Page 200 - DCOM208_BANKING_THEORY_AND_PRACTICE

Unit 12: Capital Adequacy

12.2 Basel II Norms (New Capital Adequacy Framework) Notes

The Basel Capital Accord is an Agreement concluded among country representatives in 1988 to
develop standardized risk-based capital requirements for banks across countries. The accord
was replaced with a new capital adequacy framework (Basel II), published in June 2004. The
Revised Framework was updated in November 2005 followed by a comprehensive version of
the framework was issued in June 2006. Basel II is based on three mutually reinforcing Pillars
that allow banks and supervisors to evaluate properly the various risks that banks face. The
Pillars are:
(i) Minimum capital requirements, which seek to refine the present measurement framework;
(ii) Supervisory review of an institution’s capital adequacy and internal assessment process;

(iii) Market discipline through effective disclosure to encourage safe and sound banking
practices.

Did u know? Basel 1 was generalization of capital regulations, while Basel 2 is tailor made
to condition or rating inputs of the borrowers.

12.2.1 Minimum Capital Requirement (Pillar I)

The New Capital Adequacy Framework (NCAF) provides three distinct options each for
computing capital requirement for credit risk and operational risk as under:-

Credit Risk

(a) Standardized Approach
(b) Foundation Internal Rating Based Approach

(c) Advanced Internal Rating Based Approach

Operational Risk

(a) Basic Indicator Approach
(b) Standardized Approach
(c) Advanced Measurement Approach

!
Caution All commercial banks (excluding Local Area Banks and Regional Rural Banks) are
required to adopt Standardized Approach (SA) for Credit Risk and Basic Indicator Approach
(BIA) for Operational Risk for computing Capital to Risk Weighted Asset Ratio (CRAR) so
as to fall in line with the International standards and reporting to their Boards on quarterly
intervals.
With the upgradation of the risk management framework and likely accrual of capital efficiency
thereto envisaged under Basel II as also the emerging international trend in this regard, it was
considered desirable to lay down a timeframe for migration to the advanced approaches for
credit risk and operational risk and accordingly a time frame has been drawn factoring the
likely lead time for creating requisite technological and the risk management infrastructure etc.
Banks were also advised to migrate to the approach, of course, with suitable approval from RBI.

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