Paper presented in the National Conference on
“Emerging Trends in Financial Services”
Medi-Caps Institute of Technology and Management,
Indore -453 331
What is Basel?
BASEL IS a `pocket-sized metropolis,' the third largest in Switzerland, ensconced in a triangle bordering Germany and France, where the Rhine takes a sharp northward bend.
Basel norms & bank restructuring
OF LATE, the new Basel norms for capital adequacy have been drawing a lot of attention in India, not just in banking circles but also among the general public and the media. Much of this revived interest is due to the changes likely to come about with the introduction of Basel II in 2006. In this discourse one observes an over-emphasis on financial stability as a goal in itself, even when it goes contrary to distributional norms as well as growth potentials of the economy, which are no less relevant.
The history of the Basel International codes and Standards (BIS) relating to minimum capital adequacy for banks goes back to the developed countries' initiative in 1988 to protect the Organisation for Economic Cooperation and Development (OECD) banks from the financial crises common during the 1980s.
The original accord, now known as Basel-I, was quite simple and adopted a straight-forward `one size fits all approach' that does not distinguish between the differing risk profiles and risk management standards across banks.
.As in many other developing countries, the Indian monetary authorities implemented Basel I by 1999.
New Basel norms to change complexion of banking
No doubt, the Basel-I framework played a key role in raising capital levels across the banking system over the late 1980s and 1990s. But as recent events demonstrate in the wake of financial market turmoil, following the onset of sub-prime crisis in the US and the exposure of leading financial institutions to financial innovations, Dr Wellink said it has failed to deliver on the four objectives.
v The first objective was to develop a more meaningful link between banks’ on- and off-balance sheet risk exposures and the capital supporting them.
v The second objective was to beef up the links between sound regulatory capital and risk-based supervision, as a way to foster strong risk management practices at banks.
v The third was to enhance market discipline through better information about banks’ risk profiles, risk measurement techniques and capital.
v And the fourth, the Basel Committee endeavoured to develop framework that was adaptive to rapid financial innovation.
Basel – II is bound to unleash a new wave of changes in how banking is conducted. The shape of these changes is still largely in the realm of speculation.
Impact of Basel II
Basel and NPA
NPAs seen doubling if adjusted for global norms
The improved NPA of banks was also made possible by the higher provisioning in respect of NPAs as warranted by Basel I. With the switchover from the earlier 180-day to the 90-day NPA norms by the RBI in accordance with international practice, the SCBs perforce raised provisions towards NPAs
Restructuring of banks
It, however, needs to be pointed out that the restructuring of the banking sector with the Basel norms has implications that go far beyond the performance criteria of banks, such as the reduced NPAs. One needs to look at the changes in the composition of bank assets, which have a strong bearing on the distribution of bank credit.
Better Risk management
Basel II recommends a new model of risk-weighted capital adequacy for banks, to be initiated in stages. Risk-content of bank assets, as recommended, is judged either by an external agency in terms of the standardised approach or by banks themselves through an internal rating based (IRB) model. The market thus aims to bring in, via the regulators, financial discipline for banks, expecting a greater degree of financial stability
Social commitments towards SSIs:
Small loans not exceeding Rs.10 lakh for housing have seen a steep jump over the last four years. Agriculture and small-scale industry (SSI), the remaining items on priority, have received the rest.
Impact of 2008-09 budget
New Delhi, March 6 The Rs 60,000-crore loan waiver announced in the Union Budget 2008-09 to benefit four crore farmers in the country and the hit that ICICI Bank has taken — marked-to-market losses of $264 million due to exposure to overseas credit derivatives and investments in fixed income assets — together exemplify the predicament of the country’s banking industry, in not being able to price risks properly in their core competence of lending.
The provision for capital is only the first of the three `mutually reinforcing' pillars provided for under the New Accord. `Supervisory Review,' the second pillar, is aimed at ensuring compliance with the minimum standards and qualifying criteria. Through this process, supervisors will assess whether the capital maintained is consistent with the risk profile of the bank concerned and take appropriate and timely remedial steps when the capital is found to be falling below the required standards. Among other things, this may include an upward revision in the capital to be maintained under Pillar 1.
Survey on Basel II
How would Basel-II be implemented? A survey conducted by the Financial Stability Institute (FSI), Basel, shows that more than 100 countries will be implementing Basel-II in the next few years and that, by the year 2009, more than 5,000 banks controlling 75 per cent of banking assets in 73 non-BCBS jurisdictions will be subject to Basel-II.
As for BCBS member countries, the U.S. has already announced that it will be made mandatory for the ten biggest banking groups that account for nearly 70 per cent of the country's banking assets. The European Union is also expected to implement it for all banking groups.
What will be the effects? Just as the original Basel Accord changed bank behaviour, which manifested in a slowing down of lending, moving of assets to off-balance sheet and introduction of new sophisticated products such as securitisation and credit derivatives, Basel-II is bound to unleash a new wave of changes in how banking is conducted. The shape of these changes is still largely in the realm of speculation.
What are the criticisms?
The biggest complaint is about the complexity of the rules. But, then, so is banking as a business, and increasingly so for the last three decades. Secondly, the risk-sensitive approaches, it is argued, can have pro-cyclical effects that will aggravate the booms and busts and thereby affect the real economy.
This speculation is still at the theoretical level and one will have to wait for implementation to be able to draw firmer conclusions. The anti-cyclical elements in the proposal, such as that for operational risk, and building excess capital, in times of boom, can alleviate the pro-cyclical effects to a large extent.
The banking sector in the emerging market economies may face unique problems in the absence of well-developed credit rating systems, robust data collection mechanisms and other infrastructure that will entail cruder capital assessment methods and the consequent higher capital levels that will have to be maintained. This will give rise to intra-national and cross-border implementation issues making such banks uncompetitive vis-a-vis the other savvy domestic and foreign banks operating in their terrain. The impact of both the first and the second pillars will be severe on the skills of both bankers and supervisors, which will affect the EME systems more.
v Pillar 1 of the new capital framework revises the 1988 Accord's guidelines by aligning the minimum capital requirements more closely to each bank's actual risk of economic loss.
v Pillar 2 of the new capital framework recognises the necessity of exercising effective supervisory review of banks' internal assessments of their overall risks to ensure that bank management is exercising sound judgment and has set aside adequate capital for these risks.
v Pillar 3 leverages the ability of market discipline to motivate prudent management by enhancing the degree of transparency in banks' public reporting. It sets out the public disclosures that banks must make that lend greater insight into the adequacy of their capitalisat.
Basel in India:
Punjab National Bank has led the initiative to implement Basel norms under the Indian Banks Association (IBA). Local commercial banks with overseas offices have to adopt Basel II norms latest by March 2008. Banks with only local presence have time till March 2009. Basel norms have been put in place by the Bank for International Settlements (BIS), which is regarded as the central bank of all central banks. The measure is expected to make the Indian banking sector more competitive with sound financial base so that it can withstand any international scrutiny and have global acceptability
Labour intensity of output for major undertakings in the organised big industries are alarmingly in the downtrend, both with technological upgradings and the adoption of labour market flexibility. Moreover, small and medium enterprises, which include the SSIs, currently contribute 40 per cent of the total industrial production and over 34 per cent of national exports for the country.
One observes, with serious concern, the limitations of the guiding principle of the Basel norms for banking industry in a country like India where credit needs to be re-directed to units which are deserving, not only in terms of productive contribution but also in terms of social priorities.
ficci survey reports ananlysis
The Indian banks are not prepared to implement the stringent Basel-II norms including that of capital adequacy and non-performing assets in total by 2006, according to the Federation of Indian Chambers of Commerce and Industry survey.
The survey covered 216 key decision makers from foreign, private, public sector banks and corporates.
The internal rating based on recommendations of Basel II norms would make Indian banks more resilient to risk and help them face competition better, the survey said.
On access to foreign players to Indian banking market, the survey said the banking industry would need 2-3 years to gear up to meet challenges of full market access to overseas entities.
Findings on Ficci survey:
The Ficci survey said about 56 per cent of respondents favored lifting restrictions on branch expansion, while 52 per cent sought removal of discriminatory limitations on foreign equity.
v 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.
v 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.
v Let us not forget the basic fact that employment generated by the organised sector of the manufacturing industry is only 14 per cent compared with 86 per cent by the unorganised sector of which small and medium enterprises remain the major component.
v 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.
v 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.
v The requirement for banks to perform stress tests of their on- and off-balance sheet exposures is an additional safeguard Based in part on these stress tests, banks would need to demonstrate to supervisors that they have adequate capital cushions to manage through a down cycle.
v Financial analysts contend that the country’s apex bank should take the cue from the thoughtful suggestions of Dr Wellink and maintain due vigilance on the country’s financial institutions’ growing exposure to high-risk financial instruments and also loan losses they are subjected to, at the behest of political dispensation.
v “Banks need to streamline and reorient their client acquisition and retention strategies,” RBI deputy governor V Leeladhar said. The RBI said banks were advised to undertake a self assessment of their existing risk management systems in view of three major risks covered under Basel-II and to concurrently initiate appropriate measures to upgrade them to match up to minimum standards prescribed in the accord.
Integral Institute of Advanced Management,
Basel norms and Banking Industry