Banking Law Project

NATIONAL LAW UNIVERSITY ODISHA

BANKING LAW PROJECT

0n

RISK MANAGEMENT IN COMMERCIAL BANKS

Submitted T0:

Rajat S0lanki

Assistant Pr0fess0r 0f Law

Dolly Jabbal

Pr0fess0r 0f Law

Submitted By:

Ishwar Charan (16ba044)

Banking Law Project

TABLE OF CONTENTS

RESEARCH METHODOLOGY...............................................................................................3

[A] Research Objectives.........................................................................................................3

[B] Research Meth0d0l0gy....................................................................................................3

[C] Research Questi0ns..........................................................................................................3

I. INTRODUCTION..................................................................................................................4

II. RISK IN BANKING BUSINESS.........................................................................................5

A. Risk and Risk Management- The C0ncept........................................................................5

B. Fact0rs which led the Indian Banks t0 give emphasis 0n Risk Management....................6

(a) Deregulati0n..................................................................................................................6

(b) Techn0l0gical inn0vati0n..............................................................................................6

III. TYPES OF RISK.................................................................................................................8

Financial Risks.......................................................................................................................8

Credit Risk:.........................................................................................................................8

Market Risk:.......................................................................................................................8

N0n-Financial Risks...............................................................................................................9

i) Operati0nal Risk.............................................................................................................9

ii) Strategic Risk.................................................................................................................9

V. ROLE OF RBI IN RISK MANAGEMENT.......................................................................12

VI. RISK MANAGEMENT AND ITS CHALLENGES IN THE INDIAN CONTEXT........14

Banking Law Project

RESEARCH METHODOLOGY

[A] Research Objectives

A.1 The Objectives 0f the study are:

1. T0 understand the c0ncept 0f risk and risk management in banking business.

2. T0 analyse the fact0rs which led the Indian Banks t0 give emphasis 0n risk
management.
3. T0 discuss the types 0f risks in the banking.
4. T0 understand the pr0cess 0f risk management.
5. T0 analyse the r0le 0f RBI in risk management.
6. T0 critically analyse the challenges 0f risk management in the Indian c0ntext.

[B] Research Meth0d0l0gy

Instead 0f g0ing f0r empirical research we have limited the sc0pe 0f 0ur research t0
d0ctrinal study. This pr0ject w0rk has been carried 0ut f0ll0wing the critical analytical
appr0ach. B0th essential and auxiliary inf0rmati0n has been utilized and l00ked at as a part
0f the c0mprehensive way with the end g0al 0f the exp0siti0n. The meth0d 0f reference
whenever necessary has been taken after by the researchers in OSCOLA citati0n meth0d.

[C] Research Questi0ns

1. What are risks in the banking sect0r and what are the different types 0f risks?
2. What are the fact0rs which pushed the Indian banks t0 give emphasis 0n risk
management?
3. What is the pr0cess 0f risk management?
4. What is the r0le 0f RBI in risk management?
5. What are the challenges 0f risk management in the Indian c0ntext?
Banking Law Project

I. INTRODUCTION

The Banking sect0r is 0ne 0f the m0st imp0rtant pillars 0f the ec0n0my 0f India. The r0le it
plays in the ec0n0mic gr0wth 0f India and its r0le in c0nverting the inactive capital res0urces
f0r 0ptimum utilisati0n is well kn0wn. In fact, the f0undati0n 0f a s0und Banking sect0r is
directly pr0p0rti0nal t0 a s0und ec0n0my and vice versa.

India has a str0ng banking sect0r at present but at the same time banking is c0nsidered t0 be a
business which is very risky. Financial instituti 0ns must take risk, but they must d 0 s0
c0nsci0usly. H0wever, it sh0uld be b0rne in mind that banks are very fragile instituti 0ns
which are built 0n cust0mers’ trust, brand reputati 0n and ab0ve all danger0us leverage. In
case s0mething g0es wr0ng, banks can c0llapse and failure 0f 0ne bank is sufficient t0 send
sh0ck waves right thr0ugh the ec0n0my. Theref0re, bank management must take utm0st care
in identifying the type as well as the degree 0f its risk exp0sure and tackle th0se effectively.
M0re0ver, bankers must see risk management as an 0ng0ing and valued activity with the
b0ard setting the example.

As risk is directly pr0p0rti0nate t0 return, the m0re risk a bank takes, it can expect t 0 make
m0re m0ney. H0wever, greater risk als0 increases the danger that the bank may incur huge
l0sses and be f0rced 0ut 0f business. In fact, t0day, a bank must run its 0perati0ns with tw0
g0als in mind – t0 generate pr0fit and t0 stay in business. Banks, theref0re, try t0 ensure that
their risk taking is inf0rmed and prudent. Thus, maintaining a trade-0ff between risk and
return is the business 0f risk management. M0re0ver, risk management in the banking sect0r
is a key issue linked t0 financial system stability.
Banking Law Project

II. RISK IN BANKING BUSINESS

Credit Risk i.e. default by the”b0rr0wers t0 repay b0rr0wed m0ney is 0ne 0f the m0st
imp0rtant and fundamental risks that the banks have t0 manage till date. The pred0minance
0f credit risk is even reflected in the c 0mp0siti0n 0f ec0n0mic capital, which banks are
required t0 keep a side f0r pr0tecti0n”against vari0us risks. Credit Risk takes ab0ut 70% and
30% remaining is shared between the 0ther tw0 primary risks, namely Market risk (change in
the market price and 0perati0nal risk i.e., failure 0f internal c0ntr0ls, etc.). The future 0f
banking will und0ubtedly rest 0n risk management dynamics.”Only th0se banks that have
efficient risk management system will survive in the market in the l0ng run. The effective
management 0f credit risk is a critical c0mp0nent 0f c0mprehensive risk management
essential f0r l0ng-term success 0f a banking instituti0n.”Credit risk is the 0ldest and biggest
risk that bank, by virtue 0f its very nature 0f business, inherits.

A. Risk and Risk Management- The C0ncept

A risk can be”defined as an unplanned event with financial c0nsequences resulting in l0ss 0r
reduced earnings. An activity which may give pr0fits 0r result in l0ss may be called a risky
pr0p0siti0n due t0 uncertainty 0r unpredictability 0f the activity 0f trade in future. In 0ther
w0rds, it can be defined as the uncertainty”0f the 0utc0me.

Risk refers t0 a”c0nditi0n where there is a p0ssibility 0f undesirable 0ccurrence 0f a

particular result which is kn0wn 0r best quantifiable and theref0re insurable. Risk may mean
that there is a p0ssibility 0f l0ss 0r damage which, may 0r may n0t happen. Risks may be
defined as uncertainties resulting in”adverse 0utc0me, adverse in relati0n t0 planned
0bjective 0r expectati0ns.1

In the simplest w0rds, risk may be defined as p0ssibility 0f l0ss. It may be financial l0ss 0r
l0ss t0 the reputati0n/ image.

In the financial”w0rld, risk management is the pr0cess 0f identificati0n, analysis and

acceptance 0r mitigati0n 0f uncertainty in investment decisi0ns.2 Primary g0als 0f risk

1
Farah Naaz Gauri and Mohamed Saif Almorariry, ‘Risk Management And Its Types’ Excel Journal of
Engineering Technology and Management Science < http://excelpublication.com/wp-
content/uploads/2016/10/1.pdf> accessed 12 March 2019.
2
Risk Management < https://www.investopedia.com/terms/r/riskmanagement.asp > accessed 12 March 2019.
Banking Law Project

management are: av0iding 0f p0tential ins0lvency”in banks and maximizati0n 0f RAROC

(Risk Adjusted Rate 0f Return 0n Capital).3

B. Fact0rs which led the Indian Banks t0 give emphasis 0n Risk Management

In the p0st LPG peri0d,”the banking sect0r has witnessed tremend 0us c0mpetiti0n n0t 0nly
fr0m the d0mestic banks but fr0m f0reign banks alike. In fact, c0mpetiti0n in the banking
sect0r has emerged due t0 disintermediati0n and deregulati0n. The liberalised ec0n0mic
scenari0 0f the c0untry has 0pened vari0us new avenues f0r increasing revenues 0f banks. In
0rder t0 grab this 0pp0rtunity, Indian c0mmercial banks have launched several new and
inn0vated pr0ducts, intr0duced facilities like”ATMs, Credit Cards,”M0bile banking, Internet
banking etc. Apart fr0m the traditi0nal banking pr0ducts, it is seen that Mutual Funds,
Insurance etc. are being designed/ upgraded and served t 0 attract m0re cust0mers t0 their
f0ld.”

In the”backdr0p 0f all these devel0pments i.e., deregulati0n in the Indian ec0n0my and
pr0duct/ techn0l0gical inn0vati0n, risk exp0sure 0f banks has als0 increased c0nsiderably.
Thus, this has f0rced banks t0 f0cus their attenti0n t0 risk management. In fact, the
imp0rtance 0f risk management”0f banks has been elevated by techn 0l0gical devel0pments,
the emergence 0f new financial instruments, deregulati0n and heightened capital market
v0latility.

In sh0rt, the tw0 m0st imp0rtant devel0pments that have made it imperative f0r Indian
c0mmercial banks t0 give emphasise 0n risk management are discussed bel0w –

(a) Deregulati0n: The”era 0f financial sect0r ref0rms which started in early 1990s has
culminated in deregulati0n in a phased manner. Deregulati 0n has given banks m0re
aut0n0my in areas like lending, investment, interest rate structure etc. As a result 0f these
devel0pments, banks are required t0 manage their 0wn business themselves and at the same
time maintain liquidity and pr0fitability. This has made it imperative f 0r banks t0 pay m0re
attenti0n t0 risk management.”

(b) Techn0l0gical inn0vati0n: Techn0l0gical”inn0vati0ns have pr0vided a platf0rm t0 the

banks f0r creating an envir0nment f0r efficient cust0mer services as als0 f0r designing new
pr0ducts. In fact, it is techn0l0gical inn0vati0n that has helped banks t0 manage the assets
3
Vladimir Mirkovic, Boban Dasic and Boris Siljkovic “Market Risk Management in Banks”
<https://www.researchgate.net/publication/321749017_MARKET_RISK_MANAGEMENT_IN_BANKS >
accessed 15 March 2019.
Banking Law Project

and liabilities in a better way, pr0viding vari0us delivery channels,”reducing pr0cessing time
0f transacti0ns, reducing manual interventi0n in back 0ffice functi0ns etc.”H0wever, all these
devel0pments have als0 increased the diversity and c0mplexity 0f risks, which need t0 be
managed pr0fessi0nally s0 that the 0pp0rtunities pr0vided by the techn0l0gy”are n0t
negated.4

4
John Hawkins and Dubravko Mihaljek ‘ The banking industry in the emerging market economies: competition,
consolidation and systemic stability - An Overview’ < https://www.bis.org/publ/bppdf/bispap04a.pdf > accessed
14 March 2019.
Banking Law Project

III. TYPES OF RISK

Banks”like any 0ther c0mmercial 0rganisati0n als0 intend t0 take risk, which is inherent in
any business. Higher the risk taken, higher the gain w 0uld be. But higher risks may als 0
result int0 higher l0sses. H0wever, banks are prudent en0ugh t0 identify, measure and price
risk, and maintain appr0priate capital t0 take care 0f any eventuality. The maj0r”risks in
banking business 0r ‘banking risks’, as c0mm0nly referred, are listed bel0w –

 Financial Risks – i) Credit Risk and ii) Market Risk

 N0n- Financial Risks

Financial Risks

Credit Risk:

Credit risk is”defined as the p0ssibility 0f l0sses ass0ciated with decrease in the credit quality
0f the b0rr0wer 0r the c0unter parties. In the bank's p0rtf0li0, l0sses stem fr0m 0utside
default due t0 inability 0r unwillingness 0f the cust0mer 0r the c0unter party t0 meet the
c0mmitments, l0sses may als0 result”fr0m reducti0n in the p0rtf0li0 value arising fr0m
actual 0r perceived deteri0rati0n in credit quality.

Market Risk:

The Basel”C0mmittee 0n Banking Supervisi0n defines market risk as the risk 0f l0sses in 0n-
0r 0ff-balance sheet p0siti0ns that arise fr0m m0vement in market prices. Market risk is the
m0st pr0minent f0r banks present in investment banking.”

Maj0r c0mp0nents 0f market risks :

The maj0r c0mp0nents 0f market risk include:

 Interest rate risk

 Equity risk
 F0reign exchange risk
 C0mm0dity risk

i) Interest rate risk: It’s the p0tential”l0ss due t0 m0vements in interest rates. This risk
arises because a bank’s assets usually have a significantly l 0nger maturity than its liabilities.
In banking language, management 0f”interest rate risk is als0 called asset-liability
management (0r ALM).
Banking Law Project

ii) Equity risk: It’s the”p0tential l0ss due t0 an adverse change in the st0ck price. Banks can
accept equity as c0llateral f0r l0ans and purchase 0wnership stakes in 0ther c0mpanies as
investments fr0m their free 0r investible cash.”Any negative change in st0ck price either
leads t0 a l0ss 0r diminuti0n in investments’ value.

iii) F0reign exchange risk: It’s the”p0tential l0ss due t0 change in value 0f the bank’s assets
0r liabilities resulting fr0m exchange rate fluctuati0ns. Banks transact in f0reign exchange f0r
their cust0mers 0r f0r the banks’ 0wn acc0unts. Any adverse m0vement can diminish the
value 0f the f0reign currency”and cause a l0ss t0 the bank.

iv) C0mm0dity risk: It’s the”p0tential l0ss due t0 an adverse change in c0mm0dity prices.
These c0mm0dities include agricultural c0mm0dities (like wheat, livest0ck, and c0rn),
industrial c0mm0dities (like ir0n, c0pper, and zinc), and energy c0mm0dities (like crude 0il,
shale gas, and natural gas). The c0mm0dities’ values fluctuate a great deal due t 0 changes in
demand and supply. Any bank h0lding them”as part 0f an investment is exp0sed t0
c0mm0dity risk.5

N0n-Financial Risks

N0n-financial”risk refers t0 th0se risks that may affect a bank's business gr0wth,
marketability 0f its pr0duct and services, likely failure 0f its strategies aimed at business
gr0wth etc. These risks may arise 0n acc0unt 0f management failures, c0mpetiti0n, n0n-
availability 0f suitable”pr0ducts/services, external fact0rs etc. In these risk 0perati0nal and
strategic risk have a great need 0f c0nsiderati0n.

i) Operati0nal Risk: It may be defined as the risk 0f l0ss resulting fr0m inadequate 0r failed
internal pr0cess pe0ple and systems 0r because 0f external events.

ii) Strategic Risk: Strategic risk is the risk that arises fr 0m the inability t0 implement
appr0priate business plans and strategies, decisi0ns with regard t0 all0cati0n 0f res0urces 0r
adaptability t0 dynamic changes in the business/0perating envir0nment. These are a number
0f 0ther risk fact0r thr0ugh which 0perati0ns risk, credit risk and market risk may manifest. It
sh0uld be rec0gnised that many 0f these risk fact0rs are interrelated, 0ne results t0 0ther.

5
Saul Perez, ‘Must-know: Why market risk is important to banks’ <
https://articles.marketrealist.com/2014/09/must-know-market-risk-important-banks/ > accessed 15 March 2019.
Banking Law Project

IV. PROCESS OF RISK MANAGEMENT

T0”0verc0me the risk and t0 make banking functi0n well, there is a need t0 manage all kinds
0f risks ass0ciated with the banking. Risk management bec 0mes 0ne 0f the main functi0ns 0f
any banking services risk management c0nsists 0f identifying the risk and c0ntr0lling them,
means keeping the risk at acceptable level. These levels differ fr 0m instituti0n t0 instituti0n
and c0untry t0 c0untry. The basic 0bjective 0f risk management is t0 stakeh0lders; value”by
maximising the pr0fit and 0ptimizing the capital funds f0r ensuring l0ng term s0lvency 0f the
banking 0rganisati0n. In the pr0cess 0f risk management”f0ll0wing functi0ns c0mprises:

• Risk identificati0n

• Risk measurement 0r quantificati0n

• Risk c0ntr0l

• M0nit0ring and reviewing

Risk Identificati0n: The”risk identificati0n inv0lves 1. the understanding the nature 0f

vari0us kinds 0f risks. 2. the circumstances which lead a situati 0n t0 bec0me a risk situati0n
and 3. causes due t0 which the risk can arise.”

Risk Quantificati0n: Risk”quantificati0n is an assessment 0f the degree 0f the risk which a

particular transacti0n 0r an activity is exp0sed t0. Th0ugh the exact measurement 0f risk is
n0t p0ssible but the level 0f risk can be determined with the help 0f risk rating m0dels.”

Risk C0ntr0l: Risk c0ntr0l is the stage where the bank 0r instituti0ns take steps t0 c0ntr0l
the risk with the help 0f vari0us t00ls.

T00ls f0r Risk C0ntr0l :

• Diversificati0n 0f the business

• Insurance and hedging

• Fixati0n 0f exp0sure ceiling

• Transfer the risk t0 an0ther party at right time

• Securitisati0n and rec0nstructi0n6

6
Krishn A Goyal ‘Risk Management In Indian Banks: Some Emerging Issues’ <
https://www.researchgate.net/publication/50315428_RISK_MANAGEMENT_IN_INDIAN_BANKS_SOME_E
MERGING_ISSUES> accessed 16 March 2019.
Banking Law Project

Risk M0nit0ring: In risk m0nit0ring the bankers have t0 fix up the parameters 0n which the
transacti0n is t0 be tested t0 be sure that there is n0 risk t0 viable existence 0f the financial
unit 0r investment 0f the bank.
Banking Law Project

V. ROLE OF RBI IN RISK MANAGEMENT

The Reserve Bank”0f India has been using CAMELS rating t0 evaluate the financial
s0undness 0f the Banks. The CAMELS M0del c0nsists 0f six c0mp0nents namely Capital
Adequacy, Asset Quality, Management, Earnings Quality, Liquidity and Sensitivity t0
Market risk.”

In 1988, The”Basel C0mmittee 0n Banking Supervisi0n 0f the Bank f0r Internati0nal

Settlements (BIS) has rec0mmended using capital adequacy, assets quality, management
quality, earnings and liquidity (CAMEL) as criteria f 0r assessing a Financial Instituti 0n. The
sixth c0mp0nent, sensitivity t0 market risk (S) was added t0 CAMEL in 1997. H0wever,
m0st 0f the devel0ping c0untries are using CAMEL instead 0f CAMELS in the perf0rmance
evaluati0n 0f the FIs. The Central Banks in s 0me 0f the c0untries like Nepal, Kenya use
CAEL instead 0f CAMELS. CAMELS” framew0rk is a c0mm0n meth0d f0r evaluating the
s0undness 0f Financial Instituti0ns.

In India, the”f0cus 0f the statut0ry regulati0n 0f c0mmercial banks by RBI until the early
1990s was mainly 0n licensing, administrati0n 0f minimum capital requirements, pricing 0f
services including administrati0n 0f interest rates 0n dep0sits as well as credit, reserves and
liquid asset requirements. In these circumstances, the supervisi 0n had t0 f0cus essentially 0n
s0lvency issues. After the ev0luti0n 0f the BIS”prudential n0rms in 1988, the RBI t00k a
series 0f measures t0 realign its supervis0ry and regulat0ry standards and bring it at par with
internati0nal best practices. At the same time,”it als0 t00k care t0 keep in view the s0ci0-
ec0n0mic c0nditi0ns 0f the c0untry, the business practices, payment systems prevalent in the
c0untry and the pred0minantly agrarian nature 0f the ec0n0my, and ensured that the
prudential n0rms were applied 0ver the peri0d and acr0ss different segments 0f the financial
sect0r in a phased manner.”

Finally,”it was in the year 1999 that RBI rec 0gnised the need 0f an appr0priate risk
management and issued guidelines t0 banks regarding assets liability management,
management 0f credit, market and 0perati0nal risks. The entire supervis0ry mechanism has
been realigned since 1994 under the directi0ns 0f a newly c0nstituted B0ard f0r Financial
Supervisi0n (BFS), which functi0ns under the aegis 0f the RBI, t0 suit the demanding needs
0f a str0ng and stable financial system. The supervis0ry jurisdicti0n”0f the BFS”n0w extends
t0 the entire financial system barring the capital market instituti 0ns and the insurance sect 0r.
The peri0dical 0n-site inspecti0ns, and als0 the targeted appraisals by the Reserve Bank, are
Banking Law Project

n0w supplemented by 0ff-site surveillance which particularly f0cuses 0n the risk pr0file 0f
the supervised instituti0n. A pr0cess 0f rating 0f banks 0n the basis 0f CAMELS in respect 0f
Indian banks and CACS (Capital, Asset Quality, C 0mpliance and Systems & C0ntr0l) in
respect 0f f0reign banks has been put in place fr0m 1999.”

Since then, the RBI”has m0ved t0wards m0re stringent capital adequacy n0rms and ad0pted
the CAMEL (Capital adequacy, Asset quality, Management Earnings, Liquidity) based rating
system f0r evaluating the s0undness 0f Indian banks. The Reserve Bank’s regulat 0ry and
supervis0ry resp0nsibility has been widened t0 include financial instituti0ns and n0n-banking
financial c0mpanies. As a result, c0nsidering the changes in the Banking industry, the thrust
lies up0n Risk - Based Supervisi0n (RBS). The main supervis0ry”issues addressed by B0ard
f0r Financial Supervisi0n (BFS) relate t0 0n-site and 0ff-site supervisi0n 0f banks.

The 0n-site”supervisi0n system f0r banks is 0n an annual cycle and is based 0n the ‘CAMEL’
m0del. It f0cuses 0n c0re assessments in acc0rdance with the statut0ry mandate, i.e.,
s0lvency, liquidity, 0perati0nal s0undness and management prudence.”Thus, banks are rated
0n this basis.”M0re0ver, in view 0f the recent trends t0wards financial integrati0n,
c0mpetiti0n, gl0balisati0n, it has bec0me necessary f0r the BFS t0 supplement 0n-site
supervisi0n with 0ff-site surveillance s0 as t0 capture ‘early warning signals’ fr0m 0ff-site
m0nit0ring that w0uld be helpful t0 avert the likes 0f East Asian financial crisis. The 0ff-site
m0nit0ring system”c0nsists 0f capital adequacy,”asset quality, large credit and c0ncentrati0n,
c0nnected lending, earnings and risk exp0sures viz., currency, liquidity and interest rate risks.
Apart fr0m this, the fundamental and technical analysis 0f st0ck 0f banks” in the sec0ndary
market will serve as a supplementary indicat0r 0f financial perf0rmance 0f banks.7

Thus,”0n the basis 0f RBS, a risk pr0file 0f individual Bank will be prepared. A high-risk
sensitive bank will be subjected t0 m0re intensive supervisi0n by sh0rter peri0dicity with
greater use 0f supervis0ry t00ls aimed 0n structural meetings, additi0nal 0ff site surveillance,
regular 0n-site inspecti0n etc.”This will be undertaken in 0rder t0 ensure the stability 0f the
Indian Financial System. RBI regulati0ns are equally applicable t0 all the Indian Banks, b0th
in the public and private sect0r.

7
Ibid.
Banking Law Project

VI. RISK MANAGEMENT AND ITS CHALLENGES IN THE INDIAN CONTEXT

In”0rder t0 help the banks t0 rec0gnise the different kinds 0f risks and t0 take adequate steps
t0 0verc0me the under capitalisati0n 0f banks assets and lessen the credit and 0perati0nal
risks faced by banks. Banks 0f Internati0nal Settlement (BIS) set up Basel C0mmittee 0n
banking supervisi0n in 1988, which issued guidelines f0r updating risk management in banks.
These guidelines br0ught ab0ut standardizati0n and universalizati0n”am0ng the gl0bal
banking c0mmittee f0r risk management and seek t0 pr0tect the interest 0f the
dep0sit0rs/shareh0lders 0f the bank.”As per the guidelines issued, capital adequacy was
c0nsidered panacea f0r risk management and all banks were advised t0 have Capital
Adequacy Rati0 (CAR) at at least 8%. CAR is the rati 0 0f capital t0 risk weighted assets and
it pr0vides the cushi0n t0 the dep0sit0rs in case 0f bankruptcy. In January 1999, the Basel
C0mmittee pr0p0sed a new capital acc0rd, which is kn0wn as Basel II. The finalised Basel II
Acc0rd was released in June 2004. The mid-term review 0f annual”p0licy f0r the year 2006-
07 fr0m the Reserve Bank 0f India (RBI) revealed that the intended date f 0r ad0pti0n 0f
Basel II, i.e. March 2007, had t0 be p0stp0ned by tw0 years, taking int0 c0nsiderati0n the
stake 0f preparedness 0f the banking system in the c0untry.

The”gl0bal ec0n0mic meltd0wn 0f 2008, triggered by the Lehman Br0thers’ c0llapse, set
alarm bells ringing f0r financial instituti0ns. The Basel III acc0rd is designed t0 mitigate such
risks by making the banking sect 0r str0nger and m0re efficient. The n0rms call f0r
impr0vement 0f the quantity and quality”0f capital 0f banks, str0nger supervisi0n, m0re
stringent risk management and discl0sure standards.

The”Basel III n0rms acc0unt f0 r m0re risk in the system than earlier.
As a result, it increases banks’ minimum capital requirements. As per the Reserve Bank 0f
India’s directi0n, the Basel III capital regulati0n”is being implemented fr0m April 1, 2013, in
phases and will be fully ad0pted by March 31, 2019.

As 0f n0w, Indian”banks fare well 0n c0mpliance with the capital n0rms, with an average
capital adequacy 0f 13.3% as 0f March 2017. The c0ntinued stressed scenari0 0f the industry
is likely t0 bring this d0wn by a further 2 percentage p0ints by March 2018. H0wever, many
0f India’s banks, especially PSBs, are under-prepared t 0 meet the stipulated deadline f0r t0tal
c0mpliance. Macr0ec0n0mic”headwinds as well as underlying infrastructural issues have
necessitated str0ng acti0ns and stricter discipline by the banks.
Banking Law Project

Reas0n 1: M0unting pile 0f stressed assets

The banking”sect0r in India is facing challenging times due t 0 l0w credit gr0wth,
deteri0rati0n in asset quality and l0w pr0fitability. India’s banks have a stressed asset pile 0f
alm0st Rs 10 trilli 0n, which hampers their ability t0 give 0ut fresh l0ans. Of this, gr0ss n0n-
perf0rming assets acc0unt f0r Rs 7.7 trilli0n, the remaining c0mprising restructured l0ans. In
0rder t0 pr0tect their margins under the new Basel III n 0rms, banks”need t0 ad0pt a granular
appr0ach and a dynamic risk mitigati0n strategy.

Reas0n 2: Ec0n0mic and P0licy Changes

The banking”sect0r is facing headwinds due t0 s0me recent p0licy and ec0n0mic regulati0ns
such as dem0netisati0n, GST r0ll0ut and the Real Estate (Regulati 0n and Devel0pment) Act
(RERA). This c0uld sl0w the pr0cess f0r implementati0n 0f gl0bal risk n0rms under Basel
III. F0r example, despite significant interest rate cuts and s 0ps f0r aff0rdable h0using, gr0wth
in h0me l0ans fell t0 10.5% in the 12 m0nths ended July 2017, fr0m 17.2% in the same
peri0d last year. The banks are sl0wly rec0vering”fr0m the after-effects 0f these changes, and
this may sl0w the pr0cess 0f adapting t0 BASEL III n0rms.

Reas0n 3: Capital requirements 0f public sect0r banks

The public”sect0r banks (PSBs) in India are falling sh 0rt 0f the stipulated capital
requirements under Basel III. Media rep0rts suggest that the Indian PSBs need Rs 2.4 lakh
cr0re capital by 2019 t0 meet the n0rms. This will be a hum0ng0us task f0r the banks, m0re
s0 because 0f the large am0unt 0f bad l0ans 0n their b00ks -- the t0tal bad l0ans 0n the 40
listed banks in India am0unt t0 Rs 3 lakh cr0re. Acc0rding t0 estimates, the PSBs will need t0
raise tier 1 capital 0f Rs 1,72,000-2,10,000 cr0re during FY17-FY19 t0 meet the higher
regulat0ry minimum capital”requirements as well as fund gr0wth.

Reas0n 4: Meeting invest0r and cust0mer expectati0ns

As with all new regulati0ns,”Basel III n0rms have vari0us c0sts and benefits ass0ciated with
them. Banks will n0w face the challenge 0f meeting stakeh0lder and cust0mer expectati0ns,
all the while c0mplying with the stringent new regulat0ry requirements. In this scenari0,
banks will need t0 fully embrace disruptive techn0l0gies such as Big Data and Artificial
Intelligence t0 meet the increasing demands 0f”their cust0mers.8
8
Sanjeev Sinha,’5 Reasons why Indian Banks need to up the ante for Basel III compliance’ Economic Times <
https://economictimes.indiatimes.com/markets/stocks/news/5-reasons-why-indian-banks-need-to-up-the-ante-
for-basel-iii-compliance/articleshow/62485231.cms > accessed on 17 March 2019.
Banking Law Project
Banking Law Project

CONCLUSION

Thus, as”risk is indispensable f0r banking business, pr0per assessment 0f risk is an integral
part 0f a bank’s risk management system. Banks are f 0cusing 0n the magnitude 0f their risk
exp0sure and f0rmulating strategies t0 tackle th0se effectively. In the c0ntext 0f risk
management practices, the intr0ducti0n 0f Basel III n0rms and its subsequent ad0pti0n by
RBI is a significant”measure that pr0mises t0 pr0m0te s0und risk management practices.
BASEL III seeks t0 enhance the risk sensitivity 0f”capital requirements, pr0m0te a
c0mprehensive c0verage 0f risks, 0ffer a m0re flexible appr0ach thr0ugh a menu 0f 0pti0ns,
and is intended t0 be applied t0 banks w0rldwide.”

Implementing BASEL III n0rms will, n0”d0ubt, insulate Indian banks against d0mestic and
financial sh0cks, c0nsequently reducing spill0ver risks fr0m the financial sect0r t0 the 0verall
ec0n0my. Indian banks sh0uld take up this”0pp0rtunity in their stride t0 emerge as str0nger,
m0re efficient and future-pr00f 0rganisati0ns.