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Rasleen Kaur 

Sakshi Goenka

Abhishek passi

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Introduction

Second of the Basel Accords

Issued by Basel Committee on Banking

Supervision in 2004 Capital a bank should set aside to guard

against :

- financial risk

- operational risk

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Objectives

To have enough capital on account to

meet obligations and absorb unexpected

losses

To ensure capital allocation is more risk

sensitive

To separate operational risk from credit

risk

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Three pillars

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Pillar I - Min. Capital Req.

Market Risk :

Risk of losses in on and off balance-

sheet positions arising from movementsin market prices

Factors contributing:

y Equity

y interest rate

y foreign exchange

y commodity risk

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Pillar I (contd.)

Credit Risk:

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Operational Risk:

Loss resulting from inadequate or failed

Internal processes

People

Systems or 

External events

Pillar I (contd.)

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Calculation of CAR

CAR = Total Capital

Risk weighted assets

Total capital = Tier I Capital + Tier II Capital

y Tier I Capital = Ordinary Capital+ Retained

Earnings& Share Premium - Intangible assets

y Tier II Capital = Undisclosed Reserves+ General

Bad Debt Provision+ Revaluation Reserve +

Subordinate debt+ Redeemable Preference shares

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Capital Adequacy Ratio

Indicates a bank's risk-taking ability

To check availability of enough capital toabsorb unexpected losses or risks

involved Higher the risk, more the capital back up

required

Basel I: CAR based only on credit risk Basel II: CAR based on market, credit

and operational risk

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Minimum Requirement of CAR

8% is prescribed Capital Adequacy Norm

CAR= 9% (Scheduled Commercial Banks)

CAR = 10% (New Private Sector Banks)

CAR = 10% (Banks undertaking Insurance

Business)

CAR =15% (Local Area Banks)

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Pillar II-Supervisory Review

To adopt better risk management techniques

To mandate a higher capital requirement

Risks covered:

CR,MR,OR

Credit concentration risk

Interest rate risk in banking book

Liquidity risk

Business risk

Strategic risk

Reputation risk

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Pillar III- Market Discipline

Disclosure for market discipline

Monitoring by banks, depositors,

analysts, rating agencies

For bank¶s capital adequacy assessment

Qualitative disclosures (risk managementobjectives and policies, definitions)

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Capital Arbitrag e and Core Eff ect 

of Basel II Regulatory arbitrage

Securitization

Example:Bank with portfolio of commercial loans withthe following ratings and internally generatedcapital requirements

 ± AA-A: 3%-4% capital needed

 ± B+-B: 8% capital needed ± B- and below: 12%-16% capital needed

Basel II: bank has to hold 8% risk-basedcapital against all loans

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Bank Loan Rating  and Basel ² II

Capital provided by bank against a loan

is based on credit rating assigned

Higher the credit rating, lower the risk

weight

Weaker companies affected:

Charged a higher rate of interest

 Approach another bank charging a lower 

rate of interest

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Implementation of Basel II(India)

Indian banks to ensure full

implementation of Basel II guidelines by

March 31, 2009

The minimum CAR in India placed at 9% 

(1% above the Basel II requirement)

Non-compliance attracts RBI action

(restricting lending and investmentactivities)

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SWOT Analysis of Basel II

Strengths

 Aggression towards development of 

existing standards by banks

Strong regulatory impact by central bank to

all banks for implementation

Weaknesses Ineffective risk measures

Unfavourable for smaller banks

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SWOT Analysis (contd.)

Opportunities

Increasing risk management expertise

Need significant connection among business,credit and risk management and informationtechnology

Strong asset base would help in growth

Threats

Inability to meet the additional capitalrequirements

Loss of capital to the entire banking system,due to mergers and acquisitions

Huge investments in technologies

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Ref erences

³The Evolution to Basel II´ by Donald

Inscoe

³Basel II ± Challenges Ahead of the

Indian Banking Industry´ by Jagannath

Mishra

Web References:

http://www.bis.org

http://www.rbi.org.in

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