The Basel Committee on Banking Supervision, which is setting global standards and benchmarks on regulatory/supervisory practices, had released in June 1999, a Consultative Paper on a New Capital Adequacy Framework for comments by market players and Central Banks. Recognising the implications of the new framework for emerging markets, particularly for India, The Reserve Bank of India had forwarded its comments on the new framework to the Basel Committee in March 2000. The comments were also placed on the website www.rbi.org.in

The Basel Committee released the Second Consultative Document on the proposed New Basel Capital Accord in January 2001, which contained refined proposal of the three pillars of the New Accord – Minimum Capital Requirements, Supervisory Review and Market Discipline. Several of the concerns expressed and recommendations made by India and other emerging markets on the first consultative document were taken into account and were addressed in the second document.

The Reserve Bank has examined the revised proposals in detail and has forwarded its comments on the New Accord to the Basle Committee. The Reserve Bank’s views in brief are:

(i) The complexity and sophistication of the proposals restricts its universal application in emerging markets, where the banks continue to be the major segment in financial intermediation and would be facing considerable challenges in adopting all the proposals. The spirit of flexibility, universal applicability and discretion to national supervisors, consistent with the macro economic conditions specific to emerging markets ought to be preserved while finalizing the New Accord.

(ii) The New Accord should initially be applied to all internationally active banks. Further, a simplified standardised approach may be evolved for other banks and the national supervisors should have discretion to implement the New Accord, in a phased manner.

(iii) To ensure uniform application across all jurisdictions, the Basel Committee should define what constitute internationally active and significant banks. In this regard, the reserve Bank is of the view that all banks with cross-border business exceeding 15 per cent of their total business may be defined as internationally active banks. Significant banks may be defined as those banks with complex structures and whose market share in the total assets of the domestic banking system exceeds one per cent.

(iv) To moderate the cross-holdings of capital, Basel Committee may consider prescribing a material limit (10 per cent of total capital) upto which cross-holdings of capital and other regulatory investments could be permitted and any excess investments above the limit would be deducted from total capital.

(v) External Credit Assessment Institutions (ECAIs) should not be assigned the direct responsibility for risk assessment of banking book assets. However, such of the Export Credit Agencies (ECAs) that disclose publicly their risk scores, rating process and procedure and subscribe to the publicly disclosed OECD methodology and qualify for use by national supervisors may be used for assigning preferential risk weights.

(vi) Risk weighting of banks should be de-linked from that of the credit rating of sovereigns in which they are incorporated. Instead, preferential risk weights should be assigned on the basis of their underlying strength and creditworthiness.

(vii) On the lines of discretion provided in the case of claims on sovereigns, the national supervisors may be given discretion to assign lower risk weight (one category less favourable than the risk weight to claims on sovereign), subject to a floor of 20 per cent to claims on all banks, which are denominated in domestic currency and funded in that currency. Further, preferential risk weights should not be linked to the maturity of the claims.

(viii) The adoption of the Internal Rating Based (IRB) approach, as envisaged, may be possible only for internationally active banks within the timeframe and transition period proposed by the Committee. For other banks, as an alternative, it is proposed that a simplified standardised approach to assign preferential risk weights based on internal ratings of banks may be evolved, subject to complying with the minimum standards prescribed by the Basel Committee for IRB approach. Under this approach, standardised risk weights, instead of the continuous function of Probability of Default (PD), Loss Given Default (LGD) and Exposure at Default (EAD), in the range of 20 per cent to 150 per cent could be assigned, subject to mapping of these ratings based on the robustness of the rating systems and the benchmark PD estimated by the supervisor on the basis of pooled data from select banks.

(ix) Unsecured portion of assets that are overdue over 90 days need not be placed under a separate higher-risk category.

(x) Until a scientific method to measure the operational risk across countries is evolved, the Basel Committee may consider prescribing a lower capital charge of 15 per cent of the gross income or 10 per cent of the current capital requirement to align capital to the underlying risk profile. National supervisors may, however, be given discretion to prescribe higher capital charge towards operational risk in case of banks, which may be considered as ‘outliers’.

(xi) The capital charge for specific risk in the banking and trading books should be consistent to avoid regulatory arbitrages.

(xii) The national supervisors may be given discretion to implement the New Accord, in a phased manner by banks, which are not internationally active and are engaged predominantly in traditional banking.

(xiii) Unless suitably modified, taking into account the above modifications, the adoption of the New Accord in its present format would result in significant increase in the capital charge for banks, especially in emerging markets.

It is essential that the Basel Committee should evolve a simplified standardised approach, which could be adopted uniformly by all banks that are not internationally active. Further, the transitional arrangements proposed in the New Accord may not be sufficient for these banks. National supervisors may, therefore, be given discretion to decide on the time frame for implementing the Accord and applying it to various banks in their jurisdiction depending upon the scale and complexity of their operations.

The detailed comments can be accessed at RBI’s website www.rbi.org.in