keeping in view the financial innovation and growing complexity of financial transactions, a need was felt for a more broad based and flexible framework for capital adequacy. towards this end the basel committee has formulated a new framework, popularly called “ basel ii ” which attempts to formulate more precisely than before the levels of regulatory capital that banks must hold as a cushion against the credit and other risks that banks take. cross - border supervision this would involve a greater focus on overseas operations of indian banks and in having information sharing arrangements with overseas supervisors on a firmer and more formal footing. in the context of money laundering concerns raised by some of the supervisors, it needs to be ensured that some of the branches, especially those which are not compliant with the anti - money laundering principles of the financial action task force ( fatf ), are not causes of serious operational and reputational risks to their parent banks in india. money laundering although i touched upon this issue in brief earlier while discussing cross border supervision, i would like to dwell a little bit more on this issue as it has been engaging the attention of governments, regulators and international financial community for quite some time. and there will be no exaggeration if i call it the biggest challenge before the supervisors today. post september 11, the issue that bank supervisors the world over are grappling with is “ how to root out the menace of money laundering? ” until recently, the governments talked tough about the problem, but did little about it. all that changed three years ago. the fatf was conceived by g - 7 countries as a helpful mechanism to persuade governments to combat money laundering and offer them technical assistance to do so. the laws being enacted typically require a bank to “ know the customer ” to be confident that his money is obtained by legitimate means, and to report any suspicious activity. this involves a herculean effort, thanks in part, to the growth of “ correspondent banking relationships. ” in effect, this means banks must know their customers ’ customers as well. banking supervision all over the world has to achieve the delicate balance between respect for customer privacy and making banks report suspicious transactions. this raised the toughest question : what exactly are efforts against money laundering trying to achieve? so far, countries have been free to define what they regard as illegal sources of money. some include drugs, racketeering and other dark crimes in their definition of illegal money. some, such as france, consider tax evasion to be money laundering. others like switzerland

in large banking institutions, if the development financial institutions opt for conversion into commercial banking in line with the recommendation of the second report of the narsimhan committee. in india, one of the largest financial institutions, icici, took the lead towards universal banking with its reverse merger with icici bank. idbi is also well on its way to transform itself into a universal bank. this may lead logically to promoting the concept of financial super market chain, making available all types of credit and non - funded facilities under one roof or specialised subsidiaries under one umbrella organisation. the setting up of banks by financial institutions and non - banking financial companies and setting up of insurance, merchant banking, mutual funds, housing finance and investment companies either as subsidiaries or as joint ventures has brought into focus the need for consolidated supervision. consolidated accounting and supervisory techniques would have to evolve and appropriate firewalls need to be built to address the risks underlying such large organisations and banking conglomerates. supervision / regulation of financial conglomerates the financial landscape is increasingly witnessing entry of some of the bigger banks into other financial segments like merchant banking, insurance etc., which has made them financial conglomerates. emergence of several new players with diversified presence across major segments and possibility of some of the non - banking institutions in the financial sector acquiring large enough proportions to have systemic impact make it imperative for supervision to be spread across various segments of the financial sector. in this direction, an inter - regulatory working group was constituted with members from rbi, sebi and irda. the framework proposed by the group will be complementary to the existing regulatory structure wherein the individual entities are regulated by the respective regulators and the identified financial conglomerates would be subjected to focused regulatory oversight through a mechanism of inter - regulatory exchange of information. risk management and capital adequacy financial sector reforms in the current millennium are going to focus on setting the rules of the game for financial intermediaries in such a way that risks are taken with an adequate level of capital. in other words, financial intermediaries should be free to engage in asset liability management that allows them to diversify their risk so long as they are supported by a level of capital sufficient to cushion them against their risk profile. the first capital accord of 1988 evolved by basel committee provided a framework for a fair and reasonable degree of consistency in the application of capital standards. however, the methods used to determine the capital charge for credit risk in the accord were not sufficiently sophisticated and not perceived to be risk sensitive.