Basel II comes into play on banks

Several frontline banks will be gearing up to face the challenge of conforming to tougher global banking standards from Monday under Basel II.
Basel II, which was conceived in June 2004, seeks to create an international standard that banking regulators can use to determine how much capital banks should set aside to cover their operational and financial risks.
The Basel II standards require banks to allocate capital in different proportions against various risks.
The Reserve Bank of India has decided to implement the new standards in phases. Domestic banks which have branches overseas will have to comply with the new capital adequacy standards by March 31.
The deadline for compliance with Basel II standards in the case of the remaining commercial banks is March 31 next year.
The State Bank of India (SBI), the Bank of Baroda (BoB), the Bank of India, Indian Bank and ICICI Bank will be among the first entities that will have to meet the new standards. All of them have high capital adequacy ratios under Basel I and are not expected to have any trouble in complying with the new standards.
In fact, it might be easier for them to do so as the Reserve Bank has lowered the risk weightages on some categories of loans — residential housing and education — from 125 per cent to 75 per cent under Basel II.
The banks will have to adopt the standard approach for credit risk and the basic indicator approach to operational risk while computing their capital requirements under the new framework.
In the standard approach, credit risk is measured on ratings given by an external credit rating agency. This is different from the earlier approach where there was a single risk weight of 100 per cent for all corporate loans, irrespective of their ratings.
Thus, if it was a AAA rated company or a firm with a much lower rating, banks had to allocate Rs 9 as capital (capital adequacy ratio of 9 per cent and the 100 per cent risk weight) for every Rs 100 lent.
Under the new regime, capital allocated will vary with the risk involved or the rating assigned. In the case of a corporate with a triple A rating, the risk weightage is only 20 per cent and the allocation of capital is lower.
So, if a bank lends Rs 100 to such a company, the capital allocated will be only Rs 1.80 (20 per cent of Rs 9).
This capital will progressively rise to Rs 13.50 in the case of a lowest rated company as the risk weightage in this case is 150 per cent. The risk weightage for unrated loans will be at 100 per cent.
While banks are already asking top companies to get rated, the BoB, the SBI and the three others are already Basel-II compliant.
It is estimated that in the past few months, more than 300 companies, ranging from leading firms such as Reliance Industries to other small and medium enterprises, have got themselves rated.
“We have rated more than 100 companies,” said a senior official from rating agency Crisil. Over the next few months, many more companies will get rated.
In the meantime, banks which have to comply with the new norms from next year have already entered into bilateral arrangements with various credit rating agencies to rate their corporate clients.
The basic indicator approach to operational risk requires banks to hold capital that is equal to the average of the 15 per cent annual gross income over the past three years. Gross income includes net interest income and non-interest income.
To comply with this additional capital requirement, banks had tapped the markets with follow-on offerings and other instruments to raise funds.