In Recent Years, the International Harmonization of Financial Regulation Has Been the Subject

Abstract

Basel II : A Critical Appraisal from an Indian Perspective

Dilip M. Nachane)

In recent years, the international harmonization of financial regulation has been the subject of considerable attention from academics and policymakers, alike. The two successive Accords viz. Basel I and II may be viewed as the outcome of a long-drawn out initiative to strive for greater international uniformity in prudential capital standards for banks’ credit risks. Banks, under Basel II, can choose from the following three evolutionary variants to measure credit risks, viz., (a) a basic standardized model (modified version of the existing approach), (b) an internal rating based (IRB) foundation model, and (c) an advanced IRB model. A noteworthy feature of Basel II is that it allows for a separate treatment of credit risk, market risk and operational risk. So far as the impact of Basel II on banking systems of LDCs and EMEs is concerned, three major concerns have been voiced. First, that the application of IRB is costly and discriminates against the smaller banks. Secondly, capital requirements, unless adjusted for cyclical fluctuations, are very likely to exacerbate these fluctuations. Thirdly, a problem of adverse selection arises, for only those banks likely to benefit from IRB will adopt the approach, other banks will hold on to the standardised approach. Overall the amount of banking capital is liable to decrease below the safe limits. Additionally, as pointed out by the Reserve Bank of India (RBI), in its comments on the Second Consultative Document, Basel II would involve a shift in direct supervisory focus away to the implementation issues, and that banks and the supervisors would be required to invest large resources in upgrading their technology and human resources to meet the minimum standards. Basel II is thus likely to pose profound challenges for the Indian banking system. Some of these consequences could force considerable internal adjustment on banks, a realisation which has been gradually dawning among banking circles in India.

Speaker’s profile:

Dilip M. Nachane is a senior professor at Indira Gandhi Institute of Development Research (IGIDR), Mumbai. Previously he was the Director of the Department of Economics, MumbaiUniversity. Prof. Nachane has served in many Committees set up by distinguished organizations like RBI, Clearing Corporation of India, NSE, SBI, Govt. of Maharashtra and the Govt. of India. He has been member of various academic bodies such as Indian Economic Journal, Indian Econometric Society, Journal of Quantitative Economics, Academy of Sciences, New York, USA, Tata Institute of Social Sciences,Mumbai and Indian Econometric Society. Prof. Nachane has been awarded with several prestigious awards including the 20th Century Achievement Award of American Biographical Institute, International Man of the Year 1998-99 Award by International Biographical Centre, Cambridge, U.K. and "Best Teacher" Award of the University of Mumbai, 1999-2000. He has guided 30 Ph.D. and M.Phil. theses. Prof. Nachane has published 6 books and 85 journal articles.