Final PRoj Basel

The Analysis of Basel Norms and Implementation
KLE SOCEITY’s
INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH,
VIDYANAGAR, HUBLI.
MASTERS OF BUSINESS ADMINISTRATION

( Recognised and Affiliated to Karnataka University Dharwad)
Project on
“The Analysis of Basel Norms and its implementation”
Undertaken At
State Bank of India,
Main Branch,
Dharwad
Internal Guide Company Guide

Prof: Prashanth.C Mr.Subramanya
Faculty Chief Manager
KLE’s IMSR State Bank of India
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KLE’s Institute of Manageent Studies of Research MBA IV Sem
Hubli Dharwad
DECLARATION
I, Miss Shveta.R.Chikkamath hereby declare that the project for MCP

title
“ The Study of Basel Norms and its implementation” at State Bank of
India, Main Branch Dharwad submitted in fulfillment of the
requirement for the degree of “ Master of Business Administration” by
Karnataka University Dharwad, is correct and by my own effort and is
submitted elsewhere for the award of any degree.
Date:
Place: ( Shveta.R.Chikkamath)
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ACKNOWLEDGEMENT
All my efforts will be meaningless, if I don’t express my sincere gratitude to the
authorities, who rendered their support and guided me more than what I had expected
from them, while carrying out my project. First and foremost I extend my heartfelt
gratitude to our State Bank of India, Chief Manager Dharwad for giving me an
opportunity to undertake my project in this prestigious bank.
I express my sincere gratitude to Sir R.S. Prakash, Faculty Training Centre SBI and also
Sir, Prasad Faculty Training Centre State Bank of India for their valuable support.
I also express my gratefulness to Miss Shailaja. M.S Chief Manager, SBI Zonal Office.
I also thank all SBI staff for supporting me in one or the other way.
Dr.M.M.Bagali, I/c Director KLE’s Institute of Management Studies and Research for
his encouragement in carrying out the project.
I extend gratefulness to Prof Prashanth. C my institute guide his guidance.
Lastly, I’m immensely grateful to my family and friends who have directly or indirectly
Strived hard from commencement to completion of my project.
\
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TABLE OF CONTENTS
S.NO INDEX Page No
1. EXECUTIVE SUMMARY 6-9
2. INDUSRTY PROFILE 11-26
3 COMPANY PROFILE 28-33
4 The Analysis of Basel Norms and Implementation
6 Background of Basel Accord 35-51
7 BASEL I 53-57
8 LOOPHOLES OF BASEL I 58
9 OBJECTIVES OF BASEL II 62-64
10 BASEL II GUIDELINES 65-66
11 BASEL II FRAMEWORK 67-68
12 CATEGORIES OF RISK 69-86
13 CHALLENGES FOR INDIAN BANKING UNDER 87-90
BASEL II
14 CHALLENGES FOR SBI 91
15 MIGRATION TO BASEL BY SBI 92-93
16 IMPACT OF BASEL NORMS ON INDIAN BANKS 94-98
17 IMPACT OF BASEL NORMS ON SBI 99
18 RELATION BETWEEN BASEL I & BASEL II 100
19 CONCLUSIONS 101
20 FINDINGS 102
21 SUGGESTIONS & LIMITATIONS 103
22 BIBLIOGRAPHY 105
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EXECUTIVE SUMMARY
In 1988 the Bank for International Settlements’ Basel Committee on Banking

Supervision, commonly known as the Basel Committee, imposed the Basel
Capital Accord. The Basel Capital Accord introduced a system for
implementing a credit risk framework for determining the minimum amount of
capital that a bank must hold as a cushion against risks. The Basel Capital
Accord was adopted over time not only in member countries, but in virtually all
countries operating international banks.
One problem with the original Basel Capital Accord was that it took a "one size
fits all" approach, without regard for the actual operational risk incurred by the
bank. In 2004, the Basel II Accord was established. The new accord aligns the
requirement for capital on hand with the actual risk involved, providing an
incentive for banks to improve risk management.
Managing Risk
Operational risk is a broad term that applies to various types of risk, the most
crucial of which involve a breakdown in either internal controls or corporate
governance. Other areas that introduce operational risks are information
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technology and catastrophes such as fires, floods or earthquakes. These

operational risks can lead to significant financial losses for the bank.
If not properly mitigated and managed, these risks can introduce opportunities
for loss. It may be direct fraud or error, or it could be a bank representative or
officer exceeding their authority and conducting illegal or unethical
transactions. If the proper framework is in place, these operational risks are
reduced and the bank can be considered to be more secure under the Basel II
guidelines.
OBJECTIVES OF THE PROJECT
 The analysis of what is basel 1 and why was it implemented

 To trace the loopholes of Basel I
 The analysis what is Basel II
 The objectives of Basel II
 The analysis of credit risk, market risk and operational risks are quantified.
 To analyse the challenges in implementing Basel II in State Bank of India.
 To analyse impact of Basel II on Indian Banks with special reference to State
Bank of India
Sources of Data
Primary Data:
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Most of the data was extracted from Bank, State Bank of India Zonal Office, State Bank
of India Training Centre. Discussion with Bank’s Employees, Circulars,
Documents and soft copies.
Secondary Data
Indian Banking Association Journal and Bank Website.
Significance of the Study
“ The project report helps in understanding how important the risk management is
Banking Sector”.
FINDINGS
 It was observed that while undertaking a project none of the SBI employees
knows about Basel II.
 The Bank is going to raise additional capital of by way of equity shares through
IPO to support additional capital requirement for implementing Basel II
 Earlier there were no separate departments for managing risks, but after
implementing Basel II separate departments to have been entrusted with the task
of managing Credit Risk, Market Risk and Operational Risk.
 Skilled operational personnel is required for State Bank of India.
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 Basel II tends to reduce Capital Base of Indian Banks by 1% to 2%, except a few
Banks
 Complexities in Systems and Processes involved in Basel II make the

implementation process difficult, time consuming and costly.
 Standardised Approach is adopted by bank to assess Credit Risk in which external

Credit rating Agencies are involved, this is due bank’s internal rating system is
not full proof system which is not approved by RBI.
CONCLUSIONS
 Basel II will improve risk management exercise in Banks.
 State Bank of India will get international standard for adopting Basel II.
 All the areas of risks have been taken care.
 Some additional Capital is required.
SUGGESTIONS
 Bank has to train all its employees so that everybody can understand about Basel
Accord.
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 It has to recruit operationally skilled personnel in order to implement Basel

accord.
 Bank has to develop a full proof internal credit rating system so that it can go for
Advanced approach in assessing credit risk
INDUSRTY PROFILE
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BANKING INDUSTRY OVERVIEW

History:
Banking in India has its origin as carry as the Vedic period. It is believed that the
transition from money lending to banking must have occurred even before Manu, the
great Hindu jurist, who has devoted a section of his work to deposits and advances and
laid down rules relating to the interest. During the mogal period, the indigenous bankers
played a very important role in lending money and financing foreign trade and
commerce. During the days of East India Company, it was to turn of the agency houses
top carry on the banking business. The general bank of India was the first joint stock
bank to be established in the year 1786.The others which followed were the Bank of
Hindustan and the Bengal Bank. The Bank of Hindustan is reported to have continued till
1906, while the other two failed in the meantime. In the first half of the 19th Century the
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East India Company established three banks; The Bank of Bengal in 1809, The Bank of
Bombay in 1840 and The Bank of Madras in 1843.These three banks also known as
presidency banks and were independent units and functioned well. These three banks
were amalgamated in 1920 and The Imperial Bank of India was established on the 27th
Jan 1921, with the passing of the SBI Act in 1955, the undertaking of The Imperial Bank
of India was taken over by the newly constituted SBI. The Reserve Bank which is the
Central Bank was created in 1935 by passing of RBI Act 1934, in the wake of swadeshi
movement, a number of banks with Indian Management were established in the country
namely Punjab National Bank Ltd, Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd,
The Bank of Baroda Ltd, The Central Bank of India Ltd .On July 19th 1969, 14 Major
Banks of the country were nationalized and in 15th April 1980 six more commercial
private sector banks were also taken over by the government. The Indian Banking
industry, which is governed by the Banking Regulation Act of India 1949, can be broadly
classified into two major categories, non-scheduled banks and scheduled banks.
Scheduled Banks comprise commercial banks and the co-operative banks.
The first phase of financial reforms resulted in the nationalization of 14 major

banks in 1969 and resulted in a shift from class banking to mass banking. This in turn
resulted in the significant growth in the geographical coverage of banks. Every bank had
to earmark a min percentage of their loan portfolio to sectors identified as “priority
sectors” the manufacturing sector also grew during the 1970’s in protected environments
and the banking sector was a critical source. The next wave of reforms saw the
nationalization of 6 more commercial banks in 1980 since then the number of scheduled
commercial banks increased four- fold and the number of bank branches increased to
eight fold.
After the second phase of financial sector reforms and liberalization of the sector
in the early nineties. The PSB’s found it extremely difficult to complete with the new
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private sector banks and the foreign banks. The new private sector first made their
appearance after the guidelines permitting them were issued in January 1993.
This is how the Banking Industry grew.
The Indian Banking System:
Banking in our country is already witnessing the sea changes as the banking
sector seeks new technology and its applications. The best port is that the benefits are
beginning to reach the masses. Earlier this domain was the preserve of very few
organizations. Foreign banks with heavy investments in technology started giving some
“Out of the world” customer services. But, such services were available only to selected
few- the very large account holders. Then came the liberalization and with it a multitude
of private banks, a large segment of the urban population now requires minimal time and
space for its banking needs.
Automated teller machines or popularly known as ATM are the three alphabets
that have changed the concept of banking like nothing before. Instead of tellers handling
your own cash, today there are efficient machines that don’t talk but just dispense cash.
Under the Reserve Bank of India Act 1934, banks are classified as scheduled banks and
non-scheduled banks. The scheduled banks are those, which are entered in the Second
Schedule of RBI Act, 1934. Such banks are those, which have paid- up capital and
reserves of an aggregate value of not less then Rs.5 lacs and which satisfy RBI that their
affairs are carried out in the interest of their depositors. All commercial banks Indian and
Foreign, regional rural banks and state co-operative banks are Scheduled banks. Non
Scheduled banks are those, which have not been included in the Second Schedule of the
RBI Act, 1934.
The organized banking system in India can be broadly classified into three
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categories: (i) Commercial Banks (ii) Regional Rural Banks and (iii) Co-operative banks.
The Reserve Bank of India is the supreme monetary and banking authority in the country
and has the responsibility to control the banking system in the country. It keeps the
reserves of all commercial banks and hence is known as the “Reserve Bank”.
Current scenario:-
Currently (2007), the overall banking in India is considered as fairly mature in terms of
supply, product range and reach - even though reach in rural India still remains a
challenge for the private sector and foreign banks. Even in terms of quality of assets and
capital adequacy, Indian banks are considered to have clean, strong and transparent
balance sheets - as compared to other banks in comparable economies in its region. The
Reserve Bank of India is an autonomous body, with minimal pressure from the
Government.
With the growth in the Indian economy expected to be strong for quite some time
especially in its services sector, the demand for banking services especially retail
banking, mortgages and investment services are expected to be strong. Mergers &
Acquisitions., takeovers, are much more in action in India.
One of the classical economic functions of the banking industry that has remained
virtually unchanged over the centuries is lending. On the one hand, competition has had
considerable adverse impact on the margins, which lenders have enjoyed, but on the other
hand technology has to some extent reduced the cost of delivery of various products and
services.
Bank is a financial institution that borrows money from the public and lends
money to the public for productive purposes. The Indian Banking Regulation Act of 1949
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defines the term Banking Company as "Any company which transacts banking business
in India" and the term banking as "Accepting for the purpose of lending all investment
of deposits, of money from the public, repayable on demand or otherwise and
withdrawal by cheque, draft or otherwise".
Banks play important role in economic development of a country, like:
o Bank mobilise the small savings of the people and make them available
for productive purposes.
• Promotes the habit of savings among the people thereby offering attractive
rates of
• interest on their deposits
o Provides safety and security to the surplus money of the depositors and as
well provides a convenient and economical method of payment.
• Banks provide convenient means of transfer of fund from one place to

another.
• Helps the movement of capital from regions where it is not very useful to
regions where it can be more useful.
• Banks advances exposure in trade and commerce, industry and agriculture

by knowing their financial requirements and prospects.
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• Bank acts as an intermediary between the depositors and the investors.

Bank also acts as mediator between exporter and importer who does foreign trades.
Thus Indian banking has come from a long way from being a sleepy business
institution to a highly pro-active and dynamic entity. This transformation has been
largely brought about by the large dose of liberalization and economic reforms that
allowed banks to explore new business opportunities rather than generating revenues
from conventional streams (i.e. borrowing and lending). The banking in India is highly
fragmented with 30 banking units contributing to almost 50% of deposits and 60% of
advances.
The Structure of Indian Banking:
The Indian banking industry has Reserve Bank of India as its Regulatory
Authority. This is a mix of the Public sector, Private sector, Co-operative banks and
foreign banks. The private sector banks are again split into old banks and new banks.
Reserve Bank of India

[Central Bank]
Scheduled Banks
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KLE’sScheduled
Institute of Manageent Studies of Research Scheduled
MBA IV SemCo-operative Banks
Commercial Banks
Foreign Regional
Banks Rural Banks
Public Sector Private Sector

Banks Banks
Scheduled Urban Scheduled State

Nationalized
SBI & its Co-Operative Co-Operative Banks
Associates
Banks Banks
Old Private New Private

Sector Banks
Sector Banks
Chart Showing Three Different Sectors of Banks

i) Public Sector Banks
ii) Private Sector Banks
Public Sector Banks
SBI and Nationalized Regional Rural
SUBSIDIARIES Banks Banks
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SBI and subsidiaries

This group comprises of the State Bank of India and its seven subsidiaries viz.,
State Bank of Patiala, State Bank of Hyderabad, State Bank of Travancore, State Bank of
Bikaner and Jaipur, State Bank of Mysore, State Bank of Saurashtra, State Bank of India
State Bank of India (SBI) is the largest bank in India. If one measures by the
number of branch offices and employees, SBI is the largest bank in the world.
Established in 1806as Bank of Bengal it is the oldest commercial bank in the Indian
subcontinent. SBI provides various domestic, international and NRI products and
services, through its vast network in India and overseas. With an asset base of $126
billion and its reach, it is a regional banking behemoth. The government nationalized the
bank in1955, with the Reserve bank of India taking a 60% ownership stake. In recent
years the bank has focused on two priorities, 1), reducing its huge staff through Golden
handshakeschemes known as the Voluntary Retirement Scheme, which saw many of its
best and brightest defect to the private sector, and 2), computerizing its operations.
The State Bank of India traces its roots to the first decade of19th century, when the Bank
of culcutta, later renamed theBank of bengal, was established on 2 jun 1806. The
government amalgamatted Bank of Bengal and two other Presidency banks, namely, the
Bank of Bombay and the bank of Madras, and named the reorganized banking entity the
Imperial Bank of India. All these Presidency banks were incorporated ascompanies, and
were the result of theroyal charters. The Imperial Bank of India continued to remain a
joint stock company. Until the establishment of a central bank in India the Imperial Bank
and its early predecessors served as the nation's central bank printing currency.
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The State Bank of India Act 1955, enacted by the parliament of India, authorized the
Reserve Bank of India, which is the central Banking Organisationof India, to acquire a
controlling interest in the Imperial Bank of India, which was renamed the State Bank of
India on30th April 1955.
In recent years, the bank has sought to expand its overseas operations by buying foreign
banks. It is the only Indian bank to feature in the top 100 world banks in the Fortune
Global 500 rating and various other rankings. According to the Forbes 2000 listing it tops
all Indian companies.
Nationalized banks
This group consists of private sector banks that were nationalized. The
Government of India nationalized 14 private banks in 1969 and another 6 in the year
1980. In early 1993, there were 28 nationalized banks i.e., SBI and its 7 subsidiaries plus
20 nationalized banks. In 1993, the loss making new bank of India was merged with
profit making Punjab National Bank. Hence, now only 27 nationalized banks exist in
India.
Regional Rural banks

These were established by the RBI in the year 1975 of banking commission. It
was established to operates exclusively in rural areas to provide credit and other facilities
to small and marginal farmers, agricultural labourers, artisans and small entrepreneurs.
Private Sector Banks
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Private Sector Banks
Old private New private

Sector Banks Sector Banks
Old Private Sector Banks

This group consists of the banks that were establishes by the privy sectors,
committee organizations or by group of professionals for the cause of economic
betterment in their operations. Initially, their operations were concentrated in a few
regional areas. However, their branches slowly spread throughout the nation as they
grow.
New private Sector Banks

These banks were started as profit orient companies after the RBI opened the
banking sector to the private sector. These banks are mostly technology driven and better
managed than other banks.
Foreign banks
These are the banks that were registered outside India and had originated in a
foreign country. The major participants of the Indian financial system are the
commercial banks, the financial institutions (FIs), encompassing term-lending
institutions, investment institutions, specialized financial institutions and the state-level
development banks, Non-Bank Financial Companies (NBFCs) and other market
intermediaries such as the stock brokers and money-lenders. The commercial banks and
certain variants of NBFCs are among the oldest of the market participants. The FIs, on
the other hand, are relatively new entities in the financial market place.
IMPORTANCE OF BANKING SECTOR IN A GROWING ECONOMY
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In the recent times when the service industry is attaining greater importance
compared to manufacturing industry, banking has evolved as a prime sector providing
financial services to growing needs of the economy.
Banking industry has undergone a paradigm shift from providing ordinary
banking services in the past to providing such complicated and crucial services like,
merchant banking, housing finance, bill discounting etc. This sector has become more
active with the entry of new players like private and foreign banks. It has also evolved as
a prime builder of the economy by understanding the needs of the same and encouraging
the development by way of giving loans, providing infrastructure facilities and financing
activities for the promotion of entrepreneurs and other business establishments.
For a fast developing economy like ours, presence of a sound financial system to
mobilize and allocate savings of the public towards productive activities is necessary.
Commercial banks play a crucial role in this regard.
The Banking sector in recent years has incorporated new products in their
businesses, which are helpful for growth. The banks have started to provide fee-based
services like, treasury operations, managing derivatives, options and futures, acting as
bankers to the industry during the public offering, providing consultancy services, acting
as an intermediary between two-business entities etc.At the same time, the banks are
reaching out to other end of customer requirements like, insurance premium payment, tax
payment etc. It has changed itself from transaction type of banking into relationship
banking, where you find friendly and quick service suited to your needs. This is possible
with understanding the customer needs their value to the bank, etc. This is possible with
the help of well organized staff, computer based network for speedy transactions,
products like credit card, debit card, health card, ATM etc. These are the present trend of
services. The customers at present ask for convenience of banking transactions, like 24
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hours banking, where they want to utilize the services whenever there is a need. The
relationship banking plays a major and important role in growth, because the customers
now have enough number of opportunities, and they choose according to their
satisfaction of responses and recognition they get. So the banks have to play cautiously,
else they may lose out the place in the market due to competition, where slightest of
opportunities are captured fast.
Another major role played by banks is in transnational business, transactions and
networking. Many leading Indian banks have spread out their network to other countries,
which help in currency transfer and earn exchange over it.
These banks play a major role in commercial import and export business, between parties
of two countries. This foreign presence also helps in bringing in the international
standards of operations and ideas. The liberalization policy of 1991 has allowed many
foreign banks to enter the Indian market and establish their business. This has helped
large amount of foreign capital inflow & increase our Foreign exchange reserve.
Another emerging change happening all over the banking industry is

consolidation through mergers and acquisitions. This helps the banks in strengthening
their empire and expanding their network of business in terms of volume and
effectiveness.
EMERGING SCENARIO IN THE BANKING SECTOR
The Indian banking system has passed through three distinct phases from the time
of inception. The first was being the era of character banking, where you were recognized
as a credible depositor or borrower of the system. This era come to an end in the sixties.
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The second phase was the social banking. Nowhere in the democratic developed world,
was banking or the service industry nationalized. But this was practiced in India. Those
were the days when bankers has no clue whatsoever as to how to determine the scale of
finance to industry. The third era of banking which is in existence today is called the era
of Prudential Banking. The main focus of this phase is on prudential norms accepted
internationally.
SBI Group-
The Bank of Bengal, which later became the State Bank of India. State Bank of
India with its seven associate banks commands the largest banking resources in India.
Nationalisation-
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The next significant milestone in Indian Banking happened in late 1960s when the
then Indira Gandhi government nationalized on 19th July 1949, 14 major commercial
Indian banks followed by nationalisation of 6 more commercial Indian banks in 1980.
The stated reason for the nationalisation was more control of credit delivery. After
this, until 1990s, the nationalised banks grew at a leisurely pace of around 4% also called
as the Hindu growth of the Indian economy.
After the amalgamation of New Bank of India with Punjab National Bank,
currently there are 19 nationalised banks in India
Liberalization-
In the early 1990’s the then Narasimha rao government embarked a policy of
liberalization and gave licences to a small number of private banks, which came to be
known as New generation tech-savvy banks, which included banks like ICICI and HDFC.
This move along with the rapid growth of the economy of India, kick started the banking
sector in India, which has seen rapid growth with strong contribution from all the sectors
of banks, namely Government banks, Private Banks and Foreign banks. However there
had been a few hiccups for these new banks with many either being taken over like
Global Trust Bank while others like Centurion Bank have found the going tough.
The next stage for the Indian Banking has been set up with the proposed relaxation in
the norms for Foreign Direct Investment, where all Foreign Investors in Banks may be
given voting rights which could exceed the present cap of 10%, at pesent it has gone up
to 49% with some restrictions.
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The new policy shook the Banking sector in India completely. Bankers, till this
time, were used to the 4-6-4 method (Borrow at 4%;Lend at 6%;Go home at 4) of
functioning. The new wave ushered in a modern outlook and tech-savvy methods of
working for traditional banks.All this led to the retail boom in India. People not just
demanded more from their banks but also received more.
CURRENT SCENARIO-
Currently (2007), overall, banking in India is considered as fairly mature in terms of

supply, product range and reach-even though reach in rural India still remains a challenge
for the private sector and foreign banks. Even in terms of quality of assets and capital
adequacy, Indian banks are considered to have clean, strong and transparent balance
sheets-as compared to other banks in comparable economies in its region. The Reserve
Bank of India is an autonomous body, with minimal pressure from the government. The
stated policy of the Bank on the Indian Rupee is to manage volatility-without any stated
exchange rate-and this has mostly been true.
With the growth in the Indian economy expected to be strong for quite some time-
especially in its services sector, the demand for banking services-especially retail
banking, mortgages and investment services are expected to be strong. M&As, takeovers,
asset sales and much more action (as it is unravelling in China) will happen on this front
in India.
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The next stage for the Indian Banking has been set up with the proposed relaxation in the
norms for Foreign Direct Investment, where all Foreign Investors in Banks may be given
voting rights which could exceed the present cap of 10%, at pesent it has gone up to 49%
with some restrictions.
The new policy shook the Banking sector in India completely. Bankers, till this
time, were used to the 4-6-4 method (Borrow at 4%;Lend at 6%;Go home at 4) of
functioning. The new wave ushered in a modern outlook and tech-savvy methods of
working for traditional banks.All this led to the retail boom in India. People not just
demanded more from their banks but also received more.
In March 2006, the Reserve Bank of India allowed Warburg Pincus to increase its
stake in Kotak Mahindra Bank (a private sector bank) to 10%. This is the first time an
investor has been allowed to hold more than 5% in a private sector bank since the RBI
announced norms in 2005 that any stake exceeding 5% in the private sector banks would
need to be vetted by them.
Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks
(that is with the Government of India holding a stake), 29 private banks (these do not
have government stake; they may be publicly listed and traded on stock exchanges) and
31 foreign banks. They have a combined network of over 53,000 branches and 17,000
ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks
hold over 75 percent of total assets of the banking industry, with the private and foreign
banks holding 18.2% and 6.5% respectively.
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Banking in India
1 Central Bank Reserve Bank of India

State Bank of India, Allahabad Bank, Andhra Bank,
Bank of Baroda, Bank of India, Bank of
Maharastra,Canara Bank, Central Bank of India,
2 Corporation Bank, Dena Bank, Indian Bank, Indian

Nationalised Banks
overseas Bank,Oriental Bank of Commerce, Punjab and
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Sind Bank, Punjab National Bank, Syndicate Bank,

Union Bank of India, United Bank of India, UCO
Bank,and Vijaya Bank.
Bank of Rajastan, Bharath overseas Bank, Catholic
Syrian Bank, Centurion Bank of Punjab, City Union
Bank, Development Credit Bank, Dhanalaxmi Bank,
3 Federal Bank, Ganesh Bank of Kurundwad, HDFC

Private Banks
Bank, ICICI Bank, IDBI, IndusInd Bank, ING Vysya
Bank, Jammu and Kashmir Bank, Karnataka Bank
Limited, Karur Vysya Bank, Kotek Mahindra Bank,
Lakshmivilas Bank, Lord Krishna Bank, Nainitak Bank,
Ratnakar Bank,Sangli Bank, SBI Commercial and
International Bank, South Indian Bank, Tamil Nadu
Merchantile Bank Ltd., United Western Bank, UTI
Bank, YES Bank.
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COMPANY PROFILE
STATE BANK OF INDIA
Not only many financial institution in the world today can claim the antiquity and
majesty of the State Bank Of India founded nearly two centuries ago with primarily intent
of imparting stability to the money market, the bank from its inception mobilized funds
for supporting both the public credit of the companies governments in the three
presidencies of British India and the private credit of the European and India merchants
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from about 1860s when the Indian economy book a significant leap forward under the
impulse of quickened world communications and ingenious method of industrial and
agricultural production the Bank became intimately in valued in the financing of
practically and mining activity of the Sub- Continent Although large European and Indian
merchants and manufacturers were undoubtedly thee principal beneficiaries, the small
man never ignored loans as low as Rs.100 were disbursed in agricultural districts against
glad ornaments. Added to these the bank till the creation of the Reserve Bank in 1935
carried out numerous Central – Banking functions.
Adaptation world and the needs of the hour has been one of the strengths of the Bank,
In the post depression exe. For instance – when business opportunities become extremely
restricted, rules laid down in the book of instructions were relined to ensure that good
business did not go post. Yet seldom did the bank contravenes its value as depart from
sound banking principles to retain as expand its business. An innovative array of office,
unknown to the world then, was devised in the form of branches, sub branches, treasury
pay office, pay office, sub pay office and out students to exploit the opportunities of an
expanding economy. New business strategy was also evaded way back in 1937 to render
the best banking service through prompt and courteous attention to customers.
A highly efficient and experienced management functioning in a well defined

organizational structure did not take long to place the bank an executed pedestal in the
areas of business, profitability, internal discipline and above all credibility A impeccable
financial status consistent maintenance of the lofty traditions if banking an observation of
a high standard of integrity in its operations helped the bank gain a pre- eminent status.
No wonders the administration for the bank was universal as key functionaries of India
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successive finance minister of independent India Resource Bank of governors and

representatives of chamber of commercial showered economics on it.
Modern day management techniques were also very much evident in the good old
days years before corporate governance had become a puzzled the banks bound
functioned with a high degree of responsibility and concerns for the shareholders. An
unbroken records of profits and a fairly high rate of profit and fairly high rate of dividend
all through ensured satisfaction, prudential management and asset liability management
not only protected the interests of the Bank but also ensured that the obligations to
customers were not met.
The traditions of the past continued to be upheld even to this day as the State Bank
years itself to meet the emerging challenges of the millennium.
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THE PLACE TO SHARE THE NEWS ...……

SHARE THE VIEWS ……
Togetherness is the theme of this corporate loge of SBI where the world of banking
services meet the ever changing customers needs and establishes a link that is like a
circle, it indicates complete services towards customers. The logo also denotes a bank
that it has prepared to do anything to go to any lengths, for customers.
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The blue pointer represent the philosophy of the bank that is always looking for the
growth and newer, more challenging, more promising direction. The key hole indicates
safety and security.
MISSION, VISION AND VALUES
MISSION STATEMENT:
To retain the Bank’s position as premiere Indian Financial Service Group, with world
class standards and significant global committed to excellence in customer, shareholder
and employee satisfaction and to play a leading role in expanding and diversifying
financial service sectors while containing emphasis on its development banking rule.
VISION STATEMENT:
♦ Premier Indian Financial Service Group with prospective world-class

Standards of efficiency and professionalism and institutional values.
♦ Retain its position in the country as pioneers in Development banking.
♦ Maximize the shareholders value through high-sustained earnings per

Share.
♦ An institution with cultural mutual care and commitment, satisfying and
Good work environment and continues learning opportunities.
VALUES:
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♦ Excellence in customer service

♦ Profit orientation
♦ Belonging commitment to Bank
♦ Fairness in all dealings and relations
♦ Risk taking and innovative
♦ Team playing
♦ Learning and renewal
♦ Integrity
♦ Transparency and Discipline in policies and systems.
ORGANISATION STRUCTURE
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MANAGING DIRECTOR
CHIEF GENERAL MANAGER
G. M G.M G. M G.M G.M

(Operations) (C&B) (F&S) (I) & CVO (P&D)
zonal officers
Functional Heads
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THE ANALYSIS OF BASEL NORMS AND ITS

IMPLEMENTATION
35
BACKGROUND OF BASEL ACCORD
The initiatives taken by the Basel Committee in addressing the rigidities in the 1988
Capital Accord by evolving a comprehensive and risk-sensitive New Basel Capital
Accord (the New Accord) are timely. The range of options for providing capital would
facilitate banks with varying degrees of sophistication to adopt appropriate method with
supervisory validation. Further, the emphasis laid on the role of supervisory review
process and market discipline, as essential complements to minimum capital
requirements would go a long way in enhancing the efficacy of supervision.
Reserve Bank’s association with the Basel Committee on Banking Supervision (BCBS) –
the owner of the Basel II framework- dates back to 1997 as India was among the 16 non-
member countries that were consulted in the drafting of the Basel Core Principles.
Reserve Bank of India became a member of the Core Principles Liaison Group in 1998
and subsequently became a member of the Core Principles Working Group on Capital.
Within the Working Group, RBI has been actively participating in the deliberations on
the Basel II framework and had the privilege to lead a group of six major non-G-10
supervisors which presented a proposal on a simplified approach for Basel II to the
Committee.
Approach to reforms
With the commencement of the banking sector reforms in the early 1990s, the RBI has
been consistently upgrading the Indian banking sector by adopting international best
practices. The approach to reforms is one of having clarity about the destination, deciding
on the sequence and modulating the pace of reforms to suit Indian conditions. This has
helped us in moving ahead with the reforms in a purposeful but non-disruptive manner.
36
Basel I
The progress made by the Indian banking system with regard to Basel I implementation
before we discuss Basel II implementation. Adopting our general approach of
gradualism, we implemented the Basel I framework with effect from 1992-93 which was,
however, spread over 3 years– banks with branches abroad were required to comply fully
by end March 1994 and the other banks were required to comply by end March 1996.
Further, India responded to the 1996 amendment to the Basel I framework which required
banks to maintain capital for market risk exposures, by initially prescribing various
surrogate capital charges for these risks between 2000 and 2002. These were replaced
with the capital charges as required under the BaselI framework in June 2004, which
become fully effective from March2005. With the successful implementation of banking
sector reforms over the past decade, the Indian banking system has shown substantial
improvement on various parameters. It has become robust and displayed significant
resilience to shocks. There is ample evidence of the capacity of the Indian banking
system to migrate smoothly to Basel II norms.
RBI recognises that several of the concerns expressed and recommendations made by
India and other emerging markets on the first consultative document have been taken into
account and addressed in the second consultative document. Particularly, the proposals to
do away with the sovereign floor in assigning risk weights and subscription to IMF’s
Special Data Dissemination Standards (SDDS) and Core Principles for Effective Banking
Supervision for preferential risk weighting, greater use of Export Credit Agencies
(ECAs), additional risk weight bucket of 50% in respect of claims on corporates,
simplified internal rating based approach, etc., reflect the Committee’s endeavour in
37
evolving a consensual framework which could be adapted by all countries including

emerging markets.
In this context, the Basel Committee’s concerns for the constraints which are faced by
the emerging markets and greater outreach by involving non G-10 countries in the
standards setting exercise would lead to greater appreciation for the New Accord.
However, some of the issues in the context of emerging markets are still to be addressed.
RBI feels that the complexity and sophistication of the proposals restricts its universal
application in emerging markets, where the banks continue to be the major segment in
financial intermediation and would be facing considerable challenges in adopting all the
proposals. The New Accord would involve shift in direct supervisory focus away to the
implementation issues. Further, banks and the supervisors would be required to invest
large resources in upgrading their technology and human resources to meet the minimum
standards. The increasing reliance on external rating agencies in the regulatory process
would undermine the initiatives of banks in enhancing their risk management policies and
practices and internal control systems. The minimum standards set even for the Internal
Rating Based (IRB) foundation approach are complex and beyond the reach of many
banks. Further, while the Basel Committee desires neither to produce a net increase nor a
net decrease in minimum regulatory capital, it is felt that the current proposals are going
to result in significant increase in the capital charge for banks, especially in emerging
markets. The emerging markets with their low technical skills, structural rigidities and
less robust legal system, etc. would face serious implementation challenges. RBI,
therefore, feels that the spirit of flexibility, universal applicability and discretion to
national supervisors, consistent with the macro economic conditions specific to emerging
markets ought to be preserved while finalizing the New Accord.
Scope of Application
38
RBI agrees with the Committee’s view that the focus of the New Accord may be
primarily on internationally active banks, which would be followed by adherence by all
significant banks after a certain period of time. The basic philosophy of the New Accord
being to achieve competitive equality and financial stability and the Committee’s
pronouncement that the underlying principles are generally suitable to all types of banks
around the globe, the New Accord, like the 1988 Accord, should be applied, generally to
all banks. However, RBI shares the views of Mr. Laurence H. Meyer, Member of the
Board of Governors of the Federal Reserve System that ‘it is not at all obvious that the
proposed standardised approach fits the needs of smaller banking organization engaged
primarily in traditional banking activities… but I question whether the added
implementation burdens are cost-effective for traditional banking organizations,
especially since neither the current nor the proposed capital frameworks yet address what
is perhaps the most critical risk factor for smaller banks – geographic and sectoral
concentrations of credit risk’1.
It is, therefore, suggested that a simplified standardised approach, based on internal

rating systems of banks may be evolved and applied to banks, which are not
internationally active. Under this approach, standardised risk weights in the range of 0%
to 150% on the basis of internal ratings of banks, could be assigned, subject to mapping
of such ratings with the benchmark Probability of Default (PD) estimated by the
supervisor on the basis of pooled data from select banks. As a precursor, however,
internal rating systems of banks need to be substantially upgraded and strengthened,
keeping in view the best practices and the standards prescribed by the Basel Committee
for IRB approach.
Recognising, however, the fact that even the simplified approach is likely to be more
extensive and complex than the 1988 Accord, the New Accord may be applied, in
phases, at the discretion of national supervisors to banks on the basis of the complexity,
scale of operation, etc. Each national supervisor may, however, be required to publicly
39
announce a schedule for implementation of the New Accord and the status of
implementation may be evaluated under the proposed framework for exchange of
information amongst member countries.
RBI, therefore, agrees with the view that the New Accord should initially be applied to
all internationally active banks. Further, a simplified standardised approach, as suggested
above, may be evolved for other banks and that national supervisors should have
discretion to implement the New Accord, in a phased manner.
As the main objective of the New Accord is to ensure competitive equality and
providing a reasonable degree of consistency in application, it is necessary that all
supervisors, across the world should have a common definition of internationally active
and significant banks. Basel Committee may, therefore, define what constitute
internationally active and significant banks.
In this regard, RBI is of the view that all banks with cross-border business exceeding
15% of their total business may be defined as internationally active banks. Significant
banks may be defined as those banks with complex structures and whose market share in
the total assets of the domestic banking system exceeds 1%. In the event of no consensus
evolving on a uniform definition, national supervisors should have discretion to define
what constitutes an internationally active and a significant bank. Each national supervisor
may, however, be required to announce the criteria adopted for defining internationally
active and significant banks in its jurisdiction through the Basel Committee. The criteria,
when endorsed, should be accepted by supervisors in other jurisdictions and by
international agencies.
Cross-holding of Capital
40
RBI, while appreciating the Committee’s proposal that reciprocal cross-holdings of bank
capital artificially designed to inflate capital position of banks should be deducted, feels
that cross-holdings of equity and other regulatory investments also need to be moderated
to preserve the integrity of the financial system and minimise the adverse effect of
systemic risk and contagion.
RBI is, therefore, of the view that the Basel Committee may consider prescribing a
material limit (10% of the total capital) upto which cross-holdings of capital and other
regulatory investments could be permitted and any excess investments above the limit
would be deducted from total capital.
4.3 Claims on Sovereigns
4.3.1 RBI reiterates its earlier views that it will not be proper to link the risk weights
assigned to claims on sovereigns on the basis of assessments of External Credit
Assessment Institutions (ECAIs), as their credibility and past record lack empirical
evidence. In the recent past, the credit rating agencies had resorted to sudden and rapid
downgrading of certain countries, which experienced financial crises that exacerbated the
tendency of financial institutions to risk for exit.
RBI, therefore, reiterates that the ECAIs should not be assigned the direct responsibility
for risk assessment of banking book assets. This also applies to the assessments of Export
Credit Agencies (ECAs) as their independence and judgment are also subject to the same
limitations as those of the rating agencies.
4.3.2 The Committee’s proposal that the assessments of ECAs are recognized only if they
publish their risk scores and subscribe to the OECD 1999 country risk assessment
methodology is appreciated. However, the OECD methodology and ECAs’ country risk
41
classifications are still confidential. Further, their insight into the local conditions and
issues specific to emerging markets is also not comprehensive.
RBI, therefore, feels that such of the ECAs that disclose publicly their risk scores, rating
process and procedure and subscribe to the publicly disclosed OECD methodology and
qualify for use by national supervisors should only be eligible for use in assigning
preferential risk weights.
Claims on Banks
The flexibility to provide uniform risk weight i.e. one category less favourable than that
assigned to claims on sovereign to all the banks (under first option) militates the basic
philosophy of aligning capital adequacy assessment more closely with the key elements
of risk. The mere location may not necessarily be a good indicator of a bank’s
creditworthiness. This proposal provides competitive advantage to banks with weak
financials by virtue of their having been incorporated in better-rated countries.
RBI, therefore, reiterates its earlier view that the risk weighting of banks should be de-
linked from that of the credit rating of sovereigns in which they are incorporated. Instead,
preferential risk weights should be assigned on the basis of their underlying strength and
creditworthiness.
4.4.2 Banks are strongly regulated and supervised entities. In particular, weak banks and
those banks, which show signs of problems, are subjected to rigorous on-site and off-site
supervision and stringent prudential standards. Thus, risks inherent in inter-bank
exposures are not comparable to that of the corporates. There is, therefore, a need for a
42
modified treatment for claims on banks. The Basel Committee has provided discretion to
national supervisors to assign a lower risk weight to the exposures to the sovereign of
incorporation, denominated in domestic currency and funded in that currency. A similar
flexibility should be provided in respect of claims on banks as well.
RBI, therefore, feels that on the lines of discretion provided in the case of claims on
sovereigns, the national supervisors may be given discretion to assign lower risk weight
(one category less favourable than the risk weight to claims on sovereign), subject to a
floor of 20% to claims on all banks, which are denominated in domestic currency and
funded in that currency.
The proposal to assign preferential risk weight to short-term claims may lead to
regulatory arbitrage through roll-overs, concentration of short-term borrowings and
serious asset-liability mismatches, which could trigger systemic crisis and contagion in
the domestic inter-bank market. It would also be very difficult to monitor and control the
rollovers of short-term claims, given the high volume of transactions in the inter-bank
market.
RBI, therefore, feels that preferential risk weights should not be linked to the maturity of
the claims.
Claims on Corporates
RBI appreciates the Committee’s efforts in evolving a range of risk-sensitive options for
assessing capital for credit risk. However, the reliance on ECAIs under the standardised
approach for assigning preferential risk weights may not be a better option. First, the
credibility of the rating agencies is at stake and there is no system of accountability for
sharp deterioration in the credit quality of rated entities immediately after assigning a
rating. Secondly, their access to information, especially in the absence of transparency
43
and good corporate governance principles is severely restricted. Whereas, banks are privy
to customer information and are less exposed to customer-related informational
asymmetry. Thirdly, the population of rated entities, even in the advanced countries, and
especially in the emerging markets, which have exposure to the banking system, is very
few in number. Fourthly, the use of external credit rating agencies in the regulatory
process may act as a disincentive for the banks to improve their credit risk management
systems.
It is appreciated that the expanded role envisioned for IRB approach provides positive
incentives to banks in improving their credit risk management techniques. However, the
adoption of the IRB approach, even under the foundation approach requires considerable
investments in IT / human resources and rigorous supervisory oversights. Thus, most of
the banks may not be able to adopt, even in advanced markets, the IRB foundation
approach.
RBI, therefore, feels that adoption of the IRB approach, as envisaged, may be possible
only for internationally active banks within the time frame and transition period proposed
by the Committee. For other banks, as an alternative, it is proposed that a simplified
standardised approach to assign preferential risk weights based on internal ratings of
banks may be evolved, subject to complying with the minimum standards prescribed by
the Basel Committee for IRB approach. Under this approach, standardised risk weights,
instead of the continuous function of PD, Loss Given Default (LGD) and Exposure at
Default (EAD), in the range of 20% to 150% could be assigned, subject to mapping of
these ratings based on the robustness of the rating systems and the benchmark PD
estimated by the supervisor on the basis of pooled data from select banks.
This approach could be extended to a greater number of counterparties such as unrated

borrowers in the small/retail sector and will encourage banks to refine their credit risk
assessment and monitoring process, which would facilitate better management of their
44
loan books. This will also avoid the use of ECAIs in the regulatory process and reduce
the burden of additional cost on this count. Also, the scarce supervisory resources will be
optimally utilised for validating the banks’ internal rating systems rather than for
approving ECAIs. This would also avoid conflict of jurisdiction over rating agencies.
RBI, therefore, proposes that while internationally active banks may be required to follow
the IRB approach, a simplified standardised approach may be evolved for other banks,
whereby standardised risk weights in the range of 20% to 150% could be assigned on the
basis of internal ratings of banks.
Higher-risk Categories
The Committee’s proposals to assign 150% risk weight on unsecured portion of any
asset that is past due for more than 90 days, net of specific provisions, would adversely
affect the capital position of banks, especially those incorporated in emerging markets.
Normally, banks take some time in initiating the legal process after recognising
impairment. Further, there are well-established norms for recognition of and full
provision for any known loan losses. Collaterals also back such loans. Thus, the proposal
to assign 150% risk weight even after recognising, in full, diminution in the value of
impaired loans would lead to pre-emption of scarce capital which does not reflect the
historical loan loss experiences. In India, the adoption of the proposal alone would
increase the risk-weighted assets of the banking system by USD 3.2 bio, entailing a drop
in the existing CRAR by 31 bps. as on March 31, 2000.
The 90-day norm also makes the regulatory capital extremely pro-cyclical. While during
the boom period there would be low accretion to NPAs leading to lower provisioning
45
requirements and higher capital adequacy ratio, during the recessionary phase, temporary
cash flow problems accentuate the pace of accretion to NPAs and hence the need for
higher provisioning requirements leading to lower capital adequacy ratio.
Lending by banks especially in the emerging markets is basically for productive

purposes and are adequately collateralised by various types of assets. The proposal to
reckon only the eligible collaterals for the secured portion of assets, which are past due
for more than 90 days, is too restrictive. National supervisors should have discretion to
recognise a wider range of collaterals for reckoning the secured portion of the assets.
RBI, therefore, feels that assets that are overdue over 90 days need not be placed under a
separate higher-risk category
External Credit Assessments
RBI appreciates the Committee’s endeavour in addressing most of the deficiencies

inherent in the first document regarding the use of ECAIs. The operative details about
implementation considerations viz. mapping process, multiple assessments, issuer versus
issue assessment, etc. would go a long way in addressing the supervisory concerns
expressed by many regulators including RBI. However, the proposal to use unsolicited
ratings in the same way as solicited ratings would undermine the efficacy of using
external assessments for regulatory purposes. The unsolicited ratings are generally
superficial. The use of such ratings for assigning preferential risk weights would
undermine the basic philosophy of the New Accord. It may also lead to the potential for
trade off between competition and quality in the rating industry.
46
RBI is of the view that preferential risk weights should be assigned only on the basis of
solicited ratings.
Internal Rating Based Approach
RBI appreciates the Basel Committee’s proposal to offer a range of options of increasing
sophistication for providing explicit capital charge for credit risk. RBI recognises the
inherent attractiveness of the IRB foundation approach, which will result in better
internal credit risk management and may have the potential to be used in the supervision
of banks.
However, the minimum requirements stipulated even under the IRB foundation
approach are difficult to be enforced, especially in the emerging markets. Most of the
banks do not have robust rating systems and historical data on PDs, nor do the
supervisory authorities maintain time series data for estimating LGD. The transition
period of three years proposed in the New Accord may, therefore, not be adequate for
building database on various parameters. It is pertinent to quote Mr. Laurence H. Meyer
that ‘despite the importance of evaluating a borrower’s probability of default, banks have
been surprisingly slow, it seems, to distinguish among acceptable credit risk levels in
their pricing and in their own assessments of capital adequacy… Last fall, the Basel
Committee conducted an initial survey of large internationally active banks in order to
estimate the quantitative effects of the proposal on their capital requirements. The
Committee was disappointed in the modest number of banks worldwide that could
provide meaningful distributions of credit quality, even for their corporate portfolios’2.
RBI, therefore, suggests that a simplified standardised approach as indicated in para

above might be evolved and applied to banks that are not internationally active.
47
It is well recognised that the proposal to assign banking book exposures into six broad
classes of exposures with different underlying credit risk characteristics - corporates,
sovereigns, banks, retail, project finance and equity under IRB approach would better
discriminate the likely pattern of portfolio losses. However, a common framework for
definition of these loan portfolio segments, without recognising the institutional
framework, value of accounts, geographical spread, etc., may pose severe implementation
problems to banks in emerging markets.
RBI, therefore, feels that national supervisors may have discretion and flexibility in
defining the exposure classes, viz. corporate, retail, sovereign, project finance, etc.
Operational Risk
In the context of increasing globalization, enhanced use of technology, product

innovations and growing complexity in operations, RBI agrees, in principle, with the
Committee’s proposal to assign explicit capital charge for operational risk. RBI also
acknowledges that the range of approaches of increasing sophistication - basic indicator,
standardised and internal measurement - would set the basic framework for estimating
capital for operational risk. Given the sophistication and database required for
standardised and internal measurement approaches, most of the banks, especially those
domiciled in emerging markets would be adopting the basic indicator approach.
However, the current provisional estimate of around 30% of gross income, which as per
Committee’s estimate works out to 20% of the current capital requirement as per the
1988 Accord, is expected to impose significant burden on the capital requirement of
banks. Further, it also does not reflect the risk profile of various banks, operating under
various levels of sophistication, markets, etc. It is observed that the fixed percentage has
been prescribed on the basis of economic capital set by only 6 international banks for
operational risk. As the magnitude of operational risk depends on complexity of
48
operations, absorption of technology, value of transactions, legal / supervisory

framework, internal control systems, etc., a uniform rate may not reflect the degree of
operational risk. The Committee may consider undertaking studies on operational risk
with particular reference to observed rate of losses, correlation between credit and market
risks and operational risk, etc.
RBI, therefore, feels that until a scientific method to measure the operational risk across
countries is evolved, the Basel Committee may consider prescribing a lower capital
charge of 15% of the gross income or 10% of the current capital requirement to align
capital to the underlying risk profile. National supervisors may, however, be given
discretion to prescribe higher capital charge towards operational risk in case of banks,
which may be considered as ‘outliers’.
Trading Book Issues
The Basel Committee has indicated that the changes made in the trading book are
consistent with the changes in the banking book capital requirements under the
standardised approach. However, the Committee’s proposal to provide explicit capital
charge on the basis of ratings is not consistent with the banking book capital requirements
as discussed hereunder. Under the standardised approach, discretion has been provided to
assign a lower risk weight to banks’ exposure to the sovereign of incorporation
denominated in domestic currency and funded in that currency. A similar discretion
should be provided for specific risk capital charge for trading book to avoid regulatory
arbitrage.
Further, the graduated specific risk charge for qualifying securities has not been
consistent with preferential risk weights proposed in the banking book, as these have
49
been differentiated only on the basis of maturity rather than linking the capital charge to
the rating of the instruments. Further, the uniform capital charge of 8% to other category
does not reflect and compare with the risk weight of 150% or higher being proposed for
claims on sovereigns, banks and corporates that are rated below B-. Unless, the capital
charge or risk weights are uniform both in the trading and banking books, the New
Accord may lead to banks going for regulatory arbitrage.
RBI, therefore, feels that the capital charge for specific risk in the banking and trading
books should be consistent to avoid regulatory arbitrages.
Market Discipline – Third Pillar
RBI shares the Committee’s view that too much information could blur the key signals to
the market and agrees with the proposal to make a clear distinction between core and
supplementary disclosures. Further, the proposals to mandate frequent disclosures on
information, subject to rapid time decay, would facilitate market participants in taking
informed decisions.
Transitional Arrangements
The Committee has provided a three year transition period beginning from the date of
implementation for applying full sub-consolidation. Similarly, a three-year transition
period has been provided for the foundation IRB approach, during which period, the
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requirements could be relaxed, although supervisors would be expected to ensure that

implementation of IRB approach is done by banks in a sound manner.
While RBI feels that the above transition period would be sufficient for the
internationally active banks, other banks may need more transition period even for
implementing the suggested simplified standardised approach.
RBI, therefore, feels that national supervisors may be given discretion to implement the
New Accord, in a phased manner by banks, which are not internationally active and are
engaged predominantly in traditional banking.
. General Issues
Impact on Capital under Standardised Approach
Under the standardised approach, the Committee desires neither to produce a net
increase nor a net decrease, on an average, in minimum regulatory capital, even after
accounting for 20% explicit capital charge for operational risk. The Committee’s views
are apparently based on the assumption that capital discharge would be available on
assigning preferential risk weights to claims on sovereigns, banks and corporates, on the
basis of external assessments and recognition of more collaterals under credit risk
mitigation techniques.
However, RBI feels that the adoption of the New Accord would definitely enhance the
minimum regulatory capital, especially for banks domiciled in emerging markets on
account of the following:
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i. All claims on sovereign (OECD or non-OECD) in India are currently assigned a

uniform risk weight of 0%. The discretion to assign a lower risk weight would
henceforth be available to claims on sovereign (or Central Bank) of incorporation,
denominated in domestic currency and funded in that currency. Other sovereigns
are required to be assigned risk weight in the range of 0% to 150% on the basis of
e20%. The 20% risk weight would henceforth be converted as a floor. Most of the
ii. banks are also not rated and therefore would have to be assigned a risk weight of
50%;
iii. The population of rated corporates is very few in number and most of them would
have to be risk weighted at 100%. The benefit of lower risk weight of 20% and
50% would therefore be available only to very few corporates;
iv. Unsecured portion of any asset which is past due over 90 days, net of specific
provisions, would have to be assigned a risk weight of 150%, which proposal
alone would increase the risk-weighted assets of the banking system by USD 3.2
bio, entailing a drop in the existing CRAR by 31 bps. as on March 31, 2000;
v. Claims on certain high-risk exposures viz. venture capital and private equity, at
national discretion, are also required to be assigned a higher risk weight of 150%;
vi. The deduction of significant investments in commercial entities; and
vii. Explicit capital charge, constituting 20% of the current capital requirement for
operational risk.
The benefit of credit risk mitigation techniques also may not be available as most of the
banks in emerging markets are not in a position to comply with the preconditions
stipulated by the Basel Committee.
Thus, unless suitably modified, the adoption of the New Accord in its present format
would result in significant increase in the capital charge for banks, especially in emerging
markets.
52
Areas of Further Consultation
Some of the proposals contained in the New Accord warrant further consultation and the
Committee itself has indicated that the work was in progress in specific areas viz. IRB
approach, risk mitigation techniques, capital for operational risk, etc. As the objective of
the New Accord is to evolve a consensual framework that could be adopted uniformly by
all countries including emerging markets, the Committee may hold further consultations
on these areas.
Conclusion
RBI appreciates the committee’s efforts in evolving the New Accord containing
proposals that are comprehensive in coverage. When implemented, these would go a long
way in making the capital allocation more risk-sensitive and use of supervisory oversight
with market discipline would reinforce the supervisory framework and ensure financial
stability. However, the complexity and sophistication of the proposals restricts its
universal application in emerging markets, where the banks continue to be the major
segment in financial intermediation and would be facing considerable challenges in
adopting all the proposals. Like the 1988 Capital Accord, the New Accord should also
preserve the spirit of simplicity and flexibility to ensure universal applicability including
emerging markets.
viii. The New Accord would involve shift in direct supervisory focus away to the
implementation issues. Further, banks and the supervisors would be required to
invest large resources in upgrading their technology and human resources to meet
the minimum standards. The increasing reliance on external rating agencies in the
regulatory process would undermine the initiatives of banks in enhancing their
risk external assessments;
53
Similarly, the claims on all banks are also assigned a uniform risk weight of management
policies and practices and internal control systems. The minimum standards set even for
the IRB foundation approach are complex and beyond the reach of many banks.
It is, therefore, essential that the Basel Committee should evolve a simplified
standardised approach, which could be adopted uniformly by all banks that are not
internationally active. Further, the transitional arrangements proposed in the New Accord
may not be sufficient for these banks. National supervisors may, therefore, be given
discretion to decide on the timeframe for implementing the Accord and applying it to
various banks in their jurisdiction depending upon the scale and complexity of their
operations.
54
BASEL I
55
BASEL I
Basel I is the term which refers to a round of deliberations by central bankers from
around the world, and in 1988, the Basel Committee (BCBS) in Basel, Switzerland,
published a set of minimal capital requirements for banks. This is also known as the 1988
Basel Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992,
with Japanese banks permitted an extended transition period. Basel I is now widely
viewed as outmoded, and a more comprehensive set of guidelines, known as Basel II are
in the process of implementation by several countries.
Background
The Committee was formed in response to the messy liquidation of a Cologne-based

bank in 1974. On 26 June 1974, a number of banks had released Deutschmark to the
Bank Herstatt in exchange for dollar payments deliverable in New York. On account of
differences in the time zones, there was a lag in the dollar payment to the counter-party
banks, and during this gap, and before the dollar payments could be effected in New
York, the Bank Herstatt was liquidated by German regulators.
This incident prompted the G-10 nations to form towards the end of 1974, the Basel
Committee on Banking Supervision, under the auspices of the Bank of International
Settlements (BIS) located in Basel, Switzerland.
Capital Adequacy Ratio - Basle Accord 1988
The growing concern of commercial banks regarding international competitiveness and

capital ratios led to the Basle Capital Accord 1988. The accord sets down the agreement
among the G-10 central banks to apply common minimum capital standards to their
banking industries, to be achieved by year end 1992. The standards are almost entirely
56
addressed to credit risk, the main risk incurred by banks. The document consists of two
main sections, which cover
a. the definition of capital and

b. the structure of risk weights.
Based on the Basle norms, the RBI also issued similar capital adequacy norms for the
Indian banks. According to these guidelines, the banks will have to identify their Tier-I
and Tier-II capital and assign risk weights to the assets. Having done this they will have
to assess the Capital to Risk Weighted Assets Ratio (CRAR). The minimum CRAR
which the Indian banks are required to meet is set at 9 percent.
Tier-I Capital
• Paid-up capital
• Statutory Reserves
• Disclosed free reserves
• Capital reserves representing surplus arising out of sale proceeds of assets
Equity investments in subsidiaries, intangible assets and losses in the current period and
those brought forward from previous periods, will be deducted from Tier I capital.
Tier-II Capital
• Undisclosed Reserves and Cumulative Perpetual Preference Shares

• Revaluation Reserves
• General Provisions and Loss Reserves
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Background of the Basel Accord of 1988
The major impetus for the 1988 Basel Capital Accord was the concern of the Governors
of the G10 central banks that the capital of the world's major banks had become
dangerously low after persistent erosion through competition. Capital is necessary for
banks as a cushion against losses and it provides an incentive for the owners of the
business to manage it in a prudent manner.
The Existing Framework
The 1988 Accord requires internationally active banks in the G10 countries to hold
capital equal to at least 8% of a basket of assets measured in different ways according to
their riskiness. The definition of capital is set (broadly) in two tiers, Tier 1 being
shareholders' equity and retained earnings and Tier 2 being additional internal and
external resources available to the bank. The bank has to hold at least half of its measured
capital in Tier 1 form.
A portfolio approach is taken to the measure of risk, with assets classified into four
buckets (0%, 20%, 50% and 100%) according to the debtor category. This means that
some assets (essentially bank holdings of government assets such as Treasury Bills and
bonds) have no capital requirement, while claims on banks have a 20% weight, which
translates into a capital charge of 1.6% of the value of the claim. However, virtually all
claims on the non-bank private sector receive the standard 8% capital requirement.
There is also a scale of charges for off-balance sheet exposures through guarantees,
commitments, forward claims, etc. This is the only complex section of the 1988 Accord
and requires a two-step approach whereby banks convert their off-balance-sheet positions
58
into a credit equivalent amount through a scale of conversion factors, which then are
weighted according to the counterparty's risk weighting.
The 1988 Accord has been supplemented a number of times, with most changes dealing
with the treatment of off-balance-sheet activities. A significant amendment was enacted
in 1996, when the Committee introduced a measure whereby trading positions in bonds,
equities, foreign exchange and commodities were removed from the credit risk
framework and given explicit capital charges related to the bank's open position in each
instrument.
Impact of the 1988 Accord
The two principal purposes of the Accord were to ensure an adequate level of capital in
the international banking system and to create a "more level playing field" in competitive
terms so that banks could no longer build business volume without adequate capital
backing. These two objectives have been achieved. The merits of the Accord were widely
recognised and during the 1990s the Accord became an accepted world standard, with
well over 100 countries applying the Basel framework to their banking system. However,
there also have been some less positive features. The regulatory capital requirement has
been in conflict with increasingly sophisticated internal measures of economic capital.
The simple bucket approach with a flat 8% charge for claims on the private sector has
given banks an incentive to move high quality assets off the balance sheet, thus reducing
the average quality of bank loan portfolios. In addition, the 1988 Accord does not
sufficiently recognise credit risk mitigation techniques, such as collateral and guarantees.
These are the principal reasons why the Basel Committee decided to propose a more risk-
sensitive framework in June 1999.
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Loopholes of Basel I Accord
 After ten years of implementation and taking into consideration the rapid
technological, financial and institutional changes happened during the period
many weaknesses started appearing in Basel I accord.
 Because of a flat 8% charge for claims on the private sector, banks have an
incentive to move high quality assets off the balance sheet (capital arbitrage)
through securitization. Thus, reducing the average quality of bank loan portfolio
 It does not take into consideration the operational risks of banks, which become
increasingly important with the increase in the complexity of banks.
 Also, the 1988 Accord does not sufficiently recognize credit risk mitigation
techniques, such as collateral and guarantees.
 The regulatory Capital requirement has been in conflict with increasingly

sophisticated internal measures of economic Capital
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 It was concentrating on only on credit risk.
Why Basel II
 Basel I is less Risk Sensitive

(More broad brush approach)
 Basel II is more Risk Sensitive

(Granular capturing of Risk Profile)
 It has been a long way from Basel introduced in 1988 to the present Basel II in
2006.
 The measures envisaged in Basel II are intended to identify and measure the Risk
Profile of the Exposures and help Banks to initiate appropriate Risk Mitigation
Measures.
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What is Basel II
Basel 2 is the new capital accord signed in June 2004 at Bank for International Settlement
located at Basel, Switzerland. It is an improvement over Basel 1 which had certain
deficiencies which have now been removed. Basel 2 is based on three pillars: capital
adequacy, supervisory review and market discipline. It is basically concerned with
financial health of the banks worldwide. The focus in Basel 2 is the risk determination
and quantification of credit risk, market risk and operational risk faced by banks. Reserve
Bank of India has accepted the accord and issued guidelines to ensure compliance with
the norms by March 31, 2008. Other scheduled commercial banks are required to
implement Basel 2 by March 31, 2009
• Is Basel II –
A Risk Management Exercise ? (or)
A Capital Management Exercise ?
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Basel II is basically a Risk Management Exercise
 Doesn’t seek to change business models of the Bank.
 But requires to fine-tune/update Risk Management practices.
 Robust enough to capture all possible Risks the Bank is facing or likely to
face.
 Initiate adequate and appropriate Risk Mitigation measures through effective

Systems and Procedures
63
Objectives of the New Basel Accord
Broadly speaking, the objectives of Basel II are to encourage better and more
systematic risk management practices, especially in the area of credit risk, and to provide
improved measures of capital adequacy for the benefit of supervisors and the marketplace
more generally. At the outset of the process of developing the new Accord, the Basel
Committee developed the so-called three pillars approach to capital adequacy involving
(1)minimum capital requirements,

(2) supervisory review of internal bank assessments of capital relative to risk, and
(3) increased public disclosure of risk and capital information sufficient to provide
meaningful market discipline. Although the Committee’s proposals have evolved
considerably over the past several years, these fundamental objectives and the three-pillar
approach have held constant.
It is hardly necessary to emphasize the importance of banks and banking systems to

financial and economic stability. The ability of a sound and well-capitalized banking
system to help cushion an economy from unforeseen shocks is well known, as are the
negative consequences of a banking system that itself becomes a source of weakness and
instability. A critical potential weakness of financial markets is that risks are in many
cases under-estimated and not fully recognized until too late, with a concomitant
64
potential for excessive consequences once they have been fully realized. This is why the
Basel Committee’s efforts to promote greater recognition of risks and more systematic
attention to them are vitally important.
The essence of Basel II is a focus on risk differentiation and the need for enhanced
approaches to assessing credit risk. Some critics have argued that it is preferable to
downplay differences in risk, and indeed forbearance can sometimes appear the most
expedient strategy.
But experience has also shown that this will not work as an overall approach because
ignoring risks inevitably leads to larger problems down the road. Thus, one of the key
messages of Basel II is that bankers, supervisors, and other market participants must
become better attuned to risk and better able to act on those risk assessments at the
appropriate time. Bank supervisors must get better at addressing issues pre-emptively
rather than in crisis mode.
Significant attention to risk management is one of the primary mechanisms available to

help banks and supervisors do that. Basel II seeks to provide incentives for greater
awareness of differences in risk through more risk-sensitive minimum capital
requirements. The Pillar 1 capital requirements will, by necessity, be imperfect measures
of risk as any rules-based framework will be. The objective of the proposals is to increase
the emphasis on assessments of credit and operational risk throughout financial
institutions and across markets.
65
Perhaps even more important in the long run is the second pillar of the new Accord.
Pillar 2 requires banks to systematically assess risk relative to capital within their
organization. The review of these internal assessments by supervisors should provide
discipline on bank management to take the process seriously and will help supervisors to
continually enhance their understanding of risk at the institutions. The third pillar of
Basel II provides another set of necessary checks and balances by seeking to promote
market discipline through enhanced transparency. Greater disclosure of key elements of
risk and capital will provide important information to counterparties and investors who
need such information to have an informed view of a bank’s profile.
66
BASEL II GUIDELINES
 Basel II Committee set up by Bank for International Settlements (BIS) released

the first version of Basel II in June 2006.
 A Comprehensive Version, incorporating amendments to relating to Market
Risks, Trading Activities and the Treatment of Double Default Effects, was
released in June 2006.
 Basel II Guidelines in Indian context were finalized by RBI, after due
deliberations and brain-storming by select 14-member Committee of Banks from
Public Sector and Private Sector.
 Our Bank is also a member and headed the Sub-Committee on ‘National
Discretion’.
RBI released Basel II Final Guidelines vide their notification dated

27.04.2007.
Effective Date
67
Foreign banks operating in India and Indian banks having operational presence
outside India should adopt Standardised Approach (SA) for credit risk and Basic
Indicator Approach (BIA) for operational risk for computing their capital requirements
under the Revised Framework with effect from March 31, 2008. All other commercial
banks (excluding Local Area Banks and Regional Rural Banks) are encouraged to
migrate to these approaches under the Revised Framework in alignment with them
but in any case not later than March 31, 2009. These banks shall continue to apply
the Standardised Duration Approach (SDA) for computing capital requirement for
market risks under the Revised Framework.
Parallel run
With a view to ensuring smooth transition to the Revised Framework and with a
view to providing opportunity to banks to streamline their systems and strategies,
banks were advised to have a parallel run of the revised Framework. A copy of the
quarterly reports to the Board of Directors may be continued to be submitted to the
Reserve Bank of India – one each to the Department of Banking Supervision, Central
Office and the Department of Banking Operations and Development, Central Office.
Migration to other approaches under the Revised Framework
Banks are required to obtain the prior approval of the Reserve Bank to migrate to
the Internal Rating Based Approach (IRBA) for credit risk and the Standardised
68
Approach (TSA) or the Advanced Measurement Approach (AMA) for operational risk
for computing regulatory capital requirements. A separate communication in this
regard will be issued to banks at a later date, specifying the pre-requisites and
procedure for approaching the Reserve Bank for seeking its prior approval for such
migration
BASEL II FRAMEWORK
THREE PILLARS OF BASEL

II
Supervisory Market
Minimum Review Discipline
Capital Process
Requirement
Credit Risk Market Risk Operational Risk
69
Standardised
Standardis IRBA Duration
ed Approach Internals
Approach Model
Approach
Basic Indicator Standardised Advanced

Approach Approach Measurement
Approach
1 The first Pillar:
Minimum capital requirement
The definition of capital in Basel 2 will not modify and that the minimum ratios of capital
to risk-weighted assets including operational and market risks will remain 8% for total
capital. Tier 2 capital will continue to be limited to 100% of Tier 1 capital. The main
changes will come from the inclusion of the operational risk and the approaches to measure
the different kinds of risks.
Capital Unchanged
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Basic Indicator
Approach
Risk-Based Capital Ratio= Capital

_____________________________________________
Credit Risk + Market Risk+Operational Risk
Approaches to
Measure Market Risk Approaches to
Approaches to 1.Standardised measure
measure credit Risk Approach operational risk
1.Standardised 2.Internal Model 1.Basic Indicator
Approach Approach Approach
2.IRBA 2. Standardised
Approach 3.IMA
While there were no changes in the approaches to measure the market risk there were
fundamental changes in the approaches to measure the credit risk, which we will discuss
in section 3. Regarding the operational risk it is introduced for the first time in this
accord.
In the standardized approach to credit risk, exposures to various types of counter

parties, e.g. sovereigns, banks and corporates, will be assigned risk weights based on
assessments by external credit assessment institutions. To make the approach more risk
sensitive an additional risk bucket (50%) for corporate exposures will be included.
Further, certain categories of assets have been identified for the higher risk bucket
(150%).
The “foundation” approach to internal ratings incorporates in the capital
71
calculation the banks’ own estimates of the probability of default associated with the
obligor, subject to adherence to rigorous minimum supervisory requirements. Estimates
of additional risk factors to calculate the risk weights would be derived through the
application of standardized supervisory rules. In the “advance” IRB approach, banks that
meet even more rigorous minimum requirements will be able to use a broader set of
internal risk measures for individual exposures.
The Second Pillar:

Supervisory Review Process
In Basel 1 the risk weight were fixed and the implementation of the accord was straight
forward. In Basel 2 the bank can choose from a menu of approaches to measure the credit,
market and operational risks. This process of choosing the approach requires the review of
the availability of the minimum requirements to implement the approach. In addition to that,
in IRB approaches the risk weight is computed from inputs from the bank (like the
probability of default). It is necessary in this case to make sure that the bank inputs are
measured or estimated in an accurate and robust manner. Basel
committee suggests four principles to govern the review process:
Principle 1: Banks should have a process for assessing their overall capital in relation to
72
their risk profile and a strategy for maintaining their capital levels.
Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy
assessments and strategies, as well as their ability to monitor and ensure their compliance
with regulatory capital ratios. Supervisors should take appropriate supervisory action if
they are not satisfied with the results of this process.
Principle 3: Supervisors should expect banks to operate above the minimum regulatory
capital ratios and should have the ability to require banks to hold capital in excess of the
minimum.
Principle 4: Supervisors should seek to intervene at an early stage to prevent capital from
falling below the minimum levels required to support the risk characteristics of a
particular bank and should require rapid remedial action if capital is not maintained or
restored.
The Third Pillar:
Market Discipline
The third pillar in Basel 2 aims to bolster market discipline through enhanced disclosure
by banks. Effective disclosure is essential to ensure that market participants can better
understand banks’ risk profiles and the adequacy of their capital positions. The new
framework sets out disclosure requirements and recommendations in several areas,
including the way a bank calculates its capital adequacy and its risk assessment methods.
The core set of disclosure recommendations applies to all banks, with more detailed
73
requirements for supervisory recognition of internal methodologies for credit risk,

mitigation techniques and asset securitization.
The Risk Categories of Bank
Credit risk
The risk that a borrower or counterparty might not honour its contractual obligations -
Very relevant to operating staff.
The Standardized approach for credit risk
74
The standardized approach is conceptually the same as the present Accord, but it
is more risk sensitive. The bank allocates a risk-weight to each of its assets and offbalance-
sheet positions and produces a sum of risk-weighted asset values. A risk weight
of 100% means that an exposure is included in the calculation of risk weighted assets at
10 its full value, which translates into a capital charge equal to 8% of that value. Similarly, a
risk weigh of 20% results in a capital charges of 1.6%. Because of its simplicity it is
expected that it will be used by a large number of banks around the globe for calculating
minimum capital requirements.
Under Basel 1 individual risk weights depend on the board category of borrower
(i.e. sovereigns, banks or corporates). Under Basel 2 the risk weights are to be refined by
reference to a rating provided by an external credit assessment institution (such as a
rating agency) that meets strict standards. For example, for corporate lending, the
existing Accord provides only one risk weigh category of 100% but the new Accord will
provide four categories (20%, 50%, 100% and 150%)3. The following table illustrates
the relation between the risk weights and credit assessment for corporate lending.
Credit
Assessment
AAA to AA- A+ to A- BBB+ to BB- Below BB- Unrated
Risk Weights 20% 50% 100% 150% 100%
Banks’ exposures to the lowest rated corporates are captured in the 150% risk-weight
category. 150% risk-weight can be assigned for example to unsecured portions of assets
that are past due for more than 90 days, net of specific provisions. Similar frameworks
for sovereigns and banks credit risk weighs will be applied.
For bank’s exposures to sovereigns4, the Basel 2 proposes the use of published
75
credit scores of export credit agencies (ECA) and developed a method for mapping such
ratings to the standardized risk buckets.
In a suggested simple form for the foundation method one can use for corporate risk
weight of 100% if the external credit assessment will not be available. 4 The term
“sovereigns” includes sovereign governments; central banks and public sector entities
treated as sovereign governments by the nations supervisor.
Operational requirements for the standardized approach

In the standardized approach, national supervisors will not allow banks to assign
risk weight based on external assessments in a mechanical fashion. Rather, supervisors
and banks are responsible for evaluating the methodologies used by external credit
assessment institutions (ECAI) and the quality of the ratings produced. The supervisors
will use the following six criteria in recognizing ECAIs as outlined by Basel committee:
Objectivity. The methodology for assigning credit assessments must be

rigorous, systematic, and subject to some form of validation based on historical
experience. Moreover, assessments must be subject to ongoing review and
responsive to changes in financial condition. Before being recognized by
supervisors, an assessment methodology for each market segment, including
rigorous back testing, must have been established for at least one year and
preferably three.
Independence: An ECAI should be independent and should not be subject to

political or economic pressures that may influence the rating.
International access/Transparency: The individual assessments should be
76
available to both domestic and foreign institutions with legitimate interests and at
equivalent terms. In addition, the general methodology used by the ECAI should
be publicly available.
Disclosure: An ECAI should disclose the following information: its

assessment methodologies, including the definition of default, the time horizon
and the meaning of each rating; the actual default rates experienced in each
assessment category; and the transitions of the assessments, e.g. the likelihood of
AAA rating becoming AA over time.
Resources: An ECAI should have sufficient resources to carry out high quality
credit assessments.
Credibility: To some extent, credibility is derived from the criteria above. In

addition, the reliance on an ECAI’s external credit assessments by independent
parties (investors, insurers, trading partners) is evidence of the credibility of the
assessments of an ECAI.
Banks may elect to use a subset of the ECAI assessments deemed eligible by their
national supervisor, though the assessments must be applied consistently for both risk
weighting and risk management purposes. The requirement is intended to limit the
potential for external credit assessments to be used in a manner that results in reduced
capital requirements but is inconsistent with sound risk management practices.
Basel 2 address also practical considerations, such as the use of multiple external credit
assessments, issuer versus issue assessments, short-term versus long-term assessments
and unsolicited assessments.
77
Internal ratings-based approach (IRB)

The IRB approach provides a similar treatment for corporate, bank and sovereign
exposures, and a separate framework for retail, project finance and equity exposures. For
each exposure class, the treatment is based on three main elements: risk components,
where a bank may use either its own or standardized supervisory estimates; a risk-weight
function which converts the risk components into risk weight to be used by banks in
calculating risk-weighted assets; and a set of minimum requirements that a bank must
meet to be eligible for IRB treatment.
Credit Risk – State Bank of India’s Preparedness
 Existing Internal Credit Risk Assessment System refined and extended to cover
Advance Accounts of Rs. 25 lacs and above.
78
 Existing Internal Credit Information System is being fine-tuned to meet Basel II

requirements, now covering Whole Bank.
 Models for implementation of Integrated Risk Management and Operational Risk

Management are being implemented.
 Consultants are being appointed for Portfolio Credit Risk Modelling Exercise
Credit Risk–Corporate & Retail Classification
 Fund based + Non Fund based Limits < or = Rs. 5 crs and/or Turnover <Rs. 50
crs are classified as Retail Exposures and are assigned 75% RW.
 Fund based + Non Fund based Limits > Rs. 5 crs and/or Turnover = or >Rs. 50
crs are classified as Corporate Exposures and assigned RWs as per Rating.
 Sovereigns, MDBs, Banks, Public Sector Entities, Primary Dealers, Banks and
Staff Residential Housing Loans are outside the scope of Retail and Corporate
classification.
79
 Specified categories like Commercial Real Estate, Venture Capital, Capital

Market Exposures, Personal Loans and exposures to Non-Deposit taking
Systematically Important NBFCs (Asset size of over Rs.100 crs) are outside the
scope of Retail and Corporate classification.
CREDIT RISK ASSET NETTING
 Asset Netting means reducing value of eligible Collaterals from Outstanding to

arrive at the Net Exposure amount.
80
 Basel II recognizes only Financial Collaterals and Gold for Asset Netting.
 To be eligible for Asset Netting, lien on Collaterals is to be marked and legal

certainty is to be met.
 Banker’s General Lien is not permitted (which is available in Basel I scenario).
 For Asset Netting, value of Basel II collaterals is considered account-wise and not
in aggregate. i.eThe additional collateral available for a particular Exposure
cannot be used for Asset Netting of other Exposures, unless charge is extended.
 All Advances including Staff loans are eligible for Asset Netting, if Basel II
collaterals are available
Market Risk
81
- The risk of adverse price movements such as exchange rates, the value of
securities, and interest rates - Less relevant to operating staff, more or less
centralised @ Corporate centre
Although the Basel Committee issued “Amendment to the Capital Accord to incorporate
Market Risks” in1996, RBI as an interim measure, advised banks to assign an additional
risk weight of 2.5% on the entire investment portfolio. RBI feels that over the years,
bank’s ability to identify and measure market risk has improved and therefore, decided to
assign explicit capital charge for market risk in a phased manner over a two year period
as under -.
a. Banks would be required to maintain capital charge for market risk in respect of
their trading book exposure (including derivatives) by March 2005.
b. Banks would be required to maintain capital charge for market risk in respect of
securities under available for sale category by March 2006 puting capital charge for
interest rate related instruments in the trading book, equities in the trading book
and foreign exchange risk (including gold and precious metals) in both trading and
banking book. Trading book will include:
◆ Securities included under the Held for Trading category
◆ Securities included under the Available for Sale category
◆ Open gold position limits
◆ Open foreign exchange position limits
◆ Trading position in derivatives and derivatives
entered into for hedging trading book exposures.
As per the guidelines, minimum capital requirement
is expressed in terms of two separately calculated charges:
82
a. Specific Risk and
b. General Market Risk
Specific Risk: Capital charge for specific risk is

designed to protect against an adverse movement in price
of an individual security due to factors related to individual
issuer. This is similar to credit risk. The specific risk
charges are divided into various categories such as investments
in Govt securities, claims on Banks, investments in mortgage backed securities,
securitized papers etc. and capital charge for each category specified.
General Market Risk: Capital charge for general market risk is designed to capture the
risk of loss arising from changes in market interest rates. The Basel Committee suggested
two broad methodologies for computation of capital charge for market risk, i.e.,
Standardized Method and Internal Risk Management Model Method. As Banks in India
are still in a nascent stage of developing internal risk management models, in the
guidelines, it is proposed that to start with, the Banks may adopt the Standardized
Method. Again, under Standardized Method, there are two principle methods for
measuring market risk – maturity method and duration method. As duration method is a
more accurate method of measuring interest rate risk, RBI prefers that Banks measure all
of their general market risk by calculating the price sensitivity (modified
duration) of each position separately. For this purpose detailed mechanics to be followed,
time bands, assumed changes in yield etc. have been provided by RBI.
Market Risk State Bank of India’s Preparedness
83
 Exploring the feasibility of using KVaR+ software for mapping Treasury

Operations for Market Risk.
 Developed adequate hedging mechanisms to absorb the impacts of Market Risk.
 Our Investment Risk is akin to the Country Risk and thus well protected.
 Implementation of Oracle Based ALM Software is in progress, to provide

comprehensive ALM data analysis.
Market Risk State Bank of India’s Concerns
 During the FY: 2005-06, additional Capital charge of around Rs. 1200 crores has
been provided on account of Market Risk on AFS category of Investments.
 Securitization Transactions are subjected to stringent treatment thus making them

less attractive.
84
Operational Risk
The risk of loss resulting from inadequate or failed internal processes, people, and
systems, or from external events – Newly introduced & also very relevant to operating
staff
Capital Charge for Operational Risk

The Basel Committee has defined the Operational Risk as “the risk of loss resulting from
inadequate or failed internal processes, people and systems or from external events”.
This definition includes legal risk but excludes strategic and reputational risk. The
objective of the operational risk management is to reduce the expected operational losses
using a set of key risk indicators to measure and control risk on continuous basis and
provide risk capital on operational risk for ensuring financial soundness of the Bank.
Basic Indicator Approach

Under the basic indicator approach, Banks are required to hold capital for operational risk
equal to the average over the previous three years of a fixed percentage (15% - denoted as
alpha) of annual gross income. Gross income is defined as net interest income plus net
non-interest income, excluding realized profit/losses from the sale of securities in the
banking book and extraordinary and irregular items.
85
Standardized Approach
Under the standardized approach, bank’s activities are divided into eight business lines.
Within each business line, gross income is considered as a broad indicator for the likely
scale of operational risk. Capital charge for each business line is calculated by
multiplying gross income by a factor (denoted beta) assigned to that business line. Total
capital charge is calculated as the three-year average of the simple summations of the
regulatory capital across each of the business line in each year. The values of the betas
prescribed for each business line are as under:
Business Line Beta Factor

Corporate Finance 18%
Trading and sales 18%
Retail banking 12%
Commercial banking 15%
Payment and Settlement 18%

Agency Sevices 15%
Asset Management 12%
Retail Brokerage 12%
Advanced Measurement Approach

Under advanced measurement approach, the regulatory capital will be equal to the risk
measures generated by the bank’s internal risk measurement system using the
86
prescribed quantitative and qualitative criteria.
Operational Risk State Bank Of India’s Preparedness
87
 Operational Risk Management Committee, is developing the ORM Policy to assess

the losses to:
i) Physical Assets ii) Business and Systems iii) Process Management and
Delivery Mechanism.
 Business Process Re-engineering Team is in place evaluating the processes
and redefining the Systems & Procedures to mitigate incidence of losses on
account of Processes and Systems.
Operational Risk - Our Concerns
 At 12% CAR, the Bank may be required to provide additional capital charge of
around Rs. 4500 crores towards Operational Risk.
 The Bank has established systems and procedures and hence, may be required to
provide lesser capital for Operational Risk under Advanced Approaches .
 However, given the current level of MIS and Technical Sophistication, our Bank
for the present, may be in a position to adopt Basic Indicator Approach only.
MIS – State Bank of India’s Preparedness
88
 Moving towards Core Banking Solutions, which will help byrobust MIS and mapping
of Historical Data.
 CBS Data Structure is being fine-tuned to factor-in data needs for CAR compilation.
 Data Warehouse is being setup to store and retrieve Historical Data.
 In-house teams from BI (MIS) and IT-SS Depts. are developing solutions for Auto-
generation of CAR B II on CBS and BankMaster branches respectively.
MIS and others – State Bank of India Concerns

 Quality of data inputted by the branches is found wanting.
 Developing of robust MIS to facilitate mapping of valid auditable historical data.
 Transition requires huge investments in Technical Up-gradation, for mapping of

validated auditable historical data etc
.
 Adverse balances in Agency Clearing A/c leads to additional RWs.
 Adverse comments by the Statutory Auditors
89
CHALLENGES FOR INDIAN BANKING SYSTEM UNDER

BASEL II
A feature, somewhat unique to the Indian financial system is the diversity of its
composition. We have the dominance of Government ownership coupled with significant
private shareholding in the public sector banks and we also have cooperative banks,
Regional Rural Banks and Foreign bank branches. By and large the regulatory standards
for all these banks are uniform.
Costly Database Creation and Maintenance Process:
The most obvious impact of BASEL II is the need for improved risk management and
measurement. It aims to give impetus to the use of internal rating system by the
international banks. More and more banks may have to use internal model developed in
house and their impact is uncertain. Most of these models require minimum 5 years bank
data which is a tedious and high cost process as most Indian banks do not have such a
database
Additional Capital Requirement:
In order to comply with the capital adequacy norms we will see that the overall capital
level of the banks will raise a glimpse of which was seen when the RBI raised risk
weightages for mortgages and home loans in October 2004. Here there is a worrying
aspect that some of the banks will not be able to put up the additional capital to comply
with the new regulation and they may be isolated from the global banking system.
Large Proportion of NPA's:
90
A large number of Indian banks have significant proportion of NPA's in their assets.
Along with that a large proportion of loans of banks are of poor quality. There is a danger
that a large number of banks will not be able to restructure and survive in the new
environment. This may lead to forced mergers of many defunct banks with the existing
ones and a loss of capital to the banking system as a whole
Low Degree of Corporate Rating Penetration:
India has as few as three established rating agencies and the level of rating penetration is
not very significant as, so far, ratings are restricted to issues and not issuers. While Basel
II gives some scope to extend the rating of issues to issuers, this would only be an
approximation and it would be necessary for the system to move to ratings of issuers.
Encouraging ratings of issuers would be a challenge.
Cross Border Issues for Foreign Banks:
In India, foreign banks are statutorily required to maintain local capital and the following
issues are required to be resolved;
Validation of the internal models approved by their head offices and home country
supervisor adopted by the Indian branches of foreign banks.
Date history maintained and used by the bank should be distinct for the Indian branches
compared to the global data used by the head office capital for operational risk should be
maintained separately for the Indian branches in India
91
NOT WHEN BUT HOW?
The important decision for India is not whether to stay on Basel I or move to Basel II, but
of which of the many alternatives on offer, should be adopted. Given the lack of rating
penetration, the Standardized Approach yields little in linking capital to risk while the
IRB approach looks complex to implement and difficult to monitor. In the event of some
banks adopting IRB Approach, while other banks adopt Standardised Approach, banks
adopting IRB Approach will be much more risk sensitive than the banks on Standardised
Approach, since even a small change in degree of risk might translate into a large impact
on additional capital requirement for the IRB banks.
For banks adopting Standardised Approach the relative capital requirement would be less
for the same exposure and would be inclined to assume exposures to high risk clients,
which were not financed by IRB banks. As a result, high risk assets could flow towards
banks on Standardised Approach which need to maintain lower capital on these assets.
Similarly, low risk assets would tend to get concentrated with IRB banks which need to
maintain lower capital on these assets. Hence, system as a whole may maintain lower
capital than warranted.
Keeping in view the above complications we suggest as a transitional tool, a Centralized

Rating Based(CRB) approach where the RBI dictates a rating scale and asks banks to rate
borrowers according to that centralized scale. The great benefit of the approach is that the
RBI would be able to monitor and control banks' ratings and hence monitor and control
their capital sufficiency in relation to risk much more effectively. These kinds of
comparisons combined with simple procedures for spotting outliers and keeping a track
92
of the different banks' ratings of the main borrowers from the financial system will be
extremely valuable tools for a RBI.
Finally the CRB approach should be used as a precursor to IRB. Once the CRB approach
is working the RBI could then work with banks to approve their own rating scales and
rating methodology using the basic CRB approach as a reference tool.
93
Challenges in Implementation in SBI
 Complexities in Systems and Processes involved in Basel II make the

 Availability and mapping of Validated and Auditable Data and Integration of the
same to Basel II norms.
 Adaptability of Operating Personnel to the New Skills

.
 Internationally active Bank like ours will face problem due to localization of
Basel II norms in different Geographical Zones due to Home & Host Country
Regulations
94
MIGRATION TO BASEL II BY SBI TIME LINES
 Our Bank has to migrate to Basel II Framework by 31.03.2008, both at the Solo
and at the Consolidated Level.
 The Board of Directors directed that Bank complete all Basel II related activities
and equip itself to migrate by 30.09.2007.
 The time-line set by the Board is highly demanding and requires conscious and
concerted efforts by all of us.
 Bank has to conduct Parallel Run of all Basel II related activities.
 Compilation of CAR B II is one of the important activities of Parallel Run.
95
MIGRATION TO BASEL II -MONITORING
 An Integrated Risk Governance Structure is set up to facilitate early migration to

Basel II.
 Separate departments are set up to monitor and manage Credit Risk, Market Risk
and Operational Risk.
 Risk based Internal Audit has been implemented across the Bank.
 An In-house Committee is overseeing the Transition to Basel II.
96
THE IMPACT OF BASEL NORMS
Basel II is the new regulatory framework within which all banks will have to work. Its
aim is to safeguard the stability of the financial sector and one of its aspects is a
comprehensive approach to risk.
The first phase of the Accord will take effect in 2007, and the second phase will be
implemented in 2008.
The Accord regulates the amount of capital that banks will have to set aside for their
loans. In addition, it prescribes that this capital must be a better reflection of the actual
credit risks represented by the companies to which the banks lend. Banks can select from
three methods of determining the risks and the associated capital requirements; the banks
with the most sophisticated risk management will be rewarded with a lower capital
requirement relative to their existing capital bases. This is one of the reasons why credit
will not necessarily become more expensive. There is also no question of credit crunch;
banks' loan portfolios have in fact grown as a proportion of their total assets.
As from 1 January 2007, banks will be required to have historical credit information on
their lending customers; this information is needed to evaluate their customers'
97
creditworthiness. Three quarters of companies are currently reported to have insufficient

information about the banks' new credit risk criteria.
An increase in the transparency of company accounting and of the information exchanged

with banks is intended to result in greater objectivity with regard to the granting of new
credit lines. The more favourable the company's risk profile, the better the credit risk
rating and the more favourable the bank's terms and conditions will be.
Creditworthiness a management priority
The banks' credit risk assessment will be repeated during the term of the financing; this
seems to be paving the way for a greater role for companies' accountants. Systematic
analysis of a company's creditworthiness is a useful part of medium-term planning.
A company's creditworthiness must be a management priority. Efficient debtor

management, good payment history, and up-to-date financial reporting will help to boost
credit ratings.
Banks use both quantitative and qualitative criteria to assess credit risk. The quantitative
factors are gearing, liquidity, profitability, debt repayment capacity, and security. The
qualitative factors are the quality and the expertise of the management, the market
environment, and the legal form of the business. They use many different information
sources, ranging from balance sheets and profit and loss accounts, to business plans and
tax returns, but also meetings with the management.
A company that does not score well in a bank's credit risk assessment may face
difficulties in the future. Under Basel II, the bank would then be forced to make its loans
98
more expensive, to restrict outstanding credit lines, or to refuse to grant further loans.
In order to improve their credit risk assessment or rating, companies have the option of
making greater use of off-balance sheet finance, such as leasing or factoring. Another
option is to raise private equity.
Undercapitalisation is a mortgage on the future
Under Basel II the basic lending criteria will certainly continue to be the competence of
the management, the company's ability to repay the loan, and adequate equity.
Companies demonstrate their ability to repay debt using credible business plans and
historical cash flows. Under Basel II, the cash flows that companies are able to
demonstrate will become more important.
Companies must also demonstrate their inherent profitability and the managers of many
SMEs and medium-sized corporates will certainly have to address this issue. Benefits in
kind and the segregation of corporate and personal assets must be properly organised. In
this way, the business can organise its activities at the level of a management company,
thereby increasing the transparency of the operating company.
Basel II will also have a major impact on equity, as the penalties for undercapitalisation
will increase. Undercapitalisation is generally tax-driven and under a /historically high
tax burden in many countries, overcapitalisation has become synonymous with an
expensive price tag. Too many companies have excessively high gearing. In Europe, for
instance, bank loans account for 22% of financing, compared with 12% in the UK, and
99
4% in the US.
Undercapitalisation constitutes a mortgage on the future; this situation needs to change.

Profit retention and capital injections have become fiscally more attractive in recent years
and personal equity needs to be used more extensively to finance businesses.
The new lending relationship: six recommendations
What precautions can a company take in order to avoid a poor credit risk assessment?
The European Commission has put forward six recommendations, which are the basic
rules governing lending relationships in the new Basel II environment.
The collection of information and credit rating systems vary from bank to bank. One
recommendation is that companies should obtain information at the outset on the type of
documentation that the bank issues, on its approach to credit assessment, on the
information that it will require, and on whether it will disclose the results of its credit
assessment.
The company must develop the discipline to present complete, unambiguous information
to the bank within the agreed time period.
Each bank has different credit terms. The factors that affect these terms are, in
descending order of importance: the credit risk assessment, security (in the form of cash,
property, securities, receivables, stocks, etc.), the term of the loan, special clauses
(maximum gearing, minimum liquidity, debt to equity ratio, etc.), the relationship with
100
the customer, the volume of loans (borrowers can generally secure better terms by raising
a number of loans from the same bank).
An active credit rating system requires companies' managements to be vigilant; they need
to monitor the quantitative and qualitative factors that change their companies' risk
profiles.
A company's position will be monitored from a distance throughout the term of a credit
by the bank. Disappointing figures, the expiry of supplier credit, a negative cash flow, or
fluctuating accounting ratios can result in a breach in its loan terms and all represent
alarm signals. In particular, companies should make their banks aware of the real
financial situation in the market environment.
Finally, the company can use other types of finance, including innovative products.
Measures to reduce borrowing requirements
In summary, Basel II tightens up requirements on the demand side for loans and it is
worth giving serious consideration to measures to limit borrowing requirements and to
alternative credit products, which can have a considerable impact on a company's balance
sheet.
Companies can reduce their borrowing requirements by using leasing, factoring, and/or
efficiency gains. All three are reflected on the asset side of the balance sheet. Leasing
affects capital employed, factoring affects debtors, and efficiency gains affect the assets
that can be converted into cash within one year. Efficiency gains lie primarily in lower
stocks and/or real productivity gains.
Use of alternative forms of finance is growing. These include private equity, mezzanine
101
structures, and even financial incentives, such as government subsidies. These are shown
as liabilities on the balance sheet. Private equity affects the company's capital base,
mezzanine finance affects borrowings and the capital base, and subsidies affect
borrowings.
Mezzanine finance is funding using hybrid debt and equity, and is expected to become
increasingly widely used. By 2007, all European banks will be offering this type of
finance.
IMPACT OF BASEL NORMS ON INDIAN BANKS
 Banks will have to develop:

o Credit and Operational Risk Models
o Business Models and Surrounding Processes
o Skill levels of Operating Personnel
o Valid and Integrated Data Backup
o
 Advanced Measurement Methods require at least 5 years Auditable and
Reconcilable Data
 New Framework tends to reduce Capital Base of Indian Banks by 1% to 2%,

except a few Banks.
 With the advent of Basel II, Indian Banks may be required to raise over Rs.
1,70,000 crs additional Capital during the coming 3 years.
102
IMPACT OF BASEL NORM on SBI
 Our Bank is moderately affected on account of Credit Risk, but adversely affected
on account of Operational Risk.
 Without any additional Capital support, Basel II would tend to reduce CAR of the
Bank by around 150 bps.
 The Projected CAR tends to slide immediately by around 1.50%, but the negative
impact is expected to be neutralized over a period of 5 years
103
Rationale for a new Accord or Comparison Between Both The Accords
The Existing Accord ( Basel I) The Proposed Accord ( Basel II)
For on a single risk measure More emphasis own bank’s internal

methodologies, supervisory review and
market discipline
One size fits for all Flexibility, menu of approaches, incentives

for better risk management
104
Broad Brush Approach More risk sensitivity
CONCLUSIONS
Basel II is an international Accord which is implemented India by all the internationally

active banks this will change the entire banking scenario. The norm is very complex and
it is recently implemented due to which entire data could not be collected.
 Basel II will improve risk management exercise in Banks.
 State Bank of India will get international standard for adopting Basel II.
 All the areas of risks have been taken care.
 Some additional Capital is required.
105
FINDINGS
 It was observed that while undertaking a project none of the SBI employees
knows about Basel II.
 The Bank is going to raise additional capital of by way of equity shares through
IPO to support additional capital requirement for implementing Basel II
 Earlier there were no separate departments for managing risks, but after
implementing Basel II separate departments to have been entrusted with the task
of managing Credit Risk, Market Risk and Operational Risk.
106
 Skilled operational personnel is required for State Bank of India.
 Basel II tends to reduce Capital Base of Indian Banks by 1% to 2%, except a few
Banks
 Complexities in Systems and Processes involved in Basel II make the

 Standardised Approach is adopted by bank to assess Credit Risk in which external

Credtit rating Agencies are involved, this is due bank’s internal rating system is
not full proof system which is not approved by RBI.
SUGGESTIONS
 Bank has to train all its employees so that everybody can understand about Basel
Accord.
 It has to recruit operationally skilled personnel in order to implement Basel

accord.
 Bank has to develop a full proof internal credit rating system so that it can go for
Advanced approach in assessing credit risk
107
LIMITATIONS
 The time stipulated for the project was limited
 Some confidential information was not revealed by the bank.
 Some employees were not co-operative
BIBLIOGRAPHY
• Indian Nanking Association Journal
• www.bis.com
• Bank’ Magazines
108

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The Analysis of Basel Norms and Implementation

MASTERS OF BUSINESS ADMINISTRATION

Internal Guide Company Guide

I, Miss Shveta.R.Chikkamath hereby declare that the project for MCP

In 1988 the Bank for International Settlements’ Basel Committee on Banking

technology and catastrophes such as fires, floods or earthquakes. These

OBJECTIVES OF THE PROJECT

 The analysis of what is basel 1 and why was it implemented

Significance of the Study

 Skilled operational personnel is required for State Bank of India.

 Complexities in Systems and Processes involved in Basel II make the

 Standardised Approach is adopted by bank to assess Credit Risk in which external

 Basel II will improve risk management exercise in Banks.

 All the areas of risks have been taken care.

 Some additional Capital is required.

 It has to recruit operationally skilled personnel in order to implement Basel

BANKING INDUSTRY OVERVIEW

The first phase of financial reforms resulted in the nationalization of 14 major

The Indian Banking System:

Banks play important role in economic development of a country, like:

• Banks provide convenient means of transfer of fund from one place to

• Banks advances exposure in trade and commerce, industry and agriculture

• Bank acts as an intermediary between the depositors and the investors.

The Structure of Indian Banking:

Reserve Bank of India

Public Sector Private Sector

Scheduled Urban Scheduled State

Old Private New Private

Chart Showing Three Different Sectors of Banks

ii) Private Sector Banks

Public Sector Banks

SBI and Nationalized Regional Rural

SUBSIDIARIES Banks Banks

SBI and subsidiaries

Regional Rural banks

Private Sector Banks

Private Sector Banks

Old private New private

Old Private Sector Banks

New private Sector Banks

IMPORTANCE OF BANKING SECTOR IN A GROWING ECONOMY

Another emerging change happening all over the banking industry is

EMERGING SCENARIO IN THE BANKING SECTOR

Currently (2007), overall, banking in India is considered as fairly mature in terms of

1 Central Bank Reserve Bank of India

2 Corporation Bank, Dena Bank, Indian Bank, Indian

Sind Bank, Punjab National Bank, Syndicate Bank,

3 Federal Bank, Ganesh Bank of Kurundwad, HDFC

STATE BANK OF INDIA

A highly efficient and experienced management functioning in a well defined

successive finance minister of independent India Resource Bank of governors and

THE PLACE TO SHARE THE NEWS ...……

MISSION, VISION AND VALUES

♦ Premier Indian Financial Service Group with prospective world-class

♦ Retain its position in the country as pioneers in Development banking.

♦ Maximize the shareholders value through high-sustained earnings per

♦ Excellence in customer service

CHIEF GENERAL MANAGER

G. M G.M G. M G.M G.M

THE ANALYSIS OF BASEL NORMS AND ITS

BACKGROUND OF BASEL ACCORD

evolving a consensual framework which could be adapted by all countries including

It is, therefore, suggested that a simplified standardised approach, based on internal