Basel II – A Challenge and an Opportunity to Indian Banking: Are we ready for it?

Survey Highlights

As the deadline of implementing Basel-II approaches, Indian banks are still

preparing to solve the risk puzzle for a more transparent and risk-free financial
base. The road to the Basel-II will not be an easy one for Indian banks.

FICCI has conducted a survey to analyze the state of preparedness of commercial banks
(which includes Public sector banks, Private banks and foreign banks) in Implementation
of Basel II norms. The survey questionnaire covered some of the most important aspects
related to Implementation of Basel II. Based upon the data collated, some of the
important findings of the survey are enumerated as below:

I. GENERAL STATE OF PREPAREDNESS

87 percent of the respondents were confident of meeting the deadline of

implementing the Basel II norms by 31st March 2007. These banks have already
prepared the detailed Implementation Roadmap as been instructed by Reserve Bank
of India. 80 per cent of these banks faced Data Collection as the biggest challenge in
preparing the Basel II roadmap. They also expressed that they require an ongoing
support from the regulatory authorities in this regard.

77 percent of respondent banks are still in the process of putting in place a robust
Management Information System (MIS) in order to comply with the requirements of
Pillar III – Market Discipline of the new norms.

Survey on state of preparedness of Commercial banks in respect to Basel II 1

 II. CAPITAL REQUIREMENT

54 percent of the banks are technologically equipped to face the future

challenges being posed by the Basel II norms. These banks have already put in place
the core banking solutions. Also enough attention has been focused upon networking
the banks.

All the respondent banks already have 70-90 % level of computerization in their
bank. However 60 percent of these banks are of an opinion that lower level of
computerization would not hinder their progress in implementing these norms.
Perhaps this is because banks feel that lower level of the computerization in the rural
areas is not likely to effect the implementation of Basel II norms because the bulk of
banks operations are in urban areas, which already have 100% computerization.

87 percent of respondent banks have already estimated the incremental capital

required for this purpose in their organization. 27 per cent banks expect their capital
requirements to increase by 1-2 % while 20 per cent banks expect their capital
requirements to increase by more than 3 % during the implementation stage of Basel
II norms.*

Capital Increment during Implemenatation stage

30% 27%
25%
20%
20%

15% 13%

10% 7%
5%

0%
Less than 1.0 % b/w 1-2% b/w 2-3% more than 3%
.
* The rest of the respondent banks didn’t quote the figure.

Survey on state of preparedness of Commercial banks in respect to Basel II 2

 All the respondents believe that there are sufficient resources available for raising
the higher amount of capital needed for this purpose. 62 percent of banks would
prefer to raise the requisite capital by a combination of Tier I and Tier II. To a
question on the need of further regulatory relaxations, 50% of the respondent banks
voiced that IFR (Investment Fluctuation Reserve) surplus and the Hybrid capital
should be considered in Tier I. Some of the other relaxations desired by the banks
were treatment of Investment Allowance Reserve as Tier I since it is created from
post – tax profits and Foreign currency translation reserve as Tier II capital

80 percent of respondent banks expect that there would be an increase in their

capital adequacy requirements in their organization as a result of these norms while
the rest expect the same to fall as they expect their Capital adequacy ratio to improve.

62 percent of the respondent banks believe that there is a high degree of

relationship between the size of the banks and associated risk. Since the complexity
of the new framework may be out of reach for many smaller banks, majority of the
respondents agree to the fact that this would trigger off a need for consolidation in
Indian banking system.

III. IMPACT ON CREDIT

87 percent of the respondent banks quoted that increased capital requirements

imposed by the Basel accord will not make their banks more risk averse towards
credit dispensation. Merely 13% felt that implementation of Basel II could have an
adverse impact on banks lending to commercial sector. Small and Medium enterprises
and Farm and rural sectors are likely to be the most affected sectors.

Survey on state of preparedness of Commercial banks in respect to Basel II 3

 IV. EXPECTATIONS FROM THE REGULATORS

87% of the respondents were completely satisfied with the support given by the
RBI in respect to Basel II implementation. However some of them felt that there
should be consistency in implementation of these norms in terms of timing and
approach. Further there should be greater consultation with internationally active
banks that face significant cross-border implementation challenges.

To a question on comfort level with the stricter disclosure requirements under the
Basel II norms, 50 percent of respondents expressed that they were completely
comfortable with these requirements, whereas rest felt that they were comfortable to
some extent.

Operational risk measurement is one of the new planks of the Basel II accord.
73 percent of respondents quoted that capital allocation to operational risk will not be
counter productive. They instead believe that explicit charge on operational risk will
direct more focus on it, which will further enhance operational risk management and
operational efficiency for the banks. Also such an allocation would create a cushion
for the claims or losses on this account.

However the remaining felt that in the Indian context, capital requirements are
too high as the Indian banks, unlike their foreign counterparts are not much involved
in speculative activities such as derivatives. Hence the capital requirement for
operational risk should be lower for the Indian Banks than what is specified in Basel
II Accord.

Survey on state of preparedness of Commercial banks in respect to Basel II 4