v leeladhar : basel ii accord and its implications speech by mr v leeladhar, deputy governor of the reserve bank of india, at the bankers ’ club, mangalore, 11 march 2005. * * * ladies and gentlemen, it is my pleasure to share my thoughts with you on a subject which is currently engaging the attention of the banking community, not just in india but worldwide. let me first admit upfront that although i am at the moment wearing the regulator ’ s hat, yet i have been a commercial banker for most part of my professional career. so, the banker in me still goads me to put myself in bankers ’ shoes before evaluating any regulatory options. i can better appreciate some of nuances from a practical stand point, and therefore shall try to put them more from a banker ’ s perspective rather than that of a regulator. managing risk is increasingly becoming the single most important issue for the regulators and financial institutions. these institutions have over the years recognized the cost of ignoring risk. however, growing research and improvements in information technology have improved the measurement and management of risk. it ’ s but natural therefore, capital adequacy of a bank has become an important benchmark to assess its financial soundness and strength. the idea is that banks should be free to engage in their asset - liability management as long as they are backed by a level of capital sufficient to cushion their potential losses. in other words, capital requirement should be determined by the risk profile of a bank. the initial capital accord of 1988 was hugely successful with more than 100 countries accepting it as a benchmark. one of the major reasons for the success of this framework was its being simple. it brought in uniformity and attempted to make regulatory capital requirement consistent with the economic capital. reserve bank of india introduced risk assets ratio system as a capital adequacy measure in 1992, in line with the basel accord of 1988, which takes into account the risk element in various types of funded balance sheet items as well as non - funded off balance sheet exposures. in fact, rbi norms on capital adequacy at 9 % are more stringent than basel committee stipulation of 8 %. shortcomings in the present accord however, the present accord has been criticized as being inflexible due to its focus on primarily credit risk and treating all types of borrowers under one risk category regardless of credit worthiness. the major criticism against the existing accord stems from its • broad brush approach

the great depression. the analysis shows that higher capital reduces the severity of the crises as better capitalised banks tend to provide 5 / 11 bis central bankers'speeches more credit. 25 some authors argue that the introduction of the concepts of total loss - absorbable capacity ( tlac ) and minimum requirements for eligible liabilities ( mrel ) for the purpose of bank resolution could implicate a lower capital ratio to start with. 26 however, a more recent fed paper, considering the potential effect of tlac still reaches an optimal range of capital ratio between 13 and 25 %. 27 considering these studies, there is no justification to weaken the lr standard, nor is there rationale for not restricting the use of internal models for credit risk, to be finalised before the year - end. without an agreement to finalise basel iii, we run the risk of contributing to the fragmentation of international regulation and helping those who want to destroy the multilateral approach that has served us well. but beyond solvency and high capital ratios, the crisis has illustrated liquidity risk, thus the importance of liquidity management rules introduced for the first time in basel iii standards. particularly in europe, banks relied too much on wholesale funding reaching an average creditto - deposit ratio of 145 % in 2007, a level that stands now at 120 %. in this perspective, a mandatory nsfr is quite relevant and should not be weakened or delayed. maturity transformation by banks is very much driven by housing financing and long - term mortgages. this has generated proposals to change the terms of housing financing to further reduce the risks of funding mortgage credit with short - term deposit liabilities. many ideas have been put forward to change this28 including tilting even more the nsfr to correct that bias ; encouraging more securitisation with low maturity transformation ; creating a new type of financial institutions specialised in mortgages or, introducing a new type of mortgage contract that would have more equity participation by lenders in exchange of sharing the returns of appreciating housing prices, proposed by mian and sufi in “ house of debt ”. 29 housing credit has been growing in importance for banks in many jurisdictions over the past decades. in 17 developed countries, the weight of real estate bank lending in total credit increased 40 % from 1970 to 2007. 30 new regulations restricting the role of banks in mortgage lending would therefore be a significant structural change in our financial systems. in addition to new capital and liquidity requirements, the regulatory reform had some