DBOD.No.BP.1163 /21.04.118/2004-05
February 15, 2005
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The Chairmen of all Scheduled Commercial
Banks Dear
Sir, Prudential
Guidelines on Capital Adequacy- Implementation of the New Capital Adequacy Framework
The
Basel Committee on Banking Supervision (BCBS) has released the document, 'International
Convergence of Capital Measurement and Capital Standards: A Revised Framework'
on June 26, 2004. The revised Framework has been designed to provide options for
banks and banking systems, for determining the capital requirements for credit
risk and operational risk and enables banks / supervisors to select approaches
that are most appropriate for their operations and financial markets. The Framework
is expected to promote adoption of stronger risk management practices in banks. 2.
The Revised Framework, popularly known as Basel II, builds on the current framework
to align regulatory capital requirements more closely with underlying risks and
to provide banks and their supervisors with several options for assessment of
capital adequacy. Basel II is based on three mutually reinforcing pillars - minimum
capital requirements, supervisory review, and market discipline. The three pillars
attempt to achieve comprehensive coverage of risks, enhance risk sensitivity of
capital requirements and provide a menu of options to choose for achieving a refined
measurement of capital requirements. 3.
The Revised Framework consists of three-mutually reinforcing Pillars, viz. minimum
capital requirements, supervisory review of capital adequacy, and market discipline.
Under Pillar 1, the Framework offers three distinct options for computing capital
requirement for credit risk and three other options for computing capital requirement
for operational risk. These approaches for credit and operational risks are based
on increasing risk sensitivity and allows banks to select an approach that is
most appropriate to the stage of development of bank's operations. The approaches
available for computing capital for credit risk are Standardised Approach, Foundation
Internal Rating Based Approach and Advanced Internal Rating Based Approach. The
approaches available for computing capital for operational risk are Basic Indicator
Approach, Standardised Approach and Advanced Measurement Approach. 4.
With a view to ensuring migration to Basel II in a non-disruptive manner, the
Reserve Bank has adopted a consultative approach. A Steering Committee comprising
of senior officials from 14 banks (private, public and foreign) has been constituted
where Indian Banks' Association is also represented. Keeping in view the Reserve
Bank's goal to have consistency and harmony with international standards it has
been decided that at a minimum, all banks in India will adopt Standardized
Approach for credit risk and Basic Indicator Approach for operational risk with
effect from March 31, 2007. After adequate skills are developed, both in banks
and at supervisory levels, some banks may be allowed to migrate to IRB Approach
after obtaining the specific approval of Reserve Bank. 5.
On the basis of the inputs received from the Steering Committee 'draft' guidelines
for implementation of Basel II in India have been prepared and are enclosed. Banks
are requested to study these guidelines and furnish their feedback to us within
three weeks from the date of this letter. These draft guidelines are also placed
on the web-site for wider access and feedback. 6.
Please acknowledge receipt Yours faithfully, (C.
R. Muralidharan) Chief General Manager-in-Charge |