As far back as in October 1999, the

RBI had issued guidelines, with an

integrated approach, on risk
management in banks. Having regard
to diversity of banks, they were
advised to design their own risk
management architecture, in tune with
their size, complexity of business, risk
philosophy, market perception and the
level of capital.
With a view to fine tuning the risk
management systems in banks and to
help smaller banks in achieving the
minimum standards, RBI has also
issued guidance notes on
management of credit and market risk
in October 2002. While the broad
principles underlying the guidelines
would still be valid, banks would be
well advised to modernize and
upgrade their risk management
configuration in step with the market
developments. 
HISTORY OF BASEL COMMITTEE
The Basel committee was constituted by central bank governors of the G – 10
countries in 1974.
The G-10 committee consists of members from Belgium, Canada, France,
Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland,
UK and US.
The committees secretariat is located at Bank for International Settlements in
Basel, Switzerland.
The present Chairman of this committee is Mr. Nout Wellink (President of The
Netherlands Bank). The Secretary General of the Basel Committee is Mr. Stefan
Walter.
This committee meets four times a year.
It provides forum for regular cooperation on banking supervisory matters.
This committee is best known for its international standards on capital adequacy;
the core principles of banking supervision and the concordat on cross-border
banking supervision.
The Committee today consists of central bankers and supervisory regulators from
13 countries.
GOALS OF BASEL NORMS

In the late eighties, there was a lot of cross –

border lending particularly by Japanese banks.
Japanese banks grew enormously and gathered
market share, so western banks complained about
Japanese banks being regulated badly.
To standardise the regulation governing the global
banking industry Basel I was introduced.
Basel I norms defined the minimum required
equity capital.
 BASEL I
In July 1988 Basel committee came out with a set of
recommendations, Also known as 1988 Basel Accord.
Basel I is a round of deliberations of the central banks
from all over the world.
In 1988 Basel committee in Basel, Switzerland
published a set of minimum capital requirements of
the bank and was enforced by law in G -10 countries.
It stated the minimum level of capital requirement
( single number calculated as a fraction of risk
weighted assets) to be maintained by banks.
 CONTD….

This is known as the capital adequacy ratio.

It was 8 % of their risk weighted assets.
Under Basel I assets of banks were classified into five
categories on the basis of credit risk carrying risk weights of
0, 10, 20, 50 and upto 100 percent.
Different risk weights were specified for different categories
of exposure like 0 % for government bonds and 100 % for
corporate loans.
This CAR requirement reduced the high levels of leverage in
the banking industry.
Since 1988 this framework has been introduced in G-10
member countries comprising of 13 countries.
 BASEL II

It is more comprehensive than Basel I.

It was founded in 1999 with its final directive in 2003.
Basel II are the recommendations on banking
regulations and laws issued by Basel committee on
Banking Supervision.
The purpose is to create an international standard
that banking regulators can use when creating
regulations about how much capital banks need to
put aside to guard against the types of financial and
operational risks banks face.
 BENEFITS OF BASEL II
This will help in better pricing of loans in alignment with their actual
risks.
This will enable customers with high credit worthiness to get
cheaper loans.
Higher risk sensitivity of the norms provide no incentive to lend to
borrowers with declining credit quality.
Improving overall efficiency of banking and finance systems.
Takes global aspect into consideration for more rational decision
making, improving the decision matrix for banks.
Other important risk factors such as interest rate risks, foreign
exchange risks and operational risk faced by a bank were not
addressed in Basel I.
In simple terms, it meant the greater risk to which the bank is
exposed, the greater the amount of capital the bank needs to hold to
safeguard its solvency and overall economic stability.
BASEL II THREE PILLARS

Supervisory review
- Assessment of overall Market discipline
capital adequacy . -core and supplementary
-review and evaluation of disclosures to make market
bank’s internal capital discipline more efficient.
adequacy and strategies. - Market signals
-to keep the capital at Responsiveness of banks or
more than the minimum supervisors to market
ratio. signals.
- To prevent capital falling
from below the minimum
levels.
BASEL I BASEL II

Measurement of only one risk Measurement of all the three major risks faced by
(Credit Risk). the Bank e.g. Credit Risk, Market Risk and
Operational Risk.

Broad brush structure (e.g. all banks have 20% risk More risk sensitive (measurement of risk weights
weight and all corporates have 100% risk weight). for all individual banks and corporates).

Fixed method of calculation. Flexible Menu of approaches

Incentives in capital for adopting advanced and more
risk sensitive approaches.

One size fits all. Economic Capital will vary according to the
(9% for all banks irrespective of its risk management assessed loss on account of  various risks.  It takes
capabilities). care of risk assessment and risk management
capabilities of each bank.

Structure depends only on one pillar. There are three pillars –

Minimum Capital requirement. 1. Minimum capital requirement.
2. Supervisory Review
3. Market discipline (or the nature and extent of
disclosure).
Building up of adequate capital was the main Besides building up of capital, enhancing the skills
concern of banks management.  Risk management of management and staff in risk management
was not gaining importance as risk weight of various practices has gained momentous proportion.
assets were pre-determined.
 Terms used in risk management

(1) PD or probability of default : is the likelihood that a loan

would not be repaid and will fall into default. It is
calculated for each individual client or a portfolio of clients
with similar attributes. The credit history and nature of
investment are taken into account.
(2) LGD or loss given default : is the fraction of EAD that will
not be recovered following a default. (most popular is gross
LGD where losses are divided by EAD)
(3) EAD or exposure at default : is the estimation of the extent
to which a bank may be exposed to a counterparty in the
event of and at the time of its default.
 CAPITAL ADEQUACY RATIO

The amount of regulatory capital to be maintained by a bank to

account for various risks inherent in the banking system.
Also known as “ capital to risk weighted assets ratio”.
The Capital Adequacy ratio is measured as;
CAR = tier I capital + tier II capital
risk weighted assets
Regulatory capital is defined as the minimum capital, banks are
required to hold by the regulator, i.e. "The amount of capital a
bank must have". It is the summation of Tier I (core capital i.e.
equity capital and disclosed reserves)and Tier II (secondary bank
capital includes items such as undisclosed reserves etc.) capital. 
 APPROACHES USED IN
CALCULATION OF CREDIT RISK

Standardize ●
In this the banks uses rating of external credit rating
agencies to quantify required capital for credit risk.
d approach

Foundation IRB ●
Under this banks can develop their own empirical model to estimate
PD (probability of default) for individual clients or group of clients.
(internal ratings ●

●
Banks can only used the prescribed LGD from their regulators.
The total required capital is calculated as the fixed percentage of the
based approach) estimated RWA .

Advanced In this banks use their own quantitative model to estimate

●

PD, EAD, LGD and other parameters required for calculating

the RWA.

IRB The total required capital is taken as a percentage of

●

estimated RWA.
 APPROACHES USED FOR
CALCULATION OF OPERATIONAL
RISK
●
It is simpler as compared to other methods.
Basic indicator ●
Capital to be kept aside for operational risk is the average of
previous three years of fixed percentage of annual gross income.
approach ●
The fixed percentage “alpha” is usually 15 % of the annual gross
income.

Standardized ●

●
In this bank’s activities are divided into 8 lines.
The capital charge of each individual business line is calculated by gross
approach ●
income by a factor denoted by beta assigned to that business line.
The total capital charge is the three year average of simple summation
of the regulatory capital charges across each business line.

Advanced ●
After fulfilling certain requirements as per Basel accord a
measurement bank can use its own empirical model to quantify
required capital for operational risk.
approach
 APPROACHES USED IN
CALCULATION OF MARKET RISK

 the most popular method is VaR i.e. value at risk.

It is defined with respect to specific portfolio of financial assets , at
a specified probability and a specified time horizon.
It estimates the probability of portfolio losses based on the
statistical analysis of historical price trends and volatilities.
Suppose a portfolio manager has a daily VaR equal to $1 million at
1 % . This means there is only one chance in 100 that a daily loss
bigger than $ 1 million occurs under normal market conditions.
Different risk committees have been set up to monitor risk in different
areas such as market risk management, asset liability management
etc.
The bank works as per Basel II since 2006 and follows standardised
approach for credit risk, basic indicator approach for operational risk
and standardised duration method for market risk.
The bank uses several credit assessment models.
The bank conduct industry studies regarding the risk prevalent in each
industry to be considered in lending.
For close monitoring VaR is generated on a daily basis.
Stress testing of the portfolios are done under various scenerios.
It uses the market related fund transfer pricing.
The bank manages operational risks through a comprehensive system
of internal control and systems.
Highest net profit
during 2007-08.
Capital Return on assets
Rs.6729 crores Rs.631 crores 1.01 %

Net worth Capital adequacy Net non

(capital + reserves) ratio performing assets
Rs.49033 crores 13.47 % 1.78 %
Every application that’s used at ICICI bank is first
assessed for risk before it is deployed.
Its risk assessment programs are assessed against its
security policy framework.
The most significant credit risk is assessed by the credit
risk compliance & audit department.
The department performs various functions like credit
rating of companies, monitor adherence to RBI
guidelines, credit risk information system etc.
Web based system developed to provide information on
various aspects of credit portfolio at ICICI bank.
Established a market risk compliance and audit
department.
 Profit during
Capital
2007-08
Rs.4158 crores Rs.1463 crores

Net worth
Return on assets (capital + reserves)
1.12 % Rs.46820 crores

Capital Net NPA

adequacy ratio
13.97 % 1.55 %
Risk management architecture consists of risk management structure,
policies and risk management implementation and monitoring systems.
Several credit risk cells have been formed which worked together to
identify, measure, monitor and control the bank’s credit risk exposure.
(corporate research, portfolio and review cell)
Credit exposure ceilings have been set up (500 % of the bank’s capital
funds as per last year balance sheet)
Interest rate risk is measured through interest rate sensitivity gap report
and earning at risk.
ALCO and ALM manages the liquidity risk ensuring that the negative
liquidity gap does not indicate the tolerance levels.
The bank is working upon new credit rating model to move to internal
rating based approach. It involves calculation of PD and LGD.
 Profit during
Capital Return on assets
2007-08
Rs.366 crores 0.89 %
Rs.1436 crores

Net worth Capital adequacy Net NPA

(capital + reserves) ratio
Rs.11044 crores 12.91 % 0.47 %
The bank has evolved a risk management framework
comprising of board level risk management committee.
(CRMC, ORMC, ALCO)
Each committee works towards measuring and monitoring
respective risks.
The bank is in the implementation process of its technology
based MIS system covering all its branches and offices.
AS per the RBI guidelines the bank uses standardized
approach for credit risk and basic indicator approach for
operational risk.
With effect from march 2006 it applied standardized
duration approach for computing capital requirement for
market risks.
Profit during
Capital Return on assets
2007-08
Rs.447 crores 1.32 %
Rs.975 cores

Capital
Net worth
(capital + reserves) adequacy ratio
Net NPA
Rs.5221 crores 12.04 % 0.80 %
 BOTTLENECKS TO ACHIEVE
EFFICIENT RISK MANAGEMENT
SYSTEM
Data adequacy
Lot of quantitative and qualitative historical data and
information related to credit, probability of customer’s
default, evaluation of recovery rates for the models like VaR
is required.
Lack of efficiency
Most of the banks particularly nationalized banks does not
have appropriate data and efficient people to comprehend
and go forward for advance measurements as per Basel II.
 JUDGING A BANK’S HEALTH
A bank’s health depends upon three critical parameters:
(1) capital adequacy ratio
(2) Asset quality
(3) Earnings
As per the year 2007-08 data seven banks have more than
Rs.10,000 crore worth with SBI having the highest net worth
followed by ICICI.
ICICI bank has the highest CAR – 13.97 %, overall 30 banks
have CAR more than 12 %. The higher capital base shows
they are less leveraged and hence, strong.
a higher ratio indicates more safety.
Not a single bank has less then 9 % CAR.
Around 27 banks showed atleast 1 % return on assets.
 CONCLUSION
Vijaya bank is the first in the bank in the public sector to initiate the
implementation of a enterprise wide integrated risk management
system project. (CAR 11.22 % )
As per a report by financial management services consultancy
provisions of the Indian banks are expected to increase to Rs.75,000
crore by 2013 from Rs.20,000 crore in 2008 given the tightening
economic conditions.
In a volatile and dynamic market place for achieving sustainable
business growth and shareholder’s value, it is essential to develop a
link between risks and rewards of all products and services of the
bank.
Hence, the banks should have efficient risk management
framework to mitigate all internal and external risks.
In order to be competitive in the volatile and dynamic market a bank
needs to work towards a bank wide risk management framework.
India aims at attaining global standards in terms of financial health, safety ,
transparency through the implementation of Basel II accords by 2009.
Indian banks having overseas operations and foreign banks operating in India need
to comply with the Basel II norms by March 31,2008. All other commercial banks
excluding local area and regional rural banks are required to follow the framework
by 2009.
RBI has come out with new guidelines which require the banks to keep funds for
non – financial risks related to its own reputation, under estimation of credit risk
etc.
The objective of risk management is not to prohibit or prevent risk taking activity
but to ensure that the risks are consciously taken with full knowledge, clear
purpose and understanding so that it can be measured and mitigated.
Banks will have to restructure and adopt if they are to survive in the new
environment.