"A STUDY ON THE ADOPTION OF BASEL II NORMS IN INDIAN BANKING SECTOR WITH SPECIAL REFERENCE TO SOUTH INDIAN BANK"

A PROJECT REPORT

Submitted by
Mr. ROHITH P
(Reg.No:CUAJMGT033)

in partial fulfillment of the requirement for the award of the degree of MASTER OF BUSINESS ADMINISTRATION in
DEPARTMENT OF COMMERCE & MANAGEMENT STUDIES

UNIVERSITY OF CALICUT.

JUNE 2011

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DEPARTMENT OF COMMERCE AND MANAGEMENT STUDIES UNIVERSITY OF CALICUT

Dr. M.A. JOSEPH Head Of the Department DCMS

University of Calicut Malappuram District Kerala-673635

Date:

CERTIFICATE

This is to certify that ROHITH P is an MBA student of Department Commerce and Management Studies and this project report entitled A STUDY ON THE ADOPTION OF BASEL II NORMS IN INDIAN BANKING SECTOR WITH SPECIAL REFERENCE TO SOUTH INDIAN BANK has been prepared by him in partial fulfillment of the requirement for the Award of Degree of Master of Business Administration (MBA) of the University of Calicut.

Dr. M.A. JOSEPH Head of the Department DCMS

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DEPARTMENT OF COMMERCE AND MANAGEMENT STUDIES UNIVERSITY OF CALICUT

Dr. B. VIJAYACHANDHRAN PILLAI READER , DCMS

University of Calicut Malappuram District Kerala-673635

Date CERTIFICATE

This is to certify that ROHITH P is an MBA student of Department Commerce and Management Studies and this project report entitled A STUDY ON THE ADOPTION OF BASEL II NORMS IN INDIAN BANKING SECTOR WITH SPECIAL REFERENCE TO SOUTH INDIAN BANK has been prepared by them in partial fulfillment of the requirement for the Award of Degree of Master of Business Administration (MBA) of the University of Calicut.

Dr. B. VIJAYACHANDHRAN PILLAI READER DCMS

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UNIVERSITY OF CALICUT

DECLARATION

I hereby declare that the project entitled A Study on the adoption of Basel II norms in Indian banking sector with special reference to South Indian Bank in partial fulfillment of the requirement for the award of the degree of MASTER OF BUSINESS ADMINISTRATION is a record of original project work done by me, during my period of study in Department of Commerce and Management Studies, University of Calicut 2009-2011 under the guidance of Dr. B.Vijayachandhran Pillai, Reader DCMS, University of Calicut and no part of it has been submitted for any other Degree or Diploma.

Signature of the Candidate: Name of the Candidate: Rohith.P Date: 24/06/2011 Place: Guruvayoor
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ACKNOWLEDGEMENT

I am extremely thankful to our beloved HOD Dr. M.A Joseph, (DCMS,

University Of Calicut), for showing keen interest in my effort and for being a source of
inspiration throughout the course in this college. I would like to thank my internal guide Dr. B Vijayachandran Pillai Reader, DCMS, University Of Calicut for the guidance and support which have been instrumental in accomplishing this project. I wish to convey my sincere thanks to all my teaching and non-teaching staff of the department. I thank to my Family, Friends and the Almighty for supporting me in every day they could. At last, I would like to thank all those who helped me directly or indirectly in conducting the study and preparing the project.

PLACE: DATE: ROHITH P

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TABLE OF CONTENTS

CHAPTER

TITLE CHAPTER- INTRODUCTION 1.1 INTRODUCTION 1.2 STATEMENT OF THE PROBLEM 1.3 REVIEW OF RELATED LITRATURE 1.4 OBJECTIVES, SCOPE AND SIGNIFICANCE OF THE STUDY 1.5 RESEARCH METHODOLOGY 1.6 LIMITATIONS OF THE STUDY 1.7 SCHEME OF THE PRESENTATION

PAGE NO

1 2 5

6 9 9

CHAPTER-BASEL NORMS THEORETICAL FRAME WORK 2.1 CONCEPTS OF THE STUDY 2.3 INDUSTRY PROFILE 2.4 PRODUCT PROFILE
10 31 39 49

3 4

CHAPTER-RESULTS OF THE ANALYSIS

CHAPTER- FINDINGS CONCLUSION AND SUGGESTIONS 5.1 FINDINGS OF THE STUDY 5.2 CONCLUSION 5.3 SUGGESTIONS & RECOMMENDATIONS 82 83 84

6 7

BIBIOGRAPHY ANNEXURE

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CHAPTER I INTRODUCTION

BASEL ACCORD

The Basel Accords refer to the banking supervision Accords (recommendations on banking laws and regulations) by the Basel Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS maintains its secretariat at the Bank for International Settlements in Basel, Switzerland and the committee normally meets there. Formerly, the Basel Committee consisted of representatives from central banks and regulatory authorities of the Group of Ten countries plus Luxembourg and Spain. Since 2009, all of the other G-20 major economies are represented, as well as some other major banking locales such as Hong Kong and Singapore. (See the Committee article for a full list of members.) The committee does not have the authority to enforce recommendations, although most member countries as well as some other countries tend to implement the Committee's policies. This means that recommendations are enforced through national (or EU-wide) laws and regulations, rather than as a result of the committee's recommendations - thus some time may pass between recommendations and implementation as law at the national level. With a view to adopting the Basel committee on banking supervision (BCBS) framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off- balance sheet business and also to strengthen the capital base of banks, RBI decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure. Essentially,
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under the above system the balance sheet assets, non-funded items and other off-balance sheet exposures are assigned prescribed risk weights and banks have to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. RBI has issued guidelines to banks in June 2004 on maintenance of capital charge for market risks on the lines of Amendment to the capital accord to incorporate market risks issued by BCBS in 1996. The BCBS released the International convergence of capital measurement and capital standards: A revised Framework on June 26, 2004. The revised framework was updated in November 2005 to include trading activities and the treatment of double defaults

effects and a comprehensive version of the framework was issued in June 2006 incorporating the constituents of capital and the 1996 amendment to the capital accord to incorporate Marker risk. The revised framework seeks to arrive at significantly more risksensitive approaches to capita; requirements. The Revised frame work provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and financial markets. STATEMENT OF THE PROBLEM Banking operations and system have been facing spectacular reforms in this era of globalization and liberalisation. It is a herculean task for the economists and banking experts to frame strategies in order to cope up with these changes and new challenges. Global economic turmoil which was a wakeup call for every capitalist country threw light on the importance of risk management in banking sector. Financial giants such as J.P Morgan, Lehman Brothers etc have bankrupted due to poor risk management. Even though Indian banks did well during this contagion took place. The main reason observed was the strict regulatory measures taken by RBI to control the operations of Indian banks. Moreover majority of public sector and old private sector banks operates in a traditional way without taking much risk. But the situation prevailing is changing the face of Indian
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banking industry. New generation banks are now competing with global giants. RBI is promoting all banks to grow aggressively. In this scenario they have to take various risks. So that underlines the importance of risk management. Basel II norms are now a inevitable part of banking to ensure a organized and systematic risk management. This study probes in to the adoption of Basel II norms in Indian banking sector with special reference to South Indian Bank

REVIEW OF LITERATURE The relevant studies conducted in the related area are briefly reviewed below: Daniel Tabbush, Head of CLSA Banking Research (2008) in his report stated Mortgage-loan risk weightings drop from 50% to 35% under Basel II, making them much more profitable in terms of regulatory capital required, while small and medium-sized enterprise (SME) lending can move from 100% to 75% Anand Wadadekar (2008) in his study Basel Norms & Indian Banking System revealed that Basel II Norms offers a variety of options in addition to the standard

approach to measuring risk. Paves the way for financial institutions to proactively control risk in their own interest and keep capital requirement low. C.P.Chandrasekhar & Jayati Ghosh(2007) in their study Basel II and India's banking structure examined what the guidelines involve, their effects on the banking structure and behavior and some likely outcomes of implementing them Rana Kapoor, managing director, YES Bank (the latest entrant to new generation private banks in India), holds Most (Indian) banks are likely to start with simpler,

elementary approaches, just adequate to ensure compliance to Basel II norms and gradually adopt more sophisticated approaches. The continued regulatory challenge will be to migrate to Basel II in a non-disruptive manner.
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 P.S. Shenoy, chairman and managing director, Bank of Baroda, believes Basel II compliance will eventually result in banks acquiring a competitive edge, stating `Banks that move proactively in the broad direction outlined by the Basel Committee will have acquired a definite edge over their competitors when the new accord enters the implementation phase. Niall S.K. Booker, chief executive officer, HSBC India and chairman of the IBA Committee on Basel II states There is the possibility that in international markets access may be easier and costs less for banks adopting a more sophisticated approach.however in a market like India it seems likely that the large domestic players will continue to play a very significant role regardless of the model used. Mandira Sharma & Yuko Nikaido (2007) in their study onCapital Adequacy Regime in India examined issues and challenges with regard to the implementation of

CRAR norms under Basel II regime in India. They also tried to identify limitations, gaps and inadequacies in the Indian banking system which may hamper the realization of the potential benefits of the new regime.

Ernst & Young in their survey in 2008 revealed that Basel II has changed the competitive landscape for banking. Those organizations with better risk systems are

expected to benefit at the expense of those which have been slower to absorb change due to increased use of risk transfer instruments. It also concluded that portfolio risk management would become more active, driven by the availability of better and more timely risk information as well as the differential capital requirements resulting from Basel II. This could improve the profitability of some banks relative to others, and encourage the trend towards consolidation in the sector.

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SCOPE OF THE STUDY: The project entitled A study on the adoption of Basel II norms in Indian Banking Sector with reference to South Indian Bank mainly comprises of analyzing how south Indian bank adopted Basel II accord and evaluating Indias top banks like STATE BANK OF INDIA, Canara bank, Indian bank, HDFC bank, Axis bank, and Indian Bank in terms of capital adequacy norms. Basel II norms are the international standardization provided to all the banks in the world. Through the study the performance of banks on the basis of Basel II norms are evaluated. The project is analyzed with the help of financial statements of each bank in the past three consecutive years. Basel II has made certain stipulations to Indian banking sector regarding the maintenance of minimum regulatory capital. As per the Basel II norms all the banks should maintain sufficient regulatory capital to cover themselves from various risks. Basel II is intended to improve safety and soundness in the financial system by placing increased emphasis on banks` own internal control and risk management processes and models, the supervisory review process, and market discipline. OBJECTIVES OF THE STUDY The main objectives of the study entitled A study on the adoption of Basel II norms in Indian Banking System with reference to South Indian Bank are: To study how South Indian bank adopted Basel 2 norms To find out the efficiency of each bank in implementing Basel II norms. To study about the advantages of Basel II norms implementation in banks. To analyze various factors influencing Banking operation in BASEL II .

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SIGNIFICANCE OF THE STUDY As we all know Indian Banking system is one of the best banking structure in the world due to our banking efficiency and the regulatory measures adopted by RBI. Indian banks were least affected by the global financial turmoil that hit western countries like America and other European countries. The Indian banking system has seen structural improvements during the last few years, including improved solvency, better risk management systems and greater access to capital. However, the greater complexities among Indian banks, reinforces the need for stronger risk assessment systems. The significance in implementing Basel II norms in banks are: Maintenance of minimum regulatory capital Effective managerial involvement Better handling of all risk like credit risk, operators risk and market risk Managers can easily evaluate the performance of their bank

RESEARCH METHODOLOGY Research is a scientific and systematic search for pertinent information on a specific topic. Research methodology is a way to systematically solve the research problem. It helps the researcher to know the criteria by which they can decide that certain techniques and procedure will be applicable on certain problem and other will not. In general, it refers to the research design adopted by the researches, sampling techniques followed, and data collection details. RESEARCH DESIGN Research design is not a highly specific plan to be followed without deviation but rather a series of guideposts to keep one headed in the right direction. Fundamental to the success of any formal research project is found research design. The research design is the basic
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frame work, which provides guidelines of the rest of the research process. It is a map or blue print according to which the research is to be concluded. The research design specifies the method for data collection and data analysis. It is of three types, exploratory, experimental and descriptive research design. Research design is a method the research adopts for the study. The choices of research desponds on the depth and extend of data requires, the cost and benefits of the research the urgency of work and the time available for completing it. DESCRIPTIVE RESEARCH DESIGN Descriptive studies as the name implies, is designed to describe something in detail. In descriptive study, data is collected for a definite purpose. SAMPLING DETAILS Sampling means when field studies are undertaken in practical life, considering time and cost almost invariably lead to a selection of respondents i.e. , selection of only few items. The respondents selected should be representative of the total population as possible in order to produce a miniature cross-section. The selected respondents constitute what is technically called as sample and the selection process is called as sample technique. Convenient sampling technique is used in the study. Size of Sample Here the size of the sample is taken as 6 Banks. Among six Banks three are from Nationalized Banks and the rest from Private Banks. The Banks selected for the analysis are: 1) NATIONALISED BANK State Bank of India Indian Bank Canara Bank
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2) PRIVATE BANK HDFC Bank Axis Bank South Indian Bank DATA COLLECTION METHOD For a research the researcher may depend either on primary data or secondary data or both. Primary data usually collected with the help of the questionnaire, personal interview etc. Data collection is a elaborate process in which the researcher makes a planned search for all relevant data. Data is the foundation for all research data or facts may be obtained from several sources. Data collected only from primary sources. SECONDARY DATA Secondary data is mainly comprises of the information that are collected already for some other purpose. The secondary data collected in this project are from Booklets from the Bank Magazines Websites like www.bis.org www.rbi.org.in www.southindianbank.org

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PRIMARY DATA Primary data is the original data gathered for the first time by the researcher with help of the questionnaire and from the respondents responses. Primary data is the direct method by which the research will be get the information from the respondents. In this project study primary data has been collected by conducting expert interview with the top officials of the bank. LIMITATIONS: Under the project entitled The study of the adoption of Basel II norms in Indian Banking System with reference to South Indian Bank In depth analysis of project was not possible because of the shorter time duration and unavailability of information. . SCHEME OF THE PRESENTATION OF THE PROJECT

Chapter 1: Introduction Chapter 2: Basel norms- a theoretical frame work Chapter 3: results of the analysis Chapter 4: Findings, conclusions and suggestions

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CHAPTER 2 BASEL NORMS - A THEORETICAL FRAMEWORK

BASEL I

The first step towards an organized Risk Management arose through Basel initiatives. The advent of Basel-II has certainly brought to focus the pressure on capital through different risk weights. The attempt at harmonizing the capital adequacy standards internationally date back to 1988, when the Basle committee on Banking Regulations and supervisory practices, released a capital adequacy framework, now known as BaselI. This norm was widely adopted in over 100 countries.

The committee expects its members to move forward with the appropriate adoption procedure in their respective countries. In a number of instances, these procedures will include additional impact assessment of the Committees Framework as well as further opportunities for comments by interested parties to be available for implementation as of year-end 2006. However, the committee feels that one further year of impact studies or will be available for implementation as the year end 2007. The fundamental objective of the committees work to revise the 1988 Accord has been to develop a framework that would further strengthen the soundness and stability of the international banking system while maintaining sufficient consistency that capital adequacy regulation will not be a significant source of competitive inequality among internationally active banks. The Committee believes that the revised Framework will promote the adoption of stronger risk management practices by the banking industry, and views this as one of its major benefits. The committee notes that, in their comments on the proposals, banks
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And other interested parties have welcomed the concept and rationale of the three pillars approach on which the revised Framework is based. More generally, they have expressed support for improving capital regulation to take into account changes in banking and risk management practices while at the same time preserving the benefits of a framework that can be applied as uniformly as possible at the national level. The accord, in its original form, addressed only the credit risks in the banks operations. This meant that a bank with a higher risk profile would have to maintain a higher quantum of regulatory capital. The framework also stipulated, for the first time, a regulatory capital charge for the off balance sheet business of the banks, so as to capture their risk exposures more comprehensively. Pursuant to the recommendations of the Committee on the Financial System (the first Narasimham Committee, 1991), this framework was implemented in India in 1992 in a phased manner. It was only in 1996 that an amendment was made to cover the market risks also.

BASEL II

Basel II is the second of the Basel Accords, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. The purpose of Basel II, which was initially published in June 2004, is to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face. Advocates of Basel II believe that such an international standard can help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse. In theory, Basel II attempted to accomplish this by setting up risk and capital management requirements designed to ensure that a bank holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which
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the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability LIMITATIONS OF BASEL-I WHICH PAVED THE WAY TO BASEL-II

First, the Accord had a broad-brush approach under which the entire

THE BIRTH OF BASEL-II FRAMEWORK.

In order to take care of the limitations of Basel-I as discussed above, Basel Committee on Banking Supervision (BCBS), after a world-wide consultative process and several impact assessment studies, evolved a new capital regulation framework, widely known as BaselII framework (International Convergence of Capital Measurement and Capital Standards: A Revised exposures of banks were categorized into three broad risk buckets viz., sovereign, banks and corporates, with each category attracting a risk weight of zero, 20 and 100 per cent, respectively. Such a risk weighting scheme did not provide for sufficient calibration of the counterparty risk since, for instance, a corporate with AAA rating and one with C rating would attract identical risk weight of 100 per cent and require the same regulatory capital charge. This, in turn, provided an incentive for the banks to acquire higher-risk customers in pursuit of higher returns, without necessitating a higher capital charge. Second, the Accord addressed only the credit risk and market risk in the banks operations, ignoring several other types of risks inherent in banking activity. For instance, the operational risk, that is, the risk of human error or failure of systems leading to financial loss, was not at all addressed-as were the liquidity risk, credit concentration risk, interest rate risk in the banking book, etc. Third, since 1988, the emergence of innovative financial products had transformed the contours of the banking industry and its business model. The credit-risk transfer products, such as securitization and credit derivatives, enabled removal of on-balance sheet exposures from the books of the banks, when they perceived that the regulatory capital requirement for such exposures
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was too high and hiving off such exposures would be a better strategy. The Basel-I framework did not accommodate such innovations and was, thus, outpaced by the market developments. The objectives of the revised framework, which was released in June 2004, are to broadly maintain the aggregate level of minimum capital requirements, while providing incentives to adopt more advanced risk sensitive approaches as envisaged in the revised framework. The committee has to designed the revised framework to be a more forward looking approach to capital adequacy supervision, one that the has capacity to evolve with time. This evolution is necessary to ensure that the framework keeps pace with market developments and advanced in risk management practices, and the committee intends to monitor these developments and to make revisions when necessary In this regard, the committee has enhanced opportunities for dialogue. The committee also intends to keep the industry apprised of its future work agenda.

STIPULATIONS OF THE THREE PILLARS UNDER BASEL-II

The Pillar 1 stipulates the minimum capital adequacy ratio and requires allocation of regulatory capital not only for credit risk and market risk but additionally, for operational risk as well, which was not covered in the previous accord. The Pillar 2 of the framework deals with the Supervisory Review Process (SRP), and it requires the banks to develop an Internal Capital Adequacy Assessment Process (ICAAP) which should encompass their whole risk universe by addressing all those risks which are either not fully captured or not at all captured under pillar 1 and assign an appropriate amount of capital internally. Under the Supervisory Review the supervisors would conduct a detailed examination of the ICAAP of-2- the banks, and if warranted, could prescribe a higher capital requirement, over and above the minimum capital adequacy ratio envisaged in Pillar 1. The Pillar 3 of the framework, Market Discipline, focuses on the effective public disclosures to be made by the banks, and is a critical complement to the other two Pillars.
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It is based on the basic principle that the markets would be quite responsive to the disclosures made and the banks would be duly rewarded or penalized by the market forces. It recognizes the fact that the discipline exerted by the markets can be as powerful as the sanctions imposed by the regulator.

PREPARATORY MEASURES ADOPTED BY RBI FOR BASEL-II IMPLEMENTATION In August 2004, soon after the new framework was released by the BCBS, the banks were advised to conduct a self-assessment of their risk management systems and to initiate remedial measures, as needed, keeping in view the requirements of the Basel-II framework. A Steering Committee was constituted in October 2004, comprising senior officials from 14 select banks (a mix of public sector, private sector and foreign banks). In February,2005, based on the inputs received from this committee, the RBI issuedthe draft guidelines, for public comments, on implementation of Pillar 1 and Pillar 3 requirements of the Basel-II framework. In the light of the feedback received from a wide spectrum of banks and other stake holders, the draft guidelines were revised and the final guidelines were issued on April 27, 2007. As regards the Pillar 2, the banks have been asked to put in place the requisite internal Capital Adequacy Assessment Process (ICAAP) with the approval of their Boards. The minimum capital adequacy ratio prescribed under Basel-II norms continues to be nine per cent. PRESENT LEVEL OF PREPAREDNESS OF INDIAN BANKS FOR IMPLEMENTATION OF BASEL-II

Even before the final guidelines were issued, the RBI had asked the banks in May 2006 to begin conducting parallel runs, as per the draft guidelines, so as to familiarize them with the requirements of the new framework. During the period of parallel run, the banks are required to compute, on an ongoing basis, their capital adequacy ratio both under Basel-I norms, currently applicable, as well as the Basel-II guidelines to be applicable in
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future. This analysis, along with several other prescribed assessments, is-3- to be placed before the Boards of the respective banks every quarter and is also transmitted to the RBI.

RBI GUIDELINES FOR THE IMPLEMENTATION OF BASEL-II

The foreign banks operating in India and the Indian banks having operational presence outside India are required to migrate to the Standardized Approach for credit risk and the Basic Indicator Approach for operational risk with effect from March 31, 2008. All other Scheduled commercial banks are encouraged to migrate to these approaches under BaselII, not later than March 31, 2009. It has been a conscious decision to begin with the simpler approaches available under the framework. As regards the market risk, the banks will continue to follow the Standardized-Duration Method, already adopted under the Basel-I framework, under Basel-II also.

CHALLENGES AHEAD FROM THE ADOPTION OF BASEL-II

First, the new norms might, in some cases, lead to an increase in the overall regulatory capital requirements for the banks, if the additional capital required for the operational risk is not offset by the capital relief available for the credit risk. Second, the Standardized Approach for credit risk leans heavily on the external credit ratings. While the RBI has accredited four rating agencies operating in India, the rating penetration in India is rather low and it is confined to rating of the instruments and not of the issuing entities as a whole. Third, the risk weighting scheme under Standardised Approach also creates some incentive for some of the bank clients with loan amount less than Rs.10 crores to remain unrated, since such entities receive a lower risk weight of 100 per cent against 150 per cent risk weight for a lowest rated client. Fourth, the new framework could also intensify the competition for the best clients with high credit ratings, which attract lower capital charge, but will put pressure on the net interest margins of the bank. Finally, implementing the ICAAP under the Pillar 2 of the framework would perhaps be
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the biggest challenge for the banks in India as it requires a comprehensive risk modeling infrastructure to capture all the known and unknown risks that are not covered under the other two Pillars of the framework. Though the implementation of Basel-II would be a challenge for the Indian banks, it provides an opportunity to leverage capital base, improve the risk management practices and enhance the bottom-line by moving from capital adequacy to capital efficiency

BASEL II PILLAR I The main subtitle comes under PILLAR I are I) II) III) CREDIT RISK OPERATIONAL RISK MARKET RISK

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I)

CREDIT RISK

Credit risk still claims the largest share of the regulatory capital and it underscores the significance of credit risk in banks operations. This is hardly surprising reckoning that the several banking crises in many countries had their roots in lax credit standards, poor portfolio risk management, and the inability or failure to evaluate the impact of the changing economic environment on credit worthiness of the banks borrowers. The subprime crisis in the USA is the most recent example of the inadequate credit risk assessment. The advent of advanced approaches for credit risk in India under the Basel II framework in the days to come ,could be expected to provide an impetus for adopting more sophisticated credit risk management techniques in banks. Credit Risk is defined as The inability or unwillingness of the customer or counter party to meet commitments in relation to lending, hedging, settlement and other financial transactions. Hence Credit Risk emanates when the counter party is unwilling or unable to meet or fulfill the contractual Obligations / commitments thereby leading to defaults.

THE OPTIONS FOR COMPUTING CAPITAL CHARGE FOR CREDIT RISK

Under Pillar 1, the framework offers three distinct options for computing capital requirement for credit risk. These approaches for credit risks are based on increasing risk sensitivity and allow banks to select an approach that is appropriate to the stage of development of banks operations. The approaches available for computing capital for credit risk are 1. STANDARDISED APPROACH, 2. FOUNDATION INTERNAL RATING BASED APPROACH RBI has decided to implement the Standardized Approach within the stipulated time frame. As regards the migration to advanced approaches, the RBI has not indicated any specific time frame. However, the banks that plan to migrate to the advanced approaches

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would need prior approval of RBI for which requisite guidelines would be issued in due course. 1) Standardized Approach Standardized Approach is the basic approach which banks at a minimum have to use for moving to Basel II implementation. It is an extension of the existing method of calculation of capital charge for credit risk. The existing method is refined and made more risk sensitive by: Introducing more number of risk weights thus aiding finer differentiation in risk assessment between asset groups. Assignment of Risk weights based on the ratings assigned by External Credit rating agencies recognized by RBI, in case of exposures more than Rs.5 crores. Recognizing wide range of collaterals (securities) as risk mitigates and netting them off while determining the exposure amount on which risk weights are to be applied. Introducing Retail portfolio with total exposure up to Rs.5 crores and yearly turnover less than Rs.50 crores as a separate asset group with clear cut definition and criteria. Assignment of Risk weight for NPA accounts. The rating assigned by the eligible external credit rating agencies will largely support the measure of credit risk. Unrated exposures will normally carry 100% risk weight. But for the financial year 2008-09, all fresh sanctions or renewals in respect of unrated borrowers in excess of Rs.50 crores will attract a risk weight of 150%. From 2009-10 onwards, unrated borrowings in excess of 10 crores will attract risk weight of 150%.

Credit Risk Mitigation CRM refers to permitted methods of netting the exposure value for computing Risk Weights by using Collateral, Third party guarantee (Guarantee) and On-balance sheet netting. CRM is available subject to- several conditions. Before netting, Exposure Value (EV) and Collateral Value (CV) are to be adjusted for volatility and possible future fluctuations. EV to be increased for volatility (premium factor) and CV to be reduced for volatility (discount factor). These factors are termed as Haircuts (HC).
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2) The Internal Ratings Based Approach (IRB) Under the IRB approach, different methods will be provided for different types of loan exposures. Basically there are two methods for risk measurement which are Foundation IRB and Advanced IRB. The framework allows for both a foundation method in which a bank estimate the probability of default associated with each borrower, and the supervisors will supply the other inputs and an advanced IRB approach, in which a bank will be permitted to supply other necessary inputs as well. Under both the foundation and advanced IRB approaches, the range of risk weights will be far more diverse than those in the standardized approach, resulting in greater risk sensitivity.

II)

OPERATIONAL RISK

Operational risk is defined as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events. The definition includes legal risks, but excludes strategic and reputation risk. Operational risk is pervasive and its ownership and measurement are challenges. Some of the important causes for operational risk are inadequate segregation of duties, insufficient training and poor HR Policies, lack of management supervision and inadequate security measures and systems.

METHODOLOGIES FOR CALCULATING OPERATIONAL RISK CAPITAL

Basic indicator approach, Standardised approach and Advanced Measurement Approach are the three methodologies allowed under Basel II for arriving at the capital charge for operational risk. RBI has advised the banks to apply the Basic Indicator Approach to migrate to Basel II in the beginning. Under Basic indicator approach, banks have to hold capital for operational risk equal to a fixed percentage of the average of positive annual
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gross income over the previous 3 years. Thus, capital charge under Basic indicator approach KBia = (GI / n) x A, where, KBia = Capital charge under Basic Indicator Approach GI = Total gross income over the previous three years A = 15% n = No. of years ie 3 years for which income is positive.

TOTAL CAPITAL REQUIREMENT UNDER BASEL II Banks in India are required to maintain a minimum Capital to Risk weighted Assets Ratio (CRAR) of 9% on an ongoing basis (However,

Basel II prescribes 8% only). RBI may consider prescribing a higher level of minimum capital ratio for each bank under the pillar 2 framework on the basis of their respective risk profiles and their risk management systems. Banks are also encouraged to maintain a Tier 1 CRAR of at least 6% and banks which are below this level, must achieve this ratio on or before 31st March 2010.

III)

MARKET RISK

Market Risk is the possibility of loss to a bank caused by changes in market variables. Market risk is also defined as the risk that the value of on or off balance sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices. Market Risk Management of a bank thus involves management of interest rate risk, foreign exchange risk, commodity price risk and equity price risk. Market risk is also concerned about the banks ability to meet its obligations as and when they fall due, as a consequence of liquidity risk. Sound liquidity management can reduce the probability of a default. Liquidity risk is related to banks inability to pay to its depositors. It has a strong correlation with other risks such as interest rate risk and credit risk. Under Basel II, the present system of
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computing capital requirement for Market risk under the standardized duration method will continue. BASEL II PILLAR II INTRODUCTION One of the unique aspects of Basel II is its comprehensive approach to risk measurement in the banking entities, by adopting the now-familiar three- Pillar structure, which goes far beyond the first Basel Accord. To recapitulate, these are: Pillar 1 the minimum capital ratio, Pillar 2 the supervisory review process and Pillar 3 the market discipline. The Pillar 1 provides a menu of alternative approaches, from simple to advanced ones, for determining the regulatory capital towards credit risk, market risk and operational risk, to cater to the wide diversity in the banking system across the world. Pillar 2 requires the banks to establish an Internal Capital Adequacy Assessment Process (ICAAP) to capture all the material risks, including those that are partly covered or not covered under the other two Pillars. The ICAAP of the banks is also required to be subject to a supervisory review by the supervisors. The Pillar 3 prescribes public disclosures of information on the affairs of the banks to enable effective market discipline on the banks operations

THE SECOND PILLAR: SUPERVISORY REVIEW PROCESS

Supervisory review process has been introduced to ensure not only that banks have adequate capital to support all the risks, but also to encourage them to develop and use better risk management techniques in monitoring and managing their risks. The process has four key principles

a) Banks should have a process for assessing their overall capital adequacy in relation to their
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risk profile and a strategy for monitoring their capital levels. b) Supervisors should review and evaluate banks internal capital adequacy assessment and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios.

c) 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.

d) Supervisors should seek to intervene at an early stage to prevent capital from falling below minimum level and should require rapid remedial action if capital is not mentioned or restored RBI GUIDELINES UNDER PILLAR-2 The Pillar-2 of the framework deal with the Supervisory Review Process (SRP). The objective of the SRP is to ensure that the banks have adequate capital to support all materials risks in their business as also to encourage them to adopt sophisticated risk management techniques for monitoring and managing their risks. This, in turn, would require a well-defined internal assessment process within the banks through which they would determine the additional capital requirement for all material risks, internally, and would also be able to assure the RBI that adequate capital is actually held towards their all material risk exposures. The process of assurance could also involve an active dialogue between the bank and the RBI so that, when warranted, appropriate intervention could be made to either reduce the risk exposure of the bank or augment its capital. Under Pillar-2, the banks have been advised to put in place an ICAAP, with the approval of the Board. Thus, ICAAP is an important component of the Supervisory Review Process. What is important to note here is that the Pillar 1 stipulates only the minimum
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capital ratio for the banks whereas the Pillar 2 provides for a bank-specific review by the supervisors to make an assessment whether all material risks are getting duly captured in the ICAAP of the bank. If the supervisor is not satisfied in this behalf, it might well choose to prescribe a higher capital ratio, as per its assessment.

ICAAP Pillar II envisages that Banks should establish adequate risk assessment processes The risk assessment processes should be specific to each individual bank and Each bank should develop and implement a comprehensive internal process for assessing its capital adequacy in relation to - its risk profiles as well as strategy for maintaining such capital levels.

ICAAP is expected to capture Residuary Risks such as Reputation Risk Liquidity Risk Credit Concentration Risk etc... which are not addressed by Pillar 1 These are to be captured apart from credit, Market and Operational Risks.

RISK BASED INTERNAL AUDIT

In view of New Basle Capital Accord, Reserve Bank of India has already decided to move towards Risk Based Supervision (RBS) in place of the present method of Annual financial Supervision of the Banks. For taking up RBS, Banks have been advised by RBI to adopt Risk Based Internal Audit. A sound internal audit function plays a significant role in contributing to the effectiveness of the internal control system and should provide high quality counsel to management on the effectiveness of risk assessment and internal
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controls including regulatory compliance. Traditionally the internal inspection has been concentrating on transaction based, testing of accuracy and reliability of accounting, records and financial reports, integrity, reliability and timeliness of control reports and adherence to legal and regulatory requirements. The business of Banking has undergone a sea change and more activities are undertaken by the Banks today. So for internal audit of Branches, transaction testing in itself will not be sufficient. So there is a need to re-orient internal audit function and focus on the specific risks on an on-going basis to evaluate the adequacy and effectiveness of internal control system and risk management procedures followed in the Banks. So in Risk Based Internal Audit, the role of internal auditors in mitigating risks gets more emphasis.

BASEL II PILLAR III

THE THIRD PILLAR: MARKET DISCIPLINE Market discipline imposes strong incentives to banks to conduct their business in a safe, sound and effective manner. It is proposed to be effected through a series of disclosure requirements on capital, risk exposure etc. so that market participants can assess a banks capital adequacy. These disclosures should be made at least semiannually and more frequently if appropriate. Qualitative disclosures such as risk management objectives and policies, definitions etc. may be published annually.

PURPOSE OF MARKET DISCIPLINE The purpose of Market discipline (Pillar 3) is to compliment the minimum capital requirements detailed under Pillar 1 and Pillar 2. The aim is to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution. In principle, banks disclosures should be consistent with how senior management and the Board of directors assess and manage the risks of the bank. Under Pillar 1, banks use
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specified approaches/methodologies for measuring the various risks they face and the resulting capital requirements. It is believed that providing disclosures that are based on a common

RBI GUIDELINES ON MINIMUM CAPITAL REQUIREMENT With a view to adopting the Basel committee on banking supervision (BCBS) framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off- balance sheet business and also to strengthen the capital base of banks, RBI decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure. Essentially, under the above system the balance sheet assets, non-funded items and other off-balance sheet exposures are assigned prescribed risk weights and banks have to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. RBI has issued guidelines to banks in June 2004 on maintenance of capital charge for market risks on the lines of Amendment to the capital accord to incorporate market risks issued by BCBS in 1996. The BCBS released the International convergence of capital measurement and capital standards: A revised Framework on June 26, 2004. The revised framework was updated in November 2005 to include trading activities and the treatment of double defaults

effects and a comprehensive version of the framework was issued in June 2006 incorporating the constituents of capital and the 1996 amendment to the capital accord to incorporate Marker risk. The revised framework seeks to arrive at significantly more risksensitive approaches to capita; requirements. The Revised frame work provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and financial markets.
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CAPITAL FUNDS Banks are required to maintain a minimum capital to Risk-Weighted Assets Ratio (CRAR) of 9% on an ongoing basis. The RBI will take into account the relevant risk factors and the internal capital adequacy assessments of each bank to ensure that the capital held by a bank is commensurate with banks overall risk profile. This would include, among others, the effectiveness of the banks overall risk management systems in identifying, assessing/ measuring, monitoring and managing various risks including interest rate risk in the banking book, liquidity risk, concentration risk and residual risk. Accordingly, the RBI will consider prescribing a higher level of minimum capital ratio for each bank under Pillar 2 framework on the basis of their respective risk profiles and their risk management systems. Further, in terms of the Pillar 2 requirements of the New Capital Adequacy Framework, banks are expected to operate at a level well above the minimum requirement Banks are encouraged to maintain, at both solo and consolidated level, a Tier 1 CRAR of at least 6%. Banks which are below this level must achieve this ratio on or before March 31, 2010. A bank should compute its Tier 1 CRAR and total CRAR in the following manner:

Tier 1 CRAR =

Eligible Tier 1 capital funds

Credit Risk RWA* + Market Risk RWA + Operational Risk RWA

RWA*= Risk weighted assets

Total CRAR=

Eligible total capital funds

Credit Risk RWA + Market Risk RWA + Operational Risk RWA

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Capital funds are broadly classified as Tier 1 and Tier II capital. Elements of Tier II capital will be reckoned as capital funds up to a maximum of 100% of Tier I capital, after making the deductions/ adjustments.

Elements of Tier I capital For Indian banks, Tier I capital would include the following elements: Paid up equity capital, statutory reserves, and other disclosed free reserves, if any; Capital reserve representing surplus arising out of sale proceeds of assets; Innovative perpetual debt instruments eligible for inclusion in Tier 1 capital, which comply with the regulatory requirements Perpetual non cumulative Preference shares (PNCPS), which comply with the regulatory requirements Any other type of instrument generally notified by the RBI from time to time foe inclusion in Tier 1 capital

Limits in eligible Tier 1 capital The innovative perpetual debt instruments (IPDIs), eligible to be reckoned as Tier 1 capital, will be limited to 15% of total Tier 1 capital as on march 31 of the previous FY. The above limit will be based on the amount of Tier 1 capital as on march 31 of the previous year, after deduction of goodwill, DTA and other intangible assets but before the deduction on investments The outstanding amount of tier 1 preference shares i.e Perpetual Non-Cumulative preference shares along with Innovative Tier 1 instruments shall not exceed 40% of total tier 1 capital at any point of time

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 Innovative instruments/ PNCPS, in excess of the limit shall be eligible for inclusion under Tier 2, subject to limits prescribed for tier 2 capital Elements of the Tier 2 Capital Revaluation Reserves These reserves often serve as a cushion against unexpected losses, but they are less permanent in nature and cannot be considered as Core Capital. Revaluation reserves arise from revaluation of assets that are undervalued on the banks books, typically bank premises. The extent to which the revaluation reserves can be relied upon as a cushion for unexpected losses depends mainly on the level of certainty that can be placed on estimates of the market values of the relevant assets, the subsequent deterioration in values under difficult market conditions or in forced sale, potential for actual liquidation at those values, tax consequences of revaluation, etc. Therefore it would be prudent to consider revaluation reserves at a discount of 55% while determining their value for inclusion in Tier 2 capital. Such reserves will have to be reflected on the face of the balance sheet as revaluation reserves.

General Provisions and loss reserves such reserves, if they are not attributable to the actual diminution in value or

identifiable potential loss in any specific asset and are available to meet unexpected losses, can be included in Tier 2 capital. Adequate care must be taken to see that sufficient provisions have been made to meet all known losses and foreseeable potential losses before considering general provisions and loss reserves to be part of Tier 2 capital. Banks are allowed to include the General provisions on Standard Assets, Floating Provisions, Provisions held for country Exposures, investment Reserve account and excess provisions which arise on
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account of sale of NPAs in Tier 2 capital. However, these five items will be admitted as tier 2 capital up to a maximum of 1.25 % of the total risk-weighted assets. Hybrid debt Capital Instruments In this category, fall a number of debt capital instruments, which combine characteristics of equity and certain characteristics of debt. Each has a particular feature, which can be considered to affect its quality as capital. Where these instruments have close similarities to equity, in particular when they are able to support losses on an ongoing basis without triggering liquidation, they may be included in Tier 2 capital. Banks in India are allowed to recognise funds raised through debt capital instrument which has a combination of characteristics of both equity and debt, as Tier 2 capital provided the instrument complies with the regulatory requirements. Indian banks are also allowed to issue Perpetual Cumulative Preference Shares (PCPS), Redeemable Non-Cumulative Preference Shares (RNCPS) and Redeemable Cumulative Preference Shares (RCPS), as Upper Tier 2 Capital, subject to extant legal provisions as per guidelines.

Subordinated Debt To be eligible for inclusion in Tier 2 capital, the instrument should be fully paidup, unsecured, subordinated to the claims of other creditors, free of restricted clauses, and should not be redeemable at the initiative of the older or without the consent of the RBI. They often carry a fixed maturity, and as they approach maturity, they should be subject to progressive discount, for inclusion in Tier 2 capital. Instruments with an initial maturity of less than 5 years or with a remaining maturity of one year should be included as part of Tier 2 capital. Subordinated debt instruments eligible to be reckoned as tier 2 capital.
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 Innovative Perpetual Debt Instruments (IPDI) and Perpetual Non-Cumulative Preference Shares (PNCPS) IPPDI in excess of 15% of Tier 1 capital may be include in Tier 2 capital, and PNCPS in excess of the overall ceiling of 40% may be included under Tier 2 capital, subject to the limit prescribed for Tier 2 capital

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INDUSTRY PROFILE INTORDUCTION ABOUT THE INDUSTRY :A central bank issues money on behalf of a government, and regulates the money supply a commercial bank accepts deposits and channels those deposits into lending activities, either directly or through capital markets. A bank connects customers with capital deficits to customers with capital surpluses on the world's open financial markets. A savings bank, also known as a building society in Britain is only allowed to borrow and save from members of a financial cooperative. Banking in India originated in the last decades of the 18th century. The first banks were The General Bank of India, which started in 1786, and Bank of Hindustan, which started in 1790; both are now defunct. The oldest bank in existence in India is the State Bank of India, which originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank of Bengal. This was one of the three presidency banks, the other two being the Bank of Bombay and the Bank of Madras, all three of which were established under charters from the British East India Company. For many years the Presidency banks acted as quasi-central banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of India, which, upon India's independence, became the State Bank of India Banking is generally a highly regulated industry, and government restrictions on financial activities by banks have varied over time and location. The current set of global bank capital standards is called Basel II. In some countries such as Germany, banks have historically owned major stakes in industrial corporations while in other countries such as the United States banks are prohibited from owning non-financial companies. In Japan, banks are usually the nexus of a cross-share holding entity known as the keiretsu. In Iceland banks followed international standards of regulation prior to the 2008 collapse. Indian banking system is control by an apex banking institution. Its RESERVE BANK OF INDIA. It is an authorized body which structured down all the banking rules and regulations in India. It provide many valuable in formations regarding all operation of all
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banks working in India. It safeguards the interest of all customers and all banks. RESERVE BANK dealing directly with individuals and small businesses; business banking, providing services to mid-market business; corporate banking, directed at large business entities; private banking, providing wealth management services to high net worth individuals and families; and investment banking, relating to activities on the financial markets

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HISTORY OF BANKING Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and still functioning today, is the oldest Joint Stock bank in India.(Joint Stock Bank: A company that issues stock and requires shareholders to be held liable for the company's debt) It was not the first though. That honor belongs to the Bank of Upper India, which was established in 1863, and which survived until 1913, when it failed, with some of its assets and liabilities being transferred to the Alliance Bank of Simla. When the American Civil War stopped the supply of cotton to Lancashire from the Confederate States, promoters opened banks to finance trading in Indian cotton. With large exposure to speculative ventures, most of the banks opened in India during that period failed. The depositors lost money and lost interest in keeping deposits with banks. Subsequently, banking in India remained the exclusive domain of Europeans for next several decades until the beginning of the 20th century. Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862; branches in Madras and Puducherry, then a French colony, followed. HSBC established itself in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade of the British Empire, and so became a banking centre. The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in 1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in Lahore in 1895, which has survived to the present and is now one of the largest banks in India. Around the turn of the 20th Century, the Indian economy was passing through a relative period of stability. Around five decades had elapsed since the Indian Mutiny, and the

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social, industrial and other infrastructure had improved. Indians had established small banks, most of which served particular ethnic and religious communities. The presidency banks dominated banking in India but there were also some exchange banks and a number of Indian joint stock banks. All these banks operated in different segments of the economy. The exchange banks, mostly owned by Europeans, concentrated on financing foreign trade. Indian joint stock banks were generally under capitalized and lacked the experience and maturity to compete with the presidency and exchange banks. This segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into separate and cumbersome compartments." The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi movement. The Swadeshi movement inspired local businessmen and political figures to found banks of and for the Indian community. A number of banks established then have survived to the present such as Bank of India, Corporation Bank, Indian Bank, n Bank of Baroda, Canara Bank and Central Bank of India. The fervour of Swadeshi movement lead to establishing of many private banks in Dakshina Kannada and Udupi district which were unified earlier and known by the name South Canara ( South Kanara ) district. Four nationalised banks started in this district and also a leading private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of Indian Banking". During the First World War (1914-1918) through the end of the Second World War (1939-1945), and two years thereafter until the independence of India were challenging for Indian banking. The years of the First World War were turbulent, and it took its toll with banks simply collapsing despite the Indian economy gaining indirect boost due to war-related economic activities

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POST-INDEPENDENCE The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal, paralyzing banking activities for months. India's independence marked the end of a regime of the Laissez-faire for the Indian banking. The Government of India initiated measures to play an active role in the economic life of the nation, and the Industrial Policy Resolution adopted by the government in 1948 envisaged a mixed economy. This resulted into greater involvement of the state in different segments of the economy including banking and finance. The major steps to regulate banking included: The Reserve Bank of India, India's central banking authority, was nationalized on January 1, 1949 under the terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b).[Reference www.rbi.org.in] In 1949, the Banking Regulation Act was enacted which empowered the Reserve Bank of India (RBI) "to regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new bank or branch of an existing bank could be opened without a license from the RBI, and no two banks could have common directors. NATIONALISATION Despite the provisions, control and regulations of Reserve Bank of India, banks in India except the State Bank of India or SBI, continued to be owned and operated by private persons. By the 1960s, the Indian banking industry had become an important tool to facilitate the development of the Indian economy. At the same time, it had emerged as a large employer, and a debate had ensued about the nationalization of the banking industry. Indira Gandhi, then Prime Minister of India, expressed the intention of the Government of India in the annual conference of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalization." The meeting received the paper with enthusiasm.
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Thereafter, her move was swift and sudden. The Government of India issued an ordinance and nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke of political sagacity." Within two weeks of the issue of the ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it received the presidential approval on 9 August 1969. A second dose of nationalization of 6 more commercial banks followed in 1980. The stated reason for the nationalization was to give the government more control of credit delivery. With the second dose of nationalization, the Government of India controlled around 91% of the banking business of India. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalized banks and resulted in the reduction of the number of nationalised banks from 20 to 19. After this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy. ORIGIN OF THE WORD The word bank was borrowed in Middle English from Middle French banque, from Old Italian banca, from Old High German banc, bank "bench, counter". Benches were used as desks or exchange counters during the Renaissance by Florentine bankers, who used to make their transactions atop desks covered by green tablecloths. The earliest evidence of money-changing activity is depicted on a silver Greek drachm coin from ancient Hellenic colony Trapezus on the Black Sea, modern Trabzon, c. 350 325 BC, presented in the British Museum in London. The coin shows a banker's table (trapeza) laden with coins, a pun on the name of the city. In fact, even today in Modern Greek the word Trapeza () means both a table and a bank.

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DEFINITION Under English common law, a banker is defined as a person who carries on the business of banking, which is specified as: conducting current accounts for his customers paying cheques drawn on him, and collecting cheques for his customers "Banking business" means the business of receiving money on current or deposit account, paying and collecting cheques drawn by or paid in by customers, the making of advances to customers, and includes such other business as the Authority may prescribe for the purposes of this Act; (Banking Act (Singapore), Section 2, Interpretation). INDIAN BANKING INDUSTRY The growth in the Indian Banking Industry has been more qualitative than quantitative and it is expected to remain the same in the coming years. Based on the projections made in the "India Vision 2020" prepared by the Planning Commission and the Draft 10th Plan, the report forecasts that the pace of expansion in the balance-sheets of banks is likely to decelerate. The total assets of all scheduled commercial banks by end-March 2010 is estimated at Rs 40,90,000 crores. That will comprise about 65 per cent of GDP at current market prices as compared to 67 per cent in 2002-03. Bank assets are expected to grow at an annual composite rate of 13.4 per cent during the rest of the decade as against the growth rate of 16.7 per cent that existed between 1994-95 and 2002-03. It is expected that there will be large additions to the capital base and reserves on the liability side. The Indian Banking Industry can be categorized into non-scheduled banks and scheduled banks. Scheduled banks constitute of commercial banks and co-operative banks. There are about 67,000 branches of Scheduled banks spread across India. As far as the present scenario is concerned the Banking Industry in India is going through a transitional phase. The Public Sector Banks(PSBs), which are the base of the Banking sector in India account for more than 78 per cent of the total banking industry assets. Unfortunately they
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are burdened with excessive Non Performing assets (NPAs), massive manpower and lack of modern technology. On the other hand the Private Sector Banks are making tremendous progress. They are leaders in Internet banking, mobile banking, phone banking, ATMs. As far as foreign banks are concerned they are likely to succeed in the Indian Banking Industry. In the Indian Banking Industry some of the Private Sector Banks operating are IDBI Bank, ING Vyasa Bank, SBI Commercial and International Bank Ltd, Bank of Rajasthan Ltd. and banks from the Public Sector include Punjab National bank, Vijaya Bank, UCO Bank, Oriental Bank, Allahabad Bank among others. ANZ Grindlays Bank, ABN-AMRO Bank, American Express Bank Ltd, Citibank are some of the foreign banks operating in the Indian Banking Industry.

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COMPANY PROFILE PROFILE OF SOUTH INDIAN BANK LTD The South INDIAN Bank Ltd is one of the leading scheduled commercial banks in India having their head office at Thrissur, Kerala with a strong focus technology and service culture. The South Indian Bank Ltd was incorporated on January 25, 1929 in Thrissur, Kerala. One of the earliest banks in South India, South Indian Bank came into being during the swadeshi movement. The establishment of the bank was the fulfillment of the dreams of a group of enterprising men who joined together at Thrissur , a major town(now known as Cultural Capital of Kerala), in the erstwhile state of cochin to provide for the people a safe, efficient and service oriented repository of savings of the community on one hand and to free the business community from the clutches of greedy money lenders on the other by providing need based credit at reasonable rates of interest. They became a scheduled bank in 1946.With 44 shareholders and paid up capital of Rs.22000/- the bank started functioning as a private limited company. The south Indian bank Ltd has its administrative office at Thrissur. They have implemented, Sibertech which runs on Finacle platform provided by Infosys Technologies Limited. All the branches in the major cities are covered under this project. The bank delivers their products and services through a variety of channels ranging from our extensive branch network, extension counter, ATM centers, Internet banking and mobile banking. The bank provides a range of retail banking and commercial banking products to their customers. Their retail banking portfolio include housing loans, auto loans, educational loans and other personal loans. They offer deposit services like savings, demands and time deposit to customers. They have technological products like Global debit card, credit card, anywhere banking facility, mobile banking and internet banking to serve their customers. They have arrangements to distribute third party products such as Life and non life insurance products. They also offer various commercial banking products to their commercial and corporate customers like Term loans, short loans, cash credit, working capital finance, Export credit, Bill discounting, Letter of credit and guarantees. In
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addition they have specialized products to satisfy the needs of the agriculture sector like SIB planters choice, which offers to an agriculturist to purchase land and SIB Agriflex loan for land development. They provide depository services and are depository participant for land development. They provide depository services and depository participant for central depository services (India) limited. Vision To emerge as the most preferred bank in the country in terms of brand, values, principles with core competence in fostering customer aspirations, to build high quality assets leveraging on the strong and vibrant technology platform in pursuit of excellence and customer delight and to become a major contributor to the stable economic growth of the nation.

Mission To provide a secure, agile, dynamic and conducive banking environment to customers with commitment to values and unshaken confidence, deploying the best technology, standards, processes and procedures where customer convenience is of significant importance and to increase the stakeholders value.. OBJECTIVES OF SIB: To establish and carry on the business of banking at the registered office of the company and at various branches, agencies and offices. Carrying on the business of accepting deposits of money on current amount or otherwise subject to withdrawal by cheque, draft or order and carry on the business of banking in all its branches and departments. Act as the agent of the government or local authorities or any other persons carrying on agency business of any discipline other than the business of management agents.
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 Contracting for public and private loans and negotiating and issuing the same. The borrowing , raising or taking up money, the lending or advancing of money either upon or without security, the drawing, accepting, discounting, buying, selling, collecting and dealing in Bills of Exchange, promissory notes, coupons and other instruments and securities the buying selling, dealing in foreign exchange, dealing in other instruments like share, bonds etc. Carrying out all such things as are identical or conductive to the promotion or advancement of the business of the company. To undertake and carry on all other forms of business as may be permissible for banking company. DEPARTMENTAL ANALYSIS There are various departments functioning in the bank. The bank operates through these departments. The centre of all activities is the head office situated in Thrissur. Regional offices coordinate the activities of various branches in each region. Presently SIB has 16 regional offices. The various departments in bank are: 1. Planning and Development Department: This department provided the entire infrastructure for the bank. They do corporate planning and make plans for the mobilization and growth of deposits. The department is maintaining public relation and plans all types of advertisements for banks. Their function is to make plans for the development of the business of the bank. 2. Premises and maintenance This department provides all infrastructure services of the bank. They do maintenance of the buildings of the bank. They fix rent for the buildings. They are also engaged in the provision of buildings for banking activities and also the provision of furniture and all other infrastructure facilities.

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3. Corporate Finance Management Department: This department prepares the investment portfolio of the bank. They are undertaking the profit planning at corporate level. They are having the responsibility of submission of control returns to RBI. They also undertake the audit functions of the bank. 4. Secretarial Department: This department conducts all secretarial activities. They conduct board meetings, publishing of balance sheet etc. 5. Credit Control Department: This department undertakes the credit functioning of the bank. They also undertake the monitoring of the loans given. They also ensure the recovery of the loan. 6. Inspection Department: The inspection activities of the bank are done here. They review and update the systems and procedures of the bank. 7. Accounts Department: They keep the various branch accounts and are undertaking the reconciliation of branch account. They maintain records of provident fund of employees. 8. Vigilance Department: They undertake all safety measures. They are responsible for the safety activities. 9. Legal Department: This department deals with the legal aspects of the bank. They mainly deal with the matters of loan recovery. In case of loan recovery, the branch managers have to inform the details of the legal department. The department will take immediate and appropriate decisions and will file the suit if necessary.
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10. Integrated Risk Management Department: This department deals with the management of various risks in banking industry like credit risk, market risk, operational risk etc. This department makes internal rating for various accounts and helps in the reduction of risk associated with advances. This department is also dealing with the calculation of capital adequacy ratio(Basel II) requirements as per RBI guidelines. IRMD is responsible for setting up the appropriate risk control mechanism, quantity and monitor risks, the planning and finance sections are responsible for allocating risk capital to business units, after assessing return and taking input on risk management departments. CFM department would be responsible for developing the transfer pricing mechanism. The risk management department has been established to supervise risk from a Bank wide perspective, and committees have been formed that includes members of management to take responsibilities for various forms of risk with the goals of strengthening risk management and control. Details of risk governance framework is designed keeping in mind the RBI guideline, Basel II guidelines such as the requirement of insuring independence of risk management section, i.e. the role of risk management should not be biased by consideration of profits or performance evaluation and international good practices.

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RISK GOVERNANCE STRUCTURE OF SOUTH INDIAN BANK

Board of Directors

Risk management Committee of Board

Credit Risk Management Committee Market Risk Management Committee Operational Risk Management Committee

Asset Liability Management Committee (ALCO)

Chief Risk Officer and General Manager

Credit Risk Management cell

Operational Risk Management Cell

Market Risk Management cell

Asset Liability Management cell

Market Risk Cell including mid-office at Treasury, IBD

CREDIT RISK MANAGEMENT POLICY OF SOUTH INDIAN BANK LTD CREDIT RISK MANAGEMENT: Risk management can be defined as systematic identification and analysis of various loss exposures faced by a firm/individual and the best methods of treating the identified loss exposures consistent with the firm/individuals objectives. Credit risk management as a process that puts in place systems and procedures enabling a bank to: > Identify and measure the risk involved in a credit proposition, both at the individual, transaction and portfolio level.
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> Evaluate the impact of exposure on banks balance sheet or profits. > Asses the capability of this mitigation to hedge or insure risks. > Design and appropriate risk management strategy to arrest risk migration leading to deterioration in the credit quality. It helps banks in discriminating loan accounts on the basis of risk characteristics at entry level besides paying way for timely exit at the portfolio level. In short it helps banks in minimizing the losses that could emanate from counter party default or concentration risk at portfolio level. The choice of appropriate strategies for control of credit risk by individual bank depends on their priorities and risk appetites.

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CREDIT RISK MANAGEMENT STRUCTURE

Chief Risk Officer

AGM/CM

Credit Risk Management- Basel II implications, risks warehousing, analytics & validation manager/assistant manager

Credit Risk Assessment Manager/ Assistant Manager

Credit Risk Modelling Manager/ Assistant Manager

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RISK MANAGEMENT AND BASEL II AT SOUTH INDIAN BANK

In the present volatile and rapidly changing financial scenario, it is imperative to have good risk management practices not only to manage risks inherent in the banking business but also the risks emanating from financial markets as a whole. During the year the risk management structure of the Bank was further strengthened to enable it to proactively identify and help in controlling the credit, operational and market risks faced by the Bank, while maintaining proper trade-off between risk and return thereby maximizing the shareholder value. The Bank's risk management structure is overseen by the Board of Directors and appropriate policies to manage various types of risks are approved by Risk Management Committee of Board (RMC), which provides strategic guidance while reviewing portfolio behavior. The senior level management committees like Credit Risk Management Committee (CRMC), Market Risk Management Committee (MRMC) and Operational Risk Management Committee (ORMC) develop the risk management policies and vet the risk limits. The Asset Liability Management Committee, Credit Policy Planning and Intelligence Committee and Investment Committee ensure adherence to the implementation of the above risk management policies, and develop Asset Liability Management policy, Credit policy and Investment policy within the above risk framework. The risk management policies have laid down risk management processes to identify, measure and mitigate the risks to bring the risks within the tolerance level. The Bank has already migrated to Basel II during FY 08-09 and assesses the capital adequacy for credit risk under Standardized Approach, market risk under Standardized Measurement Method and operational risk under Basic Indicator Approach. To address the issues of Pillar II, the Bank has implemented ICAAP framework (Internal Capital Adequacy Assessment Process) for integrating capital planning with budgetary planning and to capture the residual risks which are not addressed in pillar I like credit concentration risk, interest rate risk in the banking book,
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liquidity risk, earnings risk, strategic risk, reputation risk etc. For adhering to market discipline as laid down in pillar III of Basel II guidelines, the Bank has adopted a common framework for disclosures. This requires the Bank to disclose its risk exposures, risk assessment processes and its capital adequacy to the market in a more consistent and comprehensive manner.

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CHAPTER III RESULTS OF THE ANALYSIS This chapter is devoted to discuss the results of the analysis in detail: Calculation of Tier 1 Capital of South Indian Bank for the year 2010-11 TABLE NO: 1 PARTICULARS PAID UP CAPITAL FORFEITED SHARES SHARE PREMIUM ACCOUNT STATUTORY RESERVE- RESERVE FUND CAPITAL RESERVE GENERAL RESERVE DEVELOPMENT RESERVE CONTIGENCY RESERVE FOREIGN RESERVE DIVIDENT EQUALIZATION RESERVE TOTAL RESERVE P & L APPROPRIATION TOTAL LESS DEDUCTIONS TIER 1 CAPITAL (in laks) 143.84 EXCHANGE FLUCTUATION 0 0 105222.9 143.84 167796.4 2773.41 165023 AMOUNT 11300.65 0 51129.02 35841.36 3652.61 65728.96 0 0 51129.02 TOTAL 11300.65

Page | 55

Inference: Total Tier 1 capital of SIB is Rs 165023cr. Among that total paid up capital amounts to be 11300.65. Share premium account shows Rs. 51129.02cr where as various reserves such as statutory reserve, capital reserve and general reserve show balances amount to Rs. 105222.9cr. Rs. 143.84cr have been appropriated from the P & L a/c

Calculation of Tier 2 Capital of South Indian Bank for the year 2010-11 TABLE NO: 2 PARTICULARS ASSET REVALUATION RESERVE INVESTMENT FLUCTUATION RESERVE UNDISCLOSED RESERVES PROVISION FOR STANDARD ASSETS SUBORDINATED TERM DEBT 9144.2 22600 AMOUNT 6822.97 1557.28 TOTAL

TOTAL

40124.45

Inference: Total Tier II capital of South Indian Bank amounts to be Rs 40124.45cr. Various items included in Tier II capital are asset revaluation reserve, investment fluctuation reserve, provisions for standard assets and subordinated terms debt. More than 50% of the total Tier II capital is contributed by subordinated term debt which amounts to be Rs 22600cr.

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RETURN ON CAPITAL ADEQUACY AS PER BASEL 2 AS ON 31-03-2011 ASSET ITEMS TABLE NO: 3 CASH AND BALANCES WITH BANK CASH AND RBI CLAIMS ON BANKS AND NOTIFIED PFI 61861.5 20% As per CLAIMS ON FOREIGN BANKS TOTAL 1932 WN 693.3 13065.6 12372.3 NET VALUE 182819.11 RW% 0 RISK ADJUSTED VALUE 0

Inference: According to RBI guide lines on Basel II, cash deposited in RBI attracts no risk weight where as claims on banks and notified PFIs invite 20% risk weight. TABLE N0: 4 RISK NET INVESTMENTS SLR INVESTMENTS SECURITIES ISSUED/ (GOI) SLR INVESTMENTS 1118.74 0 20% 20% 223.748 0 605931.15 0% 0 VALUE RW ADJUSTED VALUE

SECURITIES/OTHER APPROVED ODS-OTHER SECURITIES

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ODS-APPROVED SECURITIES ODS-SUBORDINATED DEBT ODS-SIDBI/NABARD ODS-ALL OTHER INVESTMENTS RATED AAA AA AA BBB UNRATED CERTIFICATE BANKS EQUITIES TOTAL OF DEPOSITS-

0 0 58545.18 0 0 0 0 0 0

0 100% 100% 100% 20% 30% 50% 100% 100%

0 0 58545.18 0 0 0 0 0 0

0 24.5

20% 125%

0 30.625 58799.553

Inference: Unlike that of Basel I norms, under new accord investments attracts different risk weight according to the ratings. Investments rated AAA attracts only 20% risk weight of the value. At same time BBB rated investments and unrated investments attracts 100% risk weight. If the bank has investments in equities, it has the highest risk weight of 125%. TABLE NO: 5 RISK LOANS AND ADVANCES (Performing NET assets) CLAIMS ON CENTRAL GOVT- FOOD CREDIT DIRECT LOAN/CREDIT OVERDRAFT EXPOSURE TO STATE 0 0% 0
Page | 58

ADJUSTEDVALU RW E

VALUE

37702

0%

CENTRAL ADVANCE STATE ADVANCE

GOVT

GUARANTEED 0 0% 0

GOVT

GUARANTEED 67045.39 20% 13409.078

BILLS PURCHASED UNDER OTHER THAN OWN LC/AC BILLS PURCHASED INCLUDING 37701.29 COVERED 39.05 0% 0 100% 37701.29 287391.24 20% 57478.248

OWN BANK LC/AC DICGC CREDIT DICGC GUARANTEED UN COVERED CREDIT ECGC CREDIT ECGC GUARANTEED UN COVERED CREDIT HOUSING LOAN LOAN TO VALUE=LESS THAN 75% SL LESS THAN 30 LAC LOAN TO VALUE=LESS THAN 75% SL GTR THAN 30 LAC LOAN TO VALUE GRTE THAN 75% HOUSING LOAN ABOVE 75 LAC CONSUMER SHARES EDUCATIONAL LOANS ADVANCE TO ND-SI-NBFC ADVANCE TO OWN LOAN /AGAINST GUARANTEED COVERED GUARANTEED

26.04

100%

26.04

27257.87

20%

5451.574

13300.5

100%

13300.5 0

87384.84

50%

43692.42

13530.3 3173.92 2575.08

75% 100% 125%

10147.725 3173.92 3218.85

26502.01 6435.2 60476.45 STAFF 17896.82

125% 75% 100% 20%

33127.5125 4826.4 60476.45 3579.364

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MEMBERS RESTUCTURD ADVANCES COMMERCIAL REAL ESTATES FULLY SECURED LOANS AGAINST LIP,NSC,IVP,KVP etc. GOLD LOAN OTHER REGULATORY RETAIL 425631.42 75% 319223.565 0 109939.91 75% 125% 0 137424.8875 41206.28 12844.32 125% 100% 51507.85 12844.32

PORTFOLIO

Inference: Under Basel II norms consumer loan (against shares) and housing loans (above 75lac) attracts high risk weight of 125%.Advances which attracts zero weights are those advances to central and state government (direct loan, overdraft, claims, guaranteed advance). TABLE NO: 6 RISK NET ADVANCES- RATED ITEMS AAA AA PR1 PR2 PR4 and Lower A BBB BELOW BB ALL OTHER LOANS AND ADVANCES VALUE 33970.37 36795.41 8281.92 8874.27 0 78910.97 66931.32 16508.78 86761.57 RW% 20% 30% 30% 50% 150% 50% 100% 150% 100% ADJUSTED VALUE 6794.074 11038.623 2484.576 4437.135 0 39455.485 66931.32 24763.17 86761.57

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Inference: loans and advances to various firms, companies and institutions rated AAA invites 20% risk weight. Lower rated firms (below BB and PR4) fetch high risk weight of 150%. ADVANCES TOTAL NON PERFORMING ADVANCES TABLE NO: 7 1053275.947

RISK NET NON PERFORMING ADVANCES WHERE SPECIFIC PROVISION IS LESS THAN 20% WHERE PROVISION GRTR THAN 20% LESS THAN 50% WHERE PROVISION GREATER THAN 50% NPA ON HL WHERE PROVISION IS LESS THAN 20% NPA ON HL WHERE PROVISION IS GRTR THAN 20% & LESS THAN 50% NPA ON HL WHERE PROVISION IS GREATER THAN 50% TOTAL TOTAL(TOTAL ADVANCES + TOTAL NPA) 1063799.84 3.5 50% 1.75 10523.8925 222.41 75% 166.8075 1128.59 100% 1128.59 -1749.05 50% 0 734.66 100% 734.66 5661.39 150% 8492.085 VALUE RW ADJUSTED VALUE

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Inference: from the above table we can generalize that risk weight on NPAs depends on how much specific provision created for each NPA. Higher the provision lesser the risk weight. TABLE: 8 NET UNAVAILED PORTION OF CREDIT STAFF ADVANCE MERCANTILE CREDIT OTHER ADVANCES TOTAL TOTAL VALUE 498.9 486.11 44651.79 RW 20% 75% 100% RAV 99.78 364.5825 44651.79 45116.1525 1249941.72

Inference: other un availed portion of credit includes staff advance, mercantile credit and other advances which fetch risk weight of 20%, 75% and 100% respectively. FIRST PILLAR : MINIMUM CAPITAL REQUIREMENT

The first pillar establishes a way to quantify the minimum capital requirements. The main objective of Pillar I is to align capital the adequacy ratios to the risk sensitivity of the assets affording a greater flexibility in the computation of banks' individual risk . Capital Adequacy Ratio is defined as the amount of regulatory capital to be maintained by a bank to account for various risks inbuilt in the banking system. The focus of Capital Adequacy Ratio under Basel I norms was on credit risk and was calculated as follows:

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Tier I Capital + Tier II Capital Capital Adequacy Ratio = ----------------------------------Risk Weighted Assets

Basel Committee has revised the guidelines in the year June 2001 known as Basel II Norms. Capital Adequacy Ratio in New Accord of Basel II:

Capital Adequacy Ratio =

Total Capital (Tier I Capital + Tier II Capital)

-----------------------------------------------------------------------------Market Risk(RWA) + Credit Risk (RWA)+Operation Risk(RWA)

*RWA = Risk Weighted Assets

CALCULATION OF CAPITAL ADEQUACY RATIO:

TOTAL CAPITAL:

Total Capital constitutes of Tier I Capital and Tier II Capital less shareholding in other banks.

Tier I Capital = Ordinary Capital + Retained Earnings& Share Premium - Intangible assets.

Tier II Capital = Undisclosed Reserves + General Bad Debt Provision+ Revaluation Reserve+ Subordinate debt+ Redeemable Preference shares

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BASEL II REQUIREMENTS ACCORDING TO RBI TABLE NO: 9 Actual values Capital to Risk Weighted Ratio (CRAR) Tier 1 capital ratio 6% 9%

CAPITAL ADEQUACY COMPUTATION UNDER BASEL 2 AS ON MARCH 2011 IN SOUTH INDIAN BANK

TABLE NO: 10 CAPITAL BASE CORE (TIER ONE) CAPITAL (CC) SUPPLEMENTRY (TIER TWO) CAPITAL TOTAL CAPITAL (TC) Rs lacs 165023.06 40124.45 205147.51

TABLE: 11 RISK WEIGHTED ASSETS ASSETS (funded-BANKING BOOK) CONTIGENT CREDIT EXPOSURES FORWARD CONTRACTS/DERIVATIVES EXPOSURES RISK WEIGHTED ASSETS FOR OPERATIONAL RISK OPEN POSITION LIMIT - CAPITAL CHARGE FOREIGN EXCHANGE PRECIOUS METALS Rs lacs 1249941.72 39816.64 965.96 113063.69 1000 0 0
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TRADING BOOK TOTAL RISK WEIGHTED ASSETS (TRWA)

59863.9 1464651.91

CRAR (%TC/TRWA) CORE CRAR (%CC/TRWA) CRAR- TIER 2 CAPITAL

14.01 11.26704979 2.739521229

Inference: Capital to Risk Weighted Assets Ratio of south Indian bank is very healthy when compared to the base rate fixed by RBI on recommendations of Basel II. It depicts the bank has sufficient regulatory capital to cover various kinds of risks.

CRAR : QUATERLY INFORMATION OF SIB

16 15.5 15 14.5 14 13.5 13 1 2 3 4 CRAR

FIGURE 1

Page | 65

INFERENCE:

Though the CRAR of SIB is exceptionally good, the management should take in to account that the adequate capital of bank is diminishing throughout the quarters. In the first quarter of the financial year the CRAR was about 16% and when the year ends it has reduced to 14%.

CAPITAL TO RISK WEIGHTED ASSEST RATIO OF SIB (PREVIOUS YEARS)

Table No: 12 CRAR

YEAR 2008-09 2009-10 2010-11

CRAR 17.35% 17.86% 14.01%

Inference : It is clear from the above table that the CRAR retained by South Indian Bank is well above the required rate under Basel II of 9%. During the FY 2010-11 it has reached the maximum of 17.86%. But it should be noted that capital adequacy ratio of the bank has come down from 17.86 to 14% this year.

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CRAR
20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2008-09 2009-10 2010-11

CRAR

FIGURE 2 CRAR IF SIB TIER I RATIO Table No: 13 TIER I RATIO OF SIB

YEAR 2008-09 2009-10 2010-11 Inference :

TIER IRATIO 13.93% 14.30% 11.27%

TIER I RATIO of the bank is 13.93 in 2008-09, in 2009-10 it is 14.30. In the present FY it has reduced to 11.27%. It shows that the performance is far beyond the standard set under of BASEL II NORMs of 6%.

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TIER IRATIO
16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2008-09 2009-10 2010-11 TIER IRATIO

FIGURE: 3 TIER I RATIO Table No: 14 TOTAL RATIO of SOUTH INDIAN BANK YEAR 2008-09 2009-10 2010-11 Inference : The CRAR and TIER I RATIO of SIB are maintained according to BASEL II standards. But in the case of TIER II RATIO. CRAR 17.35% 17.86% 14.01% TIER IRATIO 13.93% 14.30% 11.28% TIER II RATIO 3.42% 3.57% 2.74%

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20.00% 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% CRAR TIER IRATIO TIER II RATIO

2008-09 2009-10 2010-11

FIGURE 4 TOTAL RATIO of SOUTH INDIAN BANK PILLAR 2 To address the issues of Pillar II, the Bank has implemented ICAAP framework (Internal Capital Adequacy Assessment Process) during the year for integrating capital planning with budgetary planning and to capture the residual risks which are not addressed in pillar I like credit concentration risk, interest rate risk in the banking book, liquidity risk, earnings risk, strategic risk, reputation risk etc.

PILLAR 3 For adhering to market discipline as laid down in pillar III of Basel II guidelines, the Bank has adopted a common framework for disclosures. This requires the Bank to disclose its risk exposures, risk assessment processes and its capital adequacy to the market in a more consistent and comprehensive manner.

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CAPITAL TO RISK WEIGHTED ASSEST RATIO OF STATE BANK OF INDIA (PREVIOUS YEARS) Table No: 14 CRAR YEAR 2007-08 2008-09 2009-10 CRAR 13.08 14.40 13.74

INTERPRETATION This chart shows the capital to risk weighted asset ratio in STATE BANK OF INDIA is 13.08 during 2007-08 and 14.40 during 2008-09 and 13.74 during 2009-10. It is showing that CRAR in STATE BANK OF INDIA is way above the CRAR of BASEL II i.e. 9%. So the bank is adhering to Basel II norms.

14.5 14 13.5 13 12.5 12 2007-08 13.08

14.4

CRAR
13.74

CRAR

2008-09

2009-10

FIGURE 5

Page | 70

TIER I RATIO Table No: 16 TIER I RATIO YEAR 2007-08 2008-09 2009-10 TIER IRATIO 8.87% 9.84% 9.62%

Inference This chart shows the performance of bank regarding the maintenances of Tier I capital. During the period of 2007-08 the ratio was 8.87% and in next year it increased to 9.84% and in 2009-10 the ratio has reduced to 9.62%.

TIER I RATIO
10 9.5 9 8.5 8 2007-08 2008-09 2009-10 8.87 TIER I RATIO 9.84 9.62

FIGURE No: 6

Page | 71

TOTAL RATIO Table No: 17 Total Ratio of STATE BANK OF INDIA YEAR 2007-08 2008-09 2009-10 CRAR 13.83% 14.40% 13.74% TIER I RATIO 8.87% 9.84% 9.62% TIER II RATIO 4.21% 4.56% 4.12%

Inference: The entire ratios showing the performance of STATE BANK OF INDIA as the Capital Adequacy Ratio is going on in a suitable way during the last three years and also in the case of Tier I ratio the values are increasing in a normal way according to BASEL II NORMS

.
16 14 12 10 8 6 4 2 0 CRAR TIER I RATIO TIER II RATIO 4.21 4.56 4.12 8.87 9.84 9.62 2007-08 2008-09 2009-10 14.4 13.74 13.08

FIGURE: 7

Page | 72

INDIAN BANK The Capital adequacy ratio of INDIAN BANK for the past three years i.e. for 2007-2008, 2008 -2009,2009-2010 are represented graphically. CAPITAL TO RISK WEIGTHED ASSET RATIO Table No : 18 Table showing the CRAR of INDIAN BANK

YEAR 2007-08 2008-09 2009-10

CRAR 13.05% 13.98% 12.81%

Inference: This chart shows the capital to risk weighted asset ratio in INDIAN BANK is 13.05 during 2007-08, 13.98 during 2008-09 and 12.81 during 2009-10. It shows that CRAR in INDIAN BANK is above the CRAR of BASEL II i.e. 9%. So the performing of bank is good in its capital adequacy.

CRAR
14.5 14 13.5 13 12.5 12 13.98 13.05 12.81

2007-08

2008-09

2009-10

FIGURE No: 8
Page | 73

TIER I RATIO Table No: 19 TIER I RATIO

YEAR 2007-08 2008-09 2009-10

TIER I RATIO 10.98% 12.09% 11.28%

Inference: This chart shows the performance of bank regarding the maintenance of Tier I ratio of INDIAN BANK. In this chart it shows that during the period of 2007-08 the ratio is 10.98 and in next year it increase to 12.09 and in 2009-10 the ratio reduces to 11.28. So this graph saying that the TIER I RATIO retained by the bank is very good according to BASEL II NORMS.

TIER I RATIO
12.5 12 11.5 11 10.5 10 2007-08 2008-09 2009-10 11.28 10.98 PERCENTAGE 12.09

FIGURE No: 9

Page | 74

TOTAL RATIO Table No: 20 TOTAL RATIO of INDIAN BANK

YEAR 2007-08 2008-09 2009-10

CRAR 13.05% 13.98% 12.81%

TIER I RATIO 10.98% 12.09% 11.28%

TIER II RATIO 2.11% 1.86% 2.66%

Inference:

The entire ratios showing the performance of INDIAN BANK as the Capital Adequacy Ratio is going on in a suitable way during the last three years and also in the case of Tier I ratio the values are increasing in a normal way according to BASEL II NORMS

16 14 12 10 8 6 4 2 0 13.05

13.98 12.81 10.98 12.09 11.28 2007-08 2008-09 2009-10 2.11 1.86 2.66

CRAR

TIER I RATIO

TIER II RATIO

FIGURE: 10

Page | 75

CANARA BANK CAPITAL TO RISK WEIGHTED ASSEST RATIO Table NO: 21 CRAR of CANARA BANK YEAR 2007-08 2008-09 2009-10 Inference : The chart shows the performance of CAPITAL TO RISK WEIGHTED ASSEST RATIO in Canara bank. It shows that the CRAR in 2007-08 is 13.45 and in 2008-09 it is 14.44% and in the year of 2009-10 it is 13.02. According to the BASEL II NORMS the standards set is 9%. And during these consecutive years the Bank performed very well in reaching the base line. CRAR 13.45% 14.44% 13.02%

CRAR
15 14.5 14 13.5 13 12.5 12 2007-08 2008-09 2009-10 13.45 13.02 PERCENTAGE 14.44

FIGURE : 11

Page | 76

TIER I RATIO Table No : 22 Table showing the TIER IRATIO

YEAR 2007-08 2008-09 2009-10

TIER IRATIO 7.51% 9.20% 8.27%

Inference: In this chart the TIER I RATIO is 7.51% in 2007-08 and 9.20 in 2008-09 and 8.27 in 2009-10. So it says that Canara Bank shows an overall good performance in maintaining Tier I Ratio and it touched base line of BASEL II.

TIER I RATIO
10 8 6 4 2 0 2007-08 2008-09 2009-10 PERCENTAGE 7.51 9.2 8.27

FIGURE NO: 12

Page | 77

TOTAL RATIO Table No: 23 TOTAL RATIO of CANARA BANK YEAR 2007-08 2008-09 2009-10 CRAR 13.45% 14.44% 13.02% TIER I RATIO 7.50% 9.20% 8.27% TIER II RATIO 6.24% 5.24% 4.75%

INTERPRETATION This chart shows that the overall performance of CANARA BANK is going on well as base line set by BASEL Standards.
16 14 12 10 8 6 4 2 0 CRAR TIER I RATIO TIER II RATIO 7.51 9.2 8.27 6.24 5.24 4.75 2007-08 2008-09 2009-10 13.45 14.44 13.02

FIGURE: 13

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HDFC BANK CAPITAL TO RISK WEIGHTED ASSEST RATIO Table No: 24 CRAR of HDFC BANK YEAR 2007-08 2008-09 2009-10 CRAR 15.4% 18.3% 16.3%

Inference: In this chart the CRAR of HDFC BANK is 15.4 % and in the year of 2008-09 it is 18.3% and in the tear of 2009-10 it is 16.3%. So the performance of HDFC BANK is good according to the BASEL II standards.

CRAR
19 18.5 18 17.5 17 16.5 16 15.5 15 14.5 14 13.5 18.3

16.8 PERCENTAGE

15.4

2007-08

2008-09

2009-10

FIGURE:14

Page | 79

TIER I RATIO Table No: 25 TIER I RATIO of HDFC BANK YEAR 2007-08 2008-09 2009-10 TIER IRATIO 10.6% 13.8% 12.1%

Inference: The chart shows that the TIER I RATIO in 2008-09 is 10.6% and in the year of 2008-09 it is 13.8% and in the year of 2009-10 it is 12.1%. TIER I RATIO of HDFC BANK is better according to BASEL II standards as the base line of Bank is beyond the BASEL II Standards. It shows the efficiency of Bank in maintaining TIER I RATIO.

TIER I RATIO
16 14 12 10 8 6 4 2 0 2007-08 2008-09 2009-10 10.6 13.8 12.1

PERCENTAGE

FIGURE: 15

Page | 80

TOTAL RATIO Table No: 26 TOTAL RATIO of HDFC BANK YEAR 2007-08 2008-09 2009-10 CRAR 15.4% 18.3% 16.3% TIER IRATIO 10.6% 13.8% 12.1% TIER II RATIO 4.8% 4.5% 4.7%

Inference: Considering all the Ratios of HDFC BANK, banks performance is far better than the standard set by BASEL II NORMS. As the CRAR of BASEL II is 9% and Bank shows a performance of 15.4%, 18.3% and 16.3% in the last 3 consecutive years.
20 18 16 14 12 10 8 6 4 2 0 CRAR TIER I RATIO TIER II RATIO 4.8 4.5 4.7 10.6 15.4 18.3 16.3 13.8 12.1 2007-08 2008-09 2009-10

FIGURE: 16

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AXIS BANK CAPITAL TO RISK WEIGHTED ASSEST RATIO Table No: 27 CRAR of AXIS BANK YEAR 2007-08 2008-09 2009-10 CRAR 13.84% 16.80% 15.80%

Inference The chart shows the CRAR of AXIS BANK. It shows that during the year of 2007-08 the ratio is 13.84% and during the year of 2008-09 it is 16.80% and during the year of 200910 the Ratio is 15.80 as against the Basel 2 norm of 9%.

CRAR
20 15 10 5 0 2007-08 2008-09 2009-10 13.84 16.8 15.8

PERCENTAGE

FIGURE: 17

Page | 82

TIER I RATIO Table No: 28 TIER I RATIO of AXIS BANK YEAR 2007-08 2008-09 2009-10 TIER I RATIO 9.46% 11.83% 11.18%

Inference: The chart shows that the TIER I RATIO of AXIS BANK during the year of 2007-08 is 9.46% and during the year of 2008-09 it is 11.83% and during the year of 2009-10 it is 11.18%. It means that TIER I RATIO in 2007-08 is than the standards set by the BASEL II NORMS but it increases in the next year to 11.83% and in 2009-10 it again increases to 11.18%.

TIER I RATIO
15 9.46 10 5 0 2007-08 2008-09 2009-10 PERCENTAGE 11.83 11.18

FIGURE: 18
Page | 83

TOTAL RATIO Table No: 29 Table showing the TOTAL RATIO of AXIS BANK YEAR 2007-08 2008-09 2009-10 CRAR 13.84% 16.80% 15.80% TIER IRATIO 9.46% 11.83% 11.18% TIER II RATIO 4.58% 4.97% 4.62%

Inference: In this chart the Ratios of AXIS BANK are evaluated and it is seeing that the CRAR are in a good position according to BASEL II NORMS.

TOTAL RATIO
18 16 14 12 10 8 6 4 2 0 CRAR TIER I RATIO TIER II RATIO 4.58 4.97 4.62 9.46 12.84 16.8 15.8

11.83

11.18 2007-08 2008-09 2009-10

FIGURE: 19

Page | 84

TABLE NO: 30

MEAN CRAR FO INDIAN BANKS FOR THE PAST 3 YEARS

18.00% 16.00% 14.00% MEAN CRAR 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% SIB SBI INDIAN BANK

CANARA

HDFC

AXIS

Series1

SIB 16.66%

SBI 13.99%

INDIAN BANK 13.28%

CANARA 13.64%

HDFC 16.67%

AXIS 15.48%

INFERENCE:

During the past three years among the samples selected HDFC bank has the highest Capital Adequacy Ratio which is almost double the prescribed rate of 9% under Basel 2 norms Kerala based private sector bank South Indian bank have the second position. It is interesting to note that those banks who maintained the highest CRAR were all from private sector banks. It shows the better risk management implemented in those banks when compared to public sector banks.

Page | 85

PILLAR II ANALYSIS SUPERVISORY REVIEW PROCESS

SOUTH INDIAN BANK The Bank has already migrated to Basel II during FY 08-09 and assesses the capital adequacy for credit risk under Standardized Approach, market risk under Standardized Measurement Method and operational risk under Basic Indicator Approach. To address the issues of Pillar II, the Bank has implemented ICAAP framework (Internal Capital Adequacy Assessment Process) during the year for integrating capital planning with budgetary planning and to capture the residual risks which are not addressed in pillar I like credit concentration risk, interest rate risk in the banking book, liquidity risk, earnings risk, strategic risk, reputation risk etc. For adhering to market discipline as laid down in pillar III of Basel II guidelines, the Bank has adopted a common framework for disclosures. This requires the Bank to disclose its risk exposures, risk assessment processes and its capital adequacy to the market in a more consistent and comprehensive manner.

INFORMATIONS GATHERED FROM PERSONNAL INTERVIEW

An interview schedule has been prepared in order to collect original data regarding the significance and effectiveness of implementation of Basel II norms in Indian banks with special reference to South Indian bank. The assistant manager in the Integrated Risk Management Department of South Indian Bank has been interviewed to collect requisite information. The resultant information are as follows: 1. The significance of the implementation of Basel II in India is high

Page | 86

2. The significance of the implementation of Basel II in south Indian bank is also high 3. High priority have been attributed to the implementation of Basel II by the management of South Indian bank 4. South Indian Bank considers the implementation of Basel II as an opportunity to improve risk management process 5. The bank sees the use of internal models for risk management and for calculation of capital requirements 6. The potential problems related to the implementation of Basel II standards is the personnel training and information system development costs 7. The employees are familiar with basic documents and have solid knowledge 8. Employees are given internal- training within the bank 9. The competency of the employees engaged in the process of risk management is good 10. 20 employees are engaged in credit risk management process in the bank whereas 5 and 3 employees are engaged in market risk and operational risk management process. 11. The bank maintains a special team for the implementation of Basel II standards. 12. The existing IT infrastructure in the bank support Basel II requirements. 13. Foundation internal Rating Approach is using for measuring credit risk in the bank 14. Bank is also using internally developed methodology for identifying and measuring credit risk for your internal needs 15. Standardized measurement approach method is being used by the bank for measuring market risk 16. Basic indicator approach is being used by for measuring operational risk 17. The bank has formulated the ICAAP with the approval of the board 18. The outcomes of the ICAAP are periodically submitted to the board and RBI. 19. The outcomes of the ICAAP are reviewed by the board on a yearly basis 20. The disclosure practices in the bank expose all types of risks to some extend
Page | 87

CHAPTER IV FINDINGS CONCLUSION AND SUGGESTIONS

FINDINGS Project entitled A study on the adoption of Basel II norms in Indian Banking sector with special reference to South Indian Bank probed how South Indian Bank have adopted various measures in implementing Basel II norms and the current capital requirements of Indian Banks in conformation to Basel II guidelines. The study begets the following outputs. 1. Indian banks do well in maintaining required regulatory capital against various risks. 2. The capital adequacy ratios upholding by Indian banks are higher than the base ratio of 9% as per the Basel II requirements. 3. All the Indian banks have been migrated to Basel II as per the RBI guidelines 4. Among the samples selected the mean CRAR of Indian Banks for the past 3 years, Private Banks maintained more regulatory capital when compared to nationalized banks. 5. Among the samples selected HDFC bank have the highest mean CRAR for the past 3 years of 16.67 followed by South Indian Bank having 16.66 mean CRAR for the past 3 years 6. Indian bank has the lowest mean CRAR of 13.28 for the last 3 years 7. South Indian bank has the CRAR of 14.01% for the year 2010/11 which is exceptionally good when compared to the Basel II requirement of 9% 8. The bank also have Tier I CRAR of 11.267% which is higher than the required rate of 6%

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9. But the CRAR of the bank is diminishing throughout the four quarters. In the first quarter of the financial year the CRAR was about 16% and when the year ends it has reduced to 14%. 10. In the previous year CRAR of the bank has touched the all time high of 17.86. 11. The competency of the employees engaged in the process of risk management is good 12. The existing IT infrastructure in the bank support Basel II requirements. 13. By evaluating the overall performance of these three Nationalized Bank, STATE BANK OF INDIA maintained more regulatory capital in terms of conformation to BASEL II Standards than INDIAN BANK and CANARA BANK. 14. By evaluating the overall performance of Private Banks according to BASEL II norms, all the banks did well especially HDFC and South Indian Bank 15. Investments in government securities, cash with RBI and investments having top rating attracts less risk weight 16. Investments in equity shares fetch high risk weight 17. Advances which attracts zero weights are those advances to central and state government (direct loan, overdraft, claims, guaranteed advance 18. Loans and advances to AAA rated institutions fetch lower risk weight compared to lower rated and unrated companies

CONCLUSION From the study it has been concluded that Indian banking sector is performing well in the area of systematic risk management. Basel II norms have been successfully implemented by all the banks following the RBI guide lines. The risk identification, risk analysis and risk management process of south Indian bank is exceptionally good.

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SUGGESTIONS

Banking industry in India is undergoing aggressive growth. So that banks needs to maintain adequate regularity capital so as to protect itself from various types of risk such as credit risk, market risk and operational risk Basel II norms provide the banks to improve the risk management process. So banks should follow the Basel II norms strictly. Apart from stipulated rate of 9% CRAR banks are required to maintain 6% core CRAR. For this strong equity capital base should be sustained other than external and sub ordinate debts. Employees should be given proper training in order to cope up with the changing stipulations under Basel accord IT infrastructure in the banks need to be more supportive for the implementation of Basel II accord Investment portfolio of the bank should be designed taking into consideration the risk weight concerted with each and every investment opportunity Minimize lending loans and advances to lower rated and unrated companies since they fetch higher risk weights

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