BASEL II and implications for a Corporate Borrower

BASEL II

BASEL II is a new capital adequacy framework designed by the BASEL Committee of Banking Supervision. It is mandated for all the scheduled commercial banks in India by the apex bank, Reserve Bank of India (RBI) to safeguard the banks from going bankrupt and to help them maintain adequate liquidity. BASEL Capital Accord is in respect of Capital Measurement and Capital Standards which outlines regulatory capital requirements closely on the basis of underlying risks. The Basel accord has been accepted over 100 countries for implementation.

Also read on GWI Role of BASEL III in Indian Banking System, BASEL III Capital Requirements & BASEL II Capital Requirements.

Capital Adequacy Ratio

If we go deeper into the norm, we find about Capital Adequacy Ratio. As the name itself suggests it is a ratio to measure capital adequacy i.e., it helps in checking if the bank is holding adequate capital to safeguard the risk associated with the underlying instruments. Mathematically/Technically it is denoted as the ratio of capital funds (own funds or net worth) to risk weighted assets.

CAR & BASEL II Norms for different Banks

Talking of Basel I norm we find that a “one size fit for all” was applicable for the assets with a weightage of 100%. The capital adequacy ratio or the CAR was required to be kept at 9%. In case of Basel II norms the CAR is unchanged at 9%, however the risk weights associated with the assets differ based on the risk and types of the assets. In order to determine the credit risk, Standardized approach was to be used by the Indian banks of all the methods. Also it was mandated for the banks to incorporate the Basel II norms by 2009. Thus the banking regulations were made more stringent and the credit risk assigned to the assets was arrived with the help of rating agencies like CRISIL Ltd.

In the Indian Territory according to the guidelines released by RBI, all the foreign banks operating in India along with the Indian banks operating outside India had to migrate to Basel II norms by March 2008. However, for the other commercial banks the norms had to be implemented no later than by March 2009. Local and regional rural banks were exempted from such mandatory clause. Modification to the unrated exposure was also made by the RBI. A risk weight of 150% was assigned to such exposure and the related threshold was limited by INR 10 Crore only.

List of Top 10 Banks in India.

How BASEL II helps the Banks & Credit Rating Agencies

There are certain advantages to the banks for getting its loan rated. Banks earn capital relief by getting exposure rated, provided the rating is under investment grade (more than BBB+). Banks save on cost of borrowing an equivalent capital from market and can also leverage this additional capital they get by having their exposure rated. They can earn margins on such lending which is an indefinite process.

Some of the key points relevant to Basel II and rating of exposure:

• Only solicited ratings are allowed to be risk weighted (sought by Bank’s Client)
• The rating needs to be current and updated (reviewed by the agency at least once in last 1 year)
• Rating is applicable to both fund and non fund based facilities of the borrower
• Cash credit exposure require long term rating
• Banks can reduce risk weights for the claims having credit risk mitigants. These include Gold, Govt. Securities, Liquid Debt Securities (Investment Grade only), listed equities, etc.
• For assets in the bank’s portfolio of maturity less than a year, short term rating of the agencies is applicable. In other cases long term rating is relevant.

Also Read Flexible Basel Liquidity Rules as the New Year gift to Banking Industry.

Thus we see that Basel II helps the rating agencies improve the business and also helps the banks in a major way. Basel II framework ensures banks to be left with enough capital liquidity, so as to absorb any unforeseen situation. Basel II has provided a new dimension to the banking and financial sector of the country.