Business policy and strategic management

A PROJECT REPORT ON

SUBMITTED BY

Varun Mishra = 20 (finance) Gomathi Thevar = 92 (finance) Suparna Samanta = 100 (H.R) Poorva Kembhavi = 120 (H.R)
FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION UNDER THE GUIDANCE OF

DR.R.GOPAL PADMASHREE DR.D.Y.PATIL UNIVERSITY DEPARTMENT OF BUSINESS MANAGEMENT

ACADEMIC YEAR 2010-2012

Basel Norms: An Introduction

Basel norms are a set of guidelines that are formulated by bank for international settlements (BIS) basel committee on banking supervision (BCBS). Globalisation banking system in India has attained vital importance. Day by day there has been increasing banking complexities in banking transactions, capital requirements, liquidity, credit and risks associated with them. The World trade organisation (WTO), of which India is a member nation, requires the countries like India to get their banking systems at par with the global standards in terms of financial health, safety and transparency hence they decided to implement basel norms in India.

BASEL COMMITTEE:
The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. The Committee's Secretariat is located at the Bank for International Settlements (BIS) in Basel, Switzerland.

NEED FOR SUCH NORMS:

The first accord by the name Basel Accord I. was established in 1988 and was implemented by 1992. It was the very first attempt to introduce the concept of minimum standards of capital adequacy. Then the second accord by the name Basel Accord II was established in 1999 with a final directive in 2003 for implementation by 2006 as Basel II Norms.

Unfortunately, India could not fully implement this but, is now gearing up under the guidance from the Reserve Bank of India to implement it from 1 April, 2009. Basel II Norms have been introduced to overcome the drawbacks of Basel I Accord. For Indian Banks, its the need of the hour to buckle-up and practice banking business at par with global standards and make the banking system in India more reliable, transparent and safe. These Norms are necessary since India is and will witness increased capital flows from foreign countries and there is increasing cross-border economic & financial transactions.

TYPES OF BASEL NORMS Basel I

In July 1988, the Basel Committee come out with a set of recommendation aimed at introducing minimum levels of income for internationally active bank. Though these proposals were not rightfully binding on the signatory countries, more than hundred supervisors from different countries agreed to implement the Basel norms next to modifications suited to their domestic economies. This first series of recommendation by Basel Committee are popularly known as Basel I norm. These norms required the bank to maintain means of at least 8 per cent of their risk-weighted loan exposures. Different risk weights be specified by the committee for different categories of exposure. For instance, parliament bonds carried risk-weight of 0 per cent, while the corporate loans had a riskweight of 100 per cent.

Basel II
To set right those aspects, the Basel Committee came up beside a new set of guidelines within June 2004, popularly known as the Basel II norm. These new norm are far more complex and comprehensive compared to the Basel I norms. Also, the Basel II norms are more risk-sensitive and they rely heavily on data analysis for risk length and management. These norms are based on the three pillars of Capital Requirement, Supervisory Review and Market Discipline. Pillar l: Capital Adequacy Requirements: Under the Basel II Norms, banks should maintain a minimum capital adequacy requirement of 8% of risk assets. For India, the Reserve Bank of India has mandated maintaining of 9%

minimum capital adequacy requirement. This requirement is popularly called as Capital Adequacy Ratio (CAR) or Capital to Risk Weighted Assets Ratio (CRAR).

Pillar II: Supervisory Review: Banks majorly encounter with 3 Risks, viz. Credit, Operational & Market Risks. Basel II Norms under this Pillar wants to ensure that not only banks have adequate capital to support all the risks, but also to encourage them to develop and use better risk management techniques in monitoring and managing their risks. The process has four key principles: a) Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for monitoring their capital levels. b) Supervisors should review and evaluate bank's internal capital adequacy assessment and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. c) Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum. d) Supervisors should seek to intervene at an early stage to prevent capital from falling below minimum level and should require rapid remedial action if capital is not mentioned or restored. Pillar III: Market Discipline: Market discipline imposes banks to conduct their banking business in a safe, sound and effective manner. Mandatory disclosure requirements on capital, risk exposure (semiannually or more frequently, if appropriate) are required to be made so that market participants can assess a bank's capital adequacy. Qualitative disclosures such as risk management objectives and policies, definitions etc may be also published.

BASEL III

Basel lll is a new global regulatory standard on bank capital adequacy and liquidity agreed by the members of the basel committee on banking supervision. The third of the basel accords was developed in a response to the deficiencies in financial regulation revealed by the global financial crisis. Basel iii strengthens bank capital requirements and introduces new regulatory requirements on bank liquidity and bank leverage. It is estimated that the implementation of basel iii will decrease annual GDP growth by 0.05 to 0.15 percentage point. Will Basel norms make the financial system safer? The Basel Committee expects that these norms will enhance the soundness of the financial system by aligning regulatory capital requirement to the underlying risks in the banking business and by encouraging better risk management by banks and enhanced market discipline. It ensures more efficient capital allocation with higher allocation for weaker assets and lower allocation for good assets. Banks with a greater-than-average risk appetite will find their capital requirements increasing, and vice-versa. The norms require more risk sensitivity, and hence more complex measurement techniques.

BASEL NORMS IN RESERVE BANK OF INDIA

Basel norms aims to encourage the use of modern risk management techniques; and to encourage banks to ensure that their risk management capabilities are commensurate with the risks of their business. Previously, regulators' main focus was on credit risk and market risk. Basel II takes a more sophisticated approach to credit risk, in that it allows banks to make use of internal ratings based Approach - or 'IRB Approach' as they have become known - to calculate their capital requirement for credit risk. It also introduces, in addition to the market risk capital charge, an explicit capital charge for operational risk. Together, these three risks - credit, market, and operational risk - are the so-called 'Pillar 1' risks. The steps taken for implementation of basel norms in RBI

The RBI had announced in its annual policy statement in May 2004 that banks in India should examine in depth the options available under Basel II and draw a road-

map by end-December 2004 for migration to Basel II and review the progress made at quarterly intervals.

The Reserve Bank organized a two-day seminar in July 2004 mainly to sensitise the Chief Executive Officers of banks to the opportunities and challenges emerging from the Basel II norms.

Soon thereafter all banks were advised in August 2004 to undertake a selfassessment of the various risk management systems in place, with specific reference to the three major risks covered under the Basel II and initiate necessary remedial measures to update the systems to match up to the minimum standards prescribed under the New Framework.

Banks were also advised to formulate and operationalise the Capital Adequacy Assessment Process (CAAP) as required under Pillar II of the New Framework.

Reserve Bank issued a Guidance Note on operational risk management in November 2005, which serves as a benchmark for banks to establish a scientific operational risk management framework.

We have tried to ensure that the banks have suitable risk management framework oriented towards their requirements dictated by the size and complexity of business, risk philosophy, market perceptions and the expected level of capital.

Risk Based Supervision (RBS) in 23 banks has been introduced on a pilot basis. As per normal practice, and with a view to ensuring migration to Basel II in a nondisruptive manner, a consultative and participative approach had been adopted for both designing and implementing Basel II. A Steering Committee comprising senior officials from 14 banks (public, private and foreign) had been constituted wherein representation from the Indian Banks Association and the RBI was ensured. The Steering Committee had formed sub-groups to address specific issues. On the basis of recommendations of the Steering Committee, draft guidelines to the banks on implementation of the New Capital Adequacy Framework have been issued.

The Reserve Bank has constituted a sub group of the Steering Committee for making recommendations on the guidelines that may be required to be issued to banks with regard to the Pillar 2 aspects. The guidelines with regard to Pillar 2 aspects proposed to be issued would cover the bank level initiatives that may be required under Pillar 2.

With a view to have an objective assessment of the true cost of implementation of Basel II, banks would be well advised to institute an internal study to make a true assessment of the costs involved exclusively for the elementary approaches. The informal feedback that we have from banks reflects that they do not see Basel II implementation as a costly proposition. However, banks need to ensure that expenditure incurred by them to improve their risk management systems, IT infrastructure, core banking solutions, risk models etc. should not be included as Basel II compliance costs, since these are expenses which a bank would incur even in the normal course of business to improve their efficiencies. Operational Risk Operational risk was one area which was expected to increase capital requirement for the banks. The Reserve Bank had announced in July 2004 that banks in India will be adopting the Basic Indicator Approach for operational risk. This was followed up with the draft guidelines for the Basel II framework in February 2005 where the methodology for computing the capital requirement under the Basic Indicator Approach was explained to banks. Even at the system level, we find that the CRAR of banks is at present well over 12 per cent. This reflects adequate cushion in the system to meet the capital requirement for operational risks, without breaching the minimum CRAR.

Rating agencies In terms of Basel II requirements, national supervisors are responsible in determining whether the rating agencies meet the eligibility criteria. The criteria specified are objectivity in assessment methodology, independence from pressures, transparency, adequate disclosures, sufficient resources for high quality credit assessments and credibility. India has four rating agencies of which three are owned partly/wholly by international rating agencies. Compared to developing countries, the extent of rating penetration has been increasing every year and a large number of capital issues of companies has been rated. However, since rating is of issues and not of issuers, it is likely to result, in effect, in application of only Basel I standards for credit risks in respect of non-retail exposures. While Basel II provides some scope to extend the rating of issues to issuers, this would only be an

approximation and it would be necessary for the system to move to rating of issuers. Encouraging rating of issuers would be essential in this regard. An internal working group is examining the process for identification of the domestic credit rating agencies which would be meeting the eligibility criteria prescribed under Basel II. It is expected that by this process would be over soon and banks would be informed the details of the rating agencies which qualify. Thereafter, the borrowers are expected to approach the rating agencies for getting themselves rated, failing which banks would be constrained to assign 100% risk weight at the minimum for unrated borrowers. The Reserve Bank had invited all the four rating agencies to make a presentation on the eligibility criteria and a self assessment with regard to these criteria. The rating agencies have since made their presentations and these are under examination vis--vis the eligibility criteria for recognising the rating agencies, whose ratings can be used by banks for risk weighting purposes.

RBI provide training to staff on Basel III norms

In a bid to put in place a better implementation of Basel III norms, Reserve Bank of India (RBI) has started training its staff through Center for Advanced Financial Research and Learning headed by former RBI Deputy Governor Usha Thorat. The Basel III is global regulatory standard for bank capital adequacy and liquidity. RBI is focusing initially on financial risk management, financial regulation, and financial markets as the areas of priority, she said. It will hold programs for senior management of the banks and courses may be for RBI people to be able to move over to more advanced methods under the Basel II and Basel III, she further said. RBI will also conduct an impact analysis resulting implementation of the Basel III framework in 10 large banks including State Bank of India, ICICI Bank, Punjab National Bank, and Canara Bank, as per the media reports. It will also release norms mandating banks to open 25% of their new branches in Tier-V and VI centers, shortly, to cover un-banked areas across the country.

Conclusion: Though the Basel Committee has only 13 members, the fact that its capital standards
were implemented by more than 100 countries points to their near universal acceptance.

Implementing Basel II norms on capital adequacy will further accentuate the trend of
moving credit away from the deserving industrial units in the small sector.

Suggestions: Banks will have to continuously improve the quality of their internal loss data with BaselII requiring them to have at least five years of data, including a downturn.

Banks will have to develop more rigorous approaches to measure and manage their
operational risk exposures and hold commensurate capital. Over and above these, 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.

SOURCES
http://www.rbi.org.in http://banking.contify.com/story/rbi-train-staff-basel-iii-norms http://www.business-standard.com