Basel frame work impact on the banks

In addition to the work on capital standards, particular supervisory questions which the Committee has addressed include the supervision of bank’s foreign exchange positions, the management of banks international lending (i.e. country risk ), the management of bank’s off –balance –sheet exposures, the prevention of criminal use of the banking system, the supervision of large exposures, risk management  guidelines for derivatives and the management of interest rate risk . Supervisors may decide to apply a 150% or higher risk weight reflecting the higher risks associated with other assets.  In the case of credit risk, it prescribes differential risk weights within each category of exposure. Credit risk could be reduced by adoption of credit risk mitigation techniques. However introduction of operational risk factor is likely to increase the capital requirement. Improved risk assessment ensures greater discipline and better information for investors in order to comprehend the bank’s risk pastures and act rationally. From 1997 onwards, Basel Committee has  taken initiative to address the rigidities in 1988 Capital Accord by evolving a comprehensive and risk- sensitive  New Basel Capital Accord. The Minimum Capital Requirements are composed of three fundamental elements: a definition of regulatory capital, risk weighted assets and the minimum ratio of capital to risk weighted assets.

 

IMPACT ON THE BANK

At the outset it is clarified that the proposed New Accord is yet in its formative/ evolutionary stage – it has been floated as a Consultative Document and the accord is not yet finalised or even fully crystallised. Many sections/ parts of the proposed Accord have scope for additional inputs/ further refinement. Further, there are also a number of areas where options are to be exercised at the supervisory level. There are also other areas where options could be exercised at individual bank level. This three-fold fluidity at the level of the Committee, the Supervisor and the Bank will render premature, any attempt at this stage to quantify the impact. It may be added that until the Committee views are firmed up, the supervisory (RBI) options can not be delineated; similarly until the supervisory options are exercised, the options available to the Bank can not be examined properly.

AREAS NOT FINALISED BY THE COMMITTEE:-    

    It is still exploring the possibility of using the country risk rating assigned to sovereigns by Export Credit Agencies(ECAs) as against using the ratings of  External Credit Assessment Institutions(ECAIs)
    The risk weights for retail portfolio have not yet been finalised.

    The proposals on the IRB approach for retail, project finance and equity exposures are yet be finalised.

    The proposals related to operational risk are still in a formative stage.

AREAS REQUIRING THE EXERCISE OF OPTIONS AT THE SUPERVISORY LEVEL :-

    Recognition of eligible ECAIs (External Credit Assessment Institutions) / ECAs (Export Credit Agencies) and discretion for assigning lower risk weights for specific exposures.

    Normally banks may use only solicited ratings, Supervisors may allow them to use unsolicited ratings.

    Claims on PSEs may be treated as claims on the Sovereigns.

    Risk weight may be increased depending upon the overall default experience of the Supervisor.

    Supervisors may decide to apply a 150% or higher risk weight reflecting the higher risks associated with other assets.

IMPACT ON CAPITAL REQUIREMENT :-

Within the above constraints, we give below our opinion which is limited to the likely direction(increase/ decrease) of change and does not extend to the magnitude thereof.

    The new accord will be extended on a consolidated basis to holding companies of banking groups. Further, individual banks within the group should also be capitalised on a stand-alone basis. Thus we will need to provide for adequate capital at all of our subsidiary companies. This could lead to additional demands on capital requirements, to compensate for deficit capital, if any, in the group.

    In the case of credit risk, it prescribes differential risk weights within each category of exposure. It is difficult to crystallise  the impact as it could move both ways. For instance, under the existing accord, all corporates get risk weighted at 100% whereas under the new accord, some may get a weightage of 20% or 50% while others may get a weightage of 150%.

    Credit risk could be reduced by adoption of credit risk mitigation techniques. It may have an effect of reduced capital requirement.

    In the case of market risks, there is no change from the existing accord. However, as it has not been implemented in India so far, there could be an additional capital requirement when RBI introduces it.

    In the case of operational risks, the consultative document states that the work is still in a developmental stage. While it is expected that the operational risk would constitute approx. 20% of the overall capital requirements under the new framework, the impact can not be assessed till further crystallisation of the committee’s views. However introduction of operational risk factor is likely to increase the capital requirement.
5.    CONCLUSION

In the light of the above, our Bank needs to have a definite agenda encompassing the following: –

    There is an urgent need to realise that adoption of advanced risk management practice is absolutely essential in its own right. New risk management models do have the potential to support rational, efficient, reliable internal control system and choices about risks. Pre-requisite for such applications require advanced IT infrastructure, robust MIS and necessary human expertise.

    Effectiveness of IRB approach and compliance with its spirit will be contingent on efficient internal audit and loan review system.

    While the efficacy of proper risk management will optimise yield on their funds, higher return on funds will facilitate ploughing back of profits into capital. Due to high cost of capital and subdued market sentiments, this is the only way left for banks to raise their capital adequacy.

    Improved risk assessment ensures greater discipline and better information for investors in order to comprehend the bank’s risk pastures and act rationally. It has to be borne in mind that improved market discipline does not necessarily amount to uniformly harsher treatment of banks by the market. On the contrary, it recognises the strengths of banks and weeds out weak links in a transparent manner.    

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About Mohan Manohar Mekap

Mohan Manohar is a blogger from India who founded Ittech back in 2007. He is passionate about all things tech and knows the Internet and computers like the back of his hand.

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