on probabilities of default, which fluctuate over the economic cycle. in a downturn, probabilities of default increase – along with the minimum capital requirements. similarly, fair value accounting means that valuations fluctuate in tandem with market prices. let me start with possible procyclical elements in the basel ii framework. so far, it is unclear – and how could it possibly be otherwise so soon after the introduction of basel ii? – whether the cyclical fluctuations of the minimum capital requirements actually impact on the propensity to lend – in other words, whether they really have a procyclical effect. the extent to which this happens hinges on a large number of factors – for example, on how far the capital buffers exceed the regulatory minimum, on the willingness of the banks to expand or contract these buffers, and, naturally enough, on the use of alternatives, such as raising additional capital. in addition, the potential antidotes to procyclicality have not yet been researched and tested in detail. this relates to components in the regulatory framework that dampen procyclicality, or even automatic stabilisers, which have an anticyclical effect and which are now being built into basel ii. for example, long - term averages are now to be used for the probabilities of default. and, by means of “ prudential filters ”, the banking supervisors have ensured that fluctuations in the balance sheets do not impact fully on the level of regulatory capital. less than one year after the introduction of basel ii in germany, the database is still very narrow. knee - jerk responses, such as the general introduction of additional general capital buffers by means of pillar 2, are therefore not appropriate in my view. what is called for instead is the close monitoring of developments and a careful analysis of the complex mechanisms of banks ’ capital management and of basel ii ’ s impact over an adequate period of time. and if, but only if, procyclical effects are found to exist on a significant scale, they should be taken into account in a system - oriented supervisory approach. i would also add that a possible procyclical nature of credit, in addition to its cyclical nature, would be an instability factor not only for the financial systems. it would also represent a further reason for focusing great attention on credit aggregates in the monetary policy analysis. regarding fair value accounting, the case for procyclicality

the basis of recommendations of the steering committee, draft guidelines to the banks on implementation of the new capital adequacy framework have been issued. • the reserve bank has constituted a sub group of the steering committee for making recommendations on the guidelines that may be required to be issued to banks with regard to the pillar 2 aspects. the guidelines with regard to pillar 2 aspects proposed to be issued would cover the bank level initiatives that may be required under pillar 2. the underlying philosophy while prescribing the basel ii principles for the indian banking sector was that this must not result in further segmentation of the sector. accordingly, it was decided that all scheduled commercial banks in india, both big and small, shall implement the standardised approach for credit risk and the basic indicator approach for operational risk with effect from march 31, 2007. however, the existing three - tier structure in respect of scbs, the cooperative banks and rrbs may continue. currently, the commercial banks are required to maintain capital for both credit and market risks as per basel i framework ; the cooperative banks, on the second track, are required to maintain capital for credit risk as per basel i framework and through surrogates for market risk ; the regional rural banks, on the third track, have a minimum capital requirement which is, however, not on par with the basel i framework. by opting to migrate to basel ii at the basic level, the reserve bank has considerably reduced the basel ii compliance costs for the system. in a way, the elementary approaches which have been identified for the indian banking system are very similar to the basel i methodology. for instance, a ) there is no change in the methodology for computing capital charge for market risks between basel i and basel ii ; b ) the computation of capital charge for operational risk under the bia is very simple and will not involve any compliance cost ; c ) the computation of capital charge for credit risk will involve compilation of information in a marginally more granular level, which is expected to be achieved with a slight re - orientation of the existing mis. in the above circumstances, it might not be an entirely correct assessment that implementation of the elementary levels of basel ii significantly increases the cost of regulatory compliance. no doubt some additional capital would be required, but the cushion available in the system, which at present has a capital to risk assets ratio ( crar ) of over 12 per cent, provides for some comfort. the banks have also started exploring various avenues for meeting the capital requirements