Basel-II has already stepped into India with foreign banks operating in the country and Indian banks operating abroad complying with its provisions since March, 2008. Other Indian banks are poised to fall in line from March, 2009.
The framework of Basel-II rests firmly on three pillars?-minimum capital requirements to cover credit, market and operational risk; suitable supervisory review process by way of internal processes to assess capital needs and external evaluations on overall risk profile so as to ensure availability of adequate capital; improvement of business discipline by way of providing greater information on the risk profile and the ability of the banks to manage them.
The adoption of Basel-II will do a world of good to the banking industry. Recent upheavals in the banking sector, worldwide, has thoroughly exposed the inadequacies in the system to contain huge losses, solely because of the absence of a healthy risk assessment and management system and strong capital base to absorb the shocks of these losses. Upto a point, Basel-I was okay in so far as it brought into focus the need to bridge the widening gap between the capital requirements and risk profiles of commercial banks. Basel-II is a step forward by forcing banks to see the need to properly distinguish between the credit quality of individual borrowers.
By suitably setting off risk against return, Basel-II helps commercial banks improve the quality of their credit portfolio and manage credit risk better. This in turn, helps in cutting down on credit losses and improve profits by way of reduced provisions and efficient and effective allocation and use of capital. On the other hand, customers stand to gain by way of finer rates of interest if they obtain a better rating. The increase in the number of well rated businesses ensures healthier economic development of the country. For the regulator and the general public, it provides increased transparency and better reporting systems. In short, compliance is a win-win situation for all concerned.
But beyond better risk and capital management, Basel-II heralds a new opening for the banks to explore better business opportunities and overhaul their business processes, by way of technological re-orientation of their working models. In order to ensure accurate collection of data, ensuring its integrity and collating the details, which is a prime requirement under Basel-II, a shift to the platform of core banking solution (CBS) has become mandatory for all banks. The shift to CBS has opened the gates for efficient management of funds and manifold improvement in volumes and turnover. This has supported the bottom line of banks substantially.
But the long term benefits of compliance to the tenets of Basel-II are the building up of reliable and consistent data. Efficient data management will help taking consistent decisions because such data will provide leads to changes in business cycles as well as history of borrowers. This is particularly beneficial because dependable data will be available on errant borrowers and help mitigate losses and reduce non performing assets. Sharing of such data will help the industry as a whole and in the long run delinquency rates will drop significantly.
One of the greatest gifts of Basel-II is the concept operations risk. This is an unexplored territory for the banking industry. The spotlight has now been turned towards the banks themselves, prompting them to introspect on their internal systems and procedures.
But will Basel-II thoroughly weed out all the ills that plague the industry? It may not, because better systems sprout newer problems. That is why Basel-II was needed to replace Basel-I in less than two decades. Maybe it may not take that long for Basel-III to be drafted!
The author is chairman & CEO of Karur Vysya Bank. The bank is the winner of the FE Best Banks award in the old private sector bank category