Basel norms and Indian banking system This article discusses about the various features of basel norms

, its need for the banks , and its scenario in Indian banking system. The globalization of banking system in india has attained vital importance. Banking complexities in banking transactions, capital requirements, liquidity, credit and risks associated with them are increasing on a day to day basis . the world trade organization , of which india is a member nation, requires the countries like india to get their banking system at par with the global standards in terms of financial health, safety and transparency, by implementing the basel II norms by 2009. BASEL COMMITTEE The basel committee on banking supervision provides a forum for regular co-operation on banking supervisory matters. Its objective is to enhance understanding of supervisory issues and improve the quality of banking supervision world wide. It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with the view to promoting common understanding . the committees secretariat is located at the Bank For International Settlements (BIS) in basel , Switzerland. Need For Such Norms The first accord by the name basel accord I was established in 1988 and was implemented by 1992. It was the very first attempt to introduce the concept of minimum standards of capital adequacy. Then the second accord by the name basel accord II was established in 1999 with a final directive in 2003 for implementation by 2006 as basel II norms. Unfortunately, india could not fully implement this but , is now gearing up under the guidance from the reserve bank of india to implement it from 1st April 2009. Basel II norms have been introduced to overcome the drawbacks of basel I accord. For Indian banks its the need of the hour to buckle up and practice banking business at par with global standards and make the banking system in india more reliable, transparent and safe. These norms are necessary since india is and will witness increased capital flows from foreign countries and there is increase cross border economic and financial transaction. Features of basel II norms

Basel II norms are considered as the reformed and refined form of basel I accord. The basel II norms primarily stress on three factors, viz. capital adequacy, supervispory review and market discipline. The basel committee call these factors as the three pillars to manage risk Pillar I: Capital adequacy requirements Under the basel two norms, bank should maintain a minimum capital adequacy requirement of 8% of risk assests. For india, the reserve bank of india has mandated maintaining of 9% minimum capital adequacy ratio (CAR) or capital to risk weighted assests ratio (CRAR)

Pillar II: banks majorly encounter with 3 risks, viz. credit, operational and market risks. Basel II norms under this pillar wants to ensure that not only banks have adequate capital to support all the risks, but also to encourage them to develop and use better risk management techniques in monitoring and managing their risks. The process has four key principles: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and the strategy for monitoring their capital levels Supervisor should review and evaluate banks internal adequacy assessment and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks hold capital in excess of the minimum. Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum level and should require rapid remedial action if capital is not mentioned or restored. Pillar III: market discipline imposes banks to conduct their banking business in a safe, sound and effective manner. mandatory disclosure requirements on capital, risk exposure (semi annually or more frequently, if appropriate) are required to be made so that market participants can assess a banks capital adequacy. Qualitatative disclosures such as risk management objectives and policies, definitions etc. may also be published. The process of implementing basel II norms in india is being carried out in phases. Phase I has been carried out for foreign banks operating in india and Indian banks having operational presence outside india with effect from March 31 2008. In phase II, all other scheduled commercial banks ( except local area banks and RRBs) will have to adhere to bael II guidelines by March 31 2009. With the deadline of March 31 2009 for full implementation of basel norms fast approaching, banks are looking to maintain a cushion in their respective capital reserves. The minimum CRAR in india is placed at 9%, one percentage point above the basel II requirements. All the banks have their

CRAR above the stipulated requirement of basel guidelines (8%) and RBI guidelines (9%). As per the basel II norms , Indian banks should maintain tier I capital of atleast 6%. The government of india has emphasized that the public sector banks should maintain CRAR of 12%. For this, it announced measures to re-capitalize most of the public sector banks , as these banks cannot dilute stake further, as the government is required to maintain a stake of minimum 51% in these banks.

Capital to risk weighted assets ratio (CRAR) is also known as capital adequacy ratio which indicates a banks risk-taking ability. The RBI uses CRAR to track whether a bank is meeting its statutory capital requirements and is capable of absorbing a reasonable amount of loss. CRAR = (Tier I capital + Tier II capital)/risk weighted assets

Capital funds are broadly classified as Tier 1 and tier2 capital. Two types of are measured: tier one capital, which absorbs losses without a bank being required to cease trading , and tier two capital, which absorbs losses in the event of winding up and so provides a lesser degree of protection of depositors. Tier I capital (core capital) is the most reliable form of capital. The major components of Tier I capital are paid up equity share capital and disclosed reserves viz. statutory reserves, general reserves, capital reserves ( other than revaluation reserves) and any other type of instrument notified by the RBI as and when for inclusion in Tier I capital. Examples of Tier 1 capital are common stock, preferred stock that is irredeemable and non-cumulative, and retained earnings. Tier II capital (supplementary capital) is a measure of a banks financial strength with regard to the second most reliable forms of financial capital. It consists mainly of undisclosed reserves, revaluation reserves, general reserves, general provisions, subordinated debt, and hybrid instruments. This capital is less permanent in nature.

6. Basel III and Indian banks Indian banking industry emerged unscathed from the global financial crisis of 2007-09 and remained sound and resilient. The primary factor behind our banks resilience during these testing times was the strength they had acquired from various structural reforms since 1991 and the cautious and vigilant approach of the RBI as a banking regulator and supervisor. The strength in the balance sheets of indian banks is partly attributed to their satisfactory capital adequacy and partly to their greater exposure to conventional domestic assests rather than to exotic structured products like subprime mortgages.