ver 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%).
Implementation of Basel II has been described as a long journey rather than a destination by itself. RBI has decided to follow a consultative process while implementing Basel II norms and move in a gradual, sequential and co-ordinated manner.
BASEL CAPITAL ACCORD However, the present accord has been criticized as being inflexible due to focus on primarily credit risk and treating all types of borrowers under one risk category irrespective of credit rating. The major criticism against the existing accord stems from its ● Broad-brush approach – irrespective of quality of counter party or credit ● Encouraging regulatory arbitrage by cherry picking ● Lack of incentives for credit risk mitigation techniques ● Not covering operational risk Moreover, years have passed since the introduction of the present accord. The business of banking, risk management practices, supervisory approaches and financial markets have undergone significant transformation since then. Therefore, the Basel Committee on Banking Supervision thought it desirable that the present accord is replaced by a more risk-sensitive framework. The new accord aims to overcome the anomalies of the present system. It emphasizes on bank’s own internal methodologies, supervisory review and market discipline.
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THE CHARTERED ACCOUNTANT
The new proposal is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that banks face and realign regulatory capital more closely with underlying risks. Each of these three pillars has risk mitigation as its central plank. The new risk sensitive approach seeks to strengthen the safety and soundness of the industry by focussing on: ● ● ●
more elaborate than the current accord. It proposes, for the first time, a measure for operational risk, while the market risk measure remains unchanged.
The new proposal is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that banks face and realign regulatory capital more closely The Second Pillar with underlying risks. - Supervisory Review
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. Pillar III The process has Market four key princiDiscipline ples a) Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for monitoring their capital levels. b) Supervisors should review and evaluate bank’s internal capital adequacy assessment and...