with internal policies.
National Discretion: Basel II norms set out a number of areas where national supervisor will
need to determine the specific definitions, approaches or thresholds that wish to adopt in
implementing the proposals. The criteria used by supervisors in making these determinations
should draw upon domestic market practice and experience and be consistent with the objectives
of Basel II norms.
Disclosure Regime: Pillar 3 purports to enforce market discipline through stricter disclosure
requirement. While admitting that such disclosure may be useful for supervisory authorities and
rating agencies – the expertise and ability of the general public to comprehend and interpret
disclosed information is open to question. Moreover, too much disclosure may cause information
overload and may even damage financial position of bank.

Disadvantage for Smaller Banks:

The new framework is very complex and difficult to understand. It calls for revamping the entire
management information system and allocation of substantial resources. Therefore, it may be out
of reach for many smaller banks. As Moody’s Investors Services puts it, “It is unlikely that these
banks will have the financial resources, intellectual capital, skills and large scale commitment
that larger competitors have to build sophisticated systems to allocate regulatory capital
optimally for both credit and operational risks.”

Discriminatory against Developing Countries:

Developing counties have high concentration of lower rated borrowers. The calibration of IRB
has lesser incentives to lend to such borrowers. This, along with withdrawal of uniform risk
weight of 0% on sovereign claims may result in overall reduction in lending by internationally
active banks in developing countries and increase their cost of borrowing.

External and Internal Auditors: The working Group set up by the Basel Committee to look into
Implemetational issues observed that supervisors may wish to involve third parties, such a
external auditors, internal auditors and consultants to assist them carrying out some of the duties
under Basel II. The precondition is that there should be a suitably developed national accounting
and auditing standards and framework, which are in line with the best international practices. A
minimum qualifying criteria for firms should be those that have a dedicated financial services or
banking division that is properly researched and have proven ability to respond to training and
upgrades required of its own staff to complete the tasks adequately.

With the implementation of the new framework, internal auditors may become increasingly
involved in various processes, including validation and of the accuracy of the data inputs, review
of activities performed by credit functions and assessment of a bank’s capital assessment
process.

BASEL II GUIDELINES

 Basel II Committee set up by Bank for International Settlements (BIS) released the first
version of Basel II in June 2006.

 A Comprehensive Version, incorporating amendments to relating to Market Risks,

Trading Activities and the Treatment of Double Default Effects, was released in June
2006.

 Basel II Guidelines in Indian context were finalized by RBI, after due deliberations and
brain-storming by select 14-member Committee of Banks from Public Sector and Private
Sector.

 Our Bank is also a member and headed the Sub-Committee on ‘National Discretion’.

RBI released Basel II Final Guidelines vide their notification dated 27.04.2007.

Effective Date

Foreign banks operating in India and Indian banks having operational presence outside India
should adopt Standardized Approach (SA) for credit risk and Basic Indicator Approach (BIA) for
operational risk for computing their capital requirements under the Revised Framework with
effect from March 31, 2008. All other commercial banks (excluding Local Area Banks and
Regional Rural Banks) are encouraged to migrate to these approaches under the Revised
Framework in alignment with them but in any case not later than March 31, 2009. These banks
shall continue to apply the Standardized Duration Approach (SDA) for computing capital
requirement for market risks under the Revised Framework.
Parallel run
With a view to ensuring smooth transition to the Revised Framework and with a view to
providing opportunity to banks to streamline their systems and strategies, banks were advised to
have a parallel run of the revised Framework. A copy of the quarterly reports to the Board of
Directors may be continued to be submitted to the Reserve Bank of India – one each to the
Department of Banking Supervision, Central Office and the Department of Banking Operations
and Development, Central Office.

Reserve Bank of India has issued a notification laying down a time schedule for all scheduled
commercial banks operating in the country for implementation of the advanced approaches for
the regulatory capital measurement under Basel II framework.

The deadline set by the regulator for accomplishing the same would thus facilitate the banks in
India to create requisite technological and risk management infrastructure, required databases,
the MIS and complete skill up gradation.

The notification states that the earliest dates of making application by banks and likely approval
by the regulator for implementing internal models approach for market risk are April 1, 2010 and
March 31, 2011 respectively. The earliest dates of making application by banks and likely
approval by the regulator for implementing the standardized approach for operational risk are
April 1, 2010 and September 30, 2010 respectively. The earliest dates of making application by
banks and likely approval by the regulator for implementing advanced measurement approach
for operational risk are April 1, 2012 and March 31, 2014 respectively.

The earliest dates of making application by banks and likely approval by the regulator for
implementing internal ratings-based approaches for credit risk (foundation- as well as advanced
IRB) are April 1, 2012 and March 31, 2014 respectively.
As per the circular released by the Indian regulator on April 27, 2007 on the new capital
adequacy framework, foreign banks operating in India and Indian banks having operational
presence outside India have migrated to the simpler approaches available under the Basel II
framework since March 31, 2008. Other commercial banks have also migrated to these
approaches from March 31, 2009. Thus, the standardized approach for credit risk, basic indicator
approach for operational risk and the standardized duration approach for market risk (as slightly
amended under Basel II framework) have been implemented for the banks in India.

The latest notification issued by the regulator states that the banks, at their discretion, would
have the option of adopting the advanced approaches for one or more of the risk categories, as
per their preparedness, while continuing with the simpler approaches for other risk categories,
and it would not be necessary to adopt the advanced approaches for all the risk categories
simultaneously. However, the banks should invariably obtain prior approval of the Reserve Bank
of India for adoption of any of the advanced approaches.

Also, if the result of a bank’s internal assessment indicates that it is not in a position to mark.
CHAPTER-6

Conclusion:

There are two problems. The Basel Accord is designed by rich countries, and is not
appropriate for other countries. Yet it is increasingly a legal requirement for all countries.
Something needs to change: if the Accord is to apply to all, it should be made more
appropriate for developing countries. Alternatively, it should cease to be an obligation.
Developing countries should cooperate, probably at the regional level, to design their
own variants. These variants should probably be simple, rule-based, non-discretionary,
and have inbuilt redundancy. No regime can fully correct for government or market
failure, but a regime designed to be robust to government failure is more likely not to fail
completely.

The concept of risk-sensitive capital requirement in the banking sector underlying the
Basel II capital accord (New Accord) is by and large theoretically sound, albeit empirical
evidence is not conclusive. In practice, the New Accord is found to be too difficult to be
implemented particularly in some of the emerging economies.

Supervisors as well as the Basel Committee have recognized these complexities. Hence
they have appreciated flexibility and gradualism in the approach to implement the New
Accord. 

In the opinion of critics, the New Accord uses credit risk measurement models as a basis
for bank capital requirements and hence it entails procyclicality and relatively high
capital requirement. For instance, in terms of internal credit risk models and also external
rating, risk-sensitive capital allocations and regulatory requirements are likely to bring
down lending capacity of banks during the recessionary period and vice-versa in the
boom period. Thus, the risk-based capital requirement causes accentuations in the
business cycle.
Given the present context of empirical literature, it would not be possible to identify all
macroeconomic effects of bank lending other structural changes having a bearing on
systemic risk unless there is in place a comprehensive, well-tested business cycle theory.
Hence, it is difficult to arrive at a definite conclusion about the procyclicality or
otherwise of the New Capital Accord on the basis of the existing literature. 

The final outcome of implementation of the Accord depends on the changes it brings
about in the areas of credit risk measurement and management, supervisory practices,
level of transparency and proactive steps of building up of buffers to absorb the shocks.
For instance, Pillar 2 and Pillar 3 of the New Capital Accord and their effective
implementation would contribute substantially to the financial stability. The high degree
of transparency coupled with the empowered supervisory review is likely to detect the
early warning signals of vulnerability14 in the financial institutions. This would enable the
early actions that would, in turn, prevent possible instability in the financial system.
 BIBLOGRAPHY:-

Books:
1. Law of Banking. Dr. S.R.Myneni, 1st Edition.

2. Tannan’s Banking Law and Practice in India, 19th Edition, 1997

3. The Law and Banking Practice By J. Milnes Holden