Basel II norms and preparedness of Indian banks

This article seeks to explore various dimensions of issues and problems that banking system might encounter after implementation of Basel II norms. To determine these issues and problems we will delve into various aspects of current banking system like role of central bank in implementing policy changes, complexity of the banking system in terms of assortment of banks of various sizes, importance in economy, geographical spread etc and current state of preparation to implement policy changes.

· Basel II – Modification of Basel I
Basel II is a modification of Basel I accord. The present accord has been criticized as being inflexible due to its focus on primarily credit risk and treating all types of borrowers under one risk category regardless of credit worthiness. The major criticism against the existing accord stems from its
• Broad brush approach – irrespective of quality of counter party or credit
• Encouraging regulatory arbitrage by cherry picking
• Lack of incentives for credit risk mitigation techniques
• Not covering operational risk
Therefore Basel committee proposed new norms which provide solutions of aforesaid problems. The newly proposed norms called as Basel II comprise of three important aspects which are termed as three pillars of Basel II. These are basically
1. Minimum Capital Requirements
2. Supervisory Review Process
3. Enhanced Disclosure


· Approach of RBI to the Basel II accord
RBI has designed a detailed road map for convergence of the banks to Basel II norms .This road map has been designed after due consultation with the banks .Banks were asked to decide upon the best alternative available to them for implementing Basel II norms and after considering this guidelines are prepared. These guidelines give due weight age to size of banks, complexity of operation, and availability of resources for implementation of these norms. Hence RBI has to formulate different guidelines for these banks which are at different stages of implementation of Basel II guidelines. For this RBI has formed a steering committee to suggest migration methodology to Basel II. Based on recommendation of steering committee RBI has proposed the “Draft guidelines for implementing new capital adequacy framework” covering the capital adequacy guidelines of the Basel II accord. These guidelines are with different level of stringency in terms of capital adequacy requirement.



· Indian banks and Basel II – Analysis of preparedness

I. General state of prepared ness: majority of the banks are confident of meeting deadline. MIS remain a major concern of majority of the banks.

II. Capital requirement: 54% of the banks are technologically equipped for Basel II norms implementation and have placed core banking solutions. 87 percent of respondent banks have already estimated the incremental capital required for this purpose in their organization. 27 per cent banks expect their capital requirements to increase by 1-2 % while 20 per cent banks expect their capital requirements to increase by more than 3 % during the implementation stage of Basel. Banks also predict that their capital requirement will increase after implementation of Basel II norms.


III. Impact on credit: 87percent of the respondent banks quoted that increased capital requirements imposed by the Basel accord will not make their banks more risk averse towards credit dispensation. Merely 13% felt that implementation of Basel II could have an
adverse impact on banks lending to commercial sector. Small and Medium enterprises and Farm and rural sectors are likely to be the most affected sectors.



· Issues and challenges for Indian banks: The issues and challenges that Indian banks might face after implementation of Basel II norms can be classified as Capital adequacy related, supervision related and disclosure related. All the issues under these heads are discussed in details in following part of the research paper.

· Conclusion: Implementation of Basel II has been described as a long journey rather than a destination by itself. Undoubtedly, it would require commitment of substantial capital and human resources on the part of both banks and the supervisors. RBI has decided to follow a consultative process while implementing Basel II norms and move in a gradual, sequential and co-coordinated manner. For this purpose, dialogue has already been initiated with the stakeholders. A steering committee comprising representatives of banks and different supervisory and regulatory departments is taking stock of all issues relating to its implementation. As envisaged by the Basel Committee, the accounting profession too, will make a positive contribution in this respect to make Indian banking system stronger.