Basel II, builds on the current framework to align regulatory capital requirements more closely with underlying risks

and provide several options for assessment of capital adequacy. Basel II is based on three mutually reinforcing pillars Pillar I : Minimum capital requirements, Pillar II : Supervisory review, and Pillar III : Market discipline. Pillar 1, Minimum capital requirment Three distinct options are available for computation of Capital requirement for Credit risk and Operational Risk based on increasing risk sensitivity perceived. Options for Credit Risk are o Standardised Approach, o Foundation Internal Rating Based Approach and o Advanced Internal Rating Based Approach. Options for operational risk are o Basic Indicator Approach, o Standardised Approach and Advanced Measurement Approach Minimum Standard Minimum Standard to to have consistency and harmony with international standards RBI has stipulated adoption by all Banks. Standardized Approach for credit risk and Basic Indicator Approach for operational risk made mandatory by all Banks. Some banks may be allowed to migrate to IRB Approach after obtaining the specific approval of Reserve Bank (likely w.e.f. 2014). Banks had a parallel run of the revised Framework with effect from April 1, 2006. Standardised Approach Bank allocates a risk-weight to each of its assets and off-balance sheet positions. The capital charge is equal to 8% - risk weight of 100% This approach, is same as in Bassel I, however, includes a higher sensitivity to risk. Difference between Bassel I & Bassel II is Bassel I -individual risk weights were dependent on the category of borrowers such as sovereign nations or banks. In Basel II these weights can be defined by referring to a rating provided by an external credit assessment agency and approved collaterals. Basic Indicator Approach Banks must hold capital for operational risk equal to the average over the previous three

years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average. If negative gross income distorts a banks Pillar 1 capital charge, RBI will consider appropriate supervisory action under Pillar 2. Pillar 2 Supervisory and Review Process

Capital, based on a thorough evaluation of its risks and sound processes at each bank. Development of an internal capital assessment process. Capital corresponding with the banks risk profile and control environment. RBI to review the process - minimum qualifying standards, reviewing operations and processes in trading, Internet Banking and Security Processing. III Pillar Market Discipline

The purpose of Market discipline (Pillar 3) is to complement the minimum capital requirements (Pillar I) and the supervisory review process (Pillar 2). The aim is to encourage disclosures which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.