REFORMS IN THE BANKING SECTOR
Banking sector reforms were initiated to upgrade the operating standards, health, and financial soundness of banks to internationally accepted levels in an increasingly globalised market.
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The government of India set up the Naraimham Committee (1991) to examine all aspects relating to Structure, Organisation, and Functioning of the Indian banking system. The recommendation of the committee aimed at creating a competitive and efficient banking system. Measures like capital adequacy, income recognition, asset classification, norms for investment, entry of private sector banks, gradual reduction of SLR and CRR were recommended and implemented to strengthen the banking system. These recommendations changed the face of Indian banking. Public sector banks faced a stiff competition with the entry of the private sector banks.
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Other committees:
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1. Khan committee (1997) constituted to examine the harmonization of the role & operations of DFI & banks. Major recommendations (1998) were: Gradual move towards universal banking. Exploring the possibility of gainful merger as between banks; banks & FI; encompassing either strong and weak entities or two strong ones. Developing a function specific regulatory framework and a risk based supervisory framework. Establishment of a super regulator to supervise and coordinate the activities of the multiple regulators. Speedy implementation of legal reforms to hasten debt recovery. Reducing CRR to international standards & phasing out SLR.
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2. Verma committee was one of the most controversial committee. Major recommendations were:
Greater use of information technology; even in weak public sector banks. Restructuring of weak banks but not merging them with the strong banks. Market driven merger sale of foreign branches. Closure of subsidiaries of weak public sector banks. VRS for at least 25% of the staff.
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The banking sector reforms aimed at:
Improving the policy framework by reducing the reserve requirements, changing the administered structure of lending rates, enlarging the scope of priority sector lending and linking the lending rates with the size of advances.
Improving the financial health by prescribing prudential norms. Improving the institutional infrastructure through recapitalization, infusing competition, and strengthening of supervisory system.
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The chief merit of the reform process is that the reform measures were undertaken and implemented gradually and cautiously. The first phase of the banking sectors is complete and the second generation reforms are under way. The second generation reforms are those that did not form part of the first generation reforms but needed to be prioritized in the agenda for the next decade. Many of the important recommendations of the Narasimham committee II have been accepted and are under implementation.
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The banking reforms concentrate on strengthening the foundation of banking sector by: Structure. Technological up gradation. Human resource development. And to move towards international best practices in the areas relating to: Banking policy, Institutional, Supervisory, and Legislation.
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Banking sector reforms
Phase I
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Recommendation of the committee of the Banking Sector Reforms, 1991, Narasimham committee I
Deregulation of the interest rate structure. Progressive reduction in pre-emptive reserves. Liberalization of the branch expansion policy. Introduction of prudential norms to oTo ensure capital adequacy, oProper income recognition classification of assets based on their quality, and oProvisioning against bad and doubtful debts. contt
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contt Decreasing the emphasis laid on directed credit and phasing out the concessional rate of interest to priority sector. Deregulation of the entry norms for the private sector banks and foreign banks. Permitting public and private sector banks to access the capital market. Setting up the asset reconstruction fund. Constituting the special debt recovery tribunals. Freedom to appoint chief executive and officers of the banks. Changes in the constitutions of the board. Bringing NBFCs under the ambit of regulatory framework.
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Recommendation of the committee of the Banking Sector Reforms, 1998, Narasimham committee II
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Capital adequacy
Capital adequacy ratio to be raised from 8% to 10% by 2002. 100% of fixed income portfolio marked-to-market by 2001 (up from 70%). 5% market risk weight for fixed income securities and open foreign exchange position limits (no market weights previously). Commercial risk weight (100%) to government guaranteed advances (previously treated as risk free).
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Asset quality
Banks should aim to reduce gross non-performing assets to 3% and net NPAs to 0% by 2002. 90 days overdue norm to be applied for cash-based income recognition (down from 180 days). Government-guaranteed irregular accounts to be classified as NPA & provided for. Asset Reconstruction Company to take on NPA of weak banks against issue of risk-free bonds. Directed credit obligations to be reduced from 40% to 10%. Mandatory general provisions of 1% of standard assets and specific provision to be made tax-deductible.
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Systems and methods
Banks to start recruitment of skilled, specialized manpower from the market. Overstaffing to be dealt with by redeployment and right-sizing via VRS. Public sector banks to be given flexibility in remuneration structure. Rapid introduction of computerization and technology.
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Industry structure
Only two categories of financial sector players to emerge: banks and non-bank finance companies; DFI to covert to banks or remain nonbanking companies. Mergers to be driven by market and business considerations, not imposed by regulators. Weak banks to convert to narrow banks, restructure, or close down if proven unviable. Entry of new private sector banks and foreign banks to continue. Banks to be given greater functional autonomy, and minimum government shareholding to be reduced to 33% from 55% for the SBI and 51% for other public sector banks.
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Regulation and supervision
Banking regulation and supervision to be progressively de linked from monetary policy. Board for financial regulation and supervision to be constituted with statutory powers; board members should be professionals. Greater emphasis on public disclosure as opposed to disclosure to regulators.
Legal amendments
Broad range of legal reforms to facilitate recovery of problem loans. Introduction of laws governing electronic funds transfer. Amendments in the Banking Regulation Act, the Nationalization Act and the State Bank of India Act to allow greater autonomy, higher private sector shareholding, and so on.
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Prudential Regulation
There are two modes for bank regulation:
Economic regulation, and Prudential regulation
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Economic regulation:
This model calls for: Imposing constraints on interest rates, Tightening entry norms, and directed lending. In the pre-reform era, the RBI regulated banks through economic regulation. However, the empirical evidences indicated that this model hampered the productivity and efficiency of the banking system. Hence, the RBI adopted prudential regulation.
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Prudential regulation
Prudential regulatory model calls for imposing the regulatory capital level to maintain the health of banks and the soundness of the financial system. It allows greater play for market forces than economic regulatory model. The RBI issued prudential norms based on the recommendations of the Narasimham committee report. The major objective of prudential norms was to ensure: Financial safety, Financial soundness, Solvency of banks. These norms strive to ensure that banks conduct their business activities as prudent entities, i.e., not indulging in excessive risk taking and violating regulations in pursuit of profit.
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Banking reforms were initiated by implementing prudential norms consisting of capital adequacy ratio, asset classification, income recognition, and provision. The core of financial sector reforms has been the broadening of prudential norms to the best internationally recognized standards.
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Capital Adequacy and Tier I and Tier II Capital
Banks are required to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures. Capital adequacy ratio is a measure of the amount of banks capital expressed as a percentage of its risk-weighted credit exposures. This capital framework was introduced for Indian scheduled commercial banks, based on the Basel Committee proposals (1998), which prescribe two tiers of capital for the banks: Tier I capital which can absorb losses without a bank being required to cease trading, and Tier II capital which can absorb losses in the event of a winding-up.
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Tier I or core capital (the most permanently and readily available support against unexpected losses) includes: Paid-up capital, statutory reserves, share premium. Capital reserve (representing surplus on sale of assets and held in a separate account only to be included) and other disclosed free reserves (if any) minus equity investments in subsidiaries, intangible assets, and losses in the current period, and those brought forward from previous periods.
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Tier II capital includes: Undisclosed reserves and fully paid-up cumulative perpetual preference shares. Revaluation reserves arising out of revaluation of assets that are undervalued in the banks books (like bank premises and marketable securities). General provisions and loss reserves, not attributable to the actual diminution in value or identifiable potential loss in any specific asset and available to meet unexpected losses. Hybrid debt capital instruments that combine characteristics of equity & debt. Subordinated debt that is fully paid up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses, and not redeemable at the initiatives of the holder or without the consent of the supervisory authority of banks. If subordinated debt carries a fixed maturity, it should be subject to progressive discounts and have an initial maturity of not less than 5 years. Tier II capital should not be more than 100% of tier I capital and subordinated debt instruments should be limited to 50% of tier I capital. Revaluation reserve should be applied a discount of 35% for inclusion in tier II capital. General provision/loss reserves should not exceed 1.25% of the total weighted risk asset.
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Banks will have to disclose any shortfall in their capital to depositors and all stakeholders. In order to provide additional options to banks for raising capital funds, the Reserve bank allowed them in January 2006 to issue instruments such as: a.Innovative perpetual debt instruments eligible for inclusion as tier I capital, b.Debt capital instruments eligible for inclusions as Upper Tier II capital, c.Perpetual non-cumulative preference shares eligible for inclusion as Tier II capital, and d.Redeemable cumulative preference shares eligible for inclusion as Tier II capital.
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Capital Adequacy Norms
Banks capital is vital as it is the lifeblood that keeps the bank alive; it also gives the bank the ability to absorb shocks and thereby, avoid the likelihood of bankruptcy. Capital adequacy ratio is a measure of the amount of a banks capital expressed as a percentage of its risk-weighted credit exposures. Capital adequacy ratio refers to the risk weight assigned to an asset raised by the banks in the process of conducting business and to the proportion of capital to be maintained on such aggregate risk weighted assets. The RBI stipulates a CAR of 9% for all banks.
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The Basel norm of capital adequacy was introduced in India following the recommendations of the Narasimham Committee (1991). Globally, the structure and operation of banks underwent a rapid transformation in the 1980s. This was due to a revolution in information technology, which led to an increase in competitive among banks and a fall in profitability of banks. As a result, there was a growing apprehension about the deteriorating levels of capital of the banks. Hence, the Basel Capital Adequacy Norms were enacted in 1988.
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The Basel Accord (1988) suggested the following principles of capital adequacy: A bank must hold equity capital at least 8 % of its assets when multiplied by appropriate risk weights. The four risk weight suggested by the Basel Committee was 0%, 1.6%, 4% and 8% for the various categories of assets. When capital falls below this minimum requirement, shareholders may be permitted to retain control provided they agree to recapitalize the bank. When this is not done, the regulatory authority may, at its discretion, sell or liquidity the banks.
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Initially, the RBI directed the banks to maintain a minimum capital of 8% on the risk-weighted assets. The Committee on banking sector reforms (1998) suggested further tightening of the capital adequacy. Subsequently the capital to risk-weighted asset ratio (CRAR) norm was revised upward to 9% to be attained by March 2000.
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The concept of capital adequacy ratio relates to risk weight assigned to an asset raised by the banks in the process of conducting business and to the proportion of capital to be maintained on such aggregate riskweighted assets. Capital adequacy ratio is calculated on the basis of risk weightages on assets in the books of banks. Each business transaction carries a specific risk and a portion of capital has to be earmarked for this risk. This portion acts as a secret reserve to cushion any possible future loss. Higher capital adequacy will drive banks towards greater efficiency and this could force banks to bring down operating costs. Capital adequacy enables banks to expand their balance sheet and strengthen their fundamentals, which, in turn, help the bank to mobilize capital at reasonable costs. Hence, quality and risk weightage of assets are the new important parameters which are crucial for the growth of banks.
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The RBI stipulates a CAR of 9% for all banks and a CAR below this stipulation indicates the inadequacy of a banks capital, compared to its assets (largely loan advanced and investments) weighted against the risk they carry. In other words, the capital for these banks does not match up to the risk profile of their advances.
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The New Basel Capital Accord
The bank for international settlement (BIS) is an international organization which fosters international monetary and financial cooperation and serves as a bank for Central banks.
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The Basel committee, established by the Central Bank Governors of the group countries at the end of 1974, meets regularly four times a year. It has about 30 technical working groups and task forces which also meet regularly. India is a member of G-20 countries that advises the Financial Stability Forum (FSF). The Core Principle Liaison Group set up the Basel Committee on Banking Supervision (BCBS) to promote and monitor principles of banking supervision and the working groups on capital, which discusses proposals for revising the capital adequacy framework. India is also an early subscriber to the Special Data Dissemination Standards (SDDS) and one of the first countries to accept the financial sector assessment programme of the IMF and the World Bank.
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Different central banks in their own respective countries governed the banks by the rules set by them. International banks had to adhere to different regulations in different countries. To provide a level playing field for banks, the group of 15 most industrialized countries agreed on some common rules which came to be known as Basel Accord. The central banks of more than 100 countries adopted it over a period of time. The problems in South-east Asian economies, recessionary trends in the Japanese economy, the financial sector problems encountered in Latin American economies, and some in European economies emphasized that capital adequacy norms were not adequate to hedge against failures.
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These norms (1988) helped to arrest the erosion of the banks capital ratios. However, they were not found to be adequate due to their perceived rigidities. Moreover, the financial markets, financial intermediaries, business of banking, risk management practices, and supervisory approaches have undergone significant changes. These baseline capital adequacy norms were found to be inadequate as they almost entirely addressed credit risk. In response to the same, the BCBS brought out their Consultative paper on New Capital Adequacy Framework in June 1999 and a second revision in January 2001 after an informed public debate. The new rules have been effective from 2005. The BCBS announced the establishment of an Accord Implementation Group.
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Basle Accord I & II - Differences
Talks of Credit Risk only Capital Charge for Credit Risk 8% Does not mention separate Capital charge for Market and Operational Risk No mention about market Discipline No effort to quantify Market and Operational Risk
Talks of Credit, Market and Operational Risks Capital Charge dependant on Risk rating of assets Capital Charge to include risks arising out of Credit, Market and Operational risks. Not a broad brush approach Quantitative approach for calculation of Market and Operational risks as for Credit Risk.
Basel II Accord- Need & Goals
Linking of risks with capital in terms of Basel Accord I needed a revision for the following reasons: - Credit assessment under Basel I is not risk sensitive enough. One Suit fit all approach was applied to all types of entities with uniform 100% risk weightage. - Risk arising out of operation were ignored though it has potential of affecting the banks survival.
The primary objectives of the new accord are: 1.The promotion of safety and soundness of the financial system, 2.The enhancement of competitive equality, 3.The constitution of a more comprehensive approach to addressing risk.
The New Basel Accord is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that the banks face. The Basel II Accord is based on three pillars: Minimum Capital Requirement Supervisory review process & Market discipline
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Three pillars of the Basel II framework
Minimum Capital Requirements
Supervisory Review Process
Market Discipline
Credit risk Operational risk Market risk
Banks own capital strategy Supervisors review
Enhanced disclosure
Three Pillars of Basel II
Minimum Capital Supervisory Review Market Discipline
The new Basel Accord is based on Three Pillars
Focus on Advanced internal methods for capabilities capital Supervisors to allocation review banks Capital charge internal for operational assessment risk and strategies
Focus on disclosure
40
Framework
The New Basel Capital Accord focuses on the following: Minimum capital requirements, which seek to refine the measurement framework, set out in the 1988 accord.
Supervisory review of an institutions capital adequacy and internal assessment process.
Market discipline through effective disclosure to encourage safe and sound banking practices.
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Pillar I-Minimum capital requirement (Measurement of Risk)
The new framework maintains both the current definition of capital and the minimum requirement of 8% of capital to risk weighted assets. The revised accord will be extended on a consolidation basis to holding companies of banking groups. The accord stresses upon the improvement in the measurement of risks. The new accord has elaborated the credit risk measurement methods and emphasized the measurement of operational risk.
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Minimum Capital Requirement Pillar One
Standardized Internal Ratings Credit Risk Credit Risk Models
Credit Mitigation
Trading Book Market Risk Banking Book
Risks
Operational Other Risks
Other
Pillar I Minimum Capital Requirements
The new Accord maintains the current definition of total capital and the minimum 8% requirement*
Total capital = Banks capital ratio Credit risk + Market risk + Operational risk (minimum 9%)
Total Capital
Total capital = Tier 1 + Tier 2 Tier 1: Shareholders equity + disclosed reserves Tier 2: Supplementary capital (e.g. undisclosed reserves, provisions) The risk of loss arising from default by a creditor or counterparty The risk of losses in trading positions when prices move adversely The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events
Credit Risk Market Risk
Operational Risk
* The revisions affect the denominator of the capital ratio - with more sophisticated measures for credit risk, and introducing an explicit capital charge for operational risk
Capital Requirement What New?
1. Minimum Capital RequirementsCredit Risk (Pillar One)
Standardized approach (External Ratings) Internal ratings-based approach
Foundation approach Advanced approach
Minimum Capital Requirement
Credit risk modeling (Sophisticated banks in the future)
The Basel II has recommended three approaches for estimating capital for credit risk: The standardized approach: expands the scale of risk weights and uses external credit ratings to categorize credits. This approach can be employed by less complex banks. The foundation internal risk based (IRB) approach: by more complex banks having more advanced risks management capabilities. This approach allows the banks to use its internal estimates of the borrowers creditworthiness to assess credit risk in the portfolio subject to strict methodological and disclosure standards. One of the most noteworthy features of Basel II is assigning capital charge for operational risk. Three approaches namely, basic indicator (BI), standardised (SA) and advanced measurement (AMA) approaches have been recommended for estimating capital for operational risk. The advanced internal risk based (AIRB) approach: calls for significant investment as compared to the other two approaches.
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Internal Ratings Based Approach
Exposures in five categories because of different risk characteristics
Sovereigns Banks Corporates Retail NPA
Evolutionary Structure of the Accord
Credit Risk Modeling ?
Advanced IRB Approach Foundation IRB Approach
Standardized Approach
Pillar I Credit Risk
Pillar 1 Credit Risk stipulates three levels of increasing sophistication. The more sophisticated approaches allow a bank to use its internal models to calculate its regulatory capital. Banks who move up the ladder are rewarded by a reduced capital charge
Advanced Internal Ratings Based Approach Foundation Internal Ratings Based Approach
Banks use internal estimations of PD, loss given default (LGD) and exposure at default (EAD) to calculate risk weights for exposure classes
Standardized Approach
Banks use internal estimations of probability of default (PD) to calculate risk weights for exposure classes. Other risk components are standardized.
Risk weights are based on assessment by external credit assessment institutions
Reduce Capital requirements
The New Basel Capital Accord
Standardized Approach
Provides Greater Risk Differentiation than 1988 Risk Weights based on external ratings Five categories [0%, 20%, 50%, 100%, 150%] The loans considered past due be risk weighted at 150 percent unless a threshold amount of specific provision has already been set aside by the bank against the loan Special treatment for Retail & SME sectors
Standardized Approach: New Risk Weights (January 2001)
Assessment Claim AAA to A+ to A- BBB+ to AASovereigns Banks Option 11 Option 22 0% 20% 20% 20% 20% 50% 50%3 50% (100%) BBB50% 100% 50%3 100% BB+ to Below BB- Un-rated BB- (B-) 100% 100% 100%3 100% (B-) 150% 150% 150% 150% 100% 100% 50% 3 100%
Corporates
1 2
Risk weighting based on risk weighting of sovereign in which the bank is incorporated.
Risk weighting based on the assessment of the individual bank.
Claims on banks .of a short original maturity, for example less than six months, would receive a weighting that is one category more favourable than the usual risk weight on the banks claims
3
The New Basel Capital Accord
Capital for Credit Risk- Internal Rating Based
Approach:
Three elements:
Risk Components [PD, LGD, EAD] Risk Weight conversion function Minimum requirements for the management of policy and processes Emphasis on full compliance EL (Expected Loss) = PDxLGDxEAD
Definitions;
PD = Probability of default LGD = Loss given default EAD = Exposure at default Note: BIS is Proposing 75% for unused commitments EL = Expected Loss
The New Basel Capital Accord
Market Risk: (a) Standardised Method (i) Maturity Method (ii) Duration Method (b) Internal Models Method
What is Operational Risk?
Earlier stood for non-financial risks Current Basel II definition is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events
Basel II definition
Cont Includes both internal and external event risk Legal risk is also included, but reputational risk not included Direct losses are included, but indirect losses (opportunity costs) are not
Examples of OR Loss Events
Types of OR*
Internal Fraud
Examples
Unauthorized transaction resulting in monetary loss Embezzlement of funds Branch robbery External Fraud Hacking damage (systems security) Employment Practices & Employee discrimination issues Workplace Safety Inadequate employee health or safety rules Money laundering Clients, Products & Business Lender liability from disclosure violations or Practices aggressive sales Natural disasters, e.g. earthquakes Damage to Physical Assets Terrorist activities Business Disruption and Utility outage (e.g. blackout) System Failures Data entry error Execution, Delivery & Incomplete or missing legal documents Process Management Disputes with vendors/outsourcing * Based on Basel Committees OR loss event classification
The New Basel Capital Accord
Capital Charge for Operational RiskAs in credit, three alternate approaches are prescribed: - Basic Indicator Approach - Standardised Approach - Advanced Measurement Approach
1). Basic Indicator Approach (Capital Charge for Operational Risk)
To begin with, RBI has advised bank to follow Basic Indicator Approach in India which is 15% of the average Gross Income over three year.
KBIA = [ (GI*) ] / n, Where KBIA = the capital charge under the Basic Indicator Approach. GI = annual gross income, where positive, over the previous three years = 15% set by the Committee, relating the industry-wide level of required capital to the industry-wide level of the indicator. n= number of the previous three years for which gross income is positive
Gross income = Net profit (+) Provisions & Contingencies (+) operating expenses (Schedule 16) (-) profit on sale of HTM investments (-) income from insurance (-) extraordinary / irregular item of income (+) loss on sale of HTM investments.
2). Standardized Approach (the betas) Capital = b*gross income, by business line
Standardized / Alternative Standardized
Banks activities divided (mapped) into 8 business lines Capital charge is sum of specified % (beta) of each business lines average annual gross income over previous 3 years* Beta varies by business line (12%-18% range) General criteria required to qualify for its use
Active involvement of Board and senior management in OR management framework Existence of OR management function, reporting and systems Systematic tracking of OR data (including losses) by business line OR processes and systems subject to validation and regular independent review by internal and external parties
Advantages/ Disadvantages
Strength:
Simplicity
Limitations:
Blunt charge, not risk-sensitive:
One size fits all Risk does not increase linearly with gross income
Fails to capture effect of banks management of operational risk
No incorporation of qualitative factors No incentive for banks to invest in op risk infrastructure
3) Advanced Measurement Approach (AMA)
(Capital Charge for Operational Risk) Capital = firm specific calculation, statistically based methodology Intended to overcome the lack of risk sensitivity in the simpler approaches by setting regulatory capital based on the banks internal risk measurement models These models use the banks own metrics to measure operational risk, internal loss data, external loss experience, scenario analysis, and risk mitigation techniques to set capital commensurate with the operational risk posed by the banks activities
ADVANTAGE
COMPARING OPERATIONALRISK WITH MARKET RISK AND CREDIT RISK
Market Risk Quantifiable exposure Exposure measure Portfolio completeness Context dependency Data frequency Risk assessment Accuracy Testing Yes Position; Risk sensitivity Known Low High VAR; Stress testing; Economic risk capital Good Adequate data for backtesting Instability of underlying price volatility; Correlation instability in stressed markets Market risk models well established and proven tools Credit Risk Yes Money lent; Potential exposure Known Medium Medium Rating models; Loss models; Economic risk capital Reasonable Backtesting difficult to perform over short term Many issues: correlations, ratings through time, data lumpy Using models considered reasonable but should be used with care Operational Risk Difficult1 Difficult no ready position equivalent available1 Unknown High Low No industry consensus; top-down scenarios may be useful Low Results very difficult to test over any time horizon Results could be misleading; distraction effect; false reliance; lack of cause and effect; redundant systems Models appear flawed
Usage issues
Summary
New Basel Accord II: supervisory review process-
Defines the role of supervisors with regard to capital adequacy
Pillar II
Pillar II-Supervisory Review Process (Assessment of Risk)
This process emphasizes the need for banks to develop sound internal processes to assess the capital adequacy based on a thorough evaluation of its risks and set commensurate targets for capital. The internal processes would then be responsible for evaluating the way the banks are measuring risks and the robustness of the systems and processes.
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The four basic and complementary principles on which the Pillar 2 rests are: a.A bank should have a process for assessing its overall capital adequacy in relation to its risk profile as well as a strategy for maintaining its capital levels; b.Supervisors should review and evaluate a banks internal capital adequacy assessment and strategy as well as its compliance with regulatory capital ratios; c.Supervisors 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; and d.Supervisors should seek to intervene at an early stage to prevent capital from dipping below prudential levels.
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Implementation of Pillar II requires that a comprehensive assessment of risks be carried out by both the banks (internally) and the supervisor (externally). A Board for Financial Supervision has been set up with an Advisory Council to strengthen the supervisory system of banks and an independent Department of Banking Supervision has been set up in the RBI to assist the board
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New Basel Accord II: Market Discipline
Disclosure requirements that allow market participants to assess key information about a banks risk profile and level of capitalisation.
Pillar-III
Pillar III-Market Discipline (Disclosure/Transparency)
Market discipline can be bolstered through enhanced disclosure by banks. The new framework sets out disclosure requirements in several areas, including the way in which banks calculate their capital adequacy and their risk assessment methods. The transparency and disclosure standards recommended in the IAS have been implemented in a phased manner. Banks are required to ensure that there are no qualifications by the auditors in their financial statements for non-compliance with any of the standards. Banks are now required to disclose maturity pattern of deposits, borrowings, investments, advances, foreign currency assets and liabilities, movements in NPA, lending to sensitive sectors, total investments made in equity share, convertible debentures and equity oriented mutual funds and movement of provisions held towards depreciation of investments.
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Basel I Focused on Single risk Measure
Basel II
More emphasis on banks own internal risk management methodologies, supervisory review and market discipline
Flexibility; Menu of approaches; Capital incentive for better risk management; Granularity in the valuation of assets and type of business and in the risk profile of their systems and operations More risk sensitive; multi-dimensional; focus on all operational components of banks
One-size-fits- all
Broad Brush structure
Table 1: Comparison of Basel I and Basel II standards Source: The new Basel capital accord: an explanatory note, BIS Ankur srivastava srivankur@rediffmail.com 09212803190
