Basel II - A reality check

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After some debate on whether Basel II should apply only to "internationally active" banks or to all commercial banks, the Reserve Bank of India (RBI) opted for the second alternative. In the Draft Guidelines for Implementation of the New Capital Adequacy Framework, released in February 2005, the RBI has stated that banks should initially adopt the standardised approach for credit risk by March 2007 and possibly move towards foundation internal ratings based approach (FIRB) a few years later. The final guidelines are awaited. The RBI has also stated that it is possible that the March 2007 implementation date may be stretched slightly, given the state of preparedness of various banks. Most banks in India are now aware that Basel II proposals aim to bring the regulatory capital more closely into line with economic capital. They also recognise that their risk management system as a whole will need to be strengthened under Basel II, and while Basel I required capital allocation only for credit and market risk, the Basel II provisions would also take operational risk into consideration. Most Indian banks will initially adopt the standardised approach for credit risk and basic indicator approach (BIA) for operational risk.

Banks that want to adopt more advanced approaches should submit a detailed roadmap to the RBI, clearly specifying their plans for migration. Banks will be allowed to adopt the advanced approaches only after obtaining the specific approval of the RBI. It is unlikely that any of the banks would follow more advanced approaches before 2009/2010. As far as computing capital for credit risk is concerned, none of the Indian banks presently have a credit-risk-grading system compatible with Basel II.

While a few of them are in the process of developing such systems, neither is their data quality (potential default (PD) rates on various classes of assets, for example) likely to be extensive, nor have their credit risk models yet been tested. Nevertheless, one or two of the more advanced Indian banks (mainly private ones) have started putting building blocks in place in order to eventually adopt FIRB, and it is possible that they may do so by 2009/2010.