The Chartered Accountant

AUDITING
Pillar 3 of Basel II purports to enforce market discipline through stricter
disclosure requirement. While admitting that such disclosure may be useful
for supervisory authorities and rating agencies, the expertise and ability of
the general public to comprehend and interpret disclosed information is
open to question. Moreover, too much disclosure may cause information
overload and may even damage financial position of bank.
record. Basel II has introduced the concept of 5
different risk weights - 20 per cent, 30 per cent,
50 per cent, 100 per cent and 150 per cent. For
the highest rated borrower, banks need to keep
only 20 per cent of 8 per cent or 1.6 per cent (8x
20 per cent) of the credit exposure as capital.
The RBI has retained the higher base level of 9
per cent against world level of 8 per cent. These
risk weights apply in tandem with credit rating
given by our accredited rating agencies who decide
the fate of the borrower. If a bank wishes
to have pity on an unrated borrower, it can do so
by keeping in more risk capital in its warehouse.
l Basel I gave no weightage to availability of security
for credit facility which has been given due
consideration in the new accord.
l Basel I prescription of allowing banks keep same
risk capital irrespective of the maturity profile
of the loan has been eroded by Basel II making
some distinction between short and long-term
loans given by banks.
l Basel I encouraged regulatory arbitrage 2 by cherry
picking which has been given no scope in Basel
II.
l The risk assessment specific to the bank, disclosures
and reporting have been emphasized by
Basel II accord through the Pillar 2 and Pillar 3.
l The new dimension of operational risk which
had gone unnoticed by Bank of International
Settlements (BIS) earlier is now being given its
due share of accreditation.
As per the RBI guidelines, Indian banks having foreign
branches and foreign banks operating in India had to
adopt the regulations under Basel II by March 31, 2008.
Except local area banks and regional rural banks, all the
other commercial banks will have to migrate to Basel
II by March 31, 2009. The Reserve Bank has adopted a
three-track approach to capital adequacy regulation in
India with the norms stipulated at varying degrees of
stringency for different categories of banks given the
variations in size, nature and complexity of operations
and relevance of different types of banks to the Indian
financial sector. Accordingly, commercial banks, which
account for a major share in the total assets of the
banking system and are Basel II standards compliant,
would be on Track I, banks which are Basel I compliant
would be on Track II and banks which are in the nature
of local community banks would be on Track III. We
are a quarter up in the financial year 2008, hence the
pertinent questions to raise are-
l Has over enthusiastic RBI which had been adamant
on imposing rigorous Basel norms which
by far exceed in severity than the ones prescribed
by BIS actually succeeded?
l Are our Indian banks actually ready to pose a
threatening competition to the global banking
giants?
There are too many questions to be raised but the answers
are few.
issues with implementation
rising Cost Curve
For Banks, the term ‘Non-Performing Assets’ rings an
alarm bell. NPAs have largely been reduced by provisioning
for bad debt or by infusion of capital from Government
or other sources. But, with the implementation
of Basel II norms, banks appetite for additional capital
has increased and they are busy in arranging for capital
outside of their own or the Government resources. In
ICRA’s 3 estimates, Indian banks would need additional
capital of up to Rs.120 billion to meet the capital requirement
for operational risk. Looking at the asset growth
witnessed in the past and the expected growth trend,
the capital charge requirement 4for operational risk will
grow by 15-20 per cent annually over three years.
2Regulatory arbitrage is where a regulated institution takes advantage of the difference between its real (or economic) risk and the regulatory
position. For example, if a bank, operating under the Basel I accord, has to hold 8% capital against default risk, but the real risk of
default is lower, it is profitable to securitize the loan, removing the low risk loan from its portfolio. On the other hand, if the real risk is
higher than the regulatory risk then it is profitable to make that loan and hold on to it, provided it is priced appropriately.
3
This estimate has been derived from ICRA 2005 report, analysis of which is based on banks financials till financial year end 2004-05.
Hence, it would be advisable to take into account the surge in banks loan portfolios and credit growth post 2006 to revise this gross
estimate upwards.
4Capital charge for operational risk is equal to the average of 15% of annual positive gross income over the past three years, excluding
any year when the gross income was negative. Gross income is defined as net interest income and non-interest income, grossed for any
provisions, unpaid interest and operating expenses (such as fees for outsourced services). It should only exclude treasury gains/losses
from banking book and other extraordinary and irregular income (such as income from insurance).
THE CHARTERED ACCOUNTANT 979 DECEMBER 2008