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As the cut-off date for implementing the Basel II Accord draws closer, Indian banks are gearing up fast to be at par with their international peers. Are they on track? 4Ps B&M’s Manish k Pandey finds the answer...

“If Basel I could be compared with an old bi-plane, then Basel II represents an advanced jet, designed to transport its passengers in utmost comfort irrespective of the turbulence and extremes of weather outside,” says a White Paper on Basel II by PricewaterhouseCoopers (PwC). Certainly, considering the rewards of the accord that include introduction of new complex financial products, improvement in risk management system, availability of a range of options for estimating regulatory capital, et al, in the Indian banking arena, the statement by PwC, no doubt, marks out the real future of banking in India or rather banking across the globe. But what really confuses and haunts one is this perplexed transition – from the age-old bi-plane to a shimmering advanced jet.

Will it be a smooth one? Are the players ready for it? These are certainly some of the questions that need apposite answers as Indian banks enter the final lag of this transition matrix. No doubt, as the cut-off date for implementing the accord draws closer, Indian banks are gearing up fast to be at par with their international peers. But are they really on track considering that it’s just a month (April 1, 2009) before the new jet finally takes off? “Yes, the implementation is on track for Indian banks, within the context of the relaxation that the RBI has implemented in light of the ongoing crisis, such as reduction in risk weights. Majority of the banks are not facing any capital shortage at present and those public sector banks (PSBs) that need capital infusion, have already been promised the same by the government,” avers Vaibhav Agrawal, Sr. Research Analyst, Angel Broking. No doubt, so far, most of the banks are comfortably placed even after switching on to the Basel II accord in FY 2008. Though some of them have reported a reduction in the total capital to risk-weighted assets ratio (CRAR) or commonly known as capital adequacy ratio (CAR – the ratio of a banks capital to its assets) by around 30 to 80 basis points, primarily on account of operational risk, there are many who have reported a capital relief. All thanks to higher exposure to better rated corporates as well as savings on the regulatory retail portfolio.

In fact, if one goes by the latest numbers, the Indian banks already seem to have conquered this long row to hoe. According to a recent report on “Trends and Progress of Banking in India 2007-08” by the RBI, “the overall capital adequacy of all scheduled commercial banks (SCBs) was at 13% as on March 31, 2008, well above the Basel II norm of 8% and the stipulated norm of 9% for banks in India. Even on an individual bank basis, the CAR of as many as 56 banks was over 12%, of 21 banks was between 10-12%, while those of the remaining two banks was between 9% and 10%.” This is indeed comparable with most of the banks in emerging markets and developed economies where CAR varied between 10% and 28.7% in FY 2008.

However, if one goes by the desired level of CAR by the government, which is 12%, the situation seems to be a little tense for as many as 14 commercial banks (11 public sector banks and 3 private sector banks). In fact, a combined capital infusion in excess of Rs.50 billion is what is needed to shove them up to that level. No doubt, banks can use the capital market route to meet the capital requirements or can use private placement to garner the additional capital but then turning to capital markets to raise funds at a time when the markets are bleeding and investors are wary of planting money into them the option really doesn’t seem to be viable at all, particularly for the small and medium sized banks.

But, overall, out of 41 banks that migrated to Basel II Accord last March, 40 banks had CAR of more than 10% and one bank had close to 10% even at the time of transition. So considering this, no doubt the Indian banks are faring well as of now, but then going deeper into the Basel II matrix, one can easily figure out that the matrix is not just about CAR. The framework has three components or ‘Pillars’. While Pillar one relates to minimum capital requirements, Pillar two is the supervisory review process (SRP) and Pillar three is all about market discipline. Moreover, it is Pillar 2 that makes the Basel II Accord more comprehensive as it aims at eying the overall risk of an institution. But if one goes by Moody’s latest report on Indian Banking then the stress surely seems to be testing Indian banks. As per the report, while financial strength rating (BFSR) of most of the Indian banks was between C- and D+, baseline credit assessment (BCA) rating too ranged between Ba1 and Baa3.

Therefore, as it’s said by many critics that “fundamental to the successful implementation of the Basel II norms is an inconvenient but necessary marriage of two of unmatched horoscopes – qualitative tools and quantitative standards,” the task of implementing the accord surely appears to be a tough one for the Indian banks. In fact, this was the main reason for the delay in implementing Basel II Accord in the country (originally set for March 31, 2007). Though foreign banks and Indian banks with overseas presence have already incorporated Basel II Accord with effect from March 31, 2008, its full execution still remains a major challenge for them – all in terms of procedures, infrastructure requirement and capacity building.

Moreover, considering the technological advances and greater reliance on technology-based solutions by conventional Indian banks, a need for adequate safeguards against fraudulent activities automatically pops in and, this is an area where the Indian banks need to work the most in order to stand equal to their international peers. No doubt, the asset quality of banks in India has improved significantly in the recent years, efforts need to be made to ensure that the hard earned gains are not frittered away, particularly in the wake of the global slowdown. Further, for banks, the implementation of Basel II Capital Accord will certainly continue to be a challenge until the regulator acts as a facilitator rather than as any gregarious procrastinator. So, just watch out for the next move!

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Source : IIPM Editorial, 2009

An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).

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