BASEL ACCORDS WITH SPECIAL REFRENCE

TO BASEL III.
By
AASIM AHMED KHANDAY
REG. No: 125860701

Submitted to Mangalore University

In partial fulfilment of the requirement of the
Master of Business Administration Degree course

Under the valuable guidance of

College Guide:

Company Guide:

Prof. Amit Menzes

Mr. Riyaz ul Rahman Wani

Faculty SIMS,
Bank.

Associate Executive, J&k

Pandeshwar, Mangalore

Department of Business Management

Srinivas institute of management studies
Pandeshwar, Mangalore.

DECLARATION
I Aasim Ahmed Khanday (Reg no.125860701) Second year MBA student of
Srinivas Institute of Management Studies, Mangalore hereby declare that this
project report entitled A study on impact of

Basel Accords with special

reference to Basel-III is my original work and has been prepared by me under

the guidance of MR Amit Menzees, Faculty, Srinivas Institute of Management
studies in partial fulfilment of the requirement of the award of the degree of
Master of Business Administration of Mangalore University and has not been
part of any other degree or diploma of any other University or institution.

Aasim Ahmed Khanday.

ACKNOWLEDGEMENT
The success of the project depends on a contribution of many people, especially
those who take time to share their thoughtful criticism and suggestions to
improve the project work.
At the very beginning I would like to thank Almighty the guiding light of my
life for granting me the potency and courage to complete this project work
successfully.
My immense gratitude to our beloved Principal Dr. P.S.Aithal and to rest of the
faculty and staff during the project course.
I am very grateful to J&K bank for having given me an opportunity to undertake
the project and Mr. RIYAZ UL RAHMAN WANI, Associate Executive,
Integrated Risk Management Department, CHQs, for guiding and inspiring me
at every point of time.
My heartful thanks to my project guide Mr. AMIT MENZEES who gave
valuable Inputs right from the start and was constantly motivating and
appreciating my Performance.
Last but never the least, I express my deep gratitude to my adorable parents,
encouraging friends and all those unsung heroes who have been indirectly or
directly responsible for the successful completion of the dissertation report.

Aasim Ahmed Khanday

Executive summary
With the financial crisis of 2008 in the hindsight, the Basel Committee on Banking
Supervision has put forward the guidelines which impose stringent capital and liquidity
requirements through Basel III. Basel III is focused on increase in capital, especially equity
capital to absorb the impact of market, credit and operational risk. As was evident from the
recent crisis, the social cost of the failure of a large bank was much larger than the loss to the
owner of capital.
Increase in the requirement of capital will affect the ROE of the banks, financial ratios would
be hurt and the public sector banks will not be able to expand their loan book due to
unavailability of capital. According to ICRA, increase in the core Tier1 capital from 6% to
8% will reduce the return on equity percentage points from 18% to 15%. Public sector banks
with core capital less than 7% will be severely impacted whereas the earnings of the private
sector banks will not be affected much as they are already well capitalized but would reduce
leveraging. Cost of capital for the banks would increase with the increase in equity in the
capital structure as equity is an expensive form of capital. As capital costs increase credit will
become more expensive. Banks will impose tougher conditions for granting credit to small
and medium sized firms and for start-up businesses. Also with deposit rates rising lower than
expectations at 14% will put further pressure of credit costs. With the credit becoming
costlier the investment activity in the country will be severely impacted. This will also
increase the cost of other off-balance items like Letter of Credit. Thus, though BASEL III
will make banks more capable of handling a financial crisis, it will have a negative impact on
the GDP of the economies like India, which should be a matter of concern.

It is more relevant at an economy's macro level to address issues such as systemic risk,
market discipline, liquidity and transparency in the risk-management framework. It is
interesting to note that though risk capital may be the necessary safety cushion for banks,
capital alone may not be sufficient to protect them from any extreme unexpected loss events.
In reality, risk capital will remain only a number and may not be effective if banks do not
assess their risk periodically and take timely corrective action when the risk exceeds the
threshold limit. Thus, whether it is Basel II or Basel III, it is crucial that a bank does not
depend solely on "regulatory capital". What is needed is a dynamic risk mitigation strategy,
where all employees act as risk managers in their own area. A proper risk culture needs to be
developed across the organization and "risk" should be an input for future business decisionmaking. Risk management should not merely be an activity to comply with regulatory
requirements.

Table of contents

Chapter
No
1
2
3
4
5
6

Title
Research methodology
Introduction-Banking
Industry and company profile
Risk overview and Basel
committee
Basel III
Impact of Basel III on India
Findings, Recommendations
and conclusion
Bibliography

Page No
01-02
03-07
08-59
60-93
94-112
113-133
134-145
146

RESEARCH
METHODOLOGY

RESEARCH METHODOLOGY:

IMPORTANCE OF THE PROJECT

The project helps in understanding the clear meaning of Risk Management. It helps to
understand how Basel committee came into existence. It has framed regulations for banks in
series called Basel Accords. The latest Accord is Basel III, which had amended Basel II, and
framed new capital regulations, so that banks can survive and face times of depression easily.
This project helps to understand regarding the impact of Basel III on banking and on the
economy as whole.

OBJECTIVES OF PROJECT

To Study the complete structure and history of Jammu and Kashmir Bank.

To understand the risk and different risk management approaches in bank.

To gain insights into the credit risk management.

To know/understand the need of Basel Accords.

To understand the Basel Accords and more particularly Basel-III in detail.

To understand the RBI guidelines regarding Basel-III.

To estimate the additional capital requirements of PSBs and Pvt. Sector.

To examine the impact of Latest Basel Accord on Indian banking.

Scope of the study:

The purpose of the study is to evaluate, analyze and examine the risk management. The Basel
Committee is raising the resilience of the banking sector by strengthening the regulatory
capital framework, building on the three pillars of the Basel II framework. The reforms raise
both the quality and quantity of the regulatory capital base and enhance the risk coverage of
the capital framework. They are underpinned by a leverage ratio that serves as a backstop to
the risk-based capital measures, is intended to constrain excess leverage in the banking
system and provide an extra layer of protection against model risk and measurement error.
Finally, the Committee is introducing a number of macroprudential elements into the capital
framework to help contain systemic risks arising from procyclicality and from the
interconnectedness of financial institutions. The study aims to find out the strategy used by

the Basel committee to maintain the risk management procedure, so that banks are well
positioned and can face the tough times at very ease.

DATA COLLECTION METHOD: To fulfill the objectives of my study, I have taken both
into considerations viz. primary & secondary data.
Primary data: Primary data has been collected through personal interview by direct contact
method. The method which was adopted to collect the information is Personal Interview
method.
Personal interview and discussion was made with manager and other personnel in the
organization for this purpose.

Secondary data:
The data is collected from the Magazines, Annual reports, Internet, Text books.
The various sources that were used for the collection of secondary data are

Internal files & materials.

Websites

LIMITATIONS:

The time constraint was a limiting factor, as more in depth analysis could not be
carried.

Some of the information is confidential in nature that could not be divulged for the
study.

Because of secrecy, it becomes difficult to obtain actual facts and figures of advances
of branches,
.

INTRODUCTION

Chapter-I Banking
Introduction
A bank is a financial institution that provides banking and other financial services to their
Customers. A bank is generally understood as an institution which provides fundamental
Banking services such as accepting deposits and providing loans. There is also nonbanking
Institutions that provide certain banking services without meeting the legal Definition of a
bank. Banks are a subset of the financial services industry. A banking system also referred as
a system provided by the bank which offers cash Management services for customers,
reporting the transactions of their accounts and Portfolios, throughout the day. The banking
system in India should not only be hassle Free but it should be able to meet the new
challenges posed by the technology and any other external and internal factors. For the past
three decades, Indias banking system has several outstanding achievements to its credit. The
Banks are the main participants of the financial system in India. The Banking sector offers
several facilities and opportunities to their customers. All the banks safeguard the money and
valuables and provide loans, Credit, and payment services, such as checking accounts, money
orders, and cashiers Cheques. The banks also offer investment and insurance products. As a
variety of models For cooperation and integration among finance industries have emerged,
some of the Traditional distinctions between banks, insurance companies, and securities firms
have Diminished. In spite of these changes, banks continue to maintain and perform their
Primary roleaccepting deposits and lending funds from these deposits.
Banking is today an integral part of our everyday life: At home, at school, at office, at
business, on travel everywhere we counter some aspect of banking. The significance of
banking in our day to day life is being felt increasingly. What are the institutions, so
inevitable in the present day set up? How do they transact? How did the concept emerge?
These are some of the simple queries that do not surface in our minds but are lurking deep
down. Money plays a dominant role in todays life. Forms of money have evolved from coin
to paper currency notes to credit cards. Commercial transactions have increased in content
and quantity from simple banker to speculative international trading. Hence the need arose
for a third party who will assist smooth banding of transaction, mediate between the seller
and buyer, hold custody of money and goods, remit funds and also to collect proceeds. He
was the banker. As the number of such mediators grew there is need to control. Such
mediating agencies gave birth to the concept of banks and banking. With the exception

of the extremely wealthy, very few people buy their homes in all-cash transactions. Most of
us need a credit in form of loans, to make such a large purchase. In fact, many people need
financial support from Bank to fulfill the financial requirement. The world as we know it
wouldn't run smoothly without credit and banks to issue it. In this article we'll, explore the
birth of this flourishing industry.
Need of the Banks
Before the establishment of banks, the financial activities were handled by money lenders and
individuals. At that time the interest rates were very high. Again there were no Security of
public savings and no uniformity regarding loans. So as to overcome such Problems the
organized banking sector was established, which was fully regulated by the Government. The
organized banking sector works within the financial system to provide Loans accept deposits
and provide other services to their customers. The following Functions of the bank explain
the need of the bank and its importance:
To provide the security to the savings of customers.
To control the supply of money and credit
To encourage public confidence in the working of the financial system, increase Savings
speedily and efficiently.
To avoid focus of financial powers in the hands of a few individuals and Institutions.
To set equal norms and conditions (i.e. rate of interest, period of lending etc) to all types of
customers.

Services provided by banking organizations

Bank essentially performs the following functions: Accepting Deposits or savings functions from customers or public by providing bank
account, current account, fixed deposit account, recurring accounts etc.
The payment transactions like lending money to the public. Bank provides an effective
credit delivery system for loan able transactions.

 Provide the facility of transferring of money from one place to another place. For
performing this operation, bank issues demand drafts, bankers cheques, and money orders
etc. for transferring the money. Bank also provides the facility of Telegraphic transfer or telecash orders for quick transfer of money.
A bank performs a trustworthy business for various purposes.
A bank also provides the safe custody facility to the money and valuables of the general
public. Bank offers various types of deposit schemes for security of money. For keeping
valuables bank provides locker facility. The lockers are small compartments with dual
locking system built into strong cupboards. These are stored in the banks strong room and
are fully secured.
Banks act on behalf of the Govt. to accept its tax and non-tax receipt. Most of the
government disbursements like pension payments and tax refunds also take place through
banks.
Users of Banking Services:
The emerging trends in the level of expectation affect the formulation of marketing mix.
Innovative efforts become essential the moment it finds a change in the level of expectations.
There are two types of customers using the services of banks, such as general customers and
the industrial customers.
General Users:
Persons having an account in the bank and using the banking facilities at the terms and
conditions fixed by a bank are known as general users of the banking services. Generally,
they are the users having small sized and less frequent transactions or availing very limited
services of banks.
Industrial Users:
The industrialists, entrepreneurs having an account in the bank and using credit facilities and
other services for their numerous operations like establishments and expansion, mergers,
acquisitions etc. of their businesses are known as industrial users. Generally, they are found a
few but large sized customers.

Economic functions of banks

Banks in any country are very important to the growth and prosperity of the
economy. So their role in the economy is very vital. The various important economic
functions of the banks are as under:
1. Credit Creation: The creation of credit or deposits is one of the most vital operations
of the commercial bank. Credit creation is the multiple expansions of banks demand
deposits. Banks advance a major portion of their deposits to the borrowers and keep
smaller parts of deposits to the customers on demand. Even then the customers of the
banks have full confidence that the depositors lying in the banks is quite safe and can
be withdrawn on demand. The banks utilize this trust of their clients and expand loans
by much more time than the amount of demand deposits possessed by them. This
tendency on the part of the commercial banks to expand their demand deposits as a
multiple of their excess cash reserve is called creation of credit.
2. Settlement of payments: Banks act as both collection and paying agents for
customers. It includesthe offsetting of payment flows between geographical areas
there by reducing the cost of settlement between them.
3. Credit intermediation: Banks borrow from one individual or institution and lend
back to other individuals and institutions there by act as credit Intermediary (middle
men).
4. Credit quality improvement: Banks lend money to commercial and personal
individuals and institutions. The improvement comes from diversification of the
bank's assets and capital which provides a buffer to absorb losses without defaulting
on its obligations.
5. Promoting capital formation: A developing economy needs a high rate of capital
formation to accelerate the economic development, but the rate of capital formation
depends upon the rate of saving. Unfortunately, in underdeveloped countries, saving
is very low. But banks encourage savings in the underdeveloped countries by
providing very attractive services. Banks also mobilize the idle capital of the country
and make it available for productive purposes.
6. Maturity transformation banks borrow more on demand debt and short term debt,
but provide more long term loans. In other words, they borrow short and lend long.
With a stronger credit quality than most other borrowers, banks can do this by
aggregating issues (e.g. accepting deposits and issuing banknotes) and redemptions
(e.g. withdrawals and redemptions of banknotes), maintaining reserves of cash,
investing in marketable securities that can be readily converted to cash if needed, and
raising replacement funding as needed from various sources (e.g. wholesale cash
markets and securities markets).
7. Facilitator of monetary policy: A well-developed banking system is on essential
pre-condition to the effective implementation of monetary policy. Under-developed
countries cannot afford to ignore this fact. Banks follow monetary policy of central
bank to bring out the necessary change in economy.

8. Influence economic activity: Banks are in a position to influence economic activity

in a country by their influence on the rate interest; they do it by influencing the rate of
interest in the money market through its supply of funds.

INDUSTRY PROFILE
AND COMPANY
PROFILE

Chapter 2- industrial profile and company profile

Evolution of Banking System
The banking history is interesting and reflects evolution in trade and commerce. It also
throws light on living style, political and cultural aspects of civilized mankind. The strongest
faith of people has always been religion and God. The seat of religion and place of worship
were considered safe place for money and valuables. Ancient homes didn't have the benefit of
a steel safe, therefore, most wealthy people held accounts at their temples. Numerous people,
like priests or temple workers were both devout and honest, always occupied the temples,
adding a sense of security. There are records from Greece, Rome, Egypt and Ancient
Babylon that suggest temples loaned money out, in addition to keeping it safe. The fact that
most temples were also the financial centers of their cities and this is the major reason that
they were ransacked during wars. The practice of depositing personal valuables at these
places which were also functioning as the treasuries in ancient Babylon against a receipt was
perhaps the earliest form of Banking.
Gradually as the personal possession got evaluated in term of money, in form of coins made
of precious metal like gold and silver, these were being deposited in the temple treasuries. As
these coins were commonly accepted form of wealth, lending activity to those who needed
it and were prepared to borrow at an interest began. The person who conducted this
lending activity was known as the Banker because of the bench he usually set. It is also
observed that the term bankrupt got evolved then as the irate depositors broke the bench and
table of the insolvent banker. With the expansion of trade the concept of banking gained
greater ground. The handling of banking transcended from individual to groups to
companies. Issuing currency was one of the major functions of the banks. The earliest from
of money coins, were a certificate of value stamped on a metal, usually gold, silver, and
bronze or any other metal, by an authority, usually the king. With the increasing belief and
faith in such authority of their valuation and the necessities of wider trade a substitute to
metal was found in paper. The vagaries of monarchical rule led to the issues of currency
being vested with the banks since they enjoyed faith, controlled credit and trading. All forms
of money were a unit of value and promised to pay the bearer of specified value. Due to
failure on account of unwise loans, to rule and organize, a stable banking system arose. The
words earliest bank currency notes were issued in Sweden by stock holms Banco in July
1661.

History of Indian Banking System

In ancient India there is evidence of loans from the vedic period (beginning 1750BC). Later
during the mayura dynasty (321 to 185BC,), an instrument called adesha was in use, which
was an order on a banker desiring him to pay the money of the note to a third person, which
corresponds to the definition of a bill of exchange as we understand it today. During the
Buddhist period, there was considerable use of these instruments.
In fact, the history of Indian banking can be easily understood under three main phases which
are as:
1. Colonial / Pre-independence period
2. Nationalization Period
3. Liberalization period

1. Colonial /Pre-independence period

During the period of British rule merchants established the union bank of Calcutta in 1829,
first as a private joint stock association, then partnership. Its proprietors were the owners of
the earlier commercial bank and the Calcutta bank, who by mutual consent created union
bank to replace these two banks. In 1840 it established an agency at Singapore, and closed the
one at Mirzapore that it had opened in the previous year. Also in 1840 the bank revealed that
it had been the subject of a fraud by the banks accountant. Union bank was incorporated in
1845 but failed in 1848, having been insolvent for some time and having used money from
depositors to pay its dividends.
The Allahabad Bank, established in 1865 and still functioning today, is the oldest joint stock
bank in India; it was not the first though. That honor belongs to the bank of Upper India,
which was established in 1863, and which survived until 1913, when it failed, with some of
its assets and liabilities being transferred to the Alliance Bank of Simla.
Foreign banks too started to appear, particularly in Calcutta, in the 1860s. the comptoir
dEscompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862;
branches in Madras and Pondicherry, then a French possession, followed HSBC established
itself in Bengal in 1869. Calcutta was the most active trading port, mainly due to the trade of
British Empire, and so became a banking centre.
The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi
movement. The Swadeshi movement inspired local businessmen and political figures to
found banks of and for the Indian community. A number of banks established then have
survived to the present such as Bank of Baroda, Corporation Bank, Bank of India, Canara
Bank and Central Bank of India.
During the First World War through the end of the second world war and two years thereafter
until the independence of India were challenging for Indian banking. The years of the First

World War were turbulent, and it took its toll with banks simply collapsing despite the Indian
economy gaining indirect boost due to war-related economic activities. At least 94 banks in
India failed between 1913 and 1918.
Post-independence
The partition of India in 1947 adversely impacted the economies of Punjab and West Bengal,
paralyzing banking activities for months. Indias independence marked the end of regime of
the laissez-faire for the Indian banking. The Government of India initiated measures to play
an active role in the economic life of the nation, and the industrial policy resolution adopted
by the government in 1948 envisaged a mixed economy. This resulted into greater
involvement of the state in different segments of the economy including banking and finance.
The major steps to regulate banking included:

The Reserve Bank of India, Indias central banking authority, was established in April
1935, but was nationalized on January 1949 under the terms of the Reserve Bank of
India Act, 1948.
In 1949, the Banking Regulation Act was enacted which empowered the Reserve
Bank of India to regulate, control, and inspect the banks in India
The Banking Regulation Act also provided that no new bank or branch of an existing
bank could be opened without a license from the RBI, and no two banks could have
common directors.

2. Nationalization Period

By the 1960s, the Indian banking industry has become an important tool to facilitate the
Development of the Indian economy. At the same time, it has emerged as a large Employer,
and a debate has ensured about the possibility to nationalise the banking Industry. Indira
Gandhi, the-then Prime Minister of India expressed the intention of the Government of India
(GOI) in the annual conference of the All India Congress Meeting In a paper entitled "Stray
thoughts on Bank Nationalisation". The paper was received with positive enthusiasm.
Thereafter, her move was swift and sudden, and the GOI issued an ordinance and nationalised
the 14 largest commercial banks with effect from the midnight of July 19, 1969. Jayaprakash
Narayan, a national leader of India, described the step as a "Masterstroke of political
sagacity" Within two weeks of the issue of the Ordinance, the Parliament passed the Banking
Companies (Acquisition and Transfer of Undertaking) Bill, and it received the presidential
approval on 9 August, 1969. A second step of nationalisation of 6 more commercial banks
followed in 1980. The stated reason for the nationalisation was to give the government more

control of credit Delivery. With the second step of nationalisation, the GOI controlled around
91% of the Banking business in India. Later on, in the year 1993, the government merged
New Bank of India with Punjab National Bank. It was the only merger between nationalised
banks and resulted in the reduction of the number of nationalised banks from 20 to 19. After
this, until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the
Average growth rate of the Indian economy. With the nationalization there were a lot of positive
changes in Indian banking system. These are discussed as under:

a) The ownership of the govt. gave a new confidence to the savers and being backed by a
sovereign the normal suspicions associated with the capabilities of the bankers in the private
sector were gone.
b) Banking ceased to be selective. The entry barriers that existed for customers to bank,
social economic and political were lowered. This resulted in a massive quantitative expansion
of the bank customer base as well as in the nature of services provided.
c) The expansion of banks also expanded the economy.
d) A large employment base was created.
e) The quality of credit assets fell because of liberal credit extension policy.
f) The credit facilities extended to the priority sector at concessional rates.

3. Liberalization Period
By the beginning of 1990, the social banking goals set for the banking industry made most of
the public sector resulted in the presumption that there was no need to look at the
fundamental financial strength of this bank. Consequently they remained undercapitalized.
The banking industry is of extreme importance, as the health of the financial sector in
particular and the economy was a whole would be reflected by its performance. The need for
restructuring the banking industry was felt greater with the initiation of the real sector reform
process in 1991.The reforms have enhanced the opportunities and challenges for the real
sector making them operate in a borderless global market place. However, to harness the
benefits of globalization, there should be an efficient financial sector to support the structural

reforms taking place in the real economy. Hence, along with the reforms of the real sector,
the banking sector reformation was also addressed
The root cause of banking reforms was:

Regulated interest rate structure.

Lack of focus on profitability.

Lack of transparency in the banks balance sheet.

Lack of competition.

Excessive regulation on organization structure and managerial

resource.

Excessive support from government

In the early 1990s, the then Narsimha Rao government embarked on a policy of
Liberalisation, licensing a small number of private banks. These came to be known as New
Generation tech-savvy banks, and included Global Trust Bank (the first of such new
generation banks to be set up), which later amalgamated with Oriental Bank of Commerce,
Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move Along with the
rapid growth in the economy of India revolutionized the banking sector in India which has
seen rapid growth with strong contribution from all the three sectors of Banks, namely,
government banks, private banks and foreign banks. The next stage for The Indian banking
has been setup with the proposed relaxation in the norms for Foreign Direct Investment,
where all Foreign Investors in banks may be given voting rights which could exceed the
present cap of 10%, at present it has gone up to 49% with some Restrictions. The new policy
shook the banking sector in India completely. Bankers, till this time, were used to the 4-6-4
method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. The new wave ushered in
a modern outlook and tech-savvy methods of working for the Traditional banks. All this led
to the retail boom in India. People not just demanded more from their banks but also received
more. Currently (2007), banking in India is generally fairly mature in terms of supply,
product range and reach-even though reach in rural India Still remains a challenge for the
private sector and foreign banks. In terms of quality of Assets and capital adequacy, Indian
banks are considered to have clean, strong and transparent balance sheets as compared to
other banks in comparable economies in its Region. The Reserve Bank of India is an
autonomous body, with minimal pressure from the government. The stated policy of the Bank
on the Indian Rupee is to manage Volatility but without any fixed exchange rate-and this has

mostly been true. With the Growth in the Indian economy expected to be strong for quite
some time-especially in its Services sector-the demand for banking services, especially retail
banking, mortgages and Investment services are expected to be strong. In March 2006, the
Reserve Bank of India allowed Warburg Pincus to increase its stake In Kotak Mahindra Bank
(a private sector bank) to 10%. This is the first time an investor has been allowed to hold
more than 5% in a private sector bank since the RBI announced Norms in 2005 that any stake
exceeding 5% in the private sector banks would need to be voted by them. In recent years
critics have charged that the non-government owned banks are too aggressive in their loan
recovery efforts in connection with housing, vehicle and Personal loans. There are press
reports that the banks' loan recovery efforts have driven defaulting borrowers to suicide.

Government policy on banking in India

Banks operating in most of the countries must contend with heavy regulations, rules Enforced
by Federal and State agencies to govern their operations, service offerings, and the manner in
which they grow and expand their facilities to better serve the public. A Banker works within
the financial system to provide loans, accept deposits, and provide other services to their
customers. They must do so within a climate of extensive Regulation, designed primarily to
protect the public interests. The main reasons why the banks are heavily regulated are as
follows:
To protect the safety of the publics savings.
To control the supply of money and credit in order to achieve a nations broad Economic
goal.
To ensure equal opportunity and fairness in the publics access to credit and other vital
financial services.
To promote public confidence in the financial system, so that savings are made speedily and
efficiently.
To avoid concentrations of financial power in the hands of a few individuals and
Institutions.
Provide the Government with credit, tax revenues and other services.

 To help sectors of the economy that they have special credit needs for eg. Housing, small
business and agricultural loans etc.
Classification of Banking Industry in India
Indian banking industry has been divided into two parts, organized and unorganized sectors.
The organized sector consists of Reserve Bank of India, Commercial Banks and Co-operative
Banks, and Specialized Financial Institutions (IDBI, ICICI, IFC etc). The unorganized sector,
which is not homogeneous, is largely made up of money lenders and indigenous bankers. An
outline of the Indian Banking structure may be presented as follows:-

Reserve bank of India

At the apex level of Indian banking industry, there is Reserve Bank of India (RBI) as central
Bank. Reserve bank of India is a central bank and was established in April 1, 1935 in
accordance with the provisions of reserve bank of India act 1934. The central office of RBI is
located at Mumbai since inception. Though originally the reserve bank of India was privately
owned, since nationalization in 1949, RBI is fully owned by the Government of India. It was
inaugurated with share capital of Rs. 5 Crores divided into shares of Rs. 100 each fully paid

up. RBI is governed by a central board (headed by a governor) appointed by the central
government of India. RBI has 22 regional offices across India. The reserve bank of India was
nationalized in the year 1949. The general superintendence and direction of the bank is
entrusted to central board of directors of 20 members, the Governor and four deputy
Governors, one Governmental official from the ministry of Finance, ten nominated directors
by the government to give representation to important elements in the economic life of the
country, and the four nominated director by the Central Government to represent the four
local boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Board
consists of five members each central government appointed for a term of four years to
represent territorial and economic interests and the interests of cooperative and indigenous
banks. The RBI Act 1934 was commenced on April 1, 1935. The Act, 1934 provides the
statutory basis of the functioning of the bank. The bank was constituted for the need of
following:
- To regulate the issues of banknotes.
- To maintain reserves with a view to securing monetary stability
- To operate the credit and currency system of the country to its advantage.
Functions of RBI as a central bank of India are explained briefly as follows:
Bank of Issue: The RBI formulates, implements, and monitors the monitory policy. Its main
objective is maintaining price stability and ensuring adequate flow of credit to productive
sector.
Regulator-Supervisor of the financial system: RBI prescribes broad parameters of banking
operations within which the countrys banking and financial system functions. Their main
objective is to maintain public confidence in the system, protect depositors interest and
provide cost effective banking services to the public.
Manager of exchange control: The manager of exchange control department manages the
foreign exchange, according to the foreign exchange management act, 1999. The managers
main objective is to facilitate external trade and payment and promote orderly development
and maintenance of foreign exchange market in India.

Issuer of currency: A person who works as an issuer, issues and exchanges or destroys the
currency and coins that are not fit for circulation. His main objective is to give the public
adequate quantity of supplies of currency notes and coins and in good quality.
Developmental role: The RBI performs the wide range of promotional functions to support
national objectives such as contests, coupons maintaining good public relations and many
more.
Related functions: There are also some of the related functions to the above mentioned main
functions. They are such as; banker to the government, banker to banks etc.
Banker to government performs merchant banking function for the central and the state
governments; also acts as their banker.
Banker to banks maintains banking accounts to all scheduled banks.
Controller of Credit: RBI performs the following tasks:
It holds the cash reserves of all the scheduled banks.
It controls the credit operations of banks through quantitative and qualitative controls.
It controls the banking system through the system of licensing, inspection and calling for
information.
It acts as the lender of the last resort by providing rediscount facilities to scheduled banks.
Supervisory Functions: In addition to its traditional central banking functions, the Reserve
Bank performs certain non-monetary functions of the nature of supervision of banks and
promotion of sound banking in India. The Reserve Bank Act 1934 and the banking regulation
act 1949 have given the RBI wide powers of supervision and control over commercial and
co-operative banks, relating to licensing and establishments, branch expansion, liquidity of
their assets, management and methods of working, amalgamation, reconstruction and
liquidation. The RBI is authorized to carry out periodical inspections of the banks and to call
for returns and necessary information from them. The nationalization of 14 major Indian
scheduled banks in July 1969 has imposed new responsibilities on the RBI for directing the
growth of banking and credit policies towards more rapid development of the economy and
realization of certain desired social objectives. The supervisory functions of the RBI have

helped a great deal in improving the standard of banking in India to develop on sound lines
and to improve the methods of their operation.
Promotional Functions: With economic growth assuming a new urgency since
independence, the range of the Reserve Banks functions has steadily widened. The bank now
performs a variety of developmental and promotional functions, which, at one time, were
regarded as outside the normal scope of central banking. The Reserve bank was asked to
promote banking habit, extend banking facilities to rural and semi-urban areas, and establish
and promote new specialized financing agencies.
Indian Scheduled Commercial Banks
The commercial banking structure in India consists of scheduled commercial banks, and
unscheduled banks.
Scheduled Banks: Scheduled Banks in India constitute those banks which have been
included in the second schedule of RBI act 1934. RBI in turn includes only those banks in
this schedule which satisfy the criteria laid down vide section 42(6a) of the Act. Scheduled
banks in India means the State Bank of India constituted under the State Bank of India Act,
1955 (23 of 1955), a subsidiary bank as defined in the State Bank of India (subsidiary banks)
Act, 1959 (38 of 1959), a corresponding new bank constituted under section 3 of the Banking
companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980), or any other
bank being a bank included in the Second Schedule to the Reserve bank of India Act, 1934 (2
of 1934), but does not include a co-operative bank. For the purpose of assessment of
performance of banks, the Reserve Bank of India categories those banks as public sector
banks, old private sector banks, new private sector banks and foreign banks, i.e. private
sector, public sector, and foreign banks come under the umbrella of scheduled commercial
banks.

Commercial Banks: Commercial banks may be defined as, any banking organization that
deals with the deposits and loans of business organizations. Commercial banks issue bank
checks and drafts, as well as accept money on term deposits. Commercial banks also act as
moneylenders, by way of installment loans and overdrafts.

Commercial banks also allow for a variety of deposit accounts, such as checking, savings,
and time deposit. These institutions are run to make a profit and owned by a group of
individuals.

Public Sector Banks: These are banks where majority stake is held by the Government of
India.
Examples of public sector banks are: SBI, Bank of India, Canara Bank, etc.

Private Sector Banks: These are banks majority of share capital of the bank is held by
private individuals. These banks are registered as companies with limited liability. Examples
of private sector banks are: ICICI Bank, Axis bank, HDFC, etc.

Foreign Banks: These banks are registered and have their headquarters in a foreign country
but operate their branches in our country. Examples of foreign banks in India are: HSBC,
Citibank, Standard Chartered Bank, etc.

Cooperative Banks: A co-operative bank is a financial entity which belongs to its members,
who are at the same time the owners and the customers of their bank. Co-operative banks are
often created by persons belonging to the same local or professional community or sharing a
common interest. Co-operative banks generally provide their members with a wide range of
banking and financial services (loans, deposits, banking accounts, etc).
Regional Rural Bank: The government of India set up Regional Rural Banks (RRBs) on
October 2, 1975. The banks provide credit to the weaker sections of the rural areas,
particularly the small and marginal farmers, agricultural labourers, and small entrepreneurs.
Initially, five RRBs were set up on October 2, 1975 which was sponsored by Syndicate Bank,
State Bank of India, Punjab National Bank, United Commercial Bank and United Bank of
India. The total authorized capital was fixed at Rs. 1 Crore which has since been raised to Rs.
5 Crores. There are several concessions enjoyed by the RRBs by Reserve Bank of India such
as lower interest rates and refinancing facilities from NABARD like lower cash ratio, lower
statutory liquidity ratio, lower rate of interest on loans taken from sponsoring banks,
managerial and staff assistance from the sponsoring bank and reimbursement of the expenses
on staff training. The RRBs are under the control of NABARD. NABARD has the
responsibility of laying down the policies for the RRBs, to oversee their operations, provide
refinance facilities, to monitor their performance and to attend their problems.

Unscheduled Banks
Unscheduled commercial banks are those banks which are not included in Second
schedule of the RBI Act of 1934.
Banking structure in India
At the end of September 2013, The Branch and ATM wise position of different categories of
banks in India is tabulated as under:
S.No

Name

Branches
Rural

Semi-

ATMs
Urban

urban

1.

Scheduled

Metro

total

Politian

ON

OFF

Site

Site

Total

23776

22468

17878

17118

81240

47545

48141

95686

commercial banks
2

Public sector banks

22188

17773

14248

13257

67466

34012

24181

58193

Nationalized banks

15606

12154

10744

10132

48636

18227

12773

31050

State bank group

6582

5619

3504

3125

18830

15735

11408

27143

Private sector

1581

4687

3569

3615

13452

13249

22830

36079

Old private sector

881

2025

1395

1085

5386

3342

2429

5771

Foreign sector

07

08

61

246

322

284

1130

1414

Source: (Reserve Bank of India)

BANKING IN INDIA
Indian banking is the lifeline of the nation and its people. Banking has helped in developing
the vital sectors of the economy and usher in a new dawn of progress on the Indian horizon.
The sector has translated the hopes and aspirations of millions of people into reality. But to
do so, it has had to control miles and miles of difficult terrain, suffer the indignities of foreign
rule and the pangs of partition. Today, Indian banks can confidently compete with modern
banks of the world. Before the 20th century, usury, or lending money at a high rate of

interest, was widely prevalent in rural India. Entry of Joint stock banks and development of
Cooperative movement have taken over a good deal of business from the hands of the Indian
money lender, who although still exist, have lost his menacing teeth. In the Indian Banking
System, Cooperative banks exist side by side with commercial banks and play a
supplementary role in providing need-based finance, especially for agricultural and
agriculture-based operations including farming, cattle, milk, hatchery, personal finance etc.
along with some small industries and self-employment driven activities. Generally, cooperative banks are governed by the respective co-operative acts of state governments. But,
since banks began to be regulated by the RBI after 1st March 1966, these banks are also
regulated by the RBI after amendment to the Banking Regulation Act 1949. The Reserve
Bank is responsible for licensing of banks and branches, and it also regulates credit limits to
state co-operative banks on behalf of primary co-operative banks for financing SSI units.
During the last 30 years since nationalization tremendous changes have taken place in the
financial markets as well as in the banking industry due to financial sector reforms. The
banks have shed their traditional functions and have been innovating, improving and coming
out with new types of services to cater emerging needs of their customers. Banks have been
given greater freedom to frame their own policies. Rapid advancement of technology has
contributed to significant reduction in transaction costs, facilitated greater diversification of
portfolio and improvements in credit delivery of banks. Prudential norms, in line with
international standards, have been put in place for promoting and enhancing the efficiency of
banks. The process of institution building has been strengthened with several measures in the
areas of debt recovery, asset reconstruction and securitization, consolidation, convergence,
mass banking etc. Despite this commendable progress, serious problem have emerged
reflecting in a decline in productivity and efficiency, and erosion of the profitability of the
banking sector. There has been deterioration in the quality of loan portfolio which, in turn,
has come in the way of banks income generation and enhancement of their capital funds.
Inadequacy of capital has been accompanied by inadequacy of loan loss provisions resulting
into the adverse impact on the depositors and investors confidence. The Government,
therefore, set up Narsimhan Committee to look into the problems and recommend measures
to improve the health of the financial system. The acceptance of the Narsimhan Committee
recommendations by the Government has resulted in transformation of hitherto highly
regimented and over bureaucratized banking system into market driven and extremely
competitive one. The massive and speedy expansion and diversification of banking has not
been without its strains. The banking industry is entering a new phase in which it will be

facing increasing competition from non-banks not only in the domestic market but in the
international markets also. The operational structure of banking in India is expected to
undergo a profound change during the next decade. With the emergence of new private
banks, the private bank sector has become enriched and diversified with focus spread to the
wholesale as well as retail banking. The existing banks have wide branch network and
geographic spread, whereas the new private banks have the clout of massive capital, lean
personnel component, the expertise in developing sophisticated financial products and use of
state-of-the-art technology. Gradual deregulation that is being ushered in while stimulating
the competition would also facilitate forging mutually beneficial relationships, which would
ultimately enhance the quality and content of banking. In the final phase, the banking system
in India will give a good account of itself only with the combined efforts of cooperative
banks, regional rural banks and development banking institutions which are expected to
provide an adequate number of effective retail outlets to meet the emerging socio-economic
challenges during the next two decades. The electronic age has also affected the banking
system, leading to very fast electronic fund transfer. However, the development of electronic
banking has also led to new areas of risk such as data security and integrity requiring new
techniques of risk management. Cooperative (mutual) banks are an important part of many
financial systems. In a number of countries, they are among the largest financial institutions
when considered as a group. Moreover, the share of cooperative banks has been increasing in
recent years; in the sample of banks in advanced economies and emerging markets analyzed
in this paper, the market share of cooperative banks in terms of total banking sector assets
increased from about 9 percent in mid-1990s to about 14 percent in 2004.
Bank Marketing In the Indian Perspective:
The formulation of business policies is substantially influenced by the emerging trends in the
national and international scenario. The GDP, per capita income, expectation, the rate of
literacy, the geographic and demographic considerations, the rural or urban orientation, the
margins in economic systems, and the spread of technologies are some of the key factors
governing the development plan of an organization, especially banking organization. In ours
developing economy, the formulation of a sound marketing mix is found a difficult task. The
nationalization of the Reserve Bank of India (RBI) is a landmark in the development of
Indian Banking system that have paved numerous paths for qualitative-cum quantities
improvements in true sense. Subsequently, the RBI and the policy makers of the public sector
commercial banks think in favour of conceptualizing modern marketing which would bring a

radical change in the process of quality up gradation and village to village commercial
viability.
Bank Marketing Mix and Strategies:
The first task before the public sector commercial Banks is to formulate that Bank marketing
mix which suits the national socio-economic requirements. Some have 4 P's and some have 7
P's of marketing mix. The common four Ps of Marketing mix are as follows:Product:
To be more specific the peripheral services need frequent innovations, since this would be
helpful in excelling competition. The product portfolio designing is found significant to
maintain the commercial viability of the public sector banks. The banks professionals need to
assign due weightage to their physical properties. They are supposed to look smart active and
attractive.
Price:
Price is a critical and important factor of bank marketing mix due numerous players in the
industry . Most consumers will only be prepared to invest their money in search of
extraordinary or higher returns. They are ready to pay additional value if there is a perception
of extra product value. This value may be improved performance, function, services,
reliability, and promptness for problem solving and of course, higher rate of return
Promotion:
Bank Marketing is actually is the marketing of reliability and faith of the people. It is the
responsibility of the banking industry to take people in favour through Word of mouth
publicity, reliability showing through long years of establishment and other services.
Place:
The choice of where and when to make a product available will have significant impact on
the customers. Customers often need to avail banking services fast for this they require the
bank branches near to their official area or the place of easy access.

Current Scenario and Future Landscape of Indian Banking

The industry is currently in a transition phase. On the one hand, the PSBs, which are the
mainstay of the Indian Banking system, are in the process of shedding their flab in terms of
excessive manpower, excessive non Performing Assets (NPAS) and excessive governmental
equity, while on the other hand the private sector banks are consolidating themselves through
mergers and acquisitions. PSBs, which currently account for more than 78 percent of total
banking industry assets are saddled with NPAs (a mind-boggling Rs 830 billion in 2000),
falling revenues from traditional sources, lack of modern technology and a massive
workforce while the new private sector banks are forging ahead and rewriting the traditional
banking business model by way of their sheer innovation and service. The PSBs are of course
currently working out challenging strategies even as 20 percent of their massive employee
strength has dwindled in the wake of the successful Voluntary Retirement Schemes (VRS)
schemes. The private players however cannot match the PSbs great reach, great size and
access to low cost deposits. Therefore one of the means for them to combat the PSBs has
been through the merger and acquisition (M& A) route. Over the last two years, the industry
has witnessed several such instances. For instance, Hdfc Banks merger with Times Bank
Icici Banks acquisition of ITC Classic, Anagram Finance and Bank of Madura, Centurion
Bank, Induslnd Bank, Bank of Punjab, Vysya Bank are said to be on the lookout. The UTI
bank- Global Trust Bank merger however opened a Pandoras box and brought about the
realization that all was not well in the functioning of many of the private sector banks.
Private sector Banks have pioneered internet banking, phone banking, anywhere banking, and
mobile banking, debit cards, Automatic Teller Machines (ATMs) and combined various other
services and integrated them into the mainstream banking arena, while the PSBs are still
grappling with disgruntled employees in the aftermath of successful VRS schemes. Also,
following Indias commitment to the WTO agreement in respect of the services sector,
foreign banks, including both new and the existing ones, have been permitted to open up to
12 branches a year with effect from 1998-99 as against the earlier stipulation of 8 branches.
Talks of government diluting their equity from 51 percent to 33 percent in November 2000
have also opened up a new opportunity for the takeover of even the PSBs. The FDI rules
being more rationalized in Q1FY02 may also pave the way for foreign banks taking the M&
A route to acquire willing Indian partners. Meanwhile the economic and corporate sector
slowdown has led to an increasing number of banks focusing on the retail segment. Many of
them are also entering the new vistas of Insurance. Banks with their phenomenal reach and a

regular interface with the retail investor are the best placed to enter into the insurance sector.
Banks in India have been allowed to provide fee-based insurance services without risk
participation invest in an insurance company for providing infrastructure and services support
and set up of a separate joint venture insurance company with risk participation.

Liberalization and de-regulation process started in 1991-92 has made a sea change in the
banking system. From a totally regulated environment, we have gradually moved into a
market driven competitive system. Our move towards global benchmarks has been, by and
large, calibrated and regulator driven. The pace of changes gained momentum in the last few
years. Globalization would gain greater speed in the coming years particularly on account of
expected opening up of financial services under WTO. Four trends change the banking
industry world over, viz. 1) Consolidation of players through mergers and acquisitions, 2)
Globalization of operations, 3) Development of new technology and 4)Universalisation of
banking. With technology acting as a catalyst, we expect to see great changes in the banking
scene in the coming years. The Committee has attempted to visualize the financial world 5-10
years from now. The picture that emerged is somewhat as discussed below. It entails
emergence of an integrated and diversified financial system. The move towards universal
banking has already begun. This will gather further momentum bringing non-banking
financial institutions also, into an integrated financial system.
The traditional banking functions would give way to a system geared to meet all the financial
needs of the customer. We could see emergence of highly varied financial products, which
are tailored to meet specific needs of the customers in the retail as well as corporate
segments. The advent of new technologies could see the emergence of new financial players
doing financial intermediation. For example, we could see utility service providers offering
say, bill payment services or supermarkets or retailers doing basic lending operations. The
conventional definition of banking might undergo changes.
The competitive environment in the banking sector is likely to result in individual players
working out differentiated strategies based on their strengths and market niches. For example,
some players might emerge as specialists in mortgage products, credit cards etc. whereas
some could choose to concentrate on particular segments of business system, while
outsourcing all other functions. Some other banks may concentrate on SME segments or high
net worth individuals by providing specially tailored services beyond traditional banking

offerings to satisfy the needs of customers they understand better than a more generalist
competitor.
International trade is an area where Indias presence is expected to show appreciable increase.
Presently, Indian share in the global trade is just about 0.8%. The long term projection for
growth in international trade is placed at an average of 6% per annum. With the growth in IT
sector and other IT Enabled Services, there is tremendous potential for business
opportunities. Keeping in view the GDP growth forecast under India Vision 2020, Indian
exports can be expected to grow at a sustainable rate of 15% per annum in the period ending
with 2010. This again will offer enormous scope to Banks in India to increase their Forex
business and international presence. Globalization would provide opportunities for Indian
corporate entities to expand their business in other countries.
Banks in India wanting to increase their international presence could naturally be expected to
follow these corporate and other trade flows in and out of India.
Retail lending will receive greater focus. Banks would compete with one another to provide
full range of financial services to this segment. Banks would use multiple delivery channels
to suit the requirements and tastes of customers. While some customers might value
relationship banking (conventional branch banking), others might prefer convenience banking
(e-banking).
One of the concerns is quality of bank lending. Most significant challenge before banks is the
maintenance of rigorous credit standards, especially in an environment of increased
competition for new and existing clients. Experience has shown us that the worst loans are
often made in the best of times. Compensation through trading gains is not going to support
the banks forever. Large-scale efforts are needed to upgrade skills in credit risk measuring,
controlling and monitoring as also revamp operating procedures. Credit evaluation may have
to shift from cash flow based analysis to borrower account behaviour, so that the State of
readiness of Indian banks for Basel II regime improves. Corporate lending is already
undergoing changes. The emphasis in future would be towards more of fee based services
rather than lending operations. Banks will compete with each other to provide value added
services to their customers.
Structure and ownership pattern would undergo changes. There would be greater presence of
international players in the Indian financial system. Similarly, some of the Indian banks

would become global players. Government is taking steps to reduce its holdings in Public
sector banks to 33%. However the indications are that their PSB character may still be
retained.
Mergers and acquisitions would gather momentum as managements will strive to meet the
expectations of stakeholders. This could see the emergence of 4-5 world class Indian Banks.
As Banks seek niche areas, we could see emergence of some national banks of global scale
and a number of regional players.
Corporate governance in banks and financial institutions would assume greater importance in
the coming years and this will be reflected in the composition of the Boards of Banks.
Concept of social lending would undergo a change. Rather than being seen as directed
lending such lending would be business driven. With SME sector expected to play a greater
role in the economy, Banks will give greater overall focus in this area. Changes could be
expected in the delivery channels used for lending to small borrowers and agriculturalists and
unorganized sectors (micro credit). Use of intermediaries or franchise agents could emerge as
means to reduce transaction costs.
Technology as an enabler is separately discussed in the report. It would not be out of place,
however, to state that most of the changes in the Landscape of financial sector discussed
above would be technology driven. In the ultimate analysis, successful institutions will be
those which continue to leverage the advancements in technology in reengineering processes
and delivery modes and offering state-of-the-art products and services providing complete
financial solutions for different types of customers.
Human Resources Development would be another key factor defining the characteristics of a
successful banking institution. Employing and retaining skilled workers and specialists, retraining the existing workforce and promoting a culture of continuous learning would be a
challenge for the banking institutions.
Challenges to Indian Banking:
The banking industry in India is undergoing a major change due to the advancement in Indian
economy and continuous deregulation. These multiple changes happening in series has a
ripple effect on banking industry which is trying to be organized completely, regulated sellers
of market to completed deregulated customers market.

1. Deregulation:
This continuous deregulation has given rise to extreme competition with greater autonomy,
operational flexibility, and decontrolled interest rate and liberalized norms and policies for
foreign exchange in banking market. The deregulation of the industry coupled with decontrol
in the interest rates has led to entry of a number of players in the banking industry. Thereby
reduced corporate credit off which has resulted in large number of competitors battling for
the same pie.
2. Modified new rules:
As a result, the market place has been redefined with new rules of the game. Banks are
transforming to universal banking, adding new channels with lucrative pricing and freebees
to offer. New channels squeezed spreads, demanding customers better service, marketing
skills heightened competition, defined new rules of the game pressure on efficiency. Need for
new orientation diffused customer loyalty. Bank has led to a series of innovative product
Offerings catering to various customer segments, specifically retail credit.
3. Efficiency:
Excellent efficiencies are required at banker's end to establish a balance between the
commercial and social considerations Bank need to access low cost funds and simultaneously
improve the efficiency and efficacy. Owing to cutthroat competition in the industry, banks
are facing pricing pressure; have to give thrust on retail assets.
4. Diffused customer loyalty:
Attractive offers by MNC and other nationalized banks, customers have become more
demanding and the loyalties are diffused. Value added offerings bound customers to change
their preferences and perspective. These are multiple choices; the wallet share is reduced per
bank with demand on flexibility and customization. Given the relatively low switching costs;
customer retention calls for customized service and hassle free, flawless service delivery.
5. Misaligned mindset:
These changes are creating challenges, as employees are made to adapt to changing
conditions. The employees are resisting changing and the seller market mindset is yet to be
changed. These problems coupled with fear of uncertainty and control orientation. Moreover

banking industry is accepting the latest technology but utilization is far below from
satisfactory level.
6. Competency gap:
The competency gap needs to be addressed simultaneously otherwise there will be missed
opportunities. Placing the right skill at the right place will determine success. The focus of
people will be doing work but not providing solutions, on escalating problems rather than
solving them and on disposing customers instead of using the opportunity to cross sell.
Strategic options to cope with the challenges:
Dominant players in the industry have embarked on a series of strategic and tactical
initiatives to sustain leadership. The major initiatives incorporate:
a) Focus on ensuring reliable service delivery through Investing on and implementing right
technology.
b) Leveraging the branch networks and sales structure to mobilize low cost current and
savings deposits.
c) Making aggressive forays in the retail advances segments of home and personal loans.
d) Implementing initiatives involving people, process and technology to reduce the fixed
costs and the cost per transaction.
e) Focusing on fee based income to compensate foe squeezed spread.
f) Innovating products to capture customer 'mind share' to begin with and later the wallet
share.
g) Improving the asset quality as Basel II norms.
Swot analysis of Indian banking industry
The bank marketing is than an approach to market the services profitability. It is a device to
maintain commercial viability. The changing perception of bank marketing has made it a
social process. The significant properties of the holistic concept of management and
marketing has made bank marketing a device to establish a balance between the commercial
and social considerations, often considered to the be opposite of each other. A collaboration
of two words banks and marketing thus focuses our attention on the following:

* Bank marketing is a managerial approach to survive in highly competitive market as well as

reliable service delivery to target customers.
* It is a social process to sub serve social interests.
* It is a fair way of making profits
* It is an art to make possible performance-orientation.
* It is a professionally tested skill to excel competition.

STRENGTH

emerging economies banks over the last few years.

the sector. These changes include strengthening prudential norms, Enhancing the payments
system and integrating regulations between commercial and co-operative banks.

banking system has reached even to the remote corners of the country.
uality of assets and capital adequacy, Indian banks are considered to have
clean, strong and transparent balance sheets relative to other banks in Comparable economies
in its region.
Foreign banks will have the opportunity to own up to 74 per cent of Indian private Sector
banks and 20 per cent of government owned banks.

WEAKNESS

marketing, service operations, risk management and the overall organisational performance
ethic & strengthen human capital.

The cost of intermediation remains high and bank penetration is limited to only a few
customer segments and geographies.
al weaknesses such as a fragmented industry structure, restrictions on Capital
availability and deployment, lack of institutional support infrastructure, Restrictive labour

laws, weak corporate governance and ineffective regulations Beyond Scheduled Commercial
Banks (SCBs)
: The government has refused to dilute its Stake in
PSU banks below 51% thus choking the headroom available to these banks for raining equity
capital.

OPPORTUNITY
The market is seeing discontinuous growth driven by new products and services that
include opportunities in credit cards, consumer finance and wealth management on the retail
side, and in fee-based income and investment banking on the wholesale banking side. These
require new skills in sales & marketing, Credit and operations.

Given the demographic shifts resulting from changes in age profile and household Income,
consumers will increasingly demand enhanced institutional capabilities and service levels
from banks.
New private banks could reach the next level of their growth in the Indian Banking sector
by continuing to innovate and develop differentiated business Models to profitably serve
segments like the rural/low income and affluent/HNI Segments; actively adopting
acquisitions as a means to grow and reaching the Next level of performance in their service
platforms. Attracting, developing and retaining more leadership capacity
Foreign banks committed to making a play in India will need to adopt alternative
Approaches to win the race for the customer and build a value-creating Customer franchise
in advance of regulations potentially opening up post 2009. At the same time, they should
stay in the game for potential acquisition opportunities as and when they appear in the near
term, maintaining a fundamentally long-term value-creation mindset.

With the growth in the Indian economy expected to be strong for quite some timeespecially in its services sector-the demand for banking services, especially retail banking,
mortgages and investment services are expected to be strong.
rnment to amend the
Banking Regulation Act to permit banks to trade in commodities and Commodity derivatives.
: In an attempt to relieve banks of their capital crunch, the RBI has allowed
them to raise perpetual bonds and other hybrid capital securities to shore up their capital. If

the new instruments find takers, it would help PSU banks, left with little headroom for raising
equity.

THREATS

stability of the system.

private players.

COMPANY PROFILE
BACKGROUND OF THE COMPANY
Jammu and Kashmir Bank Limited was incorporated on 1st October, 1938 and commenced
its business from 4th July, 1939 in Kashmir (India). The Bank was first in the country as a
State owned bank. According to the extended Central laws of the state, Jammu & Kashmir
Bank was defined as a govt. Company as per the provision of Indian companies act 1956. In
the year 1971, the Bank received the status of scheduled bank. It was declared as "A" Class
Bank by RBI in 1976. Today the bank has more than 750 branches across the country and has
recently become a billion Dollar Company.

PROFILE
1. Incorporated in 1938 as a limited company.
2. Governed by the Companies Act and Banking Regulation Act of India.
3. Regulated by the Reserve Bank of India and SEBI.
4. Listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)
5. 53 per cent owned by the Government of J&K.
6. Rated "P1+" by Standard and Poor- CRISIL connoting highest degree of safety.
7. Four decades of uninterrupted profitability and dividends.

Unique Characteristics: One of a kind

1. Private sector Bank despite government holding 53 per cent of equity.
2. Sole banker and lender of last resort to the Government of J&K.
3. Plan and non -plan funds, taxes and non-tax revenues routed through the bank.
4. Salaries of Government officials disbursed by the Bank.
5. Only private sector bank designated as agent of RBI for banking.
6. Carries out banking business of the Central Government.
7. Collects taxes pertaining to Central Board of Direct Taxes in J&K.

Brand Identity
The new identity for J&K Bank is a visual representation of the Banks philosophy and
business strategy. The three colored squares represent the regions of Jammu, Kashmir and
Ladakh. The counter-form created by the interaction of the squares is a falcon with
outstretched wings a symbol of power and empowerment.

The synergy between the three regions propels the bank towards new horizons. Green
signifies growth and renewal, blue conveys stability and unity, and red represents energy and
power. All these attributes are integrated and assimilated in the white counter-form
NATURE OF THE BUSINESS
Banks safeguard money and valuables and provide loans, credit, and payment
services, such as checking accounts, money orders, and cashiers checks and offer
investment and insurance products, which they were once prohibited from selling.
There are several types of banks, which differ in the number of services they provide
and the clientele they serve.

 Commercial banks, which dominate this industry, offer a full range of services for
individuals, businesses, and governments. These banks come in a wide range of sizes,
from large global banks to regional and community banks.
Global banks are involved in international lending and foreign currency trading, in
addition to the more typical banking services.
Regional banks have numerous branches and automated teller machine (ATM)
locations throughout a multi-state area that provide banking services to individuals.
Banks have become more oriented toward marketing and sales.
Community banks are based locally and offer more personal attention, which many
individuals and small businesses prefer.
Savings banks and savings and loan associations, sometimes called thrift institutions,
are the second largest group of depository institutions.
Federal Reserve banks are Government agencies that perform many financial services
for the Government. Their chief responsibilities are to regulate the banking industry
and to help implement Nations monetary policy.
Interest on loans is the principal source of revenue for most banks, making their
various lending departments critical to their success. The money to lend comes
primarily from deposits in checking and savings accounts, certificates of deposit,
money market accounts
Technology is having a major impact on the banking industry. Electronic banking by
phone or computer allows customers to pay bills and transfer money from one
account to another. Through these channels, bank customers can also access
information such as account balances and statement history.
Use of check imaging, which allows banks to store photographed checks on the
computer, is one such example that has been implemented by some banks.
Many banks now offer their customers financial planning and asset management
services, as well as brokerage and insurance services, often through a subsidiary or
third party. Others are beginning to provide investment banking services that help
companies and governments raise money through the issuance of stocks and bonds

VISION AND MISSION

Vision
To catalyze economic transformation and capitalize on growth.
Banks vision is to engender and catalyze economic transformation of Jammu and
Kashmir and capitalize from the growth induced financial prosperity thus engineered. The
bank aspires to make Jammu and Kashmir the most prosperous state in the country, by
helping create a new financial architecture for the J&K economy, at the center of which
will be the J&K Bank.
The Bank's vision is to be financially sound, profitable, growth and technology oriented,
committed to building and maximizing sustainable value for all its stakeholders. The
Bank is committed to achieve healthy growth in profitability and simultaneously to
remain consistent with the Bank's risk appetite and at the same time ensuring the highest
levels of ethical standards, professional integrity and regulatory compliance.
Mission
Our mission is two-fold: To provide the people of J&K international quality financial
service and solutions and to be a super-specialist bank in the rest of the country. The two
together will make us the most profitable bank in the country.
Quality Policy:
The bank begun its much-delayed expansion plan in 2011-12, improved its earnings and kept
the asset quality stable in the first half of this financial year. Recently, it sold a part of its
stake in MetLife for a profit of Rs 140-150 crore. This has made the banks share attractive to
investors, market analysts said.
At the current market price, J&K Bank is trading reasonably at 1.15x FY14 ABV. We
believe they deserve to get a better multiple, on the back of consistent performance on asset
quality as well as strong return ratios (RoA/RoE) over the last couple of years. Its superior
provision coverage ratio is icing on the cake and stands as one of the best in the industry
(greater than 93 per cent, including technical write-offs), providing cushion to its future

earnings, with any unforeseen deterioration in asset quality, going forward, said Saday
Sinha, vice-president, equity research, Kotak Securities.
PRODUCTS OF J&K BANK

LOANS

Home Finance

Educational
Finance

Automobile
Finance

Home finance: Housing Loan Schemes

Educational Finance: Education Loan Scheme
Term Loan Scheme for B.Ed / M.Ed. courses
Bud shah Primary Education Finance
Automobile Finance: Car Loan Scheme
Car Loan For Used Cars
Commercial Vehicle Finance
Commercial Vehicle Finance(Used Vehicles)
Two Wheeler Finance

Commercial
loans

Specialized
Finance

Other Finances: Consumer Loan

Consumption Loan
Personal Loan to Pensioners
Mortgage loan for Trade and Service Sector
Loans against Mortgage of Immovable Property
Fair Price Shop Scheme
Travel and Tourist taxi operators
Specialized Finance: Help Tourism (For Kashmir valley only)
All purpose Agri term Loan
Fruit Advances Scheme (Apple)
Zaffron Finance
Roshni Financing Scheme
Craft Development Finance
Dastkar Finance
Giri Finance Scheme
Khatamband Craftsmen Finance
Commercial Premises Finance
Laptop/PC Finance

Saving and Deposits

Saving Bank
Deposits

Term &
Deposits

Value Added
Services

Gift Cheque
Schemes

Current
Accounts

Saving Bank Deposits: Saving Bank Deposit Scheme

SB Ujala- No Frills Account
Term Bank Deposits: Millennium Deposits Scheme
Flexi Deposits Scheme
Fixed Deposits Scheme
Child Care Scheme
Cash Certificates
Super Earner Deposits Scheme
Recurring Deposits Scheme
Recurring Plus Account
Smart Saver Scheme
Depositors Pension Scheme
Value Added Schemes: Tax Saver Term Deposit Scheme
Mehendi Deposit Certificate
Current Accounts: Platinum Account
Gold Account
Premium Plus Account
Premium Account
Basic Account

Other Business of J&K Bank

Life Insurance

MUTUAL FUND

MetLife India
Insurance

Non Life Insurance

Bajaj Allianz
General Insurance
Co. Ltd

CARDS

Global Access
Card

Empowerment
Credit Card

Merchant
Acquiring (Point of
Sale Equipment)

AREA OF OPERATION
The Bank has its main market of operation in the state of Jammu and Kashmir. The
branch network of the bank is so dense that it has its branch every two kilometres.
The bank has also registered its presence in the main cities of India.
The bank is extensively supportive of small scale businesses and tourism in the state.
The bank constituted the J&K Bank Rural Self Employment Training Institutes
(JKBRSETI) Society, registered with Registrar of Society, Directorate of Industries
and Commerce (Kashmir), Srinagar for setting up JKBRSETIs in all the 12 lead
districts of the bank.

 The bank constituted a trust under the title Jammu and Kashmir Bank Social
Conscience Trust to prevent heritage and to take eco-preservation initiative.
The Bank operates a Regional Rural bank under the name J&K Grameen Bank.
The Bank is also active in the field of corporate social responsibility like providing
financial assistance for medical aid, supporting sports and educational institution.

OWNERSHIP PATTERN

SHARE HOLDING PATTERN AS ON 31.03.2013

SR.NO.

PARTICULARS

NO OF SHARES

TOTAL

PHYSICAL ELECTRONIC SHARES

%
TO
CAPITAL

GOVERNMENT OF J&K

25775266

25775266

53.17

INDIAN MUTUAL FUNDS

2120006

2120006

4.37

INSURANCE COMPANIES 0

215608

215608

0.44

BANKS

2100

2100

0.00

NON RESIDENT INDIANS

1600

269352

270952

0.56

10963479

10963479

22.62

FOREIGN

INST.

INVESTORS

BODIES CORPORATES

24094

3365353

3389447

6.99

RESIDENT INDIVIDUALS

2032949

3696908

5729857

11.82

CLEARING MEMBERS

11087

11087

0.02

TOTAL

2058643

46419159

48477802

100.00

INFRASTRUCTURE FACILITIES
Head Office
J&K bank has its headquarter in Srinagar. Due to extreme cold during the winters it
becomes necessary to provide heating facilities.
The four storied building has several facilities for its employees and other customers.
The building houses the office of chairman and other important personnels of the
bank.
There is a cafeteria in the premises which serves the employees with quality food.
The Basement consists of parking facility.
There is a small park in the premises for employees.
The bank currently has 11 zonal office
1. Kashmir central.
2. Kashmir south .
3. Kashmir north
4. Ladakh
5. Jammu central.
6. Jammu west
7. Jammu north
8. Upper north Mohali
9. North Delhi
10. Mumbai
11. South Bangalore.
Besides J&K bank has RCCs in Kashmir(Srinagar),Jammu, Delhi and Mumbai

Branches
The bank has more than 750 branches all over the country, and 726 ATMs across the
country as on October 1, 2013.
The branches are fully computerized with latest technology.
All the CBS branches of the bank have been enabled for RTGS and NEFT facility.

2.9 ACHIEVEMENTS AND AWARDS

J&K Banks Annual Report 2008-09 has won three awards at the prestigious LACP
2009 Vision Awards the worlds largest award programme for Annual Reports,
organized by California-based League of American Communications Professionals
(LACP), USA.
The LACP is a forum within the public relations industry that facilitates discussion of
best-in-class practices in public relations and recognizes exemplary communication
capabilities at a global level. The awards received include Rank 73 on the top
hundred list of annual reports from around the world, Platinum Award in the
Commercial Banks Up to $10billon annual revenue from the Asia Pacific Region
and Silver Award for Most Creative Report across all sectors from the Asia Pacific
Region.
J&K bank received the BANKING TECHNOLOGY 2009 Award presented by IBA
& TFCI on 28th Jan 2010.
The Bank was awarded ASIAN BANKING AWARD 2005 for its development
project financing programme in recognition of contributing significantly to the
development of tourism industry of the J&K state. The Bank has won the ASIAN
BANKING AWARD for the second consecutive year.
The J&K Bank has bagged the prestigious Financial Express Best Banks Award in the
Old Private Sector Banks category for scaling up its business and strengthening the
balance for the year ending March 2011.
The Bank has been awarded as the best Bank in the prestigious Dun & Bradstreet
(D&B) Polaris Software Banking Awards 2011. The award was conferred in the
category for Rural Reach- Private Sector.
J&k bank was conferred with the prestigious HR Leadership Award at IPE HRM
Congress Awards organized under the aegis Asia Pacific HRM Congress (APHC)
2012-13
J&K bank emerged as the Best Bank in the Old Private Sector Bank category at
the CNBC. TV18 Indias Best Bank and Financial Institution Awards 2012-13.
The Sunday Standard FINWIZ Best Bankers Award 2012-13
J&K Banks sustained focus on all the areas of banking during the past two years
enabled it to win four national awards at The Sunday Standard FINWIZ Best
Bankers Award.

 Conferred Best Banker in Financial Inclusion and Customer Friendliness

award
Runner-up for the Best Banker in priority Sector Growth and Agricultural
Credit
J&k Banks Chairman & CEO Mushtaq Ahmad were rated as the top ranked
CEO for being accomplished in all aspects of banking.

WORK FLOW MODEL

APPLICATION FROM THE CUSTOMER

DETAILED ANALYSIS OF THE APPLICATION AND DOCUMENTS

STUDY OF RESULTS BY THE CONCERNED DEPARTMENTS

RECOMMENDATIONS BY THE DEPARTMENTS

APPROVAL / REJECTION FROM THE CONCERNED MANAGER

FINAL SANCTION/ISSUE OF PRODUCTS AND SERVICES

MONITORING AND FOLLOW-UP

CONTROL

FUTURE GROWTH AND PROSPECTUS

Over the last several years RBI has undertaken wide-ranging financial sector reforms
to improve financial intermediation and maintain financial stability.
Over Rs. 30,800 Crore have been earmarked for the state under the prime ministers
Reconstruction Program for the 11th Five Year Plan.
In order to compete with other nationalized and private sector banks J&K is planning
to register its presence across India by opening its branches.
The Bank is adapting to new technologies effectively to provide faster and secure
banking services.
The bank is reviving its Human Resource policies to acquire the best talent from the
market in order to compete with other international banks in India.
Bank is emphasizing on its Small and Medium sector loans to promote growth in the
rural region of the state, including Tourism.
The Bank has also implemented Disaster Recovery Setup of a zero data loss by TCS.
The bank is also planning to atomize stationary management and Internal Audit
Reporting.
The bank will continue its efforts to make every single process technology driven. All
business units will be migrated to CBS platform and more importantly, 0-Data Loss
system (3 ways DC/DR) will be setup by March 2012.
Other future IT initiatives include introduction of mobile banking, back-up solution
upgrade tape library for DC/DR, setting up of call centre, enhanced IT security
through oracle audit vault & video surveillance for 50 business units.
Mc Kinseys 7S Frame Work
The McKinsey 7S Framework is a management model developed by well-known business
consultants Waterman and Peters in the 1980s. This was a strategic vision for groups, to
include businesses, business units, and teams. The 7S are structure, strategy, systems,
skills, style, staff and shared values.

The model is based on the theory that, for an organization to perform well, these seven
elements need to be aligned and mutually reinforcing. So, the model can be used to help
identify what needs to be realigned to improve performance, or to maintain alignment (and
performance) during other types of change.
Whatever the type of change restructuring, new processes, organizational merger, new
systems, change of leadership, and so on the model can be used to understand how the
organizational elements are interrelated, and so ensure that the wider impact of changes made
in one area is taken into consideration.
Strategy
To integrate technology and business so as to deliver more products to more
customers and to control operating costs.
To develop innovative products and services that meets the needs and wants of
targeted customers and address inefficiencies in the Indian financial sector.
To increase the visibility in the market and enhance the market share in the banking
and financial services.
High quality of customer service.
To continue to develop products and services that reduces our cost of funds.

 To focus on high earnings growth low volatility.

Systems
Under systems comes the procedures and processes to do the work, information systems,
performance appraisal system, financial systems etc.
MIS: Entire computerized credit portfolio covered.
Archival Database: For maintenance of historical records of branches rolled over to
CBS.
Disaster Recovery Setup: Implementation of a Zero Data Loss DR system by TCS.
Structure
The structure of the organization depicts the flow of work. It satisfies the interrelations
among departments. The organizational structure of j&k bank is quite good which allows
smooth functioning of work throughout the organization.
Skills:
Skills specify the capabilities of personnel or of the organization as a whole. Banking
industry requires excellent analytical decision making skills.

J&K Bank in this regard

engages its staff members in the training programs. The bank has tie up with two training
institutions where training for the organizational personnel takes place after every six months.
Staff:
At J&K Bank, we recognize staff as an area of core competence, and seek to pursue, nurture
and retain the best talent. The ultimate aim of staff function is to build and manage a
motivated pool of professionals by growing internal resources.
Creation of 22 business clusters to enhance growth, improve functional efficiency
and ensure better monitoring.
Introduction of IT based RAAHAT an employee grievance redressal mechanism
as a part of Corporate Governance.
More than 3650 officials have been trained/retrained in various fields.
Various benefit schemes like DA/Pension, 30 % increase in yearly medical aid,
Reimbursement of newspaper and telephone bills enhancement of loan limits.

 The Staff strength is around 7267 employees with a plan of adding 1000 new
employees in the year 2011-12.
Style
Being a government undertaking J&K bank follows democratic style of leadership.
To ensure smooth functioning of organization frequent Board meetings are conducted
in which participation is encouraged right from the bottom level to the chairman.
Employees are consulted frequently for their suggestions and feedbacks, and adequate
steps are taken to embrace the suggestions.
Shared Value
Being a Financial Institution ethical and moral values are emphasized in the
organization.
Most of the employees are from the J&K region which results in a homogenous
culture in all its branches.
Employees are expected to maintain confidentiality and embrace fair work practices.

SWOT ANALYSIS
STRENGTH:
Main strength of J&K Bank is its monopoly in the state of J&K. The bank has almost
negligible competitors with respect to their market capture in the state.
The bank has very strong market share in the state, with almost one branch at just
2kms of distance.
The bank has successfully created very strong brand image in the hearts and minds of
people of J&K, which is their main market. People have also great faith in the bank
that they cant think of any other bank before it.
J&K Bank is the highly growing bank which offers the widest range of financial
products.
J&K Bank offers 3 in 1 account which shows its growing.
It is one of the Indias largest Banks and has a national wide network 750 branches.
It also provides every type of credit creation towards every field.
J&K Bank pays a great attention towards rural development.

 J&K bank is also known as Billionaire Company nowadays celebrating its 75 th years
of service.
WEAKNESS:
Lack of promotional activity: The J&K Bank has targeted new customers and has
penetrated the market extensively. However, the customer relation has been a grey
area on account of growing customer disenchantment and required constant
promotional campaigns to ensure customer patronage. Hence, the level of brand
awareness and improvement has to be ameliorated to build customer patronage.
Lack of training and facilities: The Company did not hitherto provide any training to
the customers for operation of accounts. Online Trading being a new service in the
field of banking requires pertinent training as to the mode of operation, customized
facilities etc.
Higher brokerage rates: The brokerage charged by the company, especially on the
delivery transactions is very high in comparison to the competitor.
OPPORTUNITIES
Increasing users of Internet: As per research India is adding millions of internet
users every year. This provides a huge opportunity to J&K Bank to tap such users.
Increase in the number of investors entering the stock market: Recently due to the
surge in IPOS and increased income of people in India has led to more people
taking interest in stock market which is a huge opportunity for J&K Bank
Tax saving online: ICICIdirect.com offers many products like tax saving Bond and
Mutual funds. People today are keen on tax saving and for the same they can invest
in these products online. Thus this brings in a huge potential market for J&K Bank.
Providing true service: ICICIdirect.com reduces paper work, reduces hassles like
the brokers and following the investment along with this it assures safety and
security. Thus J&K Bank is potentially one of the most revolutionary products
which will find increased usage in this modern world.
THREATS:
Fear of safety: People in India are very averting to giving out their credit card
numbers or buying and selling shares. This mentality possesses a significant trend
because J&K Bank in its essence is a portal for online trading in securities.

 Emergence of other players: New players like Yes Bank and HDFC have entered the
market offering two in one (2 in 1) accounts and can in future grow into offering 3 in1
accounts.
Fluctuations in the securities Market: Stock market scams, increase in oil prices,
terrorist attracts etc. because huge fluctuations in security market which dissuades
investors who opt for liquidity or gold.

Role of j&k bank in economic development:

The Jammu and Kashmir bank had played an important role in the development of the
state and enhancing trade and commerce within and outside the state. The growth and
development of Jammu and Kashmir bank with the passage of time has been significant
and its success story is glaring and extraordinary. Jammu and Kashmir bank is touching
new highs as a successful and growing business company which has made its mark in the
country.
J&K Bank has played a key role in economic development of all the regions of the state
of Jammu and Kashmir. A large network of business units and ATMs across the length
and breadth of state speaks volumes as to how deeply this proud institution of the state is
connected with the people of the state. Bank has touched lofty heights over the decades
especially during the past 25 years. Comparative facts and figures speak volumes about
the journey of progress the bank has made. J&k Bank has also played an important role
in generating direct as well as indirect employment opportunities for the youth of the
state. The Jammu and Kashmir Bank has been playing significant role for the upliftment
of poor, to raise the living standard of masses and also to mitigate their socio-economic
conditions to achieve balanced economic growth with social justice in the state of Jammu
and Kashmir via its Services. In the backdrop, the J&K Bank has been playing significant
role for the upliftment of poor and to raise the Living standard of masses and ameliorate
their socio-economic conditions to achieve balanced economic growth with social justice
in the state of Jammu and Kashmir. The bank has reached to those people who have
certain Entitlements in the form of productive assets, education and skills; the possession
of otherwise can generate Incomes to by the food requirements above the subsistence
level. Since poverty originates in the villages the bank took various initiatives to eradicate
it. A number of banks poverty eradication programme are rural centric. Under the
programme the bank undertakes various initiatives to raise the standard of people and

elevate poverty. J&k bank believes in the upliftment of youth, to practice it has
established 12 rural self-employment training institutes (RSETIS)

SECTOR-WISE ANALYSIS OF PRIORITY SECTOR CREDIT:

I) AGRICULTURE SECTOR:
Against the annual target of Rs.3, 212.98 Crore for 3, 91,773 beneficiaries set by SLBC,
banks have disbursed a total amount of Rs.1, 094.73 Crore in favour of 93,746 beneficiaries
under Agriculture Sector by the end of September 2013 thereby registering an achievement of
34% in financial terms and 24% in physical terms. Out of this, an amount of Rs.604.80 Crore
in favour of 64,693 agriculturists has been disbursed under Crop Loan against the target of
Rs.1899.18 Crore favouring 2,86,174 beneficiaries, thereby registering achievement of 32%
in financial & 23% in physical terms.

Major contributors under Agriculture Sector are; J&K Bank (Rs.800.88 Crore i.e. 73%
vis--vis total disbursements), J&K Grameen Bank (Rs.70.39 Crore), SBI (Rs.53.62
Crore), Punjab National Bank (Rs.43.48 Crore) and EDB (Rs.39.89 Crore).

(II) MICRO & SMALL ENTERPRISES SECTOR:

As against the annual target of Rs.3, 572.86 Crore for 1, 34,362 beneficiaries, banks have
Disbursed an amount of Rs.1129.66 Crore in favour of 43,317 beneficiaries by the end of
September 2013, thereby registering an achievement of 32% of the target in financial as well
as physical terms.
Major contributors are: J&K Bank (Rs.642.97 Crore i.e. 57% vis--vis total
Disbursements), SBI (Rs.184.27 Crore), PNB (Rs.44.49 Crore) and J&K Grameen Bank
(56.72 Crore).

(III) EDUCATION:
As against the annual target of Rs.417.53 Crore in favour of 10,916 beneficiaries banks
have Disbursed total amount of Rs.53.46 Crore in favour of 3335 beneficiaries by the end of
September 2013. This works out to just 13% achievement in financial terms and 31% in
Physical terms.
Major contributors are: J&K Bank (Rs.36.22 Crore i.e. 68% vis--vis total
disbursements), SBI (Rs.7.07 Crore) & PNB (Rs.4.92 Crore).

(IV) HOUSING:
As against the annual target of Rs.2,040.33 Crore in favour of 33,124 beneficiaries banks
have disbursed total amount of Rs.655.21 Crore in favour of 24,947 beneficiaries by the end
of September 2013. This works out to an achievement of 32% in financial terms and 75% in
physical terms.
Major contributors are: J&K Bank (Rs.583.51 Crore i.e. 89% vis--vis total
disbursements), SBI (Rs.35.39 Crore) and PNB (Rs.6.50 Crore).

(V) OTHER SECTOR

As against the annual target of Rs.898.77 Crore in favour of 43,314 beneficiaries banks
have disbursed total amount of Rs.317.66 Crore in favour of 14,172 beneficiaries by the end
of September 2013. This works out to 35% achievement in financial terms and 33% in
physical terms.
Major contributors are: J&K Bank (Rs.242.39 Crore i.e. 76% vis--vis total
disbursements), SBI (Rs.43.08 Crore) and PNB (Rs.4.98 Crore).

SECTOR-WISE ANALYSIS OF NON-PRIORITY SECTOR CREDIT:

I) HEAVY INDUSTRIES SECTOR:

Against the annual target of Rs.829.60 Crore for 2,639 beneficiaries, banks have disbursed a
total amount of Rs.256.73 Crore in favour of 85 beneficiaries under Heavy Industries Sector
by the end of September 2013 thereby registering an achievement of 31% in financial terms
and 3% in physical terms.
The J&K Bank is the sole contributor under this sector (100% lending).

II) MEDIUM INDUSTRIES SECTOR:

Against the annual target of Rs.566.28 Crore for 11,516 beneficiaries, banks have disbursed
a total amount of Rs.49.25 Crore in favour of 715 beneficiaries under Medium Industries
Sector by the end of September 2013 thereby registering an achievement of 9% in financial
terms and 6% in physical terms.
Out of total disbursement of Rs.49.25 Crore, the contribution of J&K Bank alone is to
the tune of Rs.46.66 Crore, which constitutes 95% achievement.
Major contributors are: J&K Bank (Rs.46.66 Crore), SBI (Rs.1.54 Crore) & HDFC
Bank

(Rs.0.88 Crore).

(III) EDUCATION:
As against the annual target of Rs.310.64 Crore in favour of 2912 beneficiaries banks have
disbursed total amount of Rs.5.44 Crore in favour of 78 beneficiaries by the end of
September 2013. This works out to a meager achievement of 2% in financial terms and 3% in
physical terms.
Major contributors are: J&K Bank (Rs.2.47 Crore i.e. 45% vis--vis total
disbursements) & OBC (Rs.2.25 Crore i.e. 41% vis--vis total disbursements).

(IV) HOUSING:
As against the annual target of Rs.858.93 Crore in favour of 4355 beneficiaries banks have
disbursed total amount of Rs.47.16 Crore in favour of 1017 beneficiaries by the end of
September 2013. This works out to an achievement of 5% in financial terms and 23% in
physical terms.
Major contributors are: J&K Bank (Rs.30.19 Crore i.e. 64% vis--vis total
disbursements), P&S Bank (Rs.9.70 Crore i.e. 21% vis--vis total disbursements) and
SBI (Rs.5.31 Crore).

(V) OTHER SECTOR

As against the annual target of Rs.3,614.78 Crore in favour of 1,46,323 beneficiaries banks
have disbursed total amount of Rs.1998.19 Crore in favour of 54942 beneficiaries by the
end of September 2013. This works out to 55% achievement in financial and 38% in physical
terms.
Major contributors are: J&K Bank (Rs.1430.78 Crore i.e. 72% vis--vis total
disbursements), SBI (Rs.181.58 Crore), HDFC (Rs.106.07 Crore), J&K Grameen Bank
(Rs.70.97 Crore) and Bank of India (Rs.51.69 Crore).

The Banks Financial Statement for FY 2009 to FY 2013 is tabulated as under:

Profit and Loss Statement:
Schedule
no
I.

As on
31.03.2013

As on
31.03.2012

As on
31.03.2011

As on
31.03.2010

As on
31.03.2009

Income

Interest earned
Other income
Total
II. EXPENDITURE
Interest expanded
Operating expenses
Provisions and contingencies
Total
III. NET PROFIT

13

61,368,010

48,355,773

37,131,322

30,568,791

29,881,197

14

4,837,264

3,341,232

3,647,562

4,162,357

2,450,539

66,205,274

51,697,005

40,778,884

34,731,148

32,331,736

15

38,207,570

29,972,224

21,694,685

19,375,430

19,878,612

16

9,890,151

8,021,519

7,589,318

5,773,672

4,708,607

7,556,571

5,670,757

5,342,862

4,458,258

3,646,162

55,654,292

43,664,500

34,626,865

29,607,360

28,233,381

10,550,982

8,032,505

6,152,019

5,123,788

4,098,355

66,205,274

51,697,005

40,778,884

34,731,148

32,331,736

2,637,746

2,008,126

1,538,005

1,288,947

1,023,389

(487,500)

4,283,677

4,136,797

3,144,235

2,587,075

2,115,992

49,629

1,231,600

2,423,890

1,624,006

1,260,423

1,066,512

819,671

411,940

263,576

209,356

181,254

139,303

10,550,982

8,032,505

6,152,019

5,123,788

4,098,355

217.65

165.69

126.90

105.69

84.54

TOTAL
IV. APPROPRIATIONS
Transferred to
i. Statutory reserve
ii. Capital reserve
iii. Trf. From revenue and
other reserves (for
special reserves FY
2011-12)
iv. Revenue and other
reserve
v. Investment reserve
vi. Special reserve
vii. Proposed dividend
viii. Tax on dividend
TOTAL
Principal accounting policies
Notes on accounts
Earnings per
share(basic/diluted)

17
18

Balance Sheet:
Schedule no

Capital and
liabilities
Capital
Reserves and
surplus
Deposits
Borrowings
Other liabilities
and provisions
Total
Assets
Cash and
balance with
RBI
Balance with
banks &
money at call
and short
notice
Investments
Advances
Fixed assets
Other assets
Total
Contingent
liabilities
Bills for
collection
Principal
accounting
policies
Notes on
accounts

As on
31.03.2013
(000
omitted)

As on 31.03.2012
(000 omitted)

As on
31.03.2011
(000
omitted)

As on
31.03.2010
(000
omitted)

As on 31.03.2009
s(000 omitted)

484,922

484,922

484,922

484,922

484,922

48,162,020

40,446,869

34,301,946

29,619,706

25,743,684

642,206,195

533,469,016

446,759,350

372,371,604

285,932,630

10,750,000

12,409,572

11,046,502

11,002,064

9,966,265

15,830,014

15,881,824

12,488,814

11,989,652

10,696,711

717,433,151

602,692,203

505,081,534

425,467,948

327,559,871

26,951,472

27,836,539

29,749,638

27,447,263

32,199,667

27,091,812

16,702,140

5,738,477

18,695,109

12,172,743

257,410,654

216,243,188

196,957,679

139,562,473

87,576,631

392,004,104

330,774,215

261,936,350

230,572,250

188,826,118

10

4,561,791

4,202,704

3,937,702

2,041,332

1,920,015

11

9,413,318

6,933,417

6,761,688

7,149,521

4,864,697

505,081,534

425,467,948

327,559,871

12

17

18

717,433,151

602,692,203

322,827,985

150,660,768

255,176,641

114,992,485

8,959,964

9,203,354

14,616,755

5,922,643

112,644,286

6,285,380

The above financial statement can be analyzed under following Heads

a. The TOTAL INCOME TO FIXED ASSETS:
Total income to fixed assets = total income/Fixed assets*100
years

Total income

Fixed assets

Ratio (in times)

2009

66205274

4561791

14.51

2010

51697005

4202704

12.30

2011

40778884

3937702

10.35

2012

34731148

2041332

17.01

2013

32231736

1920015

16.80

Total Income to Fixed Assets

18
16
14
12
10
8

Total Income to Fixed Assets

6
4
2
0
2009

2010

2011

2012

2013

Interpretation:The total income to assets ratio shows a relation between total income and the fixed assets of
the company. A high ratio signifies a good operating position of the company while low ratio
reveals the inefficiency. From the graph it is evident that there is a sudden downturn in the
ratio for 2013. However, the ratio is satisfactory.

b. DEBT EQUITY RATIO:

Debt Equity Ratio = Total External Debt/ Internal Equities x 100

PARTICULARS

(IN CRORES)

RATIO

YEARS DEBT

EOUTY SHARE HOLDERS FUNDS

2009

306595606

26228606

11.68

2010

395363320

27104628

14.58

2011

470294666

34786868

13.51

2012

561760412

40931791

13.72

2013

668786209

48646942

13.75

DEBT EQUITY RATIO

15
10
DEBT EQUITY RATIO

5
0
2009

2010

2011

DEBT EQUITY RATIO

2012

2013

Interpretation:
The debt equity ratio is an important tool of financial analysis to appraise the financial
structure of the firm. The ratio reflects the relative contribution of creditors and owners of the
business in its financing. A high ratio shows a large share of financing by the creditors of the
firm, a lower ratio implies a smaller claim of the creditors. Debt equity ratio indicates the
margin of safety to the creditors. It is a danger signal for the creditors and the creditors are
under risk. Though the debt equity ratio is higher by observing the above table, we can say
that the ratio is gradually decreasing year by year. This shows a good sign for the creditors.

c. EARNING PER SHARE:Earnings Per Share (EPS) of Jammu and Kashmir bank over the last five years.
Year

EPS

2009

84.54

2010

105.69

2011

126.90

2012

165.69

2013

217.65

Graph showing rising trend in EPS of Jammu and Kashmir bank.

Growth in EPS
250
217.65
200
165.69

150
126.9

Growth in EPS

105.69

100
84.54
50
0
2009

2010

2011

2012

2013

Interpretation: - Earnings per share (EPS) is the portion of the companys distributable
profit which is allocated to each outstanding equity share (common share). Earnings per share
are a very good indicator of the profitability of any organization, and it is one of the most
widely used measures of profitability. EPS when calculated over a number of years indicates
whether the earning power of the company has improved or deteriorated. Growth in EPS is an
important measure of management performance because it shows how much money the
company is making for its shareholders. From the above graph its clear that the EPS of J&K
Bank has increased from year to year, which shows the ability of management of the
company.

d. NET PROFIT TO FIXED ASSETS:

Net Profit after tax / Fixed Assets x 100

(000 omitted)

(000 omitted)

YEAR

NET PROFIT

FIXED ASSETS

2008

10550982

4561791

2009

8032505

4202704

1.23

2010

6152019

3937702

1.16

2011

5123788

2041332

1.51

2012

4098355

1920015

0.97

RATIO
1.1

NET PROFIT TO FIXED ASSETS

3
2.5
2
NET PROFIT TO FIXED ASSETS

1.5
1
0.5
0
2009

2010

2011

2012

2013

Interpretation:
The net profit to total assets ratio shows a relation between the net profits of the firm and the
total assets after revaluation. The above graph shows a fluctuating trend and it shows decline
in the 2010-11. However the net profits of the bank are showing an increasing direction
indicating more investment has been done on the infrastructural facilities.

e. GROWTH IN PROFITS
Profits and percentage growth in profits for the year 2009-2013
Years

Profit 000 omitted

Growth in profits (%)

2009

4098355

100

2010

5123788

25

2011

6152019

50.

2012

8032505

96

2013

10550982

157

Graph no:-

Growth in profits
180
160
140
120
100
Growth in profits

80
60
40
20
0
2009

2010

2011

2012

2013

Interpretation:The ability of a company to survive more particularly in this competitive world, to a great
extent depends upon its generation of return/profits. It helps the company to undertake the
expansion, to face the competition effectively and to grow and prosper. From the above graph
its clear, keeping 2009 as base the profits have grown satisfactorily. Keeping 2009 as base
profits grow at 25%, 50%, 96% and finally increase of 157% in year 2012-13, which is a
good sign for the company.

RISK OVERVIEW
AND BASEL
COMMITTEEE

Chapter -3

RISK OVERVIEW
Risk is inherent in any walk of life in general and in financial sectors in particular. Till
recently, due to regulate environment, banks could not afford to take risks. But of late, banks
are exposed to same competition and hence are compelled to encounter various types of
financial and non-financial risks. Risks and uncertainties form an integral part of banking
which by nature entails taking risks.
Definition: the meaning of Risk as per Websters comprehensive dictionary is a chance of
encountering harm or loss, hazard, danger or to expose to a chance of injury or loss. Thus,
something that has potential to cause harm or loss to one or more planned objectives is called
risk.
Banks for International Settlement (BIS) has defined it as- Risk is the threat that an event or
action will adversely affect an organizations ability to achieve its objectives and successfully
execute its strategies.
The etymology of the word Risk can be traced to the Latin word Rescum meaning Risk at
Sea or that which cuts. Risk is associated with uncertainty and reflected by way of charge on
the fundamental/ basic i.e. in the case of business it is the Capital, which is the cushion that
protects the liability holders of an institution. These risks are inter-dependent and events
affecting one area of risk can have ramifications and penetrations for a range of other
categories of risks. Foremost thing is to understand the risks run by the bank and to ensure
that the risks are properly confronted, effectively controlled and rightly managed. Each
transaction that the bank undertakes changes the risk profile of the bank. The extent of
calculations that need to be performed to understand the impact of each such risk on the
transactions of the bank makes it nearly impossible to continuously update the risk
calculations. Hence, providing real time risk information is one of the key challenges of risk
management exercise. Till recently all the activities of banks were regulated and hence
operational environment was not conducive to risk taking. Better insight, sharp intuition and
longer experience were adequate to manage the limited risks. Business is the art of extracting
money from others pocket, sans resorting to violence. But profiting in business without
exposing to risk is like trying to live without being born. Everyone knows that risk taking is

failure prone as otherwise it would be treated as sure taking. Hence risk is inherent in any
walk of life in general and in financial sectors in particular. Of late, banks have grown from
being a financial intermediary into a risk intermediary at present. In the process of financial
intermediation, the gap of which becomes thinner and thinner, banks are exposed to severe
competition and hence are compelled to encounter various types of financial and nonfinancial risks. Risks and uncertainties form an integral part of banking which by nature
entails taking risks. Business grows mainly by taking risk. Greater the risk, higher the profit
and hence the business unit must strike a trade off between the two. The essential functions of
risk management are to identify, measure and more importantly monitor the profile of the
bank. While Non-Performing Assets are the legacy of the past in the present, Risk
Management system is the pro-active action in the present for the future. Managing risk is
nothing but managing the change before the risk manages. While new avenues for the bank
has opened up they have brought with them new risks as well, which the banks will have to
handle and overcome.

Financial risk
Financial risk is an umbrella term for multiple types of risk associated with financing,
including financial transactions that include company loans in risk of default. When a
company uses debt financing, its creditors will be repaid before its shareholders if the
company becomes insolvent.
Financial risk also refers to the possibility of corporation or government defaulting on its
bonds, which would cause those bondholders to lose their money.
Financial risk can be classified under two heads:
1. Systematic risk.
2. Unsystematic risk.
1. Systematic Risk
Systematic risk is due to the influence of external factors on an organization. Such factors are
normally uncontrollable from an organization's point of view.

It is a macro in nature as it affects a large number of organizations operating under a similar

stream or same domain. It cannot be planned by the organization.
2. Unsystematic Risk
Unsystematic risk is due to the influence of internal factors prevailing within an organization.
Such factors are normally controllable from an organization's point of view.
It is a micro in nature as it affects only a particular organization. It can be planned, so that
necessary actions can be taken by the organization to mitigate (reduce the effect of) the risk.

TYPES OF RISKS ASSOCIATED WITH BANKS

Financial risk is one of the high-priority risk types for every business. Financial risk is caused
due to market movements and market movements can include host of factors. Based on this,
financial risk in banks can be classified into various types such as Market Risk, Credit Risk,
Liquidity Risk, Operational Risk and Legal Risk.

CREDIT RISK
Credit Risk is the potential that a bank borrower/counter party fails to meet the obligations on
agreed terms. There is always scope for the borrower to default from his commitments for

one or the other reason resulting in crystallization of credit risk to the bank. These losses
could take the form outright default or alternatively, losses from changes in portfolio value
arising from actual or perceived deterioration in credit quality that is short of default. Credit
risk is inherent to the business of lending funds to the operations linked closely to market risk
variables. The objective of credit risk management is to minimize the risk and maximize
banks risk adjusted rate of return by assuming and maintaining credit exposure within the
acceptable parameters. Credit risk consists of primarily two components, viz Quantity of risk,
which is nothing but the outstanding loan balance as on the date of default and the quality of
risk, viz, the severity of loss defined by both Probability of Default as reduced by the
recoveries that could be made in the event of default. Thus credit risk is a combined outcome
of Default Risk and Exposure Risk. The elements of Credit Risk are Portfolio risk comprising
Concentration Risk as well as Intrinsic Risk and Transaction Risk comprising
migration/down gradation risk as well as Default Risk. At the transaction level, credit ratings
are useful measures of evaluating credit risk that is prevalent across the entire organization
where treasury and credit functions are handled. Portfolio analysis help in identifying
concentration of credit risk, default/migration statistics, recovery data, etc. In general, Default
is not an abrupt process to happen suddenly and past experience dictates that, more often than
not, borrowers credit worthiness and asset quality declines gradually, which is otherwise
known as migration. Default is an extreme event of credit migration. Off balance sheet
exposures such as foreign exchange forward contracts, swaps options etc are classified in to
three broad categories such as full Risk, Medium Risk and Low risk and then translated into
risk weighted assets through a conversion factor and summed up. The management of credit
risk includes a) measurement through credit rating/ scoring, b) quantification through
estimate of expected loan losses, c) Pricing on a scientific basis and d) Controlling through
effective Loan Review Mechanism and Portfolio Management.
Types of credit risk
Credit risk can be classified as follows
Credit default risk The risk of loss arising from a debtor being unlikely to pay its loan
obligations in full or the debtor is more than 90 days past due on any material credit
obligation; default risk may impact all credit-sensitive transactions, including loans, securities
and derivatives.

Concentration risk the risk associated with any single exposure or group of
exposures with the potential to produce large enough losses to threaten a bank's core
operations. It may arise in the form of single name concentration or industry
concentration.

Country risk The risk of loss arising from a sovereign state freezing foreign
currency payments (transfer/conversion risk) or when it defaults on its obligations
(sovereign risk); this type of risk is prominently associated with the country's
macroeconomic performance and its political stability.

Sovereign risk
Sovereign risk is the risk of a government being unwilling or unable to meet its loan
obligations, or reneging on loans it guarantees. Many countries have faced sovereign risk in
the late-2000s global recession. The existence of such risk means that creditors should take a
two-stage decision process when deciding to lend to a firm based in a foreign country. Firstly
one should consider the sovereign risk quality of the country and then consider the firm's
credit quality. Five macroeconomic variables that affect the probability of sovereign debt
rescheduling are.

Debt service ratio

Import ratio

Investment ratio

Variance of export revenue

Domestic money supply growth

The probability of rescheduling is an increasing function of debt service ratio, import ratio,
variance of export revenue and domestic money supply growth. The likelihood of
rescheduling is a decreasing function of investment ratio due to future economic productivity
gains. Debt rescheduling likelihood can increase if the investment ratio rises as the foreign
country could become less dependent on its external creditors and so be less concerned about
receiving credit from these countries/investors.
Counterparty risk

A counterparty risk, also known as a default risk, is a risk that a counterparty will not pay as
obligated on a bond, credit derivative, trade credit insurance or payment protection insurance
contract, or other trade or transaction. Financial institutions may hedge or take out credit
insurance. Offsetting counterparty risk is not always possible, e.g. because of temporary
liquidity issues or longer term systemic reasons.
Counterparty risk increases due to positively correlated risk factors. Accounting for
correlation between portfolio risk factors and counterparty default in risk management
methodology is not trivial.
Liquidity risk
In finance, liquidity risk is the risk that a given security or asset cannot be traded quickly
enough in the market to prevent a loss (or make the required profit.) .The risk stemming from
the lack of marketability of an investment that cannot be bought or sold quickly enough to
prevent or minimize a loss. Liquidity risk is typically reflected in unusually wide bid-ask
spreads or large price movements (especially to the downside). The rule of thumb is that the
smaller the size of the security or its issuer, the larger the liquidity risk. Although liquidity
risk is largely associated with micro-cap and small-cap stocks or securities, it can
occasionally affect even the biggest stocks during times of crisis. The aftermath of the 9/11
attacks and the 2007-2008 global credit crises are two relatively recent examples of times
when liquidity risk rose to abnormally high levels. Rising liquidity risk often becomes a selffulfilling prophecy, since panicky investors try to sell their holdings at any price, causing
widening bid-ask spreads and large price declines, which further contribute to market
illiquidity and so on.
Types of liquidity risk
Market liquidity An asset cannot be sold due to lack of liquidity in the market
essentially a sub-set of market risk. This can be accounted for by:

Widening bid/offer spread

Making explicit liquidity reserves

Lengthening holding period for VaR calculations

Funding liquidity Risk that liability:

Cannot be met when they fall due

Can only be met at an uneconomic price

Can be name-specific or systemic

MARKET RISK

Market Risk may be defined as the possibility of loss to bank caused by the changes in the
market variables. It is the risk that the value of on-/off-balance sheet positions will be
adversely affected by movements in equity and interest rate markets, currency exchange rates
and commodity prices. Market risk is the risk to the banks earnings and capital due to
changes in the market level of interest rates or prices of securities, foreign exchange and
equities, as well as the volatilities, of those prices. Market Risk Management provides a
comprehensive and dynamic frame work for measuring, monitoring and managing liquidity,
interest rate, foreign exchange and equity as well as commodity price risk of a bank that
needs to be closely integrated with the banks business strategy. Scenario analysis and stress
testing is yet another tool used to assess areas of potential problems in a given portfolio.
Identification of future changes in economic conditions like economic/industry overturns,
market risk events, liquidity conditions etc that could have unfavourable effect on banks
portfolio is a condition precedent for carrying out stress testing. As the underlying
assumption keep changing from time to time, output of the test should be reviewed
periodically as market risk management system should be responsive and sensitive to the
happenings in the market.

a) Liquidity Risk:

Bank Deposits generally have a much shorter contractual maturity than loans and liquidity
management needs to provide a cushion to cover anticipated deposit withdrawals. Liquidity is
the ability to efficiently accommodate deposit as also reduction in liabilities and to fund the
loan growth and possible funding of the off-balance sheet claims. The cash flows are placed
in different time buckets based on future likely behaviour of assets, liabilities and off-balance
sheet items. Liquidity risk consists of Funding Risk, Time Risk & Call Risk. Funding Risk: It
is the need to replace net out flows due to unanticipated withdrawal/nonrenewal of deposit
Time risk: It is the need to compensate for non receipt of expected inflows of funds, i.e.
performing assets turning into nonperforming assets. Call risk: It happens on account of
crystallisation of contingent liabilities and inability to undertake profitable business

opportunities when desired. The Asset Liability Management (ALM) is a part of the overall
risk management system in the banks. It implies examination of all the assets and liabilities
simultaneously on a continuous basis with a view to ensuring a proper balance between funds
mobilization and their deployment with respect to their a) maturity profiles, b) cost, c) yield,
d) risk exposure, etc. It includes product pricing for deposits as well as advances, and the
desired maturity profile of assets and liabilities. Tolerance levels on mismatches should be
fixed for various maturities depending upon the asset liability pro-file, deposit mix, nature of
cash flow etc. Bank should track the impact of pre-payment of loans & premature closure of
deposits so as to realistically estimate the cash flow profile.

b) Interest Rate Risk

Interest Rate Risk is the potential negative impact on the Net Interest Income and it refers to
the vulnerability of an institutions financial condition to the movement in interest rates.
Changes in interest rate affect earnings, value of assets, liability off-balance sheet items and
cash flow. Hence, the objective of interest rate risk management is to maintain earnings,
improve the capability, ability to absorb potential loss and to ensure the adequacy of the
compensation received for the risk taken and affect risk return trade-off. Management of
interest rate risk aims at capturing the risks arising from the maturity and re-pricing
mismatches and is measured both from the earnings and economic value perspective.
Earnings perspective involves analyzing the impact of changes in interest rates on accrual or
reported earnings in the near term. This is measured by measuring the changes in the Net
Interest Income (NII) equivalent to the difference between total interest income and total
interest expense. In order to manage interest rate risk, banks should begin evaluating the
vulnerability of their portfolios to the risk of fluctuations in market interest rates. One such
measure is Duration of market value of a bank asset or liabilities to a percentage change in
the market interest rate. The difference between the average duration for bank assets and the
average duration for bank liabilities is known as the duration gaps which assess the banks
exposure to interest rate risk. The Asset Liability Committee (ALCO) of a bank uses the
information contained in the duration gap analysis to guide and frame strategies. By reducing
the size of the duration gap, banks can minimize the interest rate risk. Economic Value
perspective involves analyzing the expected cash inflows on assets minus expected cash out
flows on liabilities plus the net cash flows on off-balance sheet items. The economic value

perspective identifies risk arising from long-term interest rate gaps. The various types of
interest rate risks are detailed below:
Gap/Mismatch risk:
It arises from holding assets and liabilities and off balance sheet items with different principal
Amounts, maturity dates & re-pricing dates thereby creating exposure to unexpected changes
in the level of market interest rates.
Basis Risk:
It is the risk that the Interest rate of different Assets/liabilities and off balance items may
change in different magnitude. The degree of basis risk is fairly high in respect of banks that
create composite assets out of composite liabilities.
Embedded option Risk:
Option of pre-payment of loan and Fore- closure of deposits before their stated maturities
constitute embedded option risk
Yield curve risk:
Movement in yield curve and the impact of that on portfolio values and income.
Reprice risk:
When assets are sold before maturities.
Reinvestment risk:
Uncertainty with regard to interest rate at which the future cash flows could be reinvested.
Net interest position risk:
When banks have more earning assets than paying liabilities, net interest position risk arises
in case market interest rates adjust downwards.
There are different techniques such as a) the traditional Maturity Gap
Analysis to measure the interest rate sensitivity, b) Duration Gap Analysis to measure interest
rate sensitivity of capital, c) simulation and d) Value at Risk for measurement of interest rate
risk. The approach towards measurement and hedging interest rate risk varies with
segmentation of banks balance sheet. Banks broadly bifurcate the asset into Trading Book
and Banking Book. While trading book comprises of assets held primarily for generating
profits on short term differences in prices/yields, the banking book consists of assets and
liabilities contracted basically on account of relationship or for steady income and statutory
obligations and are generally held till maturity/payment by counter party. Thus, while price
risk is the prime concern of banks in trading book, the earnings or changes in the economic
value are the main focus in banking book. Value at Risk (VaR) is a method of assessing the
market risk using standard statistical techniques. It is a statistical measure of risk exposure

and measures the worst expected loss over a given time interval under normal market
conditions at a given confidence level of say 95% or 99%. Thus VaR is simply a distribution
of probable outcome of future losses that may occur on a portfolio. The actual result will not
be known until the event takes place. Till then it is a random variable whose outcome has
been estimated. As far as Trading Book is concerned, bank should be able to adopt
standardized method or internal models for providing explicit capital charge for market risk.

c) Forex Risk

Foreign exchange risk is the risk that a bank may suffer loss as a result of adverse exchange
rate movement during a period in which it has an open position, either spot or forward or both
in same foreign currency. Even in case where spot or forward positions in individual
currencies are balanced the maturity pattern of forward transactions may produce
mismatches. There is also a settlement risk arising out of default of the counter party and out
of time lag in settlement of one currency in one center and the settlement of another currency
in another time zone. Banks are also exposed to interest rate risk, which arises from the
maturity mismatch of foreign currency position. The Value at Risk (VaR) indicates the risk
that the bank is exposed due to uncovered position of mismatch and these gap positions are to
be valued on daily basis at the prevalent forward market rates announced by FEDAI for the
remaining maturities. Currency Risk is the possibility that exchange rate changes will alter
the expected amount of principal and return of the lending or investment. At times, banks
may try to cope with this specific risk on the lending side by shifting the risk associated with
exchange rate fluctuations to the borrowers. However the risk does not get extinguished, but
only gets converted in to credit risk. By setting appropriates limits-open position and gaps,
stop-loss limits, Day Light as well as overnight limits for each currency, Individual Gap
Limits and Aggregate Gap Limits, clear cut and well defined division of responsibilities
between front, middle and back office the risk element in foreign exchange risk can be
managed/monitored.

d) Country Risk

This is the risk that arises due to cross border transactions that are growing dramatically in
the recent years owing to economic liberalization and globalization. It is the possibility that a
country will be unable to service or repay debts to foreign lenders in time. It comprises of

Transfer Risk arising on account of possibility of losses due to restrictions on external

remittances; Sovereign Risk associated with lending to government of a sovereign nation or
taking government guarantees; Political Risk when political environment or legislative
process of country leads to government taking over the assets of the financial entity (like
nationalization, etc) and preventing discharge of liabilities in a manner that had been agreed
to earlier; Cross border risk arising on account of the borrower being a resident of a country
other than the country where the cross border asset is booked; Currency Risk, a possibility
that exchange rate change, will alter the expected amount of principal and return on the
lending or investment. In the process there can be a situation in which seller (exporter) may
deliver the goods, but may not be paid or the buyer (importer) might have paid the money in
advance but was not delivered the goods for one or the other reasons.
As per the RBI guidance note on Country Risk Management published recently, banks should
reckon both fund and non-fund exposures from their domestic as well as foreign branches, if
any, while identifying, measuring, monitoring and controlling country risk. It advocates that
bank should also take into account indirect country risk exposure. For example, exposures to
a domestic commercial borrower with large economic dependence on a certain country may
be considered as subject to indirect country risk. The exposures should be computed on a net
basis, i.e. gross exposure minus collaterals, guarantees etc. Netting may be considered for
collaterals in/guarantees issued by countries in a lower risk category and may be permitted
for banks dues payable to the respective countries. RBI further suggests that banks should
eventually put in place appropriate systems to move over to internal assessment of country
risk within a prescribed period say by 31.3.2004, by which time the new capital accord would
be implemented. The system should be able to identify the full dimensions of country risk as
well as incorporate features that acknowledge the links between credit and market risks.
Banks should not rely solely on rating agencies or other external sources as their only country
risk-monitoring tool. With regard to inter-bank exposures, the guidelines suggests that banks
should use the country ratings of international rating agencies and broadly classify the
country risk rating into six categories such as insignificant, low, moderate, high, very high &
off-credit. However, banks may be allowed to adopt a more conservative categorization of
the countries. Banks may set country exposure limits in relation to the banks regulatory
capital (Tier I & II) with suitable sub limits, if necessary, for products, branches, maturity etc.
Banks were also advised to set country exposure limits and monitor such exposure on weekly
basis before eventually switching over to real tie monitoring. Banks should use variety of
internal and external sources as a means to measure country risk and should not rely solely on

rating agencies or other external sources as their only tool for monitoring country risk. Banks
are expected to disclose the Country Risk Management policies in their Annual Report by
way of notes.

OPERATIONAL RISK

Always banks live with the risks arising out of human error, financial fraud and natural
disasters. The recent happenings such as WTC tragedy, Barings debacle etc. has highlighted
the potential losses on account of operational risk. Basel I and II accords differentiate risk
into three broad categories, market, credit (counter-party) and operational risks.
Basel I defined operational risk as the risk of direct or indirect loss resulting from
inadequate or failed internal processes, people and systems or from external events. Basel II,
however, defined the operational risk as, the risk of loss resulting from inadequate or failed
internal processes, people and systems or from external events. For emergence of such a risk
four causes have been mentioned and they are people, process, systems and external factors.
The causal based definition is more relevant for managing operational risk. Operational Risk
includes all the aspects of keeping the exposure running on the books of the financial
institution. These aspects are primarily internal to the financial institution and include issues
like Human resources. Organizational set up, legal/regulatory aspects, technology and
procedures followed and systems availed of. The entire focus is on uninterrupted continuity
of operations, which should be achieved as the core of operational risk management process.
Operational Risk differs from other banking risks as it is not typically directly taken in return
for an expected reward but exists in natural course of corporate activity, and that it affects the
risk management process. The most significant difference in Operational Risk and other risks
is that the capital charge for operational risk is not based on quantum of risk-weighted assets.
Failure to address to this risk may result in misstatement of the risk profile of an institution
thereby exposing to significant losses.
SOURCES OF OPERATIONAL RISK
The primary causes that give rise to Operational Risk are lack of control, inadequate
recognition and assessment of the risk of certain banking activities, absence/failure of key
control structures, inadequate communication of information and laxity in audit/monitoring.
Basel II identifies the following risk events,
Internal fraud.
External fraud.
Employment practices and workplace safety.
Clients, products and business practices.
Damage to physical assets.
Business disruption and system failures.
Execution, delivery and process management.

A few more like the following can be added to the list,

Highly Automated Technology.
Emergence of E- Commerce.
Emergence of banks acting as very large volume service providers.
Outsourcing.
Large-scale acquisitions, mergers, de-mergers and consolidations.
Engagement in risk mitigation techniques giving rise to legal risk.
Based on the foregoing, the sources of Operational Risk can be identified.
People Risk: The first source of risk is people. The technology could only reduce the human
intervention but cannot substitute the same. The differing background, education, skills,
personal expectations/ambitions, ethical standards are unique to each individual. Lack of
understanding, skill gaps and above all inadequate training cause problems on manpower
front. The risk has been more than adequately reflected in instances like Barings.
Process Risk: The process in undertaking any transactions entails a chain that includes,
transaction risk, documentation/contract risk, and control risk. Every transaction is an
exposure and completing the end to end is the test. The ratification of transaction is done
through formal documentation that is fraught with risk of legality and regulatory aspects.
These are the potential risk areas. Controlling the transaction can cause an error that can put
the contract or transaction in jeopardy. It is challenging to make any process foolproof to
avoid risk. The miscreants play with the system as they are always on look out for finding the
loopholes in the process. Bank frauds have amply proved this point.
Systems Risk: Financial institutions have two major systems that facilitate doing business.
The first is technology that can create an issue. Failure or inadequate functioning of
technology support can give rise to risky situations. The core of decision-making process is
decision support system provided by the MIS (Management Information System). Reflection
of insufficient or inadequate information while making a decision is another operational risk.
Legal and Regulatory Risk: Compliance with relevant rules/laws/regulations is a herculean
task. Failure to comply with acts related to anti-money laundering can result in anything
between levying pecuniary fines/penalties to cancellation of license to do business. It can be
the same case with US laws on anti-boycott. Even failures to meet with statutory
requirements like cash reserve ratio can be a matter of concern from the risk perspective.
Reputational Risk: Every organization carries a baggage of the past. The revived banks would
not get as much acceptability as the peers because of shady past. At times, a particular sector
comes into disrepute.
Event Risk: Things could go wrong for no fault on the part of the financial institution. Events
like floods or like 9/11 can have disastrous impact on the risk profile. The situation of
insurance business after the floods can be considered as an example in this context.

REGULATORY RISK

When owned funds alone are managed by an entity, it is natural that very few regulators
operate and supervise them. However, as banks accept deposit from public obviously better
governance is expected of them. This entails multiplicity of regulatory controls. Many Banks,
Having already gone for public issue, have a greater responsibility and accountability. As
banks deal with public funds and money, they are subject to various regulations. The very
many regulators include Reserve Bank of India (RBI), Securities Exchange Board of India
(SEBI), Department of Company Affairs (DCA), etc. Moreover, banks should ensure
compliance of the applicable provisions of The Banking Regulation Act, The Companies Act,
etc. Thus all the banks run the risk of multiple regulatory-risks which inhibits free growth of
business as focus on compliance of too many regulations leave little energy and time for
developing new business. Banks should learn the art of playing their business activities
within the regulatory controls.

ENVIRONMENTAL RISK

As the years roll by and technological advancement takes place, expectation of the customers
change and enlarge. With the economic liberalization and globalization, more national and
international players are operating the financial markets, particularly in the banking field.
This provides the platform for environmental change and exposes the bank to the
environmental risk. Thus, unless the banks improve their delivery channels, reach customers,
innovate their products that are service oriented; they are exposed to the environmental risk
resulting in loss in business share with consequential profit.

REPUTATIONAL RISK

Reputational risk, often called reputation risk, is a risk of loss resulting from damages to a
firm's reputation, in lost revenue or destruction of shareholder value, even if the company is
not found guilty of a crime. Reputational risk can be a matter of corporate trust, but serves
also as a tool in crisis prevention. This type of risk can be informational in nature that may be
difficult to realize financially. Extreme cases may even lead to bankruptcy (as in the case of

Arthur Andersen). Recent examples of companies include: Toyota, Goldman Sachs, Oracle
Corporation, NatWest and BP. The reputational risk may not always be the company's fault
as per the case of the Tylenol cyanide panic after seven people died in 1982.
Reputational risks can occur when there is a mismatch between public perceptions and the
actual objectives and resources of the central bank. Serious misconduct, human or system
failures or major difficulties in meeting objectives are not frequent among central banks, but
they can seriously damage credibility when they do occur. Questions concerning ethical
conduct and core principles such as honesty and integrity can pose a more severe test than
purely legal issues, such as litigation against the organisation.

RISK MANAGEMENT
Risk Management: Risk Management is a planned method of dealing with the potential loss
or damage. It is an ongoing process of risk appraisal through various methods and tools
which continuously

Assess what could go wrong

Determine which risks are important to deal with
Implement strategies to deal with those risks

Principles of risk management

The International Organization for Standardization (ISO) identifies the following principles
of risk management:
Risk management should:

create value resources expended to mitigate risk should be less than the consequence of
inaction, or (as in value engineering), the gain should exceed the pain
be an integral part of organizational processes
be part of decision making process
explicitly address uncertainty and assumptions
be systematic and structured process
be based on the best available information
be tailor able
take human factors into account
be transparent and inclusive
be dynamic, iterative and responsive to change
be capable of continual improvement and enhancement
be continually or periodically re-assessed

The risk management objectives are as under

Analyzing and managing all risks (financial, human, information system, strategic
risks) to avoid vertical segmentation effects and all potential impacts from such risks
(financial and non-financial impacts such as reputation, know-how). The scope of
analysis covers the FRR and its stakeholders: its custodian/account-holder, external asset
managers, index providers and other suppliers. One of the sources of added value of this
approach lies in aggregating all of the major risks and ensuring the global consistency of
the risk analysis and organizational action plans.
Alerting the Executive Board of the potential occurrence of major risks and risks deemed
to be unacceptable.
Propose and coordinate the roll-out of action plans designed to reduce or change the
profile of these risks.
Assist with the dissemination of best practices and a risk management culture within the
FRR.
Give the Executive Board an independent opinion on the management indices chosen by
the Finance Division of the Fund for its own management.
Propose or validate risk thresholds by major risk type or area of activity.
Prior to launch, analyze new investment processes from the perspective of financial and
operational risks. Set limits for these new investment processes.

Risk management process

Risk management is a 5 stage process. These processes go simultaneously. These steps are to
be followed for having a good risk management. These steps are listed and explained below:-

1- Risk Identification:This is the first and the most important step of risk management. One cannot do anything
with the risk unless and until that risk has been clearly identified. Risk identification starts
from where the problem originates. Risk identification can be objective based, scenario
based, taxonomy based and common risk checking.

2- Risk Analysis:Risk analysis includes analyzing the risk and measuring its vulnerability or its impact.
Frequency and severity of the risk will be analyzed as well. Risk management can be
quantitative as well as qualitative. Numerically determining the probabilities of various
adverse events and expected extent of losses if any unexpected event occurs is a
Quantitative Analysis where as defining the various threats, devising countermeasures and
determining the extent of vulnerabilities is referred to as Qualitative Risk Analysis.
3- Risk Control:After analyzing the risk then decided that how can the risk be controlled. If the risk can be
controlled by in house then well and good, if not then decide on how to transfer that risk.
Risk control is the entire process of procedures, systems, policies an organization needs to
manage prudently for all the risks which are arising.
4- Risk Transfer:If the risk is not manageable and one cannot retain that risk, then we have to transfer that risk
to a third party. This is the stage where insurance comes in action. Insurance will be willing
to take on those risks which the organization cant handle.
5- Risk Review:Risk review is the last step in which all the above mentioned steps are evaluated. Review
must be regular as the conditions and the circumstances of the business and organizations
changes continuously. It should be monitored that the desired results of the risk management
are being achieved or not and if not then identifying that where the problem occurred and
then reviewing all the steps and making the changed in the management according to
scenario.

Risk Mitigation
Risk mitigation planning is the process of developing options and actions to enhance
opportunities and reduce threats to project objectives. The risk mitigation step involves
development of mitigation plans designed to manage, eliminate, or reduce risk to an

acceptable level. Once a plan is implemented, it is continually monitored to assess its efficacy
with the intent of revising the course-of-action if needed.
Risk Mitigation Strategies
The objectives of risk mitigation and planning are to explore risk response strategies for the
high risk items identified in the qualitative and quantitative risk analysis. The process
identifies and assigns parties to take responsibility for each risk response. It ensures that each
risk requiring a response has an owner. The owner of the risk could be an agency planner,
engineer, or construction manager, depending on the point in project development, or it could
be a private sector contractor or partner, depending on the contracting method and risk
allocation.
Risk mitigation and planning efforts may require that agencies set policies, procedures, goals,
and responsibility standards. Formalizing risk mitigation and planning throughout a highway
agency will help establish a risk culture that should result in better cost management from
planning through construction and better allocation of project risks that align teams with
customer-oriented performance goals. The risk mitigation options include:

Avoidance-The team changes the project plan to eliminate the risk or to protect the
project objectives from its impact. The team might achieve this by changing scope,
adding time, or adding resources (thus relaxing the so-called triple constraint).
Transference-The team transfers the financial impact of risk by contracting out some
aspect of the work. Transference reduces the risk only if the contractor is more
capable of taking steps to reduce the risk and does so.
Mitigation-The team seeks to reduce the probability or consequences of a risk event to
an acceptable threshold. It accomplishes this via many different means that are
specific to the project and the risk. Mitigation steps, although costly and time
consuming, may still be preferable to going forward with the unmitigated risk.
Acceptance-The project manager and team decide to accept certain risks. They do not
change the project plan to deal with a risk or identify any response strategy other than
agreeing to address the risk if it occurs.

Origin of Risk Management in Banks-BASEL ACCORDS

The breakdown of the Bretton Woods system of managed exchange rates in 1973 soon led to
casualties. On 26 June 1974, West Germany's Federal Banking Supervisory Office withdrew
Bankhaus Herstatt's banking license after finding that the bank's foreign exchange exposures
amounted to three times its capital. Banks outside Germany took heavy losses on their
unsettled trades with Herstatt, adding an international dimension to the debacle.
In October the same year, the Franklin National Bank of New York also closed its doors
after racking up huge foreign exchange losses. Three months later, in response to these and

other disruptions in the international financial markets, the central bank governors of the G10
countries established a Committee on Banking Regulations and Supervisory Practices.
Later renamed as the Basel Committee on Banking Supervision, the Committee was designed
as a forum for regular cooperation between its member countries on banking supervisory
matters. Its aim was and is to enhance financial stability by improving supervisory knowhow
and the quality of banking supervision worldwide.
The Committee seeks to achieve its aims by setting minimum supervisory standards; by
improving the effectiveness of techniques for supervising international banking business; and
by exchanging information on national supervisory arrangements. And, to engage with the
challenges presented by diversified financial conglomerates, the Committee also works with
other standard-setting bodies, including those of the securities and insurance industries.
Since the first meeting in February 1975, meetings have been held regularly three or four
times a year. After starting life as a G10 body, the Committee expanded its membership in
2009 and now includes 27 jurisdictions. The Committee now reports to an oversight body, the
Group of Central Bank Governors and Heads of Supervision (GHOS), which comprises
central bank governors and (non-central bank) heads of supervision from member countries.
This committee has taken various measures to strengthen the banking structure, to enable the
banks to face the financial crisis, and to survive in the period of stress. Namely, this
committee has given following three accords:
1. BASEL I
2. BASEL II
3. BASEL III
The first concrete evidence of global coordination in banking regulation were felt towards the
end of 1974, when the G-10 countries (now its G-20 group of nations) took the initiative to
form the Basel Committee on Banking Supervision (BCBS) under the auspices of Bank for
International Settlements (BIS) comprising of

central bank governors of participating

countries.

Basel Committee on Banking Supervision (BCBS)

The Basel committee on banking supervision provides a forum for regular cooperation on
banking supervisory matters. Its objective is to enhance understanding of the key issues and

improve the quality of banking supervision Worldwide. It seeks to do so by exchanging

information on national supervisory issues, approaches, and techniques with a view to
promote common understanding. At times the committee uses this common understanding to
develop guidelines and supervisory standards in areas where they are considered desirable. In
this regard, the committee is best known for its international standards on capital adequacy;
the core principles for effective banking supervision; and the concordat on cross-border
banking supervision.

Main Expert Sub-Committee under BCBS are as below:

Basel committee on banking supervision
The standards implementation

The policy development group

The accounting Task Force

The Basel consultative group

Basel I Accord:
Capital adequacy soon became the main focus of the Committee's activities. In the early
1980s, the onset of the Latin American debt crisis heightened the Committee's concerns that
the capital ratios of the main international banks were deteriorating at a time of growing
international risks. Backed by the G10 Governors, the Committee members resolved to halt
the erosion of capital standards in their banking systems and to work towards greater
convergence in the measurement of capital adequacy. This resulted in a broad consensus on a
weighted approach to the measurement of risk, both on and off banks' balance sheets.
There was a strong recognition within the Committee of the overriding need for a
multinational accord to strengthen the stability of the international banking system and to
remove a source of competitive inequality arising from differences in national capital
requirements. Following comments on a consultative paper published in December 1987, a

capital measurement system commonly referred to as the Basel Capital Accord (or the 1988
Accord) was approved by the G10 Governors and released to banks in July 1988.
The Accord called for a minimum capital ratio of capital to risk-weighted assets of 8% to be
implemented by the end of 1992. Ultimately, this framework was introduced not only in
member countries but also in virtually all other countries with active international banks. In
September 1993, a statement was issued confirming that all the banks in the G10 countries
with material international banking business were meeting the minimum requirements set out
in the 1988 Accord.
The 1988 capital framework was always intended to evolve over time. In November 1991, it
was amended to give greater precision to the definition of general provisions or general loanloss reserves that could be included in the capital adequacy calculation. In April 1995, the
Committee issued an amendment to the Capital Accord, to take effect at end-1995, to
recognize the effects of bilateral netting of banks' credit exposures in derivative products and
to expand the matrix of add-on factors. In April 1996, another document was issued
explaining how Committee members intended to recognize the effects of multilateral netting.
The Committee also refined the framework to address risks other than credit risk, which was
the focus of the 1988 Accord. In January 1996, following two consultative processes, the
Committee issued the so-called Market Risk Amendment to the Capital Accord to take effect
at the end of 1997 at the latest.
This was designed to incorporate within the Accord a capital requirement for the market risks
arising from banks' exposures to foreign exchange, traded debt securities, equities,
commodities and options. An important aspect of this amendment is that banks are allowed to
use internal value-at-risk models as a basis for measuring their market risk capital
requirements, subject to strict quantitative and qualitative standards. Much of the preparatory
work for the market risk package was undertaken jointly with securities regulators. It
provided level playing field by stipulating the amount of capital that needs to be maintained
by internationally active banks.

Limitations of Basel I
However, Basel I comprised of some rigidities, as it did not discriminate between different
levels of risks. As a result, a loan to an established corporate borrower was considered as
risky as a loan to a new business. .So all loans given to corporate borrowers were subject to
the same capital requirements, without taking into account the ability of the counterparties to
repay. It also did not take cognizance of the credit rating, credit history and corporate
governance structure of all corporate borrowers. Moreover, it did not adequately address the
risk involved in increasing the use of financial innovations like securitization of assets and
derivatives and credit risk inherent in these developments. The important category of risk i.e.,
operational risk also was not given the attention it deserved.
Limited differentiation of credit risk
Static measure of default risk
No recognition of term-structure of credit risk
Simplified calculation of potential future counterparty risk
Lack of recognition of portfolio diversification effects

Basel II Accord: Banking has changed dramatically since the Basel I document of 1988.
Advances in risk management and the increasing complexity of financial activities /
instruments (like options, hybrid securities etc.) prompted international supervisors to review
the appropriateness of regulatory capital standards under Basel I. To meet this requirement,
the Basel I accord was amended and refined, which came out as the Basel II accord.

Capital Adequacy
Recognizing the need for a more comprehensive, broad based and flexible framework, Basel
committee proposed an improved version in 1999, which provides for better alignment of
regulatory capital with underlying risk and also addresses the risk arising from financial
innovation thereby contributing to enhanced risk management and control. This sophisticated
and superior framework was formally endorsed by central bank governors and heads of
banking supervisory authorities of various countries on June 26, 2004 under the name
International Convergence of Capital Measurement and Capital Standards popularly known
as Basel II or New Basel Capital Accord. This new set of international standards requires
banks to maintain minimum level of capital, to ensure that they can meet their obligations,
cover unexpected losses and improve public confidence. Basel II captures the risk on a

consolidated basis for internationally active banks and attempts to ensure that capital
recognized, set aside in capital adequacy measures and provide adequate protection to
depositors. It brings into focus the contemporary risk management techniques and seeks to
establish a more risk responsive linkage between the bank operations and their capital
requirements. It also provides strong incentive to banks to upgrade their risk management
standards. The accord is a cornerstone of the current international financial architecture. Its
overriding goal is to promote safety and soundness in the international financial system. The
provisioning of adequate capital cushion is central to this goal and the committee ensures that
new framework maintains the overall level of capital currently in the banking system.

The advocates of Basel II believe that creating such an international standard can help to
protect the international financial system from various types of financial and operational risks
that banks may encounter. It also attempts to set up such rigorous risk and capital
management requirements to ensure that banks hold sufficient capital reserves appropriate to
the risk the bank exposes itself through its lending and investment activities. The objectives
of the new Basel accord as enunciated by BIS are fivefold:
1. Promoting safety and soundness of financial system
2. Enhance competitive equality
3. Greater sensitivity to the degree of risk involved in banking positions, activities
4. Constitute a more comprehensive approach to addressing risk and Focus on internationally
active banks, with capability of being applicable the banks with varying level of complexity
and supervision.

BASEL II FRAMEWORK
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.

Basel II
Framework

Pillar I

Pillar II

Pillar III

Minimum Capital

Supervisory

Market

Requirements

Review Process

Discipline

The structure of Basel II framework has its foundation on three mutually reinforcing pillars
(as shown in the above diagram ) that allow banks and bank supervisors to evaluate properly
the various risks that banks face and realign regulatory capital more closely with inherent
risks . These three pillars are discussed as under:

Pillar I: Minimum Capital requirement

The first pillar of Basel II deals with maintenance of regulatory capital, i.e. minimum capital
required by banks as per their risk profile. As in Basel I, Basel II also has same provisions
relating to regulatory capital requirements i.e. 8 % Capital Adequacy Ratio (CAR). CAR
under Basel II is the ratio of Regulatory Capital to risk weighted assets which signifies the
amount of regulatory capital to be maintained by banks to guard against various risks inherent
in banking system. Capital Adequacy Ratio = Total Regulatory Capital (Tier I + Tier II + Tier
III) Risk weighted Assets (Credit risk + Market risk+ Operational risk). The risks covered
under CAR in Basel II are credit risk, market risk and operational risk. Pillar I focuses on
new approaches for calculating minimum capital requirements under credit risk, market risk
and operational risk vary from simple to sophisticated and allow bank Supervisors to choose
an approach that seems most appropriate according to their risk profile, activities and internal
control.

Pillar II: Supervisory Review

The Second Pillar of Basel II provides key principles for supervisory review, risk
management guidance and supervisory transparency and accountability as under: Banks
should have a process for assessing their overall capital adequacy in relation to their risk
profile and a strategy for maintaining their capital levels. Supervisors should review and
evaluate banks internal capital adequacy assessments and strategies, as well as their ability to
monitor and ensure their compliance with regulatory capital ratios and should take
appropriate action if they are not satisfied with the result of this process. Supervisors should
expect banks to operate above the minimum regulatory capital ratios. Supervisors should
intervene at an early stage to prevent capital from declining below benchmark level. Pillar II
cast responsibility on the supervisors to exercise best ways to manage the risks specific to
that bank and also to review and validate banks risk measurement modes. All the supervisors
should evaluate the activities and risk profiles of individual banks to determine whether those

organizations should hold higher levels of capital than the minimum requirements and to see
whether is any need for remedial action to ensure that each financial institution adopts
effective internal processing for risk management.

Pillar III: Market Discipline

The objective of Pillar III is to improve market discipline through effective public disclosure
to complement requirements under Pillar I and Pillar II. Pillar III relates to periodical
disclosures to regulators, board of bank and market about various parameters which indicate
risk profile of the bank. It introduces substantial new public disclosure requirements and
allows market participants to analyze key pieces of information on the scope of application,
risk exposures, risk assessment and management processes and hence the capital adequacy of
the institution. The disclosures provided under Pillar III must fulfil the criteria of
comprehensiveness, relevance, timeliness, reliability, comparability and materiality of
disclosure to enable the interested parties to make informed decision about the bank. The
Three pillars of Basel II framework provides a kind of triple protection by Encompassing
three complementary approaches that work together towards ensuring the capital adequacy of
institutional practices prevalent in the banks .Taken individually each pillar has its merits, but
they are even more efficient when they are synergized in a common framework.

COMPUTATION OF CAPITAL REQUIREMENT

CREDIT RISK APPROACHES

Credit Risk

Standardized approach

Advanced Approach

Foundation IRB

Advanced IRB

Standardized approach: the Basel committee as well as RBI provides a simple methodology
for risk assessment and calculating capital requirements for credit risk called Standardized

approach. This approach is divided into the following broad topics for simpler and easier
understanding
1. Assignment of Risk Weights: all the exposures are first classified into various customer
types defined by Basel committee or RBI. Thereafter, assignment of standard risk weights is
done, either on the basis of customer type or on basis of the asset quality as determined by
rating of the asset, for calculating risk weighted assets.

2. External Credit Assessments: the regulator or RBI recognizes certain risk rating agencies
and external credit assessment institutions (ECAIs) and rating assigned by these ECAIs to the
borrowers may be taken as a basis for assigning risk weights to the borrowers. Better rating
means better quality of assets and lesser risk weights and hence lesser requirement of capital
allocation.

3. Credit Risk Mitigation: Basel recognized Collaterals and Basel recognized Guarantees are
two securities that banks obtain for loans / advances to cover credit risk, which are termed as
Credit Risk Mitigants

Advanced Approach: Basel II framework also provides for advanced approaches to

calculate capital requirement for credit risk. These approaches rely heavily on a banks
internal assessment of its borrowers and exposures. These advanced approached are based on
the internal ratings of the bank and are popularly known as Internal Rating Based (IRB)
approaches. Under Advanced Approaches, the banks will have 2 options as under
a) Foundation Internal Rating Based (FIRB) Approaches.
b) Advanced Internal Rating Based (AIRB) Approaches.

The differences between foundation IRB and advanced IRB have been captured in the
following table:

Data Input

Foundation IRB

Probability of Default

Provided by bank based on Provided by bank based on own

own estimates

Loss Given Default

Advanced IRB

estimates

Supervisory values set by the Provided by bank based on own

Committee

Exposure at Default

estimates

Supervisory values set by the Provided by bank based on own

Committee

Effective Maturity

estimates

Supervisory values set by the Provided by bank based on own

Committee

estimates Or At the national

discretion, provided by bank
based on own estimates

MARKET RISK APPROACHES

Market Risk

Standardized

Internal Model

Approach

Based approach

Maturity

Duration

Based

Based

RBI has issued detailed guidelines for computation of capital charge on Market Risk in June
2004. The guidelines seek to address the issues involved in computing capital charge for
interest rate related instruments in the trading book, equities in the trading book and foreign
exchange risk (including gold and precious metals) in both trading and banking book.
Trading book will include:

Securities included under the Held for trading category

Securities included under the Available for Sale category

Open gold position limits

Open foreign exchange position limits

Trading position in derivatives and derivatives entered into for hedging trading book
exposures.

2.9.3 OPERATIONAL RISK APPROACHES

Operational
Risk

Basic Indicator

Standardized

Approach

Approach

Advanced
Measurement
Approach

Basic Indicator Approach: Under the basic indicator approach, Banks are required to hold
capital for operational risk equal to the average over the previous three years of a fixed
percentage (15% - denoted as alpha) of annual gross income. Gross income is defined as net
interest income plus net non-interest income, excluding realized profit/losses from the sale of
securities in the banking book and extraordinary and irregular items.

Standardized Approach: Under the standardized approach, banks activities are divided into
eight business lines. Within each business line, gross income is considered as a broad
indicator for the likely scale of operational risk. Capital charge for each business line is
calculated by multiplying gross income by a factor (denoted beta) assigned to that business
line. Total capital charge is calculated as the three-year average of the simple summations of
the regulatory capital across each of the business line in each year.

Advanced Measurement Approach: Under advanced measurement approach, the regulatory

capital will be equal to the risk measures generated by the banks internal risk measurement
system using the prescribed quantitative and qualitative criteria.

IMPROVEMENT OF BASEL II OVER BASEL I

1. Better allocation of capital and reduced impact of moral hazard through reduction in
the scope for regulatory arbitrage: By assessing the amount of capital required for each
exposure or pool of exposures, the advanced approach does away with the simplistic risk
buckets of current capital rules.

2. Improved signal quality of capital as an indicator of solvency: the rule is designed to

more accurately align regulatory capital with risk, which will improve the quality of capital
as an indicator of solvency.

3. Encourages banking organizations to improve credit risk management: One of the

principal objectives of the rule is to more closely align capital charges and risk. For any type
of credit, risk increases as either the probability of default or the loss given default increases.

4. More efficient use of required bank capital: Increased risk sensitivity and improvements
in risk measurement will allow prudential objectives to be achieved more efficiently.

5. Incorporates and encourages advances in risk measurement and risk management:

The rule seeks to improve upon existing capital regulations by incorporating advances in risk
measurement and risk management made over the past 15 years.

6. Recognizes new developments and accommodates continuing innovation in financial

products by focusing on risk: The proposed rule also has the benefit of facilitating
recognition of new developments in financial products by focusing on the fundamentals
behind risk rather than on static product categories.

7. Better alignment of capital and operational risk and encourages banking

organizations to mitigate operational risk: Introducing an explicit capital calculation for
operational risk eliminates the implicit and imprecise buffer that covers operational risk
under current capital rules.

8. Enhanced supervisory feedback: all three pillars of the proposed rule aim to enhance
supervisory feedback from federal banking agencies to managers of banks and thrifts.
Enhanced feedback could further strengthen the safety and soundness of the banking system.

9. Enhanced disclosure promotes market discipline: The proposed rule seeks to aid market
discipline through the regulatory framework by requiring specific disclosures relating to risk
measurement and risk management.

10. Preserves the benefits of international consistency and coordination achieved with
the 1988 Basel Accord: An important objective of the 1988 Accord was competitive
consistency of capital requirements for banking organizations competing in global markets.
Basel II continues to pursue this objective.

LIMITATIONS OF BASEL II:

1. Lack of sufficient public knowledge: knowledge about banks portfolios and their future
risk-weight, since this will also depend on whether banks will use the standardized or IRB
approaches.

2. Lack of precise knowledge: as to how operational risk costs will be charged. The banks
are expected to benefit from sharpening up some aspects of their risk management practices
preparation and for the introduction of the operational risk charge.

3. Lack of consistency: at least at this stage, as to how insurance activities will be accounted
for. One treatment outlined in the Capital Accord is that banks deduct equity and other
regulatory capital investments in insurance subsidiaries and significant minority investments
in insurance entities. An alternative to this treatment is to apply a risk weight age to
insurance investments.

Basel III
"Basel III" is a comprehensive set of reform measures, developed by the Basel Committee on
Banking Supervision, to strengthen the regulation, supervision and risk management of the
banking sector. These measures aim to:

improve the banking sector's ability to absorb shocks

arising from financial and economic stress, whatever
the source

improve risk management and governance

Strengthen banks' transparency and disclosures.

The reforms target:

Bank-level, or Microprudential, regulation, which will

help raise the resilience of individual banking
institutions to periods of stress.

Macroprudential, system wide risks that can build up

across the banking sector as well as the procyclical
amplification of these risks over time.

These two approaches to supervision are complementary as greater resilience at the

individual bank level reduces the risk of system wide shocks.
Basel III is part of the Committee's continuous effort to enhance the banking regulatory
framework. It builds on the International Convergence of Capital Measurement and Capital
Standards document (Basel II).
Finally, a brief comparison of all the three Basel accords is illustrated in below table:
BASEL I

BASEL II

BASEL III

Focus on single measure

Three pillars introduced-

Significant

Capital Adequacy,

quality

Supervisory Review, Market

capital

and

increases
quantity

in
of

Discipline
One size fits all

Different approaches

Quantitative

buffers

allowed; in effect since 2004

introduced

such

procyclicality

conservation

as

buffer
Broad brush approach

More risk sensitive

Revised metrics proposed to

capture counterparty credit
risk, such as, credit valuation
adjustments, wrong way risk,
asset value correlation.

The below table illustrates the various milestones, initiatives taken to counter the risk.

Milestones in the history of Risk Management

1730

First futures contracts on the price of Rice in Japan.

1864

First futures contracts on Agricultural products at the Chicago Board

of Trade.

1900

Louis Bacheliers thesis theorie de la speculation Brownian

motion

1932

First issue of the Journal of Risk and Insurance

1946

First issue of the Journal of Finance

1952

Publication of Markowitz article Portfolio selection

1961-66

Treynor , sharpe, linter and Mossin develop the CAPM.

1963

Arrow introduces optimal insurance, moral hazard, and adverse

selection.

1972

Future contracts on currencies at the Chicago Mercantile Exchange.

1973

Option valuation formulas by black and Scholes and Merton.

1974

Mertons default risk model.

1977

Interest rate models by vasicek and cox, Ingersoll and Ross(1985)

1980-90

Exotic options, swaptions and stock derivatives

1979-82

First OTC contracts in the form of swap currency and interest rate
swaps.

1985

Creation of the swap Dealers Association, which established the

OTC exchange standards.

1987

First risk management department in bank (Merrill Lynch)

1988

Basel I

Late 1980s

Value at Risk (VaR) and calculation of optimal capital.

1992

Article by Heath, Jarrow and Morton on the forward rate curve

1992

Integrated Risk Management

1997

Credit metrics

1997-98

Asian and Russian crisis and LTCM collapse

2001

Enron bankruptcy

2002

New governance rules by Sarbanes- only and NYSE

2004

Basel II

2007

Beginning of the financial crisis

2009

Solvency II (implemented in March 2013)

2010

Basel III

Risk management in Indian banks

Risk management in Indian banks is a relatively newer practice, but has already shown to
increase efficiency in governing of these banks as such procedures tend to increase the
corporate governance of a financial institution. In times of volatility and fluctuations in the
market, financial institutions need to prove their mettle by withstanding the market variations
and achieve sustainability in terms of growth and well as have a stable share value. Hence, an
essential component of risk management framework would be to mitigate all the risks and
rewards of the products and service offered by the bank. Thus the need for an efficient risk
management framework is paramount in order to factor in internal and external risks.
The financial sectors in various economies like that of India are undergoing a monumental
change factoring into account world events such as the ongoing Banking Crisis across the
globe. The 2007present recession in the United States has highlighted the need for banks to
incorporate the concept of Risk Management into their regular procedures. The various
aspects of increasing global competition to Indian Banks by Foreign banks, increasing
Deregulation, introduction of innovative products, and financial instruments as well as
innovation in delivery channels have highlighted the need for Indian Banks to be prepared in
terms of risk management.
Indian Banks have been making great advancements in terms of technology, quality, as well
as stability such that they have started to expand and diversify at a rapid rate. However, such
expansion brings these banks into the context of risk especially at the onset of increasing
Globalization and Liberalization. In banks and other financial institutions, risk plays a major
part in the earnings of a bank. The higher the risk, the higher the return, hence, it is essential
to maintain a parity between risk and return. Hence, management of financial risk
incorporating a set systematic and professional methods especially those defined by the Basel

II becomes an essential requirement of banks. The more risk averse a bank is, the safer is
their Capital base.
KEYS FOR EFFECTIVE RISK MANAGEMENT:

To direct risk behavior & influence the shape of a firms risk profile, management
should use all available options. Using financial incentives and penalties to influence
risk taking behavior is effective management tool.

Sharing of information by keeping confidentiality intact is also helpful to find out

different ways for controlling the risk as valuable inputs may be received through this
sharing. Even information on creditworthiness of counterparties that are known to
take substantial risk can also help.

Diversification is extremely important. As it lowers the variance in investor

portfolios, improves corporate ability to raise debt, reduces employment risks, &
heightens operating efficiency.

Governance should never be ignored. Careful structuring of the alliance in advance of

the deal and continual adjustment thereafter help to build a constructive relationship.

One should not trust while in business. Personal chemistry is good but is no substitute
for monitoring mechanism, co-operation incentives, & organizational alignment.

Without support system within the organization itself, external alliances are doomed
to fail.

BASEL III

Chapter 4BASEL III

A strong and resilient banking system is the foundation for sustainable economic growth, as
banks are at the centre of the credit intermediation process between savers and investors. And
provide critical services to consumers, small and medium-sized Business, large corporate
firms and governments who rely on them to conduct their daily business, both at a domestic
and international level. One of the main reasons the economic and financial crisis of 2007
became so severe was that the banking sectors of many countries had built up excessive on
and off-balance sheet leverage. This was accompanied by a gradual erosion of the level and
quality of the capital base. At the same time, many banks were holding insufficient liquidity
buffers. The banking system therefore was not able to absorb the resulting systemic trading
and credit losses nor could it cope with the reinter mediation of large off-balance sheet
exposures that had built up in the shadow banking system. The crisis was further amplified by
a pro-cyclical deleveraging process and by the interconnectedness of systemic institutions
through an array of complex transactions. During the most severe episode of the crisis, the
market lost confidence in the solvency and liquidity of many banking institutions. The
weaknesses in the banking sector were rapidly transmitted to the rest of the financial system
and the real economy, resulting in a massive contraction of liquidity and credit availability.
Ultimately the public sector had to step in with unprecedented injections of liquidity, capital
support and guarantees, exposing taxpayers to large losses.
To address the market failures revealed by the crisis, the Basel Committee on Banking
Supervision (BCBS) introduced Basel III as fundamental reforms to the international
regulatory framework. The reforms strengthen bank-level, or micro prudential, regulation,
which will help raise the resilience of individual banking institutions to periods of stress. The
reforms also have a macro prudential focus, addressing system-wide risks that can build up
across the banking sector as well as the procyclical amplification of these risks over time.
Clearly these micro and macroprudential approaches to supervision are interrelated, as greater
resilience at the individual bank level reduces the risk of system-wide shocks.
Under Basel III, the quality and composition of capital are expected to be increased in a
phased manner spanning up to year 2019. While Tier-1 capital has to be increased from 4.5%
in 2013 to 6% by 2019, the overall capital, including capital conservation buffers and
counter-cyclical buffers, is required to be increased from 8% in 2013 to 10.5% in 2019.

Liquidity ratios are envisaged to be initiated in a phased manner beginning with an

observation period that commenced in 2011. The introduction of minimum standards for
liquidity ratios are expected to be between 2014 and 2018. The most discussed leverage ratio
is monitored from 2011. Below table captures the key elements of Basel-III framework and
the timeline for their full compliance as per BCBS. (time frame by whom)
Key elements

Capital

Process and IT implemented;

Full Compliance

Readiness to report to regulator

required

New market-risk and Jan 2012

Jan 2012

securitization
framework
Counter credit risk

Jan 2013

Jan 2013

Minimum core Tier 1 Jan 2013

Jan 2015

ratio

Leverage

Capital quality

Jan 2013

Jan 2022

Capital deductions

Jan 2014

Jan 2018

Conservation buffer

Jan 2016

Jan 2019

Leverage buffer

Jan 2013

Jan 2018

coverage Jan 2013

Jan 2015

Net stable funding Jan 2014

Jan 2018

Liquidity/funding Liquidity
ratio

ratio

Background to Basel III

The approach to capital regulation based on so-called Basel I and Basel II was
identified by many regulators and commentators as one of the key factors contributing to the
financial crisis. Under the pre-crisis capital adequacy rules, the minimum regulatory capital
levels of banks were insufficient in relation to the exposures and actual losses of the banks
suffered during the financial crisis. Also the quality of regulatory capital appeared often
insufficient to absorb bank losses effectively. The capital adequacy rules of Basel I and Basel
II did not adequately capture risks posed by bank exposures to transactions such as
securitizations, derivatives and repurchase agreements or take into account the systemic risks
associated with the build-up of leverage in the financial system. Moreover, Basel I and II

focused on capital only, with no internationally agreed quantitative standards for liquidity.
This is often perceived to have been a serious shortcoming when the financial crisis unfolded
in 2007 and liquidity evaporated in the key funding markets used by many banks and banksponsored vehicles.
In response to the financial crisis, the Basel Committee undertook to develop standards to
supplement and, in certain respects, replace, the existing standards of Basel I and Basel II. In
July 2009, the Basel Committee released proposed revisions principally addressing risk-based
capital and disclosure requirements for a banks trading book (the July 2009 Release).
Proposals regarding revised risk-based capital requirements, the introduction of a leverage
ratio requirement and new liquidity standards followed in December 2009 (the December
2009 Release). In September 2010, the Basel Committee formally adopted the name Basel
III for the reforms that developed from these releases and in December 2010 the Basel
Committee issued the finalized text for the core elements of the Basel III framework. While
the basic building blocks of the existing framework would remain largely in place, there are
several important new elements, relating in particular to minimum capital ratios, rules which
define eligibility of regulatory capital, leverage and liquidity requirements.
The Basel Committee on Banking Supervision (the Basel Committee) released a near final
version of its new bank capital and liquidity standards, referred to as Basel III, in
December 2010. Subsequent guidance was issued in January 2011 regarding minimum
requirements for regulatory capital instruments. The United States and the European Union
have publicly endorsed the Basel III standards and are considering how to implement them
into law in their respective jurisdictions. Legal and compliance personnel at impacted
financial institutions will need to work alongside risk management staff to ensure their
institution is able to comply with the new standards.
Basel III is an evolution rather than a revolution in the area of banking regulation. Drawing
largely from the already Basel II framework. Basel III aims to build robust capital base for
banks and ensure sound liquidity and leverage ratios in order to weather away any banking
crises in the future and thereby ensure financial stability.
Basel III is a series of amendments to the existing Basel II framework. The core aspects of
Basel III are implemented into national law by January 1, 2013; certain aspects of the new
standards are slated to become effective upon implementation while others will be phased in
over several years. It become essential for legal and compliance professionals at many
institutions to have a working understanding of the new Basel III standards in order to be able

to assist in the development of a bank capital plan that meets supervisory expectations. In the
U.S., for example, large banking groups are required to demonstrate their ability to comply
with Basel III standards both as a formal part of their capital plans and as a condition for
regulatory approval of actions that could diminish their capital bases, such as paying
dividends.

Fig. 4.0 Evaluation of Basel II to Basel III

PILLAR I

PILLAR II

PILLAR III

Pillar I

Pillar II

Pillar III

Minimum
capital
requirements

Supervisory
review
process

Disclosure
And market
Discipline

Enhanced
Minimum
capital and
liquidity
requirements

Enhanced
Supervisory
review process for
firm-wide Risk
Management and
capital planning

Enhanced
Risk
Disclosure
and market
Discipline

BASEL II

BASEL III

Basel III documents present the Basel committees reforms to strengthen global capital and
liquidity rules with the goal of promoting a more resilient banking sector. The objective of
the reforms is to improve the banking sectors ability to absorb shocks arising from financial
and economic stress (whatever is the source), thus reducing the risk of spillover from the
financial sector to the real economy.
4.1 Features of the Basel III
1.) Enhanced Capital Requirement: New requirements represent tighter definitions of
Common Equity. Banks will be required to hold more reserves by January 1, 2015, with
Common Equity requirements raised to 4.5% from 2% at present. It means that banks are
required to hold more capital under Basel III. The main aim of raising the capital requirement
is to make banks more strong to face the times of stress and losses.
2.) Tier 1 Capital requirements: Basel III also introduces stricter regulatory deductions
(e.g. for minority interests) for calculating Tier 1 capital and tighter requirements for

capital instruments which are not common equity to form part of Tier 1 capital. Under
the new rules, the mandatory reserve (known as Tier 1 capital) will be raised from 4%
to 6% by 2015.
3.) Introduction of a Capital Conservation Buffer
The Capital Conservation Buffer is an additional reserve buffer of 2.5% to "withstand
future periods of stress", bringing the total Tier 1 Capital reserves required to 7%.
This buffer is introduced to meet one of the four key objectives identified by the
Committee in the December 2009 Consultative Document Strengthening the
resilience of the banking sector; conserve enough capital to build buffers at
individual banks and the entire banking sector which can then be used in times of
stress.
The broad basis for this proposal comes from the observation that some institutions
with heavy losses and depleted capital from the crisis still made distributions to
shareholders. The Basel Committee argues that this should not occur and that banks
who suffer losses should rebuild their capital by retaining earnings and raising new
capital. The guiding principle is to shift the risk as much as possible from depositors
to shareholders and employees of banks.

4.) Introduction of Countercyclical Buffer

According to the new rules local regulators are not only responsible for controlling banks
compliance with the Basel requirements but also for regulating credit volume in their national
economies. If credit is expanding faster than GDP, bank regulators can increase their capital
requirements with the help of the Countercyclical Buffer. Varying between 0% - 2.5% it can
thus, preserve national economies from excess credit growth. As such, the buffers are not
additional, minimum capital requirements. Instead, if an institution does not have the required
capital buffers, Basel III will restrict the institutions ability to distribute earnings.
5.) Leverage Ratio (Ratio of Tier 1 Capital to Total Assets)
In addition to increased risk-based capital requirements, Basel III introduces for the
first time a leverage ratio. The intention is to constrain the buildup of leverage in the
banking sector with a simple metric. The current proposal by the Basel Committee is

to test a leverage ratio set at 3 per cent of Tier 1 capital as part of the Pillar 2
supervisory review with a view to migrating this to a Pillar 1 requirement by 1
January 2018. Capital requirements are supplemented by a non-risk-based leverage
ratio that will serve as a backstop to the risk-based measures described above.

6.) Liquidity Risk Measurement

Basel III introduces a new instrument for liquidity risk measurement Liquidity
Coverage Ratio (LCR). It is designed to ensure that a bank maintains an adequate
level of unencumbered, high-quality assets that can be converted into cash to meet its
liquidity needs for a 30-day time horizon under an acute liquidity stress scenario
specified by supervisors. The standard requires that the ratio be no lower than 100%.
Its implementation is planned for 2015. To ensure that investment banking
inventories, offbalance sheet exposures, securitization pipelines and other assets and
activities are funded with at least a minimum amount of stable liabilities in relation to
their liquidity risk profiles the new Accord introduces Net Funding Stability Ratio
(NFSR). It is defined as the ratio, for a bank, of its available amount of stable
funding divided by its required amount of stable funding. The standard requires
that the ratio be no lower than 100%.

4.2 BASEL III OBJECTIVES

According to the BCBS, the Basel III proposals has two main objectives:
1.) To strengthen global capital and liquidity regulation with the goal of promoting a
more resilient banking sector.
2.) To improve the banking sectors ability to absorb shocks arising from financial and
economic stress, which, in turn, would reduce the risk of a spillover from the financial
sector to the real economy.
To achieve these objectives Basel III proposals are breakdown into three parts on the basis
of main areas they address
a.) Capital reform (including quality and quantity of capital, complete risk coverage,
leverage ratio and the introduction of capital conservation buffer, and a countercyclical capital buffer.)

b.) Liquidity reform (short term and long term ratios)

c.) Other elements relating to general improvements to the stability of the financial
system.
To achieve these objectives Basel committee has issued its guidelines:
1. Increased capital requirements: under Basel III the capital requirements have been
raised in order to make banks more strong to face the times of stress, and to meet the
challenges effectively.
2. Enhanced Tier 1 capital requirements
3. Introduction of capital conservation buffer.
4. Introduction of counter cyclical buffer.
5. Banks are also required to maintain leverage ratio as per BCBS.
In order to achieve the above objectives with the help of above mentioned measures,
BCBS have formulated a time frame, so that banks can easily incorporate the
requirements under Basel III.

Fig 4.2. Break down of the Basel III proposals

CAPITAL REFORM

LIQUIDITY STANDARDS

SYSTEMATIC RISK AND

INTERCONNECTEDNESS

Quality, consistency and

transparency of capital
base

Short term liquidity coverage

ratio (LCR)

Capital incentive for using

CCPs for OTC

Capturing of all risks

Long-term: net stable

Funding Ratio (NSFR)

Higher capital for systemic

derivatives

Controlling leverage

Higher capital for interfinancial exposures

contingent capital

Capital surcharge for

systemic banks

Buffers

4.3 BASEL III FRAMEWORK

Under the framework of Basel III, the quality and composition of capital are expected to be
increased in a phased manner spanning up to year 2019. The so much discussed framework of
Basel III is as under:

4.3.1 Capital standards

Basel III has prescribed standards for capital to be maintained. The main objective of BCBS
is to improve the quality of capital. It prescribes the capital ratios to be maintained by the
bank. These ratios i.e. capital will helps banks to face the difficult times.
Basel III recommends raising the quality, consistency, and transparency of banks regulatory
capital base. The primary intention is to declare common equity and retained earnings as the
predominant form of Tier 1 capital. The previous capital regulation did not require banks to
hold a defined level of common equity and set limits only on total Tier 1 capital and total
capital. Basel II stated that banks have held as little as 2 % of assets in common equity
without breaking regulatory standards. As such, banks could hold high capital ratios but with
majority of capital in preferred stock or supplementary capital. The best quality of capital is
the common equity as it subordinate to all other types of funding that can absorb losses and
has no maturity date. Accordingly, any assets included in Tier 1 capital from common equity
must be able to absorb effectively. The ability to immediately counteract losses characterizes
han assets capacity for absorption of uncertain losses.
Table .4.1. Calibration of Capital Framework
Common Equity Tier 1
Minimum capital

4.5%

Conservation Buffer

2.5%

Minimum Capital plus

7.0%

Conservation Buffer

Tier 1 Capital

Total Capital

6.0%

8.0%

8.5%

10.5%

Counter Cyclical Range

0-2.5%

The capital conservation buffer above the regulatory minimum requirement is calibrated at
2.5% and must be met with common equity, after the application of deductions. The main
purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can
be used to absorb losses during periods of financial and economic stress. While banks are
allowed to draw on the buffer during such period of stress, the closer their regulatory capital
ratios approach the minimum requirement, the greater the constraints on earnings
distributions.
Table. 4.2. Capital Conservation Buffer Conservation Ratios
Common Equity Tier 1 ratio

Minimum capital conservation ratio

(% of earnings)

4.5%-5.125%

100%

5.125%-5.75%

80%

5.75%-6.375%

60%

6.375%-7.0%

40%

7.0% and above

0%

The counter cyclical buffer (CCB) will be between 0 and 2.5% (such range will be phased in
and fully effective in January 2019-Countries may consider an accelerated phase in); the
counter cyclical buffer is to be met with Common Equity Tier 1 but the use of other fully loss
absorbing capital is under consideration). Countries may apply higher buffers domestically
but the international reciprocity requirement of the Basel countercyclical buffer would be
capped at 2.5% by jurisdiction.
Table. 4.3. Countercyclical Capital Buffer Conservation Ratios
Individual bank minimum capital buffer conservation standards
Common Equity Tier 1 (including other

Minimum Capital Conservation ratios

fully loss first absorbing capital)

(expressed as a % of earnings)

Within first quartile of buffer

100%

Within second quartile of buffer

80%

Within third quartile of buffer

60%

Within fourth quartile of buffer

40%

Above top of buffer

0%

Table. 4.4. Basel-III Phase-in Arrangements

(Transition period showed in shaded area) (All dates are effective from 1 jan of that year according to BCBS
2011

2012

2013

2014

2015

2016

2017

2018

As of 0101-2019

Leverage ratio

Supervisory monitoring

Parallel run 1-jan-20131 Jan 2017

Migration to
pillar 1

Disclosure starts 1-01-2015

Minimum common

3.5%

4%

4.5%

4.5%

4.5%

4.5%

4.5%

0.625%

1.25%

1.875%

2.5%

equity capital ratio

Capital conservation
buffer

Minimum common

3.5%

4%

4.5%

5.125%

5.75%

6.375%

7%

20%

40%

60%

80%

100%

100%

4.5%

5.5%

6%

6%

6%

6%

6%

8%

8%

8%

8%

8%

8%

8%

8%

8%

8%

8.625%

9.25%

9.875%

10.5%

equity plus capital

conservation buffer
Phase-in of
deduction from CET
1
Minimum Tier 1
capital
Minimum Total
capital
Minimum total
capital plus
conservation buffer
Capital instrument
that no longer
qualify as non-core
Tier1 cap or tier 2

Phase out over 10 years horizon started from 2013

cap
Liquidity coverage

Observation

Introduces

ratio

period begins

minimum

standard
Net stable Funding

Observation

Introduce

ratio

period begins

minimum

4.4 BASEL III CAPITAL REGULATIONS

Enhancing the quality and quantity of Tier 1 capital (particularly the common equity held)
will improve the banks ability to absorb losses during difficult periods. During crisis, banks
with more Tier 1 capital and greater reliance on deposits could receive higher returns. Greater
common equity requirements will also encourage investors and other banks to trust banks
reported capital ratios. It may be recalled that as the crisis reduced the banks retained
earnings component of Tier 1 capital reserves since it was difficult to observe which banks
held sufficient common stock to endure the crisis.
Basel III capital regulations will increase banks amount and cost of capitals. Banks common
equity has limited investor demand. Thus, forcing banks to hold substantially more common
stock will require issuance at increasingly unfavorable terms to attract more investors. It is
estimated that global capital may be insufficient for banks to effectively recapitalize
according to the new accord (Canadian Bankers Association, 2010). Consequently, increased
cost of capital would result in increased cost of borrowing for the retail and commercial
customers. As such, banks will make efforts to recuperate increased operating costs by
charging higher interest on retail and commercial loans. Increased cost of capital will reduce
banks lending capacity in order to maintain a minimum capital ratio of high quality capital to
total risk-weighted assets. It is required to observe that requirement of higher common equity
will constrain the availability of affordable high quality assets, and banks must, therefore
reduce total assets including loans. It is also opined that requiring banks to hold too much
capital may be as damaging to the world economy as allowing banks to operate with too little
capital. It is predicted by the institute of international Finance (IIF) study that Basel III capital
requirements could decrease potential gross domestic product (GDP) growth by 3% and
decrease the number of available jobs by 10 million in the United States, the European
Union, and Japan.

4.4.1 LEVERAGE RATIO

Basel III recommends supplementing the risk-based capital of Basel II with a bank leverage
ratio. This leverage ratio is based on banks total exposure and is expected to protect against
their model risks and measurement errors. While the numerator of the leverage ratio consists
of high quality capital, the denominator includes both the on-balance sheet and off-balance
sheet assets. The aim of the leverage ratio is to limit the banks leverage and discourage rapid
deleveraging that may destabilize the overall economy. The overall economy can be
destabilized by loss spiral. A loss spiral follows when leveraged investors assets drop in
value and hence their net worth declines drastically because of the effect of the leverage.
According to Basel III high quality assets, total repurchase agreements, and securitizations be
included in the calculation of exposure while disallowing netting. The committee has
proposed a minimum tier-1 leverage ratio of 3% in a July 26, 2010 statement.

4.4.1(2). HOW EFFECTIVE IS BASEL III LEVERAGE RATIO:

The leverage ratio stipulated provides a non risk based measure. As previously mentioned,
Basel II imposes a minimum capital requirement using a ratio of high quality capital to riskweighted assets. Risk is quantified through financial modeling and dependence on credit
rating agencies. The leverage ratio increases transparency by supplementing the risk-based
models with a boarder models that does not distinguish between low-risk high-risk assets.
The ratio could help to identify banks that are operating radically different from their peers.
One of the primary merits of the Basel III leverage ratio is the monitoring of the off-balance
sheet leverage. It has to be noted that banks heavily expanded both on-balance sheet and offbalance sheet leverage prior to the financial crisis. For example, Lehman Brothers reported a
leverage ratio of 30.7 to 1 in the companys 2007 annual report. However, Lehman Brothers
also boasted a tier 1 capital ratio of 11% just five days before the firms collapse. Banks were
therefore, able to significantly expand their risk profile without exceeding the regulatory
limits. In this backdrop, proposed Basel III leverage ratio intends to monitor the off-balance
sheet leverage too unlike earlier scenario.
One of the weakness of the Basel III leverage ratio stipulation is that it may have unintended
consequences as assigning too much significance to a leverage ratio could incentivize banks
to focus more on higher-risk assets with greater return than low-risk assets with lower yield
because all assets are equally weighted. Further, one more apprehension is that allowing the

ratio to be too broad may also counteract the significance of the ratio by overstating potential
risks and therefore making the identification of outliers more difficult.

4.4.2 COUNTER-CYCLICAL CAPITAL BUFFERS:

Basel III proposes the maintenance of capital buffers during the stable periods to absorb
losses during the periods of stress. A capital buffer is a range of defined above the regulatory
minimum capital requirement to insure against losses. Counter-cyclical capital buffers entail
banks to hold capital greater than the regulatory minimum during the periods of stability to
sufficiently maintain themselves during a sudden downward spiral. Regulators would enact
constraints when capital levels fall within a range. For example, a bank could maintain a
capital buffer of 3% above the minimum capital requirement of 8% during the stable periods.
Regulators would interfere when banks capital ratio fell below 11%. Banks would then
replenish capital by limiting dividends, share buybacks, and bonuses as banks capital ratio
approaches the minimum regulatory requirement. Thus, the aim of the counter-cyclical
buffers is to respond to excessive leverage and unwarranted lending during expansionary
periods. Central Banks (supervisors) can also release buffer during periods of stress to
increase credit supply during economic downswings.

4.4.2(1) HOW EFFECTIVE IS COUNTER-CYCLICAL BUFFERS:

It is obvious that many accept greater risk during the favorable times and pursue less risk
during the uncertain periods. Market participants are known, generally, to act in a procyclical manner. Periods of certain expansion often precede liquidity crisis. During the
financial crisis, heavy losses destabilized the banking sector following a period of excess
lending. Some banks further undermined the system by resuming paying bonuses and
dividends early in the crisis. In addition, many banks hurriedly returned to paying the
dividends and distributing bonuses following the crisis, although the system remained so
fragile. For example, in 2009, the investment bank Goldman Sachs distributed annual
bonuses equal to the record payouts made in 2007.
The proposed capital buffer is felt as an alternative to a global tax on banks. The International
Monetary Fund proposed two global bank taxes in April 2019. While the first of the two
taxes proposed was a flat-rate tax on all banks, insurance companies and hedge funds, the
second was a tax on profits and compensation. A bank tax can be compared to a capital buffer
centralized at the regulating govt. with the idea that the govt.s would move the funds raised

from such taxation into an external fund or general govt. reserves in order to support the
failing banks during future crises. However, several opinions opposed the implementation of
banks ability to absorb loss and would lead to more hazard. The capital buffer proposed
under Basel III serves a similar purpose to a bank tax but avoids the moral hazard and does
not require responsible banks to pay for the poor management of other irresponsible banks.
Further, it is opined that capital buffer may have negative consequences similar to those
caused by improving banks capital base. High capital surpluses would increase capital costs,
thus reducing the financial institutions profitability (Canadian Bankers Association, 2010).
Therefore, capital accumulation would be more difficult during expansionary periods. Banks
may, therefore, attempt to compensate for large excess capital by increasing risk during
upturns in an effort to improve lower profitability.

4.4.3 LIQUIDITY STANDARDS:

Basel III proposals International Framework for liquidity risk measurement, standards, and
monitoring supplements the principles for sound liquidity risk management and supervision,
resilience to liquidity problems in the market. Financial institutions must be able to withstand
periods of low market liquidity. Basel III recommendations include two liquidity ratios
intended to monitor both short-term and long-term scenarios. Liquidity Coverage Ratio
(LCR) and Net Stable Funding Ratio (NSFR). Two new ratios will be made mandatory as
part of pillar 1
Firstly, the objective of the standard: minimum liquidity standards is intended towards
introducing internationally harmonized and robust liquidity standards as stronger capital
requirements may be necessary but not a sufficient condition for banking sector stability.
Measures recommended to implement the above objective include:
I.

Introduction of liquidity coverage ratio to ensure sufficient high quality liquid

resources to cope with an acute stress scenario lasting one month

II.

Introduction of net stable funding ratio, which has a longer time horizon of one year
to provide sustainable maturity structure of assets and liabilities

Secondly, the objective of the standard: Qualitative Liquidity Metrics is aimed at imparting
consistency in quantitative metrics used by supervisors to capture liquidity risks. One
significant measure proposed to realise the above objective is introduction of metrics, which

include among others, contractual maturity mismatch, concentration of funding, available

unencumbered assets and liquidity coverage ratio by currency.

4.4.4 LIQUIDITY COVERAGE RATIO:

Liquidity coverage ratio as a short-term metric (standard) aims to ensure that a bank
maintains an adequate level of unencumbered, high-quality liquid assets that can be
converted into cash to meet its liquidity needs for a 30 day time horizon under a significantly
severe liquidity stress scenario specified by supervisors. At a minimum, the stock of liquid
assets should enable the bank to survive until day 30 of the stress scenario, by which time it is
assumed that appropriate corrective actions can be taken by management and/or supervisors,
and/or the bank can be resolved in an orderly way. The LCR builds on traditional liquidity
coverage ratio methodologies used internally by banks to assess exposure to contingent
liquidity events. Banks are expected to meet this requirement continuously and hold a stock
of unencumbered, high-quality liquid assets as a defense against the potential onset of severe
liquidity stress.
Further, Basel III advises the supervisors to define a stress scenario and requires banks to
demonstrate their ability to remain solvent for one month. The stress scenario includes a
downgrade of the banks public credit rating, a partial loss of deposits, a loss of unsecured
wholesale funding, and an increase in derivative collateral calls.

4.4.5 NET STABLE FUNDING RATIO (NSFR):

The objective of NSFR is to promote more medium and long-term funding of the assets and
activities of banking organizations. This metric establishes a minimum acceptable amount of
stable funding based on the liquidity characteristics of an institutions assets and activities
over a one year horizon. According to BCBS, this standard is designed to act as a minimum
enforcement mechanism to complement the LCR and reinforce other supervisory efforts by
promoting structural changes in the liquidity risk profiles of institutions away from short-term
funding mismatches and toward more stable, longer-term funding of assets and business
activities.

Net stable funding ratio= (

The NSFR is expressed as the amount of available amount of stable funding to the amount of
required stable funding. This ratio must be greater than 100%. Stable funding is defined as
the portion of those types and amounts of equity and liability financing expected to be
reliable sources of funds over a one-year time horizon under conditions of extended stress.
The amount of such funding required of a specific institution is a function of the liquidity
characteristics of various types of assets held, OBS contingent exposures incurred and/or the
activities pursued by the institution.
Table. 4.5. Comparison of capital requirements under Basel II and Basel III
Requirements

Under Basel II

Under Basel III

Minimum Ratio of Total

8%

10.5%

2%

4.5% to 7%

Tier 1 capital to RWAs

4%

6%

Core Tier 1 capital to RWAs

2%

5%

capital conservation Buffers

None

2.5%

Leverage Ratio

None

3%

Countercyclical Buffer

None

0% to 2.5%

Minimum liquidity coverage

None

From 2015

None

From 2018

None

From 2011

capital to RWAs
Minimum Ratio of common
Equity to RWAs

to RWAs

Ratio
Minimum Net stable Funding
Ratio
Systemically important
Financial Institutions Charge

4.5 MEASURES TO COUNTERPARTY CREDIT RISK:

Basel III imposes more conservative measures for calculating counterparty credit risk as
Basel II did not require banks to hold enough capital to limit counterpart credit risk. For
example banks calculate capital requirements for counterparty risk using historical data when
estimating volatility and correlation assumptions in their internal risk measurement models.

However, according to Basel III, banks are required to include a period of economic and
market stress when making model assumptions. Basel III also requires the banks to apply a
multiplier of 1.25 to historical observations when calculating the correlation between
financial firms asset value and the economy. Thus, higher correlation observations will
require the banks to hold more capital to protect against the negative effects of other financial
institutions credit risk. Basel III also proposes that banks exposure to counterparty risk
receive a zero-risk weight if deals are processed through exchanges and clearing houses.
It could be observed that previous capital accords did not take account the fact that there is
indeed a high inter- connectedness of large financial institutions resulting in higher level of
interdependence on each other. Thus, increasing the correlations assumptions would result in
increasing risk-adjusted weighting for banks funding from other financial institutions and as
such banks will strive for to hold fewer assets from other financial institutions. This would
result in decreased dependence of financial institutions on one another.
However, Basel III proposals step to require the banks to move the processing of over-thecounter derivative transactions outside of banks may have intended consequences. Hedging
instruments, such as options futures and swaps, will continue to be necessary for firms that
seek to offset their perceived risks. This would result in increase in the cost of hedging the
interest rate and currency risk, thereby the banks passing on these costs to the end-user.

4.6 IMPLEMENTATION OF BASEL III

Under the framework of Basel III, the quality and composition of capital are expected to be
increased in a phased manner spanning up to year 2019. While Tier-1 capital has to be
increased from 4.5% in 2013 to 6% by 2019, the overall capital, including capital
conservation buffers and counter-cyclical buffers, is required to be increased from 8% in
2013 to 10.5% in 2019. Liquidity ratios are envisaged to be initiated in a phased manner
beginning with an observation period that commenced in 2011. The introduction of minimum
standards for liquidity ratios are expected to be between 2014 and 2018. The most discussed
leverage ratio is monitored from 2011. Below table captures the key elements of Basel-III
framework and the timeline for their full compliance.
Table . 4.6.
Key elements

Process and IT implemented;

Full Compliance

Readiness to report to regulator

Capital

New market-risk and Jan 2012

required
Jan 2012

securitisation
framework
Counter credit risk

Jan 2013

Jan 2013

Minimum core Tier 1 Jan 2013

Jan 2015

ratio

Leverage

Capital quality

Jan 2013

Jan 2022

Capital deductions

Jan 2014

Jan 2018

Conservation buffer

Jan 2016

Jan 2019

Leverage buffer

Jan 2013

Jan 2018

coverage Jan 2013

Jan 2015

Net stable funding Jan 2014

Jan 2018

Liquidity/funding Liquidity
ratio

ratio

4.7 HOW DIFFERENT IS BASEL III FROM BASEL II

Basel III framework has brought significant changes to Basel II in order to address topical
and much debated issues of procyclicality, maintenance of adequate liquidity levels, robust
capital levels to encounter any situation like the recent experienced global financial crisis.
Below table presents a brief description of the changes from Basel II to Basel III
Table. 4.7. A brief summary of changes from Basel II to Basel III
Basel II
Tier 1 & 2 capital ratios

Basel III

50% deduction in Tier 1 1250% risk weight

capital; 50% deduction in
Tier 2 capital

Common equity ratio

No deduction of

Risk-weighted assets include

securitization exposures

1250%

of

securitization

exposures
Collateral haircut

No

explicit

haircuts

for Explicit haircuts that are two

securitization exposures

times the corporate bonds;

resecuritisation not eligible

Market risk

No specific risk haircuts for Specific risk haircuts for

securitization exposures

securitization and
resecuritisation

Undeniably, Basel III will have wide-ranging implications for banks globally. Basel-III
framework would have a potential impact in financial system in reducing the systematic risk,
lowering of credit extension and may lead to lowering of economic growth. Looking at
potential impact on individual banks, Basel-III would lead to;
(1) Crowding out of weaker players,
(2) Pressure on profitability and ROE,
(3) Increased customer pricing,
(4) Increased dividend volatility
(5) Change in demand from short-term to long-term funding.
(6) Potential reorganization of legal entities,
(7) Increased focus on active balance sheet management and
(8) Redesign of business models and portfolio focus.

IMPACT ON
INDIA

Basel III- EFFECTS ON INDIA

Chapter 5

5.1 Introduction to Basel III Guidelines for Indian Banking according to

RBI
The reform package concerning to capital regulation, together with the enhancements to
Basel II framework and amendments to market risk framework is aimed at improving the
quality, consistency, and transparency of the capital base. With the disclosure of all the
elements of capital required to be disclosed along with a detailed reconciliation to the
published accounts, it is expected that the transparency of capital base would be improved the
market discipline under Pillar 3 of the Basel III framework.
Measures are initiated towards enhancing risk coverage. Currently, the counterparty credit
risk in the trading book covers only the risk of counterparty default. The Basel III norms
include an additional capital charge for credit value adjustment (CVA) risk which captures
risk of mark-to-market losses due to deterioration in the credit worthiness of a counterparty.
The risk of interconnectedness among larger financial firms will be better captured through
a prescription of 25% adjustment to the asset value correlation (AVC) under IRB
approaches to credit risk. In addition, the guidelines on counterparty risk management with
regard to collateral, margin period of risk and central counterparties and counterparty credit
risk management requirements have been strengthened.
The capital conservation buffer (CCB) has been proposed in order to ensure that banks build
up capital buffers during normal times, which can be drawn down as losses are incurred
during a stressed period. These capital conservation rules are designed to avoid breaches of
minimum capital requirements during the times of crisis. As a result, besides the minimum
total capital of 8%, banks will be require to hold a capital conservation buffer of 2.5% of
RWSs in the form of common equity to withstand future periods of stress bringing the total
common equity requirement of 8% of RWAs and total capital to RWAs to 10.5%. The capital
conservation buffer in the form of common equity will be phased-in over a period of four
years in a uniform manner of 0.625% per year, commencing from January 1, 2016.

In addition to CCB, a countercyclical capital buffer within a range of 0-2.5% of common

equity or other fully loss absorbing capital would be put into effect according to domestic
circumstances. The aim of countercyclical capital buffer is to achieve the broader macroprudential goal of protecting the banking sector from periods of excessive aggregate credit
growth. This countercyclical capital buffer will only be in effect whenever there is excess
credit growth that results in a system- wide build-up of risk and would be an extension of the
capital conservation buffer range.

5.2 BASEL III CAPITAL REQUIREMNETS

As a response to the aftermath of global financial crisis (GFC), with a view to improving the
quality and quantity of regulatory capital, RBI has stated that the predominant form of Tier 1
capital must be common equity; as it is critical that banks risk exposures are backed by high
quality capital base. As a result, under Basel III guidelines, total regulatory capital will
consist of the sum of the following categories:
12. Tier 1 capital (going-concern capital)
a. Common equity Tier 1
b. Additional Tier 1
13. Tier 2 capital (gone-concern capital)
Furthermore, in addition to the minimum common Equity Tier 1 capital of 5.5% of RWAs,
banks are also required to maintain a capital conservation buffer (CCB) of 2.5% of RWAs in
the form of common equity Tier 1 capital. Consequently, with full implementation of capital
ratios and CCB the capital requirements are summarised in below table:
Table- 5.0.
REGULATORY CAPITAL REQUIREMENTS IN INDIA AS PER BASEL III
S. NO

Regulatory capital

As % to RWAs

(1)

Minimum common equity Tier 1 ratio

5.5

(2)

Capital conservation buffer (comprised of common

2.5

equity)
(3)

Minimum common equity Tier 1 ratio plus capital

8.0

conservation buffer [(1)+(2)]

(4)

Additional Tier 1 capital

1.5

(5)

Minimum Tier 1 capital ratio [(1)+(4)]

7.0

(6)

Tier 2 capital

2.0

(7)

Minimum total capital ratio [(4)+(5)]

9.0

(8)

Minimum total capital ratio plus capital conservation

11.5

buffer [(7)+(2)]

5.2.1 Elements of common Equity Tier 1 capital

According to RBI, the common equity component of Tier 1 capital will comprise of;
a. Common shares (paid-up equity shares) issued by the bank, which meet the criteria
for classification as common shares for regulatory purposes
b. Stock surplus (share premium) resulting from the issue of common shares
c. Statutory reserves
d. Capital reserves representing surplus arising out of sale proceeds of assets
e. Other disclosed free reserves, if any
f. Balance in profit & loss account at the end of the previous financial year
g. While calculating capital adequacy at the consolidated level, common shares
issued by consolidated subsidiaries of the bank and held by third parties (i.e.
Minority interest) which meet the criteria for inclusion in common equity Tier 1
capital and
h. Less: Regulatory adjustments/deductions applied in the calculation of common
equity Tier 1 capital [i.e. to be deducted from the sum of items (a) to (g)

5.2.3 Elements of additional Tier 1 capital

Additional tier 1 capital according to RBI consists of the sum of the following elements:
I.

Perpetual non-cumulative preference shares (PNCPS), which comply with the

regulatory requirements.

II.

Stock surplus (share premium) resulting from the issue of instruments included in
additional Tier 1 capital.

III.

Debt capital instruments eligible for inclusion in additional Tier 1 capital, which
comply with the regulatory requirements.

IV.

Any other type of instrument generally notified by the Reserve Bank from time to
time for inclusion in additional Tier 1 capital.

V.

While calculating capital adequacy at the consolidated level, additional Tier 1

instrument issued by consolidated subsidiaries of the bank and held by third parties
which meet the criteria for inclusion in additional Tier 1 capital. And

Less, Regulatory adjustments/deductions applied in the calculation of additional Tier 1

capital [i.e.; to be deducted from the sum of items (i) to (v)].

5.3.4 Elements of tier 2 capital:

I.

General provisions and loss provisions

According to RBI guidelines, the following are reckoned as general provisions and loss
provisions:
a) Provisions for loan-loss reserves held against future, presently unidentified losses,
which are freely available to meet losses, which subsequently materialize, will qualify
for inclusion within Tier 2 capital. Accordingly, general provisions on standard assets,
floating provisions, provisions held for country exposures, investment reserve
account, excess provisions which arise on account of sale of NPAs and
countercyclical provisioning buffer will qualify inclusion in Tier 2 capital. However,
these items together will be admitted as Tier 2 capital up to a maximum of 1.25% of
the total credit risk-weighted assets under the standardised approach. Under Internal
Ratings Based (IRB) approach, where the total expected loss amount is less than total
eligible provisions, banks may recognize the difference as Tier 2 capital up to a
maximum of 0.65% of credit-risk weighted assets calculated under the IRB approach.
b) Provisions attributed to identified deterioration of particular assets or loan liabilities,
whether individual or grouped should be excluded. Accordingly, for example, specific
provisions on NPAs, both at individual account or at portfolio level, provisions in lieu
of diminution in the fair value of assets in the case of restructured advances,
provisions against depreciation in the value of investments will be excluded.
II.
III.

Debt capital instruments issued by banks.

Preference share capital instruments [perpetual cumulative preference shares
(PCPS)/redeemable

non-cumulative

preference

shares

cumulative preference shares (RCPS) issued by the banks.

(RNCPS)/redeemable

IV.

Stock surplus (share premium) resulting from the issue of instruments included in Tier
2 capital.

V.

While calculating capital adequacy at the consolidated level, Tier 2 capital instrument
issued by consolidated subsidiaries of the bank and held by third parties, which meet
the criteria for inclusion in Tier 2 capital.

VI.
VII.

Revaluation reserves at a discount of 55%.

Any other type of instrument generally notified by the RBI from time to time for
inclusion in Tier 2 capital. And

VIII.

Less, Regulatory adjustments/deductions applied in the calculation of Tier 2 capital

[i.e.; to be deducted from the sum of items (i) to (viii)]

Table-5.1: Regulatory capital ratios in the year 2018

i.

Common equity Tier

7.5% of RWAs

ii.

capital conservation buffer

2.5% of RWAs

iii.

Total CET 1

10% of RWAs

iv.

PNCPS/PDI

3.0% of RWAs

v.

PNCPS/PDI eligible for Tier 1 capital

2.05%

of

RWAs

{(1.5/5.5)*7.5%

of

CET 1}
vi.

PNCPS/PDI not eligible for Tier 1 capital

0.95% of RWAs (32.05)

vii.

Eligible total Tier 1 capital

9.55% of RWAs

viii.

Tier 2 issued by bank

2.5% of RWAs

Tier 2 capital eligible for CRAR

2.73%

ix.

of

{(2/5.5)*7.5%

RWAs
of

CET 1}
x.

PNCPS/PDI eligible for Tier 2 capital

0.23%

of

RWAs

(2.73-0.23)
xi.

PNCPS/PDI not eligible for Tier 2 capital

0.72%

of

(0.95-0.23)
xii.

Total available capital

15.50%

xiii.

Total capital

4.78%

RWAs

(12.28%+2.5%)
(CET 1-10%+ AT12.05%+Tier 2-2.73)

Source: Reserve Bank of India

5.3.5 Regulatory Adjustments/Deductions:

The existing guidelines stipulate the banks to make regulatory adjustments/deductions from
either Tier 1 capital or 50% from Tier 1 to 50% from Tier 2 capital. Therefore, it has been
possible for some banks under the current standard to display strong Tier 1 ratios with limited
tangible common equity. On the other hand, the crisis has revealed that credit losses and
write-downs were absorbed by common equity. Therefore, it is the common equity base
which best absorbs losses on a going concern basis. Consequently, under Basel III, most of
the deductions are required to be applied to common equity both at solo and consolidated
level.
The regulatory adjustments/deductions would include;
a. Goodwill and other intangible assets.
b. Deferred Tax Assets (DTAs)
c. Cash flow hedge reserve.
d. Shortfall of the stock of provisions to expected losses.
e. Gain-on-sale related to securitization transactions.
f. Cumulative gains and losses due to change in own credit risk on fair valued financial
liabilities.
g. Defined Benefit Pension Fund assets and liabilities.
h. Investment in own shares (Treasury stock). And
i. Investment in the capital of banking, financial and insurance Entities.

5.3.6 Disclosure requirements:

According to Basel III, in order to ensure adequate disclosure of details of the
components of capital aimed at improving transparency of regulatory capital reporting
as well as improving market discipline, banks are required to disclose.
a) Full reconciliation of all regulatory capital elements back to the balance sheet
in the audited financial statements.

b) Separate disclosure of all regulatory adjustments and the item not deducted
from common equity.
c) Description of all limits and minima, identifying the positive and negative
elements of capital to which the limits and minima apply. And,
d) Description of the main features of capital instruments issued. Further, banks,
which disclose ratios involving components of regulatory capital (e.g. Equity
Tier 1 or Tangible common equity ratios, must accompany such
disclosures of how these ratios are calculated).
Banks are also required to make available on their websites the full terms and
conditions of all instruments include in regulatory capital. Further, during the
transition phase banks are required to disclose the specific components of
capital, including capital instruments and regulatory adjustments, which are
benefiting from the transitional provisions.

5.3.7 Transitional Arrangements:

In order to ensure smooth migration to Basel III without aggravating any near term stress,
appropriate grandfathering and transitional arrangements have been suggested. Having regard
to relatively higher common equity Tier 1 capital ratio of banks operating in India, the
transitional arrangements could be shorter than that envisaged by the BCBS. As such, the
transition phase would commence from January 1, 2013. However, target ratio to be achieved
in subsequent years will be aligned with annual closing of banks. Capital ratio and deductions
from common equity will be fully phased in and implemented as on March 31, 2017. The
phase- in arrangements for banks operating in India are indicated in the following table- 6. 3;

Table-5.2: Basel III: Transactional Arrangements-scheduled commercial banks in india

(excluding LABs and RRBs)

Minimum

capital March

ratio
Minimum

2013
common 4.5

March

March

March

March

March

4014

2015

2016

2017

2018

5.0

5.5

5.5

5.5

5.5

0.625

1.25

1.875

2.5

equity Tier 1 (CET 1)

Capital conservation
buffer (CCB)

Minimum CET1+CCB 4.5

5.0

6.125

6.75

7.375

8.0

Minimum

6.5

7.0

7.0

7.0

7.0

9.0

9.0

9.0

9.0

9.0

9.0

Minimum total capital 9.0

9.0

9.625

10.25

10.875

11.5

40

60

80

100

100

Tier

1 6.0

capital
Minimum total capital

+CCB
Phase in of all 20
deductions from CET
1 (in %)
Source: Reserve bank of India
It is clarified that capital instruments, which no longer qualify as non-common equity. Tier1
capital or Tier 2 capital (e.g. .Tier 2 debt instruments with step-ups) will be phased out
beginning January 1, 2013. Fixing the base at the nominal account of such instruments
outstanding on January 1, 2013, their recognition will be capped at 90% from January 1,
2013, with the cap reducing by 10% age points in each subsequent year. This cap is
applicable to additional Tier 1 and Tier 2 instruments separately and refers to the total
amount of instruments outstanding, which no longer meet the relevant entry criteria. To the
extent, as instrument is redeemed, or its recognition in capital is ,after amortised, after
January 1, 2013, the nominal amount serving as the base is not reduced. The minimum capital
conservation ratios a bank must meet at various levels of the common equity Tier 1 capital
ratios.
Banks are required to maintain a capital conservation buffer of 2.5%, comprised of Common
Equity Tier 1 capital, above the regulatory minimum capital requirement41of 9%. Banks
should not distribute capital (i.e. pay dividends or bonuses in any form) in case capital level
falls within this range. However, they will be able to conduct business as normal when their
capital levels fall into the conservation range as they experience losses. Therefore, the
constraints imposed are related to the distributions only and are not related to the operations
of banks. The distribution constraints imposed on banks when their capital levels fall into the
range increase as the banks capital levels approach the minimum requirements. The Table
below shows the minimum capital conservation ratios a bank must meet at various levels of
the Common Equity Tier 1 capital ratios.

Table-5.3: Minimum capital conservation standards for individual bank

Common equity Tier Minimum

1 ratio

capital

conservation

ratios

(expressed as a % of earnings )

5.5%-6.125%

100%

>6.125%-6.75%

80%

>6.75-7.35%

60%

>7.375%-8%

40%

>8.0%

0%
Source: Reserve bank of India

For example, a bank with a Common Equity Tier 1 capital ratio in the range of 6.125% to
6.75% is required to conserve 80% of its earnings in the subsequent financial year (i.e. payout
no more than 20% in terms of dividends, share buybacks and discretionary bonus payments is
allowed).

5.4 Significance of Basel III for Indian banking:

Basel III guidelines attempt to enhance the ability of banks to withstand periods of economic
and financial stress by prescribing more stringent capital and liquidity requirements for them.
The new Basel III capital requirement would be a positive impact for banks as it raises the
minimum core capital stipulation, introduces counter-cyclical measures, and enhance banks
ability to conserve core capital in the event of stress through a conservation capital buffer.
The prescribed liquidity requirements, on the other hand, would bring in uniformity in the
liquidity standards followed by the banks globally. This liquidity standard requirement,
would benefit the Indian banks manage pressure on liquidity in a stress scenario more
effectively.
Although implementing Basel III will only be an evolutionary step, the impact of Basel III on
banking sector cannot be underestimated, as it will drive significant challenges that need to
be understood and addressed. Working out the most cost-effective model for implementation
of Basel III will be a critical issue for Indian banking.
1. Impact on the financial system:

Basel III framework implementation would lead to reduced risk of systematic banking crisis
as the enhanced capital and liquidity buffers together lead to better management of probable
risks emanating due to counterparty defaults and or liquidity stress circumstances. Further,
in view of the stricter norms on Inter-bank liability limits, there would be reduction of the
interdependence of the banks and thereby reduced interconnectivity among banks would
save the banks from contagion. Undoubtedly, Basel III implementation would strengthen
the Indian banking sectors ability to absorb shocks arising from financial and economic
stress, whatever the source be, and consequently reduce the risk of spillover from the
financial sector to the real economy.

2. Higher Capital Requirement

Presently, in India, most banks' common equity ratio falls in the range of about 6-10 per cent.
Hence, in my opinion, banks may able to comply with the higher capital requirement as per
Basel III norms at least till 2014/15. This, without infusing any fresh equity, even while
taking into account the marginal increase in capital requirement. However, the increase in the
minimum capital ratio, combined with loan growth outpacing internal capital generation in
most government banks, will lead to a shortfall of capital. This will mount mainly between
2015/16 and 2017/18 due to introduction of a Capital Conservation Buffer (CCB). The CCB
is designed to ensure that banks build up capital buffers during normal times, which can be
drawn down as losses are incurred during a stressed period. The requirement of capital will
be less to large private sector banks due to their higher capital ratios and stronger
profitability. However, some public sector banks are likely to fall short of the revised core
capital adequacy requirement and would therefore depend on government support to augment
their core capital. The additional equity capital requirements in the public sector banks,
mainly due to Basel III norms in the next five years, work out to around Rs 1,400-1,500
billion. If the government holds the existing shareholding, the recapitalization burden borne
by it will be to the extent of around Rs 900-1,000 billion. This will contribute to additional
government borrowing to the extent of Rs 1,000 billion. As per the analysis, on account of
this extra government borrowing, the country's fiscal deficit is expected to increase further,
by about 25 basis points per annum. This will widen the fiscal deficit, inflation, lower
economic growth, credit offtake and thereby bank profitability.
3. Pressure on Return on Equity:
To meet the new norms, apart from government support a significant number of banks have
to raise capital from the market. This will push the interest rate up, and in turn, cost of capital

will rise while return on equity (RoE) will come down. To compensate the RoE loss, banks
may increase their lending rates. However, this will adversely affect the effective demand for
loan and, thereby, interest income. Further, with effective cost of capital rising, the relative
immobility displayed by Indian banks with respect to raising fresh capital is also likely to
directly affect credit offtake in the long run. All these affect the profitability of the banks
4.

Pressure on Yield on Assets:

On account of higher deployment of funds in liquid assets that give comparatively lower
returns, banks' yield on assets, and thereby their profit margins, may be under pressure.
Further higher deployment of more funds in liquid assets may crowd out good private sector
investments and also effect economic growth.
5.

On weaker banks:

Further, there would be a drastic impact on the weaker banks leading to their crowding out.
As is well established, as conditions deteriorate and the regulatory position gets even more
intensive, the weaker banks would definitely find it very challenging to raise the required
capital and funding. In turn, this would affect their business in favor of large financial
institutions and thereby tilting the competition.
6.

Increased supervisory vigil:

Banking operations might experience a reduced pace as there would be an increased

supervisory vigil on the activities of the banks in terms of ensuring the capital standards,
liquidity ratios-LCR and NSFR and others.
7.

Reorganization of institutions:

The increased focus of the regulatory authorities on the organizational structure and capital
structure ability of the financial firms (mainly banks) would lead the banks to reorganize their
legal identity by resorting to mergers and disposals of portfolios, entities, or parts of entities
wherever possible.
8.

International Arbitrage:

In case of inconsistent implementation of Basel III framework among different countries

would lead to international arbitrage thereby resulting in disruption of global financial
stability.

5.5 Action Required from Banks

To address these issues and to protect their profitability margins, banks need to look beyond
regulatory compliance and take proactive actions - assessing their lines of business, level of

risk profiles, economizing capital and drawing up funding strategies.

In this regard the following strategies need to be adopted:

1. Change in Business Mix:

Since retail banking has a comparatively lower risk weight compared to corporate banking
(except in the case of clients who are A rated and above), the impact on higher allocation of
capital will be less on retail banking. Further, in corporate banking, as chances of a default in
short-term loans is less, on an average, compared to chances of a default in long-term loans,
banks need to shift towards short-term/retail loans. And to take a granular approach to protect
their margins under the new Basel III norms.

2. Change in Customer Mix:

Banks need to review their capital allocation to each client segment and price it in line with
the profile to ensure that capital is allocated to segments that generate higher risk-adjusted
returns.

3. Low-Cost Funding:
One of the most important factors to meet the new regulations is to have a stable low-cost
deposit base. For this, banks need to focus more on having business
correspondents/facilitators to reach customers as adding branches will increase costs and
have an impact on the profit margin.

4. Improvement in systems and procedures:

Refining the rating model/data cleaning/ modernization of systems and procedures may help
banks economize their risk-weighted assets, which will help reduce capital requirements to
some extent.

5. Additional capital:
In order to fully compliment with the Basel III capital requirements banks require additional
capital, banks need to frame out the proper strategy regarding procurement of needed funds.

5.6 Capital standards for India:

Indian banks need to look for quality capital and also have to preserve the core capital as well
as use it more efficiently in the backdrop of Basel III implementation. Though on the basis of
numbers (refer table 5.4). Indian banks look comfortably placed; they will have to phase out
those instruments from their capital that are disallowed under Basel III. The difference in the
guidelines on deductions are presented in table 5.4
Table-5.4:
Minimum capital ratio

Basel III

Basel III

Existing

PCBs

Private

of BCBS

of RBI

RBI

current

banks

norms

position

current
position

Minimum common equity Tier 1

4.5%

5.5%

3.6%

7.3%

11.2%

Capital conservation buffer (CCB)

2.5%

2.5%

11.2%

Minimum CET 1+CCB

7%

8%

3.6%

7.3%

11.2%

Minimum Tier 1 capital

7.0%

7.0%

3.6%

7.3%

11.2%

Minimum total capital including

8%

9.0%

6%

8,1%

11.5%

Minimum total capital+ CCB

10.5%

11.5%

9.0%

12.1%

15.9%

Additional countercyclical buffer in

0-2.5%

0-2.5%

NA

NA

NA

(CET 1)

buffer

the form of common equity capital

Source: Reserve Bank of India

Table-5.5:
Basel III of RBI

Existing RBI norms

Impact

Limit on

Deductions would be

All deductibles to be

Positive

deductions

made if deductibles

deducted

exceed the 15% of core

capital at an aggregate
level, or 10% at the
individual item level.
Deductions from

All deductions from core 50% of the deductions

Tier 1 or Tier 2

capital.

from Tier 1 and remaining

Negative

50% from Tier 2 capital

(excepting DTAs and
intangibles where 100%
deductions is made from
Tier 1 capital)
Treatment from

Aggregated total equity

For investment up to: (a)

significant

investment in entities

30%: 125% risk weight or

investments in

where banks own more

risk weight as warranted by

common shares of

than 10% of shares- (a)

external rating (b) 30-50%:

unconsolidated

Less than 10% of banks

50% deductions from Tier

financial entities

common equity-250 risk

1 capital and 50% from

weight (b) More than

Tier 2 capital.

Negative

10% will be deducted

from common equity.
Source: RBI

5.7. Basel IIIs impact on capital

Basel III capital requirement projections for Indian banks

In the wake of the new Basel III regime in the Indian context, it is attempted in this section of
the study to estimate additional minimum Tier-1 capital for the banks. This would enable the
banks to plan their capital raising activity in tune with the regulatory requirements. This
exercise is carried out based on the data sourced from capitaline plus database. As such, these
estimates as the best can be termed as approximations as these have data limitations with
regard to details required in the estimation process.
The methodology adopted includes the estimation process based on the reported Tier-1, Tier2 capital, total capital and RWAs sourced from the Basel disclosures made by the banks in
their websites. The data for all the scheduled commercial banks has been collected
accordingly and grouped based on the bank groups namely; public sector banks and private
banks. The important assumption made in the estimation process is that RWAs of these banks
grow by 10% points annually in scenario-1 and 12% per annum in scenario-2 and 15% in
scenario-3. This increase in RWAs is considered because of the reasoning that the banks
grow their loan book size approximately in the range of 20-25% and also considering the past
trend of RWAs.

The estimates are presented in the tables here below, with an assumed growth of RWAs at
10%, banks in India would require additional minimum tier-1 capital of INR 2, 51,106.57
crores. With RWAs growth at 12% and 15%, the requirement would be in the order of INR
3.36, 390.41 crores and INR 4, 74,168.60 crores respectively.
Table-5.6: Basel III Compliance Required Minimum Tier-1 capital

Amount in INR crores

By Year

PSBs

Private Banks

Total amount

Scenario-1 with 10% growth in RWAs

2013

6,173.54

0.00

6,173.54

2014

16,206.69

0.00

16.206.69

2015

62,103.88

22,54.28

64,358.16

2016

82,070.48

5,158.26

87,228.74

2017

1,37,120.89

13,263.44

1,50,384.33

2018

2,14,104.12

37,002.44

2,51,106.57

Scenario-2 with 12% growth in RWAs

2013

7,188.12

0.00

7,188.12

2014

30,403.23

5.48

30,408.72

2015

75,469.86

4,694.77

80,164.63

2016

1,19,891.65

10,265.87

1,30,157.51

2017

1,84,195.79

30,082.58

2,14,224.37

2018

2,74,793.18

61,597.23

3,36,390.41

Scenario-3 with 15% growth in RWAs

2013

7,049.99

0.00

7,049.99

2014

1.10,613.04

1,099.52

1,11,712.56

2015

1,17,188,41

8,601,80

1.25.790,21

2016

1,70,369.71

22,517.34

1,92,887.06

2017

2,56,646.88

51,563.57

3,08,210.45

2018

3,78,891.07

95,277.53

4,74.168.60

Source:

Table-5.7: Basel III Compliance Total Capital Requirement

Amount in INR crores

By Year

PSBs

Private Banks

Total amount

Scenario-1 with 10% growth in RWAs

2013

3,26,499.99

4,055.91

3,30,555.90

2014

1,09,542.06

7,646.42

1,17,188.49

2015

1,70,730.60

22,536.63

1,93,366.24

2016

2,40,687.89

46,101.28

2,86,789.18

2017

3,20,555.80

74,139.92

3,94,695.73

2018

4,11,616.88

1,27,583.67

5,39,200.55

Scenario-2 with 12% growth in RWAs

2013

3,34,423.13

5,672.23

3,40,095.35

2014

1,28,809.76

12,112.95

1,40,922.71

2015

2,01,228.73

35,785.75

2,37,014.49

2016

2,85,755.51

65,655.85

3,51,411.36

2017

3,84,253.13

1,02,123.01

4,86,376.14

2018

4,98,857.402

1,68,255.16

6,67,112.56

Scenario-3 with 15% growth in RWAs

2013

3,46,575.50

7,369.00

3,53,944.50

2014

1,59,028.77

18,801.17

1,77,829.94

2015

2,50,141.67

48,625.57

2,98,767.24

2016

3,59,669.83

88,312.77

4,47,982.60

2017

4,91,087.79

1,35,931.68

6,27,019.46

2018

6,48,498.11

2,20,880.63

8,69,378.74

Source:
These estimations are comparable to the estimates of the finance ministry of government of
India for public sector banks. According to the newspaper reports quoting GOI sources, the
additional capital needs of the public sector banks would be of order of INR 3 lakh crores.
Further the estimations are similar to the ones announced by various private research/rating
houses in the country such as CRISIL, ICRA, CARE, FITCH and others.
A study by rating agency Fitch estimates the additional capital requirements at about INR 2.5
lakh crores to 2.75 lakh crores for Indian banks. Moodys Indian subsidiary ICRA said banks
in the country would require equity capital ranging from 3.9lakh crores to 5 lakh crores to
comply with the Basel III standards. According to CRISIL, Indian banks may have to raise a
total of about 2.4 trillion to meet growth needs in compliance with The Reserve Bank of
Indias final guidelines on capital adequacy requirements under the Basel III norms by March
2018.
In view of the predicted favourable economic growth over the next three years, it would
enable the banks to shore up their capital bases through issuance of equity. However, a few of
the below average performing banks may be necessitated to raise additional equity capital to
maintain the required 7%.

5.8. Are Indian banks ready to implement Basel III?

Most of the private sector and foreign banks are in a comfortable position since they have a
core capital in excess of 9% whereas this is not the case with the public sector banks.
According to an ICRA report, public and private sector banks would require an additional
capital of 600000 crore, assuming a 20% growth in risk-weighted assets, which is
achievable so long as banks can find investors for the riskier additional tier I capital, says
ICRA.
Out of the total requirement 75-80% will be required by the public sector banks. Thus the
burden will fall on the cash-stripped government which will need to infuse massive amount
of capital to maintain its shareholding of 51%.This looks difficult to achieve seeing the
current state of the government financials with high fiscal deficit of 4.8% in 2012-13 and
massive subsidy burden. The government is not in a position to provide the capital nor will it

allow other investors to do so because it would reduce the governments grip on public sector
banks.
The leverage ratio of 3% will not affect the Indian banks much because this is meant for
banks with large trading book and exposure to off balance sheet derivatives and Indian banks
dont have much exposure to the derivatives market. Liquidity coverage Ratio (LCR) requires
banks to hold enough liquid assets to cover cash outflows during a 30 day stress period.
Indian banks are fairly comfortable on this front as well as they hold 24% in government
securities in form of SLR(Statutory Liquidity Ratio) and 4.75% in cash in form of CRR(Cash
Reserve Ratio) with the RBI.
However the ultimate LCR burden would depend on how much CRR and SLR can be offset
against LCR. Basel III will also force banks to put a large part of their profit back in the
balance sheet as retained earnings rather than distributing dividends. Although there is no
significant improvement in capital requirement under Basel3 as compared to Basel 2 but the
problem is change in way that some of the capital market instruments will be treated.
Perpetual debt which is now treated as Tier 1 capital will be excluded under Basel3, putting
more pressure in the requirement of core capital.

5.9. Basel III--- Impact on the Indian economy

Increase in the requirement of capital will affect the ROE of the banks, financial ratios would
be hurt and the public sector banks will not be able to expand their loan book due to
unavailability of capital. According to ICRA, increase in the core Tier1 capital from 6% to
8% will reduce the return on equity percentage points from 18% to 15%. Public sector banks
with core capital less than 7% will be severely impacted whereas the earnings of the private
sector banks will not be affected much as they are already well capitalized but would reduce
leveraging.
Cost of capital for the banks would increase with the increase in equity in the capital structure
as equity is an expensive form of capital. As capital costs increase credit will become more
expensive. Banks will impose tougher conditions for granting credit to small and medium
sized firms and for start-up businesses. Also with deposit rates rising lower than expectations
at 14% will put further pressure of credit costs. With the credit becoming costlier the

investment activity in the country will be severely impacted thus impacting the economic
growth.
Indian banks will have to learn the art of balancing growth with capital requirements. Indian
banks have not utilized properly the base of Tier 2 capital, except for some private sector
banks. The ability to efficiently manage the tier 1 and tier 2 capitals will be critical to manage
return on equity. Indian banks should move quickly to advanced approaches of risk
estimation from the formula based approaches to avoid over-estimation in capital
requirements for credit and operational risk. The Basel committee is also proposing to
increase the credit conversion factor of off-balance sheet items from 20% to 100%. This will
mean that the banks will have to set aside more capital against asset backed loans, thus
reducing their leverage and bringing in more stability in the banking sector.
This will also increase the cost of other off-balance items like Letter of Credit. Letter of
Credit is a low risk product which requires detailed documentation and collaterals and the
stringent norms of Basel III would have a negative impact on global trade. The increase in the
cost of Letter of Credit will be passed on entirely to the customer or the bank may focus on
other profitable activities by reducing the issuance of Letter of Credit. As a result of Letter of
Credit becoming more expensive, traders will switch to alternative instruments of trade
finance like unsecured financing in the form of forfeiting. These instruments though less
expensive but add onus to the companies for counterparty and country risk evaluation.
With the implementation of BASEL III the banks will move to risk-averse mode which could
severely impact the Indian economy, which needs large amounts of credit especially the
infrastructure sector with requirements of 1 trillion over next five years. The big question is
whether it is right to implement the same kind of stringent measures to economies which are
inherently differently in their risk appetite. While the developed world aims at avoidance of
the 2008 crisis, for the developing world and the emerging markets the objective is growth to
meet the needs of increasing population. So BASEL III should provide a solution which is
tailored made for the developing economies. Thus, though BASEL III will make banks more
capable of handling a financial crisis, it will have a negative impact on the GDP of the
economies like India, which should be a matter of concern.

5.10.Challenges with the Indian Banking Industry

The feature of additional capital requirements, will pose a challenge for the Indian banks
though, the overall capital level of the banks will see an increase. Another challenge is restructuring the assets of some of the banks would be a tedious process, since most of the
banks have poor asset quality leading to significant proportion of NPA. This also may lead to
Mergers & Acquisitions, which itself would be loss of capital to entire system. The new
norms seem to favor the large banks that have better risk management and measurement
expertise, who also have better capital adequacy ratios and geographically diversified
portfolios. The smaller banks are also likely to be hurt by the rise in weightage of inter-bank
loans that will effectively price them out of the market. Thus, banks will have to re-structure
themselves if they are to survive in the new environment. Improved risk management and
measurement aim to give impetus to the use of internal rating system by the international
banks. More and more banks may have to use internal models developed in house and their
impact is uncertain. Most of these models require minimum historical bank data that is a
tedious and high cost process, as most Indian banks do not have such a database.
The technology infrastructure in terms of computerization is still in a nascent stage in most
Indian banks. Computerization of branches, especially for those banks, which have their
network spread out in far-flung areas, will be a daunting task. Penetration of information
technology in banking has been successful in the urban areas, unlike in the rural areas where
it is insignificant. Experts say that dearth of risk management expertise in the Asia Pacific
region will serve as a hindrance in laying down guidelines for a basic framework for the new
capital accord. An integrated risk management concept, which is the need of the hour to align
market, credit and operational risk, will be difficult due to significant disconnect between
business, risk managers and IT across the organizations in their existing set-up.
Implementation of the Basel III will require huge investments in technology. According to
estimates, Indian banks, especially those with a sizeable branch network, will need to spend
well over $ 50-70 Million on this.

5.11LOOKING BEYOND BASEL III

Increased global regulation will impact the structure, profitability and management of the
banking and financial industry by:
(I)

Reducing the risk of another systemic global financial crisis

(II)

The impact of systemic crisis

(III)

Systemically important institutions

(IV)

Higher capital and liquidity requirements reduce leverage and earnings

(V)

Lower risk premium

(VI)

Capital costs

(VII) Increased demands on risk management and risk adjusted pricing

(VIII) Complex risk management mandates and
(IX)

Deployment of capital, employees and business infrastructure.

FINDINGS,
RECOMMENDATIONS
AND CONCLUSION

Chapter 6
Findings
The new capital requirements under Basel III would have a positive impact for banks as they
raise the minimum core capital, introduces counter-cyclical measures, and enhance banks
ability to conserve core capital in the event of stress through a conservation capital buffer.
The liquidity standards requirements would benefit the Indian banks in managing the
pressures on liquidity in a stress scenario more effectively. However, in case of inconsistent
implementation of a new framework among different countries would lead to international
arbitrage thereby resulting in disruption of global financial stability.
Basel III frameworks impact on the financial system would be significant, as its
implementation would lead to reduced risk of systemic banking crises as the enhanced capital
and liquidity buffers together lead to an improved management of probable risk emanating
due to counter party defaults and or liquidity stress circumstances. The stricter norms on inter
-bank liability limits would reduce the interdependence of the banks and the reduced
interconnectivity among the banks would save the banks from contagion risk during the times
of crisis.
There would be a strong impact on the weaker banks leading to their crowding out. As the
conditions deteriorate and the regulatory position gets even more intensive, the weaker banks
would definitely find it very challenging to raise the required capital and funding. Further,
this would affect their business models apart from titling the banking business in favor of
large financial institutions and thereby titling the competition in the light of increased
regulatory oversight on the organizational structure and capital structure of the financial firms
(mainly banks), there would be scenarios where the banks may look towards reorganizing
their legal identity by resorting to mergers and acquisitions and disposal of portfolios,
entities, or parts of entities wherever possible.

6.1 Summary of Basel III implications

1) Increased quality of capital
Basel III contains various measures aimed at improving the quality of capital, with the
ultimate aim to improve loss-absorption capacity in both going concern and liquidation
scenarios.
Description of change
-

Common

Implications

equity

and

retained

BCBS measures are already discounted

earnings should be the predominant

by markets so banks are likely to clean up

component of tier 1 capital instead of

their balance sheets as soon as possible.

debt-like instruments, well above the

current 50% rule.
-

Harmonized

requirements

for

and
Tier2

simplified
capital

with

Likely to see raising of significant

capital by banks, along with retention of

explicit target for tier 2 capital

profits and reduced dividends.

Gradual phase out of hybrid tier 1

Systemically important banks (and,

components, including many of the set-

potentially, all banks) may be allowed to issue

up/innovative/SPV-issued

contingent convertibles to meet additional

Tier1

instruments used by banks over the past

capital requirements.

decade.

2) Increased quantity of capital

Basel III contains various measures aimed at increasing the level of capital held by
institutions, as well as providing counter-cyclical mechanisms
Description of change

Implications

1) Minimum common equity Tier1:

Banks will face a significant additional

Increased from 2.0% to 4.5%

capital requirement and the bulk of this

Plus

shortfall will need to be raised as

capital

conservation

buffer of 2.5%
Bringing

total

common
common

equity requirements to 7.0%

equity

retaining earnings

or

otherwise

by

 To be phased in from 2013 to

2019.
2) Minimum total capital:
Increased
10.5%

from

8.0%

In principle, banks will be able to draw

to

on the capital conservation buffer

(including

during periods of stress, but it seems

conservation buffer)

unlikely that they would do so, given

To be phased in from 2013 to

the associated constraints on their

2019.

earning distribution.

.
3) Reduced leverage
Leverage ratio acts as non-risk sensitive backstop measure to reduce the risk of build
up of excessive leverage in the institution and in the financial system as a whole.

Description of change
1)

Implications

The leverage limit is set as 3%, i.e. -

The introduction of leverage ratio

banks total assets should not be more than 33 could lead to reduced lending and is a
times of bank capital.
2)

clear incentive to banks to strengthen their

In 2011, reporting templates has been capital position, although it remains to be

developed.

In

2013,

regulators

started seen whether the ratio will bite for

monitoring leverage ratio data. And the ratio will individual firms.
be effective from Jan 2018.
3)

The non-risk adjusted measure

The ratio is introduced to supplement the could incentivize banks to focus on higher

risk based measures of regulatory capital.

4)

risk/higher return lending.

The leverage ratio is implemented on a -

Pressure arises on banks to sell

gross and unweighted basis, not taking into low margin assets which could drive
account the risks related to the assets.

down prices on these assets.

-

Banks may be required by the

market and other rating agencies to

maintain a higher leverage ratio than
required by the regulators.

4) Increase short term liquidity coverage

The regulatory response to the financial crisis has seen a long overdue rebalancing towards
the importance of the liquidity risk management and to complement its principles for sound
liquidity risk management and supervision, the Basel committee has further strengthened its
liquidity frameworks by developing two minimum standards for funding liquidity:

have a

negative impact on probability.

Description of change
1.

Implications

The 30-day liquidity coverage ratio

The risk of impact from a bank run should

(LCR) is intended to promote short term

be reduced, which would improve the overall

resilience to potential liquidity disruptions.

stability of the financial sector.

The LCR will help ensure that global banks

have sufficient high quality assets to with-

banks to hold significantly more liquid, low-

stand a stressed funding scenario specified by

yielding assets to meet the LCR, which will

supervisors.
2.

The introduction of the LCR will require

Banks will change their funding profile,

For the LCR, the stock of high quality

which will lead to more demand for longer-term

liquid assets is compared with expected cash

funding. These institutional investors that generally

outflows over a 30-day stress scenario. The

seek to reduce their holdings in financial sector.

expected cash outflows are to be covered by

sufficiently liquid, high-quality assets.

3.

Interpretation of right run-off rates by

national regulators may cause level-playing field

Assets gets a liquidity based

discussions.

weighting varying from 100% for GOVT.

bonds and cash to weighting of 0%-50%for
corporate bonds.

5) Increased stable long term balance sheet funding

The Net Stable Funding Ratios (NSFR) is designed to encourage and incentivize the
banks to use stable source to fund their activities to reduce the dependency on shortterm funding.
Description of change

Implications

The NSFR compares available

funding source

with

The NSFR incentivize for banks to

funding needs

reduce their reliance on short-term wholesale

resulting from the assets on the balance

funding and increase stability of the funding

sheet.

mix.

Available stable funding required

stable funding.

Banks

will

need

to

increase

the

proportion of wholesale and corporate deposits

Required and available funding

with maturities greater than 1 year but,

amounts are determined using weighing

currently the appetite for term debts is limited.

factors, reflecting the stability of the

funding available and the duration of the

increase the proportion of wholesale deposits

assets.

with maturities greater than 1 year (limited

The weighing factors for assets

For most banks it will be difficult to

market demand), which is likely to lead to

vary from 0% and 5% for cash and govt.

higher funding costs.

bonds, respectively to, 65% for mortgages,

85% for retail loans and 100% for other

assets mix will likely result in an increase in

assets.

the proportion of short term assets, reducing

For determining stable funding

available for liabilities, the weighing

Managing the NSFR by altering the

yield.

Stronger banks with a higher NSFR will

factors vary from 100% for Tier 1 capital

be able to influence market pricing of assets.

to 90% for unsecured wholesale funding.

Weaker banks will see their competitiveness

ECB funding is weighed at 0%.

reduced, which will potentially decrease the

level of competition.

6) Strengthen risk capture, notably counterparty risk:

The BCBs seek to ensure full coverage of risks in the Pillar 1 framework increasing the
capital requirements against risks not adequately captured in the Basel II framework.
Significant increases for trading book and securitization positions have already been
introduced in Basel 2.5 proposals (July 2009). The Basel III proposals primarily modify the
treatments of exposure to financial institutions and the counterparty risk on derivative
exposures and will be effective from January 1, 2013.

Descriptions of the key changes

Calibration of counterparty credit

Implications

Still a degree of uncertainty over

risk modeling approaches such as

the final capital impact as credit

Internal Model Methods (IMM) to

valuation adjustments charge is being

stressed periods.

revised to reflect significant industry

criticism.

Increased correlation for certain

financial institutions in the IRB formula

to reflect experience of the recent crisis,

risk management is critical as risk is

new capital charges for credit valuation

focused on central bodies.

adjustments, arid wrong-way risk

sector business arising from increased

Carrot and Stick approach to

Controls and quality of the CCPs

Reduce level of intra-financial

encouraging use of central counterparty

capital charges intra-sector.

(CCPs) for standardized derivatives.

Improved

counterparty

Costs of dealing with financial

risk

counterparties need to be priced into the

management standards in the areas of

business, lending to a review of the

collateral

business model.

management

and

stress

testing.

Capital requirement of Indian banks

This study has estimated the approximations of additional capital requirements of Indian
banks in the wake of the new Basel III regime in the Indian context. This would enable the
banks to plan their capital raising activity in tune with the regulatory requirements. The
important assumption made in the estimation process was that RWAs of these banks would
grow by 10% points annually in scenario-1 and 12% p.a. in scenario-2 and 15% in scenario-3.
This increase in RWAs is considered because of the reasoning that the banks grow their loan
book size approximately in the range of 20-25% and also considering the past trend of
RWAs. The estimates of this study are compared with that of other comparable studies by
reputed professional research houses in India presented here below.
Research house
Swamy
study

Estimations

(2012) Swamy (2012) study estimates that with an assumed growth of RWAs at
10%, Indian banks would require additional minimum tier-1 capital of
INR 2, 51,106.57 crores. With RWAs growth at 12% and 15%, the
requirement would be in the order of INR 3, 36,390.41 crores and INR 4,
74,168.60 crores respectively.

Ernst & young Ernst and Young study anticipates that by 2019, the Indian banking
study

system is projected to require additional capital of INR 4,31,517 crores of

which 70% will be required in the firm of common equity.

ICRA study

ICRA study pegs this figure at INR 6.00,000 crores of which 70-75% will
be the requirement of public sector banks.

PWC study

PWC study estimates that Indian banks would have to raise RS. 6,00,000
crore in external capital over next 8-9 years, out of which 70-75% would
be required for the public sector banks and rest for the for private sector
banks. Further, the study observed that one percentage point rise in
banks actual ratio of tangible common equity to risk-weighted assets
(CAR) could lead to a 0.20 per cent drop in GDP.

Fitch Ratings

Fitch estimates the additional capital requirements at about INR 2.5 lakh
crores to 2.75 lakh crores for Indian banks.

Macquarie

Indian banks would have to go on a massive capital raising to the extent

of over USD 30 billion (INR 1.67 lakh crores) over the next five years to
cater to their growth requirements and Basel III implementation charges.

CRISIL

Indian banks may have to raise a total of about RS. 2.4 trillion to meet
growth needs in compliance with the Reserve Bank of Indias final
guidelines on capital adequacy requirements under the new Basel III
norms by March 2018.

Basel III Timeline- How effective is it.

The timeline proposed under Basel-III has widely pleased the proponents of stricter standards
though the standards are relatively aggressive and make for safer banks that can better absorb
losses when deep recessions and financial crisis suddenly strike. Nevertheless, some critics of
systemically financial institutions are concerned with the ample time permitted for banks to
comply. Nobel prize-winning economist Joseph Stiglitz is quoted to have opined that delay in
quicker and fuller implementation is exposing the public to continued risk. The argument
sounded by Stiglitz is that banks will continue to pocket their profits instead of pooling the
money as a capital buffer and continue to take big risks as long as possible to collect big
bonuses while they still can make a healthy return on their relatively lower level of capital
required.
However, in the Indian context, the timeline for Basel III implementation may not have
any serious impact as the banks are relatively well positioned for smoother implementation of

new capital standards with an exception of some of the public sector banks. The arguments
held out against the timeline in the case of global banks and particularly that of U.S need not
hold good in the case of Indian banks, which are not exposed to volatile and toxic assets.
Furthermore, in view of the increased disclosure norms, banks would be guided by the market
forces to increasingly Basel III complaint well before the suggested timeline by RBI.
In effect, the Basel III timeline offers is a prudent approach by allowing the struggling
banks ample time to ramp up their capital without harming their business, but still compelling
them to make gradual progress towards the desired finish. In the meanwhile, banks that can
comply earlier will likely do so quite ahead of the timeline suggested.

RECOMENDATIONS (Actions to consider)

6.2 Actions to consider in respect of capital management

Carry out appropriate scenario planning and impact assessments to ensure the
development of a successful capital strategy.

Identify which businesses have most attractive fundamentals under Basel III and
which businesses in the firms portfolio should be considered for exiting, growing, or
diverting.

Ensure managers have adequate incentive to optimize use of capital.

Apply consistent, quantified capital objectives throughout the group.

Identify the changes needed to fine-tune/lower capital consumption.

Ensure the firm is geared up to deliver measurement and management and

requirements on a sufficiently timely basis.

Consider how to address the pricing implications arising from changes in the capital
requirements for certain products.

Review whether the same business models can continue under a different structure,
minimizing capital penalties (e.g. branch versus subsidiary).

Prepare to be able to meet accelerated implementation time scales if required.

6.3 Actions to consider in respect of liquidity Management

Ensure an understanding of current liquidity position in sufficient detail and

possession of knowledge of where the stress points are.

Ensure management has adequate incentive to optimize use of capital.

Consider the impact of new liquidity rules on profitability and whether it has been
factored into key business process and pricing.

Check that liquidity planning, governance, and modelling are in line with leading
industry practice.

Determine an appropriate series of liquidity stress test and how these will change
overtime.

Gain awareness of the likely implementation timetable for different elements of the
global and national framework being proposed.

Assess the firms strategy in light of the existing legal and regulatory structure of the
organization and identity whether the system, data, and management reporting are
adequate to meet the requirements.

6.4. Actions to consider in respect of general capital planning:

Ensure that business is correctly charged for the capital costs of the business that they
are doing.
Ensure that Basel III capital implications are taken into account for new business and
consider how existing long-dated business can be revisited.
Consider the introduction of external capital into specialist structure models to
mitigate the capital impacts arising.
Focus on Basel III implementation as well as Basel III given that Basel III amplifies
any increase in RWAs arising from Basel II.
Examine the performance of existing assessment methodologies (e.g. IRB Models)
Review existing data qualityAre the benefits from collateral information or
improved re-rating of obligors due to inappropriate process missing?

CONCLUSION
It needs to be clearly understood that Basel III is an evolution rather than a revolution rather
than a revolution for many banks. It is an improvement over the existing Basel II framework;
the most significant among the differences for banks are the introduction of liquidity and
leverage ratios, and enhanced minimum capital requirements. Basel III provides for a
timeline of implementation that is quite acceptable in the case of Indian context as it is
observed that Indian banks are relatively well positioned for smoother implementation of the
new standards.

While the effective implementation of Basel III will demonstrate to the stakeholders that the
bank is quite well positioned, a speedy implementation will lead to contribute to banks
competitiveness by delivering better management insight into the business, enabling it to take
strategic advantage of future opportunities.

One of the main significant challenges posed by Basel III apart from the increased capital
standards is that of creating a new risk management culture with a greater rigor and
accountability. In effect, Basel III is changing the way the banks look at their risk
management functions and might imply them to go for a robust risk management framework
to ensure a true enterprise risk management. From the regulators angle, it requires RBI to be
proactive, and stricter in terms of regulatory supervision surveillance.

In order to achieve better risk management and to comply with the revised regulatory
reporting requirements, the risk management teams would require quick and speedy access to
quality data that is clean and accurate. This would call for proper data flow and management
systems in tune with the evolving risk management practices. Effective data management
systems are not going to cheap as they involve significant costs in their acquisition, up
gradation and maintenance.

The major challenge the Indian banks face is the deteriorating quality of assets and reduced
profitability. Dr. D. Subha Rao, Former Governor R.B.I. has rightly opined that effective
implementation of Basel III was going to make Indian banks, stronger more stable and
sound that they could deliver value to the real sectors of the economy. By far, the most
important reform is that there should be a radical change in banks approach to risk

management. Banks in India are currently operating on the standardized approaches of Basel
II. Since Basel III is a Universal compulsion, Indian Banks have no choice but to prepare
themselves for achieving this Herculean task of capital augmentation. The large scale banks
needed to migrate to the advanced approaches especially as they expend their overseas
presence. The adoption of advanced approaches to risk management would enable banks to
manage their capital more efficiently and improve their profitability.

As Basel III aims at providing a solid foundation for financially sound banking, it is both a
challenge and an opportunity for Indian banks. The opportunity comes in the form of
acquiring new quality capital, selection of technology architecture and redesigning of the risk
management as well as risk reporting. The challenge is for the bank management and the
regulator in successfully implementing the new standards as per the suggested timeline and
win over the stakeholders.

BIBLIOGRAPHY
Reference books
I.M.Pandey-Financial Management(vikas),9/e
Financial Institutions and Markets ,L.M.Bhole-TMH
M.Y.Khan and P.K.Jain-Financial Management (TMH),5/e
Mithani and Gordon, Banking and Financial systems,- Himalaya Publishing
House.
Prasana Chandra: Financial Management (TMH), 7/e
Punithavathy pandian -security analysis & portfolio management .
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www.reservebankofindia.com