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CHAPTER-1

INTRODUCTION

The Basel Committee was formed in response to the messy liquidation of a Cologne-based bank
in 1974. On 26 June 1974, a number of banks had released Deutschmark to the Bank Herstatt in
exchange for dollar payments deliverable in New York. On account of differences in the time
zones, there was a lag in the dollar payment to the counter-party banks, and during this gap, and
before the dollar payments could be effected in New York, the Bank Herstatt was liquidated by
German regulators.

This incident prompted the G-10 nations [The Group of Ten is made up of eleven industrial
countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden,
Switzerland, the United Kingdom and the United States] which consult and co-operate on
economic, monetary and financial matters to form towards the end of 1974, the Basel Committee
on Banking Supervision, under the auspices of the Bank of International Settlements (BIS)
located in Basel, Switzerland.

The major impetus for the 1988 Basel Capital Accord was the concern of the Governors of the
G10 central banks that the capital of the world's major banks had become dangerously low after
persistent erosion through competition. Capital is necessary for banks as a cushion against losses
and it provides an incentive for the owners of the business to manage it in a prudent manner.

The Existing Framework

The 1988 Accord requires internationally active banks in the G10 countries to hold capital equal
to at least 8% of a basket of assets measured in different ways according to their riskiness. The
definition of capital is set (broadly) in two tiers, Tier 1 being shareholders' equity and retained
earnings and Tier 2 being additional internal and external resources available to the bank. The
bank has to hold at least half of its measured capital in Tier 1 form.
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A portfolio approach is taken to the measure of risk, with assets classified into four buckets (0%,
20%, 50% and 100%) according to the debtor category. This means that some assets (essentially
bank holdings of government assets such as Treasury Bills and bonds) have no capital
requirement, while claims on banks have a 20% weight, which translates into a capital charge of
1.6% of the value of the claim. However, virtually all claims on the non-bank private sector
receive the standard 8% capital requirement.

There is also a scale of charges for off-balance sheet exposures through guarantees,
commitments, forward claims, etc. This is the only complex section of the 1988 Accord and
requires a two-step approach whereby banks convert their off-balance-sheet positions into a
credit equivalent amount through a scale of conversion factors, which then are weighted
according to the counterparty's risk weighting.

The 1988 Accord has been supplemented a number of times, with most changes dealing with the
treatment of off-balance-sheet activities. A significant amendment was enacted in 1996, when
the Committee introduced a measure whereby trading positions in bonds, equities, foreign
exchange and commodities were removed from the credit risk framework and given explicit
capital charges related to the bank's open position in each instrument.

Impact of the 1988 Accord

The two principal purposes of the Accord were to ensure an adequate level of capital in the
international banking system and to create a "more level playing field" in competitive terms so
that banks could no longer build business volume without adequate capital backing. These two
objectives have been achieved. The merits of the Accord were widely recognized and during the
1990s the Accord became an accepted world standard, with well over 100 countries applying the
Basel framework to their banking system. However, there also have been some less positive
features. The regulatory capital requirement has been in conflict with increasingly sophisticated
internal measures of economic capital. The simple bucket approach with a flat 8% charge for
claims on the private sector has given banks an incentive to move high quality assets off the
balance sheet, thus reducing the average quality of bank loan portfolios. In addition, the 1988
Accord does not sufficiently recognize credit risk mitigation techniques, such as collateral and
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guarantees. These are the principal reasons why the Basel Committee decided to propose a more
risk-sensitive framework in June 1999.

The June 1999 proposal

The initial consultative proposal had a strong conceptual content and was deliberately rather
vague on some details in order to solicit comment at a relatively early stage of the Basel
Committee’s thinking. It contained three fundamental innovations, each designed to introduce
greater risk sensitivity into the Accord. One was to supplement the current quantitative standard
with two additional “Pillars” dealing with supervisory review and market discipline. These were
intended to reduce the stress on the quantitative Pillar 1 by providing a more balanced approach
to the capital assessment process. The second innovation was that banks with advanced risk
management capabilities would be permitted to use their own internal systems for evaluating
credit risk, known as “internal ratings”, instead of standardized risk weights for each class of
asset. The third principal innovation was to allow banks to use the grading provided by approved
external credit assessment institutions (in most cases private rating agencies) to classify their
sovereign claims into five risk buckets and their claims on corporate and banks into three risk
buckets. In addition, there were a number of other proposals to refine the risk weightings and
introduce a capital charge for other risks. The basic definition of capital stayed the same. The
comments on the June 1999 paper were numerous and can be said to reflect the important impact
the 1988 Accord has had. Nearly all commenter’s welcomed the intention to refine the Accord
and supported the three Pillar approach, but there were many comments on the details of the
proposal. A widely-expressed comment from banks in particular was that the threshold for the
use of the IRB approach should not be set so high as to prevent well managed banks from using
their internal ratings. Intensive work has taken place in the eighteen months since June 1999.
Much of this has leveraged off work undertaken in parallel with industry representatives, whose
cooperation has been greatly appreciated by the Basel Committee and its Secretariat.
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Implementation in India

Ever since its introduction in 1988, capital adequacy ratio has become an important benchmark
to assess the financial strength and soundness of banks. It has been successful in enhancing
competitive equality by ensuring level playing field for banks of different nationality. A survey
conducted for 129 countries participating in the ninth International Conference of Banking
Supervision showed that in 1996, more than 90% of the 129 countries applied Basel-like risk
weighted capital adequacy requirement. Reserve Bank of India introduced risk assets ratio
system as a capital adequacy measure in 1992, in line with the capital measurement system
introduced by the Basel Committee in 1988, which takes into account the risk element in various
types of funded balance sheet items as well as non-funded off-balance sheet exposures. Capital
adequacy ratio is calculated on the basis of various degrees of risk weights attributed to different
types of assets. As per current RBI guidelines, Indian banks are required to achieve capital
adequacy ratio of 9% (as against the Basel Committee stipulation of 8%.
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CHAPTER-2

Basel I

It is the term which refers to a round of deliberations by central bankers from around the world,
and in 1988, the Basel Committee (BCBS) in Basel, Switzerland, published a set of minimal
capital requirements for banks. This is also known as the 1988 Basel Accord, and was enforced
by law in the Group of Ten (G-10) countries in 1992, with Japanese banks permitted an extended
transition period. Basel I is now widely viewed as out modeled, and a more comprehensive set of
guidelines, known as Basel II are in the process of implementation by several countries.

Background

The Committee was formed in response to the messy liquidation of a Cologne-based bank in
1974. On 26 June 1974, a number of banks had released Deutschmark to the Bank Herstatt in
exchange for dollar payments deliverable in New York. On account of differences in the time
zones, there was a lag in the dollar payment to the counter-party banks, and during this gap, and
before the dollar payments could be effected in New York, the Bank Herstatt was liquidated by
German regulators.

This incident prompted the G-10 nations to form towards the end of 1974, the Basel Committee
on Banking Supervision, under the auspices of the Bank of International Settlements (BIS)
located in Basel, Switzerland.

Capital Adequacy Ratio - Basle Accord 1988

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

a. The definition of capital and

b. The structure of risk weights.
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Based on the Basel norms, the RBI also issued similar capital adequacy norms for the Indian
banks. According to these guidelines, the banks will have to identify their Tier-I and Tier-II
capital and assign risk weights to the assets. Having done this they will have to assess the Capital
to Risk Weighted Assets Ratio (CRAR). The minimum CRAR which the Indian banks are
required to meet is set at 9 percent.

Tier-I Capital

• Paid-up capital
• Statutory Reserves
• Disclosed free reserves
• Capital reserves representing surplus arising out of sale proceeds of assets

Equity investments in subsidiaries, intangible assets and losses in the current period and those
brought forward from previous periods, will be deducted from Tier I capital.

Tier-II Capital

• Undisclosed Reserves and Cumulative Perpetual Preference Shares

• Revaluation Reserves
• General Provisions and Loss Reserves

Loopholes of Basel I Accord

 After ten years of implementation and taking into consideration the rapid technological,
financial and institutional changes happened during the period many weaknesses started
appearing in Basel I accord.

 Because of a flat 8% charge for claims on the private sector, banks have an incentive to
move high quality assets off the balance sheet (capital arbitrage) through securitization.
Thus, reducing the average quality of bank loan portfolio
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 It does not take into consideration the operational risks of banks, which become
increasingly important with the increase in the complexity of banks.

 Also, the 1988 Accord does not sufficiently recognize credit risk mitigation techniques,
such as collateral and guarantees.

 The regulatory Capital requirement has been in conflict with increasingly sophisticated
internal measures of economic Capital

 It was concentrating on only on credit risk.

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CHAPTER-3

Why Basel II

The new framework intends to provide approaches which are both more comprehensive
and more sensitive to risks than the 1988 Accord,

While maintaining the overall level of regulatory capital. Capital requirements that are more in
line with underlying risks will allow banks to manage their businesses more efficiently. The new
framework is less prescriptive than the original Accord. At its simplest, the framework is
somewhat more complex than the old, but it offers a range of approaches for banks capable of
using more risk-sensitive analytical methodologies. These inevitably require more detail in their
application and hence a thicker rule book. The Committee believes the benefits of a regime in
which capital is aligned more closely to risk significantly exceed the costs, with the result that
the banking system should be safer, sounder, and more efficient.

What is Basel II

Basel 2 is the new capital accord signed in June 2004 at Bank for International Settlement
located at Basel, Switzerland. It is an improvement over Basel 1 which had certain deficiencies
which have now been removed. Basel 2 is based on three pillars: capital adequacy, supervisory
review and market discipline. It is basically concerned with financial health of the banks
worldwide. The focus in Basel 2 is the risk determination and quantification of credit risk,
market risk and operational risk faced by banks. Reserve Bank of India has accepted the accord
and issued guidelines to ensure compliance with the norms by March 31, 2008. Other scheduled
commercial banks are required to implement Basel 2 by March 31, 2009.
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Rationale for a new Accord: need for more flexibility and risk sensitivity

The existing Accord The proposed new Accord

Focus on a single risk measure More emphasis on banks’ own internal

methodologies, supervisory review, and
market discipline

One size fits all Flexibility, menu of approaches, incentives

for better risk management

Broad brush structure

More risk sensitivity

Basel II is basically a Risk Management Exercise

 Doesn’t seek to change business models of the Bank.

 But requires to fine-tune/update Risk Management practices.

 Robust enough to capture all possible Risks the Bank is facing or likely to face.

 Initiate adequate and appropriate Risk Mitigation measures through effective Systems
and Procedures
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Objectives of the New Basel Accord

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

Reasons:

Safety and soundness in today’s dynamic and complex financial system can be attained only by
the combination of effective bank-level management, market discipline, and supervision. The
1988 Accord focused on the total amount of bank capital, which is vital in reducing the risk of
bank insolvency and the potential cost of a bank’s failure for depositors. Building on this, the
new framework intends to improve safety and soundness in the financial system by placing more
emphasis on banks’ own internal control and management, the supervisory review process, and
market discipline.

Although the new framework’s focus is primarily on internationally active banks, its underlying
principles are intended to be suitable for application to banks of varying levels of complexity and
sophistication. The Committee has consulted with supervisors worldwide in developing the new
framework and expects the New Accord to be adhered to by all significant banks within a certain
period of time.

The 1988 Accord provided essentially only one option for measuring the appropriate capital of
internationally active banks. The best way to measure, manage and mitigate risks, however,
differs from bank to bank. An Amendment was introduced in 1996 which focused on trading
risks and allowed some banks for the first time to use their own systems to measure their market
risks. The new framework provides a spectrum of approaches from simple to advanced
methodologies for the measurement of both credit risk and operational risk in determining capital
levels. It provides a flexible structure in which banks, subject to supervisory review, will adopt
 P a g e | 11

approaches which best fit their level of sophistication and their risk profile. The framework also
deliberately builds in rewards for stronger and more accurate risk measurement.

Structure of the new Accord

Three pillars of the new Accord

 First pillar: minimum capital requirement

 Second pillar: supervisory review process
 Third pillar: market discipline

The new Accord consists of three mutually reinforcing pillars, which together should contribute
to safety and soundness in the financial system. The Committee stresses the need for rigorous
application of all three pillars and plans to work actively with fellow supervisors to achieve the
effective implementation of all aspects of the Accord It is hardly necessary to emphasize the
importance of banks and banking systems to financial and economic stability. The ability of a
sound and well-capitalized banking system to help cushion an economy from unforeseen shocks
is well known, as are the negative consequences of a banking system that itself becomes a source
of weakness and instability. A critical potential weakness of financial markets is that risks are in
many cases under-estimated and not fully recognized until too late, with a concomitant potential
for excessive consequences once they have been fully realized. This is why the Basel
Committee’s efforts to promote greater recognition of risks and more systematic attention to
them are vitally important.

The essence of Basel II is a focus on risk differentiation and the need for enhanced approaches to
assessing credit risk. Some critics have argued that it is preferable to downplay differences in
risk, and indeed forbearance can sometimes appear the most expedient strategy.

But experience has also shown that this will not work as an overall approach because ignoring
risks inevitably leads to larger problems down the road. Thus, one of the key messages of Basel
 P a g e | 12

II is that bankers, supervisors, and other market participants must become better attuned to risk
and better able to act on those risk assessments at the appropriate time. Bank supervisors must
get better at addressing issues preemptively rather than in crisis mode.

Significant attention to risk management is one of the primary mechanisms available to help
banks and supervisors do that. Basel II seeks to provide incentives for greater awareness of
differences in risk through more risk-sensitive minimum capital requirements. The Pillar 1
capital requirements will, by necessity, be imperfect measures of risk as any rules-based
framework will be. The objective of the proposals is to increase the emphasis on assessments of
credit and operational risk throughout financial institutions and across markets.

Perhaps even more important in the long run is the second pillar of the new Accord. Pillar 2
requires banks to systematically assess risk relative to capital within their organization. The
review of these internal assessments by supervisors should provide discipline on bank
management to take the process seriously and will help supervisors to continually enhance their
understanding of risk at the institutions. The third pillar of Basel II provides another set of
necessary checks and balances by seeking to promote market discipline through enhanced
transparency. Greater disclosure of key elements of risk and capital will provide important
information to counterparties and investors who need such information to have an informed view
of a bank’s profile.

BASEL II FRAMEWORK
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THREE PILLARS OF BASEL

II

Supervisory Market
Minimum Review Discipline
Capital Process
Requirement

Credit Risk Market Risk Operational Risk

Standardized
Standardized IRBA Duration
Approach Approach Internals
Model
Approach

Basic Indicator Standardised Advanced

Approach Approach Measurement
Approach
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The first Pillar:

Minimum capital requirement

The definition of capital in Basel 2 will not modify and that the minimum ratios of capital
to risk-weighted assets including operational and market risks will remain 8% for total
capital. Tier 2 capital will continue to be limited to 100% of Tier 1 capital. The main
changes will come from the inclusion of the operational risk and the approaches to measure the
different kinds of risks.

Risk-Based Capital Ratio= Capital

_____________________________________________

Credit Risk + Market Risk+Operational Risk

Approaches to Approaches to
Approaches to Measure Market Risk measure
measure credit Risk 1.Standardised operational risk
1.Standardised Approach 1.Basic Indicator
Approach 2.Internal Model Approach
2.IRBA Approach 2. Standardised
Approach 3.IMA
 P a g e | 15

Pillar 1 stipulates the following options for assigning capital to meet credit risk:

1. Standardized Approach

2. Internal Rating Based (IRB) Approach

3. Advanced IRB Approach.

Standardized Approach

Banks may use external credit ratings by institutions recognized for the purpose by the central
bank for determining the risk weight. Exposure on sovereigns and their central banks could vary
from zero percent to 150 percent depending on credit assessment from ‘AAA’ to below B- .
Similarly, exposure on public sector entities, multilateral development banks, other banks,
securities firms and corporates also may have risk weights from 20 percent to 150 percent.
Exposure on retail portfolio may carry risk weight of 75 percent. While Basel II stipulates
minimum capital requirement of 8 percent on risk weighted assets, India has prescribed 9
percent. Under Basel II exposure on a corporate with ‘AAA’ rating will have a risk weight of
only 20 percent. This implies that for Rs. 100 crore exposure on a ‘AAA’ rated corporate the
capital adequacy will be only Rs.1.8 crore (100 x 20% x 9%) compared to the earlier requirement
of Rs. 9 crore. However, claims on a corporate with below BB- rating will carry a risk weight of
150 percent and the capital requirement will be Rs.13.50 crore (100 x 150% x 9%). Thus, a bank
with a credit portfolio with superior rating may be able to save capital while banks having lower
rated credit exposure will have to mobilize more capital. Risk weights can go beyond 150
percent in respect of exposures with low rating. For example, securitization tranches with rating
between BB+ and BB- may carry risk weight of 350 percent. In order to adopt standardized
approach, banks will have to encourage their corporate customers to go in for ‘obligor rating’
and get them rated. The central bank has to accredit External Credit Assessment Institutions
(ECAI) who satisfy defined criteria of objectivity, independence, international access,
transparency, disclosure, resources and credibility.
 P a g e | 16

Internal Ratings Based (IRB) Approach: Foundation and Advanced Approach.

Banks, which have developed reliable Management Information System (MIS) and have
received the approval of the central bank, can use the IRB approach to measure credit risk on
their own. The bank should have reliable data on Probability of Default (PD), Loss Given
Default (LGD), Exposure at Default (EAD) and effective maturity (M) to make use of IRB
approach.

Minimum requirements to adopt the IRB approach are:

• Bank’s overall Credit Risk management practices must be consistent with the sound

practice guidelines issued by the Basel committee and the National Supervisor.

• Rating dimensions to include both Borrower Rating and Facility Rating and has to be

applied to all asset classes.

• The Rating Structure adopted need to have minimum 7 grades of performing borrowers

and a minimum 1 Grade of non-performing borrowers and enough grades to avoid undue

concentrations of borrowers in particular grades.

• Criteria of Rating Systems to be documented and have the ability to differentiate risk,

predictive and discriminatory power.

• Assessment Horizon for PD estimation to be 1 year Use of models to be coupled with the

use of human judgment and oversight.

• Rating Assignment and Rating Confirmation to be independent.

 P a g e | 17

• The PD to be a long run average over an entire economic cycle (at least 5 years)

• Banks should have confidence in the robustness of PD estimates and the underlying

statistical analysis.

• Data collection and IT systems to improve the predictive power of rating systems and PD

estimate

• Validation of internal Rating systems/ Models by the Supervisor.

• Streamlining use of credit risk mitigants and ensuring legal certainty of executed

documents.

Under foundation approach banks provide more of their own estimates of PD and rely on
supervisory estimates for other risk components. In the case of advanced approach banks provide
more of their own estimate of PD, LGD, EAD and M, subject to meeting minimum stipulated
standards.

The differences between foundation IRB and advanced IRB have been captured in the following
Table:
 P a g e | 18

Migration to other approaches under the Revised Framework

Banks are required to obtain the prior approval of the Reserve Bank to migrate to the Internal
Rating Based Approach (IRBA) for credit risk and the Standardized Approach (TSA) or the
Advanced Measurement Approach (AMA) for operational risk for computing regulatory capital
requirements. A separate communication in this regard will be issued to banks at a later date,
specifying the pre-requisites and procedure for approaching the Reserve Bank for seeking its
prior approval for such migration.

Securitization Framework: Banks must apply the securitization framework for determining
regulatory capital requirement on exposure arising from securitization. Banks that apply the
standardized approach to credit risk for the underlying exposure must use the standardized
approach under the securitization framework. Similarly, banks that have received approval to use
IRB approach for the type of underlying exposure must use the IRB approach for the
securitization. Capital Charge for Market Risk Although the Basel Committee issued
“Amendment to the Capital Accord to incorporate Market Risks” in 1996, RBI as an interim
measure, advised banks to assign an additional risk weight of 2.5% on the entire investment
 P a g e | 19

portfolio. RBI feels that over the years, bank’s ability to identify and measure market risk has
improved and therefore, decided to assign explicit capital charge for market risk in a phased
manner over a two year period as under -.

Banks would be required to maintain capital charge for market risk in respect of their trading
book exposure (including derivatives) by March 2005.

Banks would be required to maintain capital charge for market risk in respect of securities under
available for sale category by March 2006.

Market Risk:
 P a g e | 20

RBI has issued detailed guidelines for computation of capital charge on Market Risk in June
2004. The guidelines seek to address the issues involved in computing capital charge for interest
rate related instruments in the trading book, equities in the trading book and foreign exchange
risk (including gold and precious metals) in both trading and banking book. Trading book will
include:
• Securities included under the Held for Trading category
• Securities included under the Available for Sale category
• Open gold position limits
• Open foreign exchange position limits Trading position in derivatives and derivatives
entered into for hedging trading book exposures.

As per the guidelines, minimum capital requirement is expressed in terms of two separately
calculated charges:

• Specific Risk and

• General Market Risk

Specific Risk: Capital charge for specific risk is designed to protect against an adverse
movement in price of an individual security due to factors related to individual issuer. This is
similar to credit risk. The specific risk charges are divided into various categories such as
investments in Government securities, claims on Banks, investments in mortgage backed
securities, securitized papers etc. and capital charge for each category specified. General Market
Risk: Capital charge for general market risk is designed to capture the risk of loss arising from
changes in market interest rates. The Basel Committee suggested two broad methodologies for
computation of capital charge for market risk, i.e., Standardized Method and Internal Risk
Management Model Method. As Banks in India are still in a nascent stage of developing internal
risk management models, in the guidelines, it is proposed that to start with, the Banks may adopt
the Standardized Method. Again, under Standardized Method, there are two principle methods
for measuring market risk – maturity method and duration method. As duration method is a more
 P a g e | 21

accurate method of measuring interest rate risk, RBI prefers that Banks measure all of their
general market risk by calculating the price sensitivity (modified duration) of each position
separately. For this purpose detailed mechanics to be followed, time bands, assumed changes in
yield etc. have been provided by RBI. Capital Charge for Equities: Capital charge for specific
risk will be 9% of the Bank’s gross equity position. The general market risk charge will also be
9%. Thus the Bank will have to maintain capital equal to 18% of investment in equities (twice
the present minimum requirement).

Capital Charge for Foreign Exchange Risk:

A bank’s investment portfolio is impacted by the fluctuation in prices of securities. Even in
respect of sovereign exposure there will be change in market price because of interest rate
movements. When the prices of securities are marked to market, a bank may incur loss if the
prices have declined. Change in interest rates, foreign exchange rates and prices of equity,
corporate debt instruments and commodities may involve market risk for the bank. Mismatches
in interest rates on assets and liabilities may also entail risk for the bank. The investment
portfolio has to be divided into the trading book and the banking book. While the trading book
has to be valued on a daily basis on mark to market basis, for the banking book, there should be
frequent assessment of shock absorption capacity of the portfolio to interest rate movements.

Operational Risk:
 P a g e | 22

Basic Indicator Approach Under the basic indicator approach, Banks are required to hold capital
for operational risk equal to the average over the previous three years of a fixed percentage
(15% - denoted as alpha) of annual gross income. Gross income is defined as net interest income
plus net non-interest income, excluding realized profit/losses from the sale of securities in the
banking book and extraordinary and irregular items.

Standardized Approach

Under the standardized approach, bank’s activities are divided into eight business lines. Within
each business line, gross income is considered as a broad indicator for the likely scale of
operational risk. Capital charge for each business line is calculated by multiplying gross income
by a factor (denoted beta) assigned to that business line. Total capital charge is calculated as the
three-year average of the simple summations of the regulatory capital across each of the business
line in each year. The values of the betas prescribed for each business line are as under:

Advanced Measurement Approach

Under advanced measurement approach, the regulatory capital will be equal to the risk measures
generated by the bank’s internal risk measurement system using the prescribed quantitative and
qualitative criteria.
 P a g e | 23

A bank also encounters risks other than on account of default by a third party or adverse market
rate movements. These risks can be attributed to failed internal systems, processes, people and
external events. Mistakes committed because of weak internal systems may lead to losses.
Frauds may be committed on the bank by some customers, outsiders and even by employees. If a
proper KYC system is not in place, a bank may be exposed to loss of money and reputation in a
punitive action by the regulators. To minimize operational risks Know your Employee (KYE)
principles are also to be observed before employees are entrusted with sensitive assignments.
Pillar 1 envisages that banks assess credit risk, market risk and operational risk and provide for
adequate capital to cover the risks.

Capital Requirement for Credit Risk:

The New Accord provided for the following alternative methods for computing capital
requirement for credit risk
 P a g e | 24

Credit Risk - The Standardized Approach: The standardized approach is conceptually the same
as the present accord, but is more risk sensitive. The bank allocates a risk weight to each of its
assets and off-balance sheet positions and produces a sum of risk weighted asset values. A risk
weight of 100% means that an exposure is included in the calculation of risk weighted assets
value, which translates into a capital charge equal to 9% of that value. Individual risk weight
currently depends on the broad category of borrower (i.e. sovereign, banks or corporate). Under
the new accord, the risk weights are to be refined by reference to a rating provided by an external
credit assessment institution (such as rating agency) that meets strict standards.

Option 1 = Risk weights based on risk weight of the country

Option 2a = Risk weight based on assessment of individual bank
Option 2b = Risk weight based on assessment of individual

Banks with claims of original maturity of less than 6 months.

 P a g e | 25

Retail Portfolio (subject to qualifying criteria) 75%

Claims secured by residential property 35%
Non-performing assets:
If specific provision is less than 20% 150%
If specific provision is more than 20% 100%
The Committee has not proposed significant change in respect of off-balance Sheet items except
for commitment to extend credit.

The Second Pillar:

Supervisory Review Process

Compliance of requirements under Pillar 1 and providing adequate capital alone may not be
enough to prevent bank failures and to protect the interests of depositors. Therefore, under Pillar
2 which deals with key principles of supervisory review, risk management guidance and
supervisory transparency and accountability with respect to banking risks, including guidance
relating to the treatment of interest rate risk in the banking book, credit risk (stress testing,
definition of default, residual risk and credit concentration risk), operational risk, enhanced cross
border communication and co-operation and securitization, supervisors are expected to evaluate
how well banks are assessing their capital needs relative to their risks and to intervene where
appropriate. This interaction is intended to foster an active dialogue between banks and
supervisors so that when deficiencies are identified, prompt and decisive action can be taken to
reduce risk or restore capital. Supervisors may focus more intensely on banks with risk profiles
or operational experience, which warrants such attention.

There are the following four main areas to be treated under Pillar 2:
 P a g e | 26

• Risks considered under Pillar 1 that are not fully captured by Pillar 1 process (e.g credit
concentration risk);
• Those factors not taken into account by Pillar 1 process (e.g. interest rate risk in the
banking book, business and strategic risk).
• Factors external to the bank (e.g. business cycle effects).
• Assessment of compliance with minimum standards and disclosure requirements of the
more advanced methods under Pillar 1.

• Supervisors have to ensure that these requirements are being met both as qualifying
criteria and on a continuing basis.

The four key principles of supervisory review are:

Principle 1:
Banks should have a process for assessing their overall capital adequacy in relation to their risk
profile and a strategy for maintaining their capital levels.

The five main features of a rigorous process are as follows:

1. Board and senior management oversight;

2. Sound capital assessment;
3. Comprehensive assessment of risks;
4. Monitoring and reporting; and
5. Internal control review.

Principle 2:

Supervisors should review and evaluate banks’ internal capital adequacy assessments and
strategies, as well as their ability to monitor and ensure their compliance with regulatory capital
 P a g e | 27

ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the
result of this process.

Principle 3:

Supervisors should expect banks to operate above the minimum regulatory capital ratios and
should have the ability to require banks to hold capital in excess of the minimum.

Principle 4:
Supervisors should seek to intervene at an early stage to prevent capital from falling below the
minimum levels required to support the risk characteristics of a particular bank and should
require rapid remedial action if capital is not maintained or restored.

Reserve Bank of India has implemented the risk-based supervision and has made a good
beginning in implementation of the guidelines under Pillar 2. Internal inspections of banks in
India are also tuned more towards risk-based audit.

The Third Pillar:

Market Discipline

The third pillar in Basel 2 aims to bolster market discipline through enhanced disclosure by
banks. Effective disclosure is essential to ensure that market participants can better understand
banks’ risk profiles and the adequacy of their capital positions. The new framework sets out
disclosure requirements and recommendations in several areas, including the way a bank
calculates its capital adequacy and its risk assessment methods. The core set of disclosure
recommendations applies to all banks, with more detailed requirements for supervisory
recognition of internal methodologies for credit risk, mitigation techniques and asset
securitization.
 P a g e | 28

Disclosure requirements are stipulated for banks to encourage market discipline. This will help
the market participants to assess the information on capital, risk exposures, risk assessment
processes and capital adequacy of the bank. Such disclosures are more important in the case of
banks, which are permitted to rely on internal methodologies giving them more discretion in
assessing capital requirements. Market discipline supplements regulation as sharing of
information facilitates assessment of the bank by others including investors, analysts, customers,
other banks and rating agencies. It also leads to good corporate governance. Supervisors can
stipulate the minimum disclosures to be made by banks. Banks can also have Board approved
policies on disclosure. A transparent organization may create more confidence in the investors,
customers and counter parties with whom the bank has dealings. It would also be easier for such
banks to attract more capital.

All the requirements under the three Pillars of Basel II can be met only if banks have a robust
and reliable MIS. Technology therefore plays a crucial role in implementation of Basel II.
Beyond Core Banking which facilitates networking of branches to put through customer
transactions with ease and speed, technology should be able to play a supportive role in enabling
banks to access and use data in a meaningful manner so that the demands of Basel II can be met
in a cost effective manner. Reliance on internal methodologies will save cost and provide greater
discretion to banks to make assessment of capital requirements. Capital is a very scarce resource
and it needs to be put to optimum use. As per present norms, tier II capital can be only 100
percent of Tier I capital. The stipulation of minimum Government holding of 51 percent poses
challenges for public sector banks in raising tier I capital. India may have to find a solution to
this issue by asking for acceptance of new instruments as tier I capital. In the context of the very
robust growth in credit, which supports a buoyant economy, more capital becomes indispensable
for the Indian banking system. And compliance of Basel II norms will help Indian banks adopt
best international practices, enable them to have a larger global presence and attract capital even
from abroad.
Timeframe for Implementation
The Basel Committee first released the proposal to replace the 1988 Accord with a more risk
sensitive framework in June 1999, on which more than 200 comments were received. Reflecting
on those comments the Committee presented a more concrete proposal in January 2001 seeking
 P a g e | 29

more comments from interested parties. The third consultative paper was released in April 2003.
Furthermore the Committee conducted three quantitative impact studies to assess the impact of
the new proposals. Thereafter, the final version of the New Accord has been published on
June 26, 2004, which is designed to establish minimum level of capital for internationally active
banks? The new framework is to be made from 2006 end. The more advanced approaches will be
implemented by the end of year 2007.

CHAPTER-4

ISSUES AND CHALLENGES

While there is no second opinion regarding the purpose, necessity and usefulness of the proposed
new accord – the techniques and methods suggested in the consultative document would pose
considerable implementation challenges for the banks especially in a developing country like
India.

Capital Requirement: The new norms will almost invariably increase capital requirement in all
banks across the board. Although capital requirement for credit risk may go down due to
adoption of more risk sensitive models – such advantage will be more than offset by additional
capital charge for operational risk and increased capital requirement for market risk. This partly
explains the current trend of consolidation in the banking industry.

Profitability: Competition among banks for highly rated corporates needing lower amount of
capital may exert pressure on already thinning interest spread. Further, huge implementation cost
may also impact profitability for smaller banks.
 P a g e | 30

Risk Management Architecture: The new standards are an amalgam of international best
practices and calls for introduction of advanced risk management system with wider application
throughout the organization. It would be a daunting task to create the required level of
technological architecture and human skill across the institution.

Rating Requirement: Although there are a few credit rating agencies in India – the level of
rating penetration is very low. A study revealed that in 1999, out of 9640 borrowers enjoying
fund-based working capital facilities from banks – only 300 were rated by major agencies.
Further, rating is a lagging indicator of the credit risk and the agencies have poor track record in
this respect. There is a possibility of rating blackmail through unsolicited rating. Moreover rating
in India is restricted to issues and not issuers. Encouraging rating of issuers would be a
challenge.

Choice of Alternative Approaches: The new framework provides for alternative approaches for
Computation of capital requirement of various risks. However, competitive advantage of IRB
approach may lead to domination of this approach among big banks. Banks adopting IRB
approach will be more sensitive than those adopting standardized approach. This may result in
high-risk assets flowing to banks on standardized approach - as they would require lesser capital
for these assets than banks on IRB approach. Hence, the system as a whole may maintain lower
capital than warranted and become more vulnerable. It is to be considered whether in our quest
for perfect standards, we have lost the only universally accepted standard. Absence of Historical
Database: Computation of probability of default, loss given default, migration mapping and
supervisory validation require creation of historical database, which is a time consuming process
and may require initial support from the supervisor. Incentive to Remain Unrated: In case of
unrated sovereigns, banks and corporates the prescribed risk weight is 100%, whereas in case of
those entities with lowest rating, the risk weight is 150%. This may create incentive for the
category of counterparties, which anticipate lower rating to remain unrated.

Supervisory Framework: Implementation of Basel II norms will prove a challenging task for
the bank supervisors as well. Given the paucity of supervisory resources there is a need to
 P a g e | 31

reorient the resource deployment strategy. Supervisory cadre has to be properly trained for
understanding of critical issues for risk profiling of supervised entities and validating and
guiding development of complex IRB models.

Corporate Governance Issues:

Basel II proposals underscore the interaction between sound risk management practices and
corporate good governance. The bank’s board of directors has the responsibility for setting the
basic tolerance levels for various types of risk. It should also ensure that management establishes
a framework for assessing the risks, develop a system to relate risk to the bank’s capital levels
and establish a method for monitoring compliance with internal policies.

National Discretion: Basel II norms set out a number of areas where national supervisor will
need to determine the specific definitions, approaches or thresholds that wish to adopt in
implementing the proposals. The criteria used by supervisors in making these determinations
should draw upon domestic market practice and experience and be consistent with the objectives
of Basel II norms.
Disclosure Regime: Pillar 3 purports to enforce market discipline through stricter disclosure
requirement. While admitting that such disclosure may be useful for supervisory authorities and
rating agencies – the expertise and ability of the general public to comprehend and interpret
disclosed information is open to question. Moreover, too much disclosure may cause information
overload and may even damage financial position of bank.

Disadvantage for Smaller Banks:

The new framework is very complex and difficult to understand. It calls for revamping the entire
management information system and allocation of substantial resources. Therefore, it may be out
of reach for many smaller banks. As Moody’s Investors Services puts it, “It is unlikely that these
banks will have the financial resources, intellectual capital, skills and large scale commitment
that larger competitors have to build sophisticated systems to allocate regulatory capital
optimally for both credit and operational risks.”

Discriminatory against Developing Countries:

 P a g e | 32

Developing counties have high concentration of lower rated borrowers. The calibration of IRB
has lesser incentives to lend to such borrowers. This, along with withdrawal of uniform risk
weight of 0% on sovereign claims may result in overall reduction in lending by internationally
active banks in developing countries and increase their cost of borrowing.

External and Internal Auditors: The working Group set up by the Basel Committee to look into
Implemetational issues observed that supervisors may wish to involve third parties, such a
external auditors, internal auditors and consultants to assist them carrying out some of the duties
under Basel II. The precondition is that there should be a suitably developed national accounting
and auditing standards and framework, which are in line with the best international practices. A
minimum qualifying criteria for firms should be those that have a dedicated financial services or
banking division that is properly researched and have proven ability to respond to training and
upgrades required of its own staff to complete the tasks adequately.

With the implementation of the new framework, internal auditors may become increasingly
involved in various processes, including validation and of the accuracy of the data inputs, review
of activities performed by credit functions and assessment of a bank’s capital assessment
process.
BASEL II GUIDELINES

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

RBI released Basel II Final Guidelines vide their notification dated 27.04.2007.
 P a g e | 33

Effective Date
Foreign banks operating in India and Indian banks having operational presence outside India
should adopt Standardized Approach (SA) for credit risk and Basic Indicator Approach (BIA) for
operational risk for computing their capital requirements under the Revised Framework with
effect from March 31, 2008. All other commercial banks (excluding Local Area Banks and
Regional Rural Banks) are encouraged to migrate to these approaches under the Revised
Framework in alignment with them but in any case not later than March 31, 2009. These banks
shall continue to apply the Standardized Duration Approach (SDA) for computing capital
requirement for market risks under the Revised Framework.

Parallel run
With a view to ensuring smooth transition to the Revised Framework and with a view to
providing opportunity to banks to streamline their systems and strategies, banks were advised to
have a parallel run of the revised Framework. A copy of the quarterly reports to the Board of
Directors may be continued to be submitted to the Reserve Bank of India – one each to the
Department of Banking Supervision, Central Office and the Department of Banking Operations
and Development, Central Office.

Reserve Bank of India has issued a notification laying down a time schedule for all scheduled
commercial banks operating in the country for implementation of the advanced approaches for
the regulatory capital measurement under Basel II framework.

The deadline set by the regulator for accomplishing the same would thus facilitate the banks in
India to create requisite technological and risk management infrastructure, required databases,
the MIS and complete skill up gradation.

The notification states that the earliest dates of making application by banks and likely approval
by the regulator for implementing internal models approach for market risk are April 1, 2010 and
March 31, 2011 respectively. The earliest dates of making application by banks and likely
 P a g e | 34

approval by the regulator for implementing the standardized approach for operational risk are
April 1, 2010 and September 30, 2010 respectively. The earliest dates of making application by
banks and likely approval by the regulator for implementing advanced measurement approach
for operational risk are April 1, 2012 and March 31, 2014 respectively.

The earliest dates of making application by banks and likely approval by the regulator for
implementing internal ratings-based approaches for credit risk (foundation- as well as advanced
IRB) are April 1, 2012 and March 31, 2014 respectively.

As per the circular released by the Indian regulator on April 27, 2007 on the new capital
adequacy framework, foreign banks operating in India and Indian banks having operational
presence outside India have migrated to the simpler approaches available under the Basel II
framework since March 31, 2008. Other commercial banks have also migrated to these
approaches from March 31, 2009. Thus, the standardized approach for credit risk, basic indicator
approach for operational risk and the standardized duration approach for market risk (as slightly
amended under Basel II framework) have been implemented for the banks in India.

The latest notification issued by the regulator states that the banks, at their discretion, would
have the option of adopting the advanced approaches for one or more of the risk categories, as
per their preparedness, while continuing with the simpler approaches for other risk categories,
and it would not be necessary to adopt the advanced approaches for all the risk categories
simultaneously. However, the banks should invariably obtain prior approval of the Reserve Bank
of India for adoption of any of the advanced approaches.

Also, if the result of a bank’s internal assessment indicates that it is not in a position to mark.
 P a g e | 35

CHAPTER-5

TOWARDS BASEL III

This is an attempt to trace the progress of the Basel Accord, and visualize Basel III framework.

Stage 1 (Pre-1988):

Though bank failures were not unheard of, it was the failure of Bank Herstatt in Germany, in
1974, which received international attention, on account of its regulatory implications. The bank
became insolvent on account of its large and risky foreign exchange business, and its losses
amounted to DM 470 million. The tremors felt in the International structure as a result of this
catastrophe led to the drawing up of the Basel I Accord by the Basel Committee on Banking
Supervision (BCBS) in 1988.
Stage 2 (1988- 2004):
The Basel I Accord was built on the sole pillar of Capital adequacy, to insulate the banking
structure from losses incurred. Though the recommendation of 8% capital adequacy (figure
arrived at post intense debate and discussion), were not regulatory in nature, the
recommendations were implemented by most Central Banks.
However, despite the implementation of the Basel I framework, a series of incidents continued to
send tremors throughout the financial world.
 P a g e | 36

1. Bank of Credit and Commerce International (1991): one of the world’s worst financial
scandals and what was called a “$20-billion-plus heist”. The Bank of England closed down
BCCI after it was found to be involved in money laundering, bribery, support of terrorism, arms
trafficking, the sale of nuclear technologies, the commission and facilitation of tax evasion,
smuggling, illegal immigration, and the illicit purchases of banks and real estate. The bank was
found to have at least $13 billion unaccounted for.
2. Metallgesellschaft – a subsidiary of Deutsche Bank (1993): losses of over $1.4 billion due to
‘model error’ resulting from incorrect assumptions about futures prices in energy markets.
3. Bankers Trust (1993): losses of over $400 million due to selling ‘inappropriate’ products to
clients;

Stage 3 (2004 – the Present)

Following the failure of the one size fits all approach and the lessons drawn from financial
tragedies, the BCBS released the Basel II framework in 2004. The Basel II framework rested on
the 3 pillars of Capital Adequacy, Supervisory Review and Market Discipline.
Operational Risk was defined as a new risk category requiring specific attention. While the
Central Banks across the world debated over the proposed framework, the moral degradation
across the international financial world continued.
1. Kidder Peabody (1994): losses of over $350 million due to alleged concealment of trading
losses to protect bonuses.
2. Barings Bank (1995) Collapsed in 1995 after one of the bank’s employees, Nick Leeson, lost
$1.4 billion in speculation primarily on futures contracts.
3. Daiwa Bank (1995): losses of over $1.1 billion due primarily to fraudulent trading over 11
years by an employee to cover trading losses.
4. Republic Securities (1999): losses of over $600 million and loss of trading license due to its
support of fraudulent trading by a broker for which it provided false documentation to the
broker’s clients and regulators. The broker’s fraudulent activities were known to the
management of the firm’s futures division and persisted for several years and hence should have
been picked up by management and auditors.
 P a g e | 37

5. Enron (2001): achieved infamy when it was revealed that it’s reported financial condition was
sustained mostly by institutionalized, systematic, and creatively planned accounting fraud. Enron
has since become a popular symbol of willful corporate fraud and corruption.
6. Allied Irish Bank (2002): losses of $691.2 million on account of an apparent currency fraud at
its Baltimore based subsidiary, All first, perpetrated by a trader named John Rusnak. It was one
of the biggest ‘rogue trader’ scandals since Nick Leeson brought down Barings bank in 1995.
7. China Aviation Oil (2004): Losses of over $500 million due to fraudulent trading by an
employee to cover energy trading losses

Stage 4 (The Present 11- Basel III)

Increasingly it is becoming evident that Capital Adequacy norms alone are insufficient. In fact
capital adequacy is a tool being employed at the lower end of the value chain, rendered toothless
if not supported by strong supervisory norms and market disclosure requirements.

BASEL III refers to a new update to the Basel Accords that is under development. While the
Bank for International Settlements (BIS) does not currently specify this work as "Basel III", the
term appeared in the literature as early as 20051 and is now in common usage2 anticipating this
next revision to the Basel Accords.

The draft Basel III regulations include:

• Tighter definitions of Tier 1 capital,

• The introduction of a leverage ratio,

1
From Basel II to Basel III By: Schulte-Herbrüggen, Walter; Becker, Gernot. Risk, Jan2005, Vol. 18 Issue 1, p58.
2
The Basel III Proposals' Flaws... By: Cassidy, Gerard S.. American Banker, 5/13/2010, Vol. 175 Issue 74, p8-8,
1/2p, The Lesson of Basel's Bean Counters by George Melloan, The Wall Street Journal, April 24, 2010
 P a g e | 38

• A framework for counter-cyclical capital buffers,

• Measures to limit counterparty credit risk, and

• Short and medium-term quantitative liquidity ratios3.

Professionals and officers with Basel II knowledge and experience will be required to lead the
new Basel III projects, and they have started studying the differences from the Basel II
framework4.

Overview
In response to the recent financial crisis, the Basel Committee on Banking Supervision (BCBS)
set forth to update their guidelines for capital and banking regulations:
This consultative document presents the Basel Committee's proposals to strengthen global capital
and liquidity regulations with the goal of promoting a more resilient banking sector. The
objective of the Basel Committee's reform package is to improve the banking sector's ability to
absorb shocks arising from financial and economic stress, whatever the source, thus reducing the
risk of spillover from the financial sector to the real economy.
While Basel 3 has the potential to address some of these issues, the comparability of regulatory
ratios would still be blurred by differences between banks' internal rating models and by the
availability of various options to assess identical risks. Equally, we do not expect Basel 3 to
resolve all of the differences in approach between national regulators. We note that the U.S., for
example, has been slower than other major countries in its implementation of Basel 2, and we
consider that similar variations are likely under Basel 3.

We view positively the strong improvement in transparency and the emphasis placed on market
discipline in the various elements of the Basel 3 proposals. To date, we believe the disclosure
provided by banks regarding regulatory capital measures has frequently been deficient.

3
http://www.webcitation.org.
4
http://www.basel-iii-association.com
 P a g e | 39

We are currently reviewing the detail of the Basel 3 consultative documents, and we intend to
publish more extensive analysis of them before the comment period ends on April 16, 2010. "At
this early stage, we do not expect that Basel 3, once implemented, would likely have a material
impact on our bank ratings, which are partly predicated on capitalization being strengthened
before governments reduce their support of the banking system," said Mr. Barnes. We will, of
course, revisit this conclusion as the Basel 3 proposals move closer to their final form.

On December 19, 2009 the BCBS issued a press release 5 which presented to the public two
consultative documents for review and comment:

* Strengthening the resilience of the banking sector.

* International framework for liquidity risk measurement, standards and monitoring.

The BCBS allowed a public comment period (ended April 16, 2010) resulting in 272 responses
to their request for comment.
• Development of the New Basel III Standard

• Summary of Changes Proposed in Basel III

Development of the New Basel III Standard

• First, the quality, consistency, and transparency of the capital base will be raised.

• Tier 1 capital: the predominant form of Tier 1 capital must be common shares and
retained earnings.

5
Consultative proposals to strengthen the resilience of the banking sector announced by the Basel Committee.
 P a g e | 40

• Tier 2 capital instruments will be harmonized.

• Tier 3 capital will be eliminated.

The risk coverage of the capital framework will be strengthened.

• Strengthen the capital requirements for counterparty credit exposures arising from
banks’ derivatives, repo and securities financing transaction.

• Raise the capital buffers backing these exposures.

• Reduce procyclicality and

• Provide additional incentives to move OTC derivative contracts to central counterparties

(probably clearing houses).

• Provide incentives to strengthen the risk management of counterparty credit exposures

The Committee will introduce a leverage ratio as a supplementary measure to the Basel
II risk-based framework.
 P a g e | 41

The Committee therefore is introducing a leverage ratio requirement that is intended to achieve
the following objectives:
• Put a floor under the build-up of leverage in the banking sector.

• Introduce additional safeguards against model risk and measurement error by

supplementing the risk based measure with a simpler measure that is based on gross
exposures.

The Committee is introducing a series of measures to promote the buildup of capital

buffers in good times that can be drawn upon in periods of stress ("Reducing procyclicality
and promoting countercyclical buffers").
The Committee is introducing a series of measures to address procyclicality
• Dampen any excess cyclicality of the minimum capital requirement.

• Promote more forward looking provisions.

• Conserve capital to build buffers at individual banks and the banking sector that can be
used in stress; and

• Achieve the broader macro prudential goal of protecting the banking sector from periods
of excess credit growth.

• Requirement to use long term data horizons to estimate probabilities of default.

• downturn loss-given-default estimates, recommended in Basel II, to become mandatory

• Improved calibration of the risk functions, which convert loss estimates into regulatory
capital requirements.

• Banks must conduct stress tests that include widening credit spreads in recessionary
scenarios.

• Promoting stronger provisioning practices (forward looking provisioning).

 P a g e | 42

• Advocating a change in the accounting standards towards an expected loss (EL)

approach (usually, EL Amount: = LGD*PD*EAD) loss given default, probability of
default and exposure at default.

The Committee is introducing a global minimum liquidity standard for internationally active
banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term
structural liquidity ratio.

The Committee also is reviewing the need for additional capital, liquidity or other supervisory
measures to reduce the externalities created by systemically important institutions.

Key Dates Milestone

December 19, 2009 BIS published documents for public review/comment

April 16, 2010
April 23, 2010
June 3-5, 2010
June 26—27, 2010
June 30, 2010
October 22-23, 2010
November 11-12, 2010
December 31, 2010
December 31, 2011
December 31, 2012
End of the public comment period
Meeting of G-20 Finance Ministers and Central Bank Governors,
Meeting of Finance Ministers and Central Bank Governors Busan.
G-20 Toronto Summit
Comprehensive impact assessment & calibration
Meeting of Finance Ministers and Central Bank Governors,
G-20 Seoul Summit
fully calibrated set of standards will be developed
all major G-20 financial centers commit to have adopted the Basel
III Capital Framework by 2011.
Target for implementation of Basel III

CHAPTER-6
Conclusion:
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There are two problems. The Basel Accord is designed by rich countries, and is not appropriate
for other countries. Yet it is increasingly a legal requirement for all countries. Something needs
to change: if the Accord is to apply to all, it should be made more appropriate for developing
countries. Alternatively, it should cease to be an obligation. Developing countries should
cooperate, probably at the regional level, to design their own variants. These variants should
probably be simple, rule-based, non-discretionary, and have inbuilt redundancy. No regime can
fully correct for government or market failure, but a regime designed to be robust to government
failure is more likely not to fail completely.

Implementation of Basel III has been described as a long journey rather than a destination by
itself. Undoubtedly, it would require commitment of substantial capital and human resources on
the part of both banks and the supervisors. RBI has decided to follow a consultative process
while implementing Basel III norms and move in a gradual, sequential and co-ordinate manner.
For this purpose, dialogue has already been initiated with the stakeholders. As envisaged by the
Basel Committee, all the professionals will make a positive contribution in this respect to make
Indian banking system stronger.