Indian Banking System—Gearing up for Basel II

The dequate capital backup, to take care of unexpected losses, has become the real license to conduct and expand banking business, especially in the case of asset portfolio. The Indian banking system is better prepared to adopt Basel II than it was for Basel I. Nevertheless, the task is daunting enough, requiring more rigor and improvement in risk management systems, especially credit risk measurement and related database. The past trends indicate that to maintain the present 12% level of Capital to Risk Weighted Assets Ratio), even in March 2007, banks in India may fall short of capital by Rs. 30,000-Rs. 57,000 cr. Owing to an estimated increase of risk weighted assets by 15-30%, mainly on account of operational and market risk (if not credit risk) during Basel II era, nationalized banks and private sector banks seem to be more vulnerable when compared to the State Bank group and foreign banks in accomplishing such task. The size of bank being a helpful factor to improve the risk-bearing capacity, consolidation through orderly mergers and acquisition may be necessary. Asset expansion through proper risk management culture is another important strategic dimension in the Basel II context with matching supervision, audit and vigilance systems, which should encourage capturing business rather than driving it away. Degovernmentalization of public sector banks, through managerial autonomy, will ensure prompt organizational responses to the fast changing market developments. Draft guidelines issued by RBI in February 2005 on Basel II implementation clearly indicate a phased approach, without putting undue pressure on the banking system and, at the same time, aiming to reach international standards and best practices. Basel II transition should further strengthen the banks to play a crucial role in ensuring that the fruits of economic reforms, especially the financial sector reforms, are in the reach of the vast and vulnerable sections of the society.