v leeladhar : india ’ s preparedness for basel ii implementation address by mr v leeladhar, deputy governor of the reserve bank of india, at the panel discussion during the “ ficci - iba conference on global banking : paradigm shift ”, mumbai, 13 september 2007. * * * dear friends, it is my pleasure and privilege to be here with you this morning and to be sharing my experience and views with this august audience regarding india ’ s preparedness for basel ii implementation. i am very thankful to the organisers for having afforded me this opportunity today. as you are well aware, implementation of the new capital adequacy framework has been a long and exacting journey in most of the jurisdictions, and so is the case with india. the countries are at various stages of implementation. in india, having regard to the country context and in tune with the overall approach to regulatory reforms, we have adopted a calibrated approach for a phased implementation of basel ii so as to secure a non - disruptive migration to the new framework. in my remarks today, i would like to briefly touch upon the evolution of the revised framework, its broad structure, preparatory measures taken by the rbi for implementing this framework and the challenges that will need to be tackled in migration to basel ii. at the outset, let me hasten to add that while we are moving towards the basel ii framework, the rbi has adopted a three - track approach to capital adequacy regulation in india, with the norms stipulated at varying degrees of stringency for different categories of banks. similar differentiated approach has been adopted in some other jurisdictions also. this has been a deliberate choice for us having regard to the size, nature and complexity of operations and relevance of different types of banks to the indian financial sector, the need to achieve greater financial inclusion and to provide an efficient credit delivery mechanism. thus, the commercial banks, which account for the lion ’ s share in the total assets of the banking system, will be on basel ii standards while the co - operative banks will remain on basel i norms for credit risk with surrogate measures for market risk. the regional rural banks, on the other hand, which have limited operations in rural areas, will be on non - basel standards. basel ii the attempts at harmonising the capital adequacy standards internationally date back to 1988, when the “ basle committee on banking regulations and supervisory practices ”, as it was then named, released a capital ade

margins of the bank. the banks would, therefore, need to streamline and reorient their client acquisition and retention strategy. finally, implementing the icaap under the pillar 2 of the framework would perhaps be the biggest challenge for the banks in india as it requires a comprehensive risk modelling infrastructure to capture all the risks that are not covered under the other two pillars of the framework. the validation of the internal models of the banks by the supervisors would also be an arduous task. in regard to adoption of advanced approaches available under basel ii, the rbi has not stipulated any timeframe for adoption of these approaches but a migration to advanced approaches would certainly pose significant challenges to both – the banks as well as the supervisors. in this case, a slightly different set of issues and challenges is likely to arise which would need to be kept in view in any decision to migrate to them. first and foremost, the banks will need to demonstrate to the supervisors that they meet the minimum criteria stipulated in the basel ii framework to be eligible to adopt the irb approaches. this could require, inter alia, suitable adjustments in the risk - rating design and its operations for various product lines in the banks as also the governance structure to ensure the integrity of the rating process. second, unlike the simpler approaches under basel ii, the advanced approaches are very data intensive and require high - quality, consistent, time - series data for various borrower - and facility - categories for a period of five to seven years to enable computation of the required risk parameters ( such as default probability and loss given default, etc. ). the banks would perhaps need a thorough review of their internal processes with a view to redesign and upgrade them to be able to capture the information needed for creating the requisite databases. third, a robust risk management architecture, including a strong stress - testing framework for scenario analyses, would be a necessity under the advanced approaches. a system within the banks to validate the accuracy of the internal rating processes would be an essential element of the risk management set up. fourth, an overarching requirement for efficient data management and for effective risk management structures, would be an state - of - the - art technological infrastructure which might need significant investment and improvement to achieve seamless enterprise - wide integrated risk management, for which sharply focused strategic planning would be necessary. fifth, with considerable leeway available to the banks under the advanced approaches in determining the regulatory capital requirements, the highest standards of corporate governance would be critical for maintaining