shyamala gopinath : approach to basel ii keynote address by ms shyamala gopinath, deputy governor of the reserve bank of india, at the iba briefing session on " emerging paradigms in risk management ", bangalore, 12 may 2006. the assistance of shri k damodaran in preparing this address is gratefully acknowledged. * * * ladies and gentlemen, it is my pleasure to be here at this program on emerging paradigms in risk management. as expected of me, in my address today, i intend to share with you the broad contours of the regulatory approach, process and thinking in regard to some of the issues arising in context of basel ii. basel ii aims to encourage the use of modern risk management techniques ; and to encourage banks to ensure that their risk management capabilities are commensurate with the risks of their business. previously, regulators'main focus was on credit risk and market risk. basel ii takes a more sophisticated approach to credit risk, in that it allows banks to make use of internal ratings based approach - or " irb approach " as they have become known - to calculate their capital requirement for credit risk. it also introduces, in addition to the market risk capital charge, an explicit capital charge for operational risk. together, these three risks - credit, market, and operational risk - are the so - called " pillar 1 " risks. banks'risk management functions need to look at a much wider range of risks than this - interest rate risk in the banking book, foreign exchange risk, liquidity risk, business cycle risk, reputation risk, strategic risk. the risk management role of helping identify, evaluate, monitor, manage and control or mitigate these risks has become a crucial role in modern - day banking. indeed, it is probably not exaggerating the importance of this to say that the quality of a bank's risk management has become one of the key determinants of a success of a bank. the policy approach to basel ii in india is to conform to best international standards and in the process emphasis is on harmonization with the international best practices. commercial banks in india will start implementing basel ii with effect from march 31, 2007 though, as indicated by governor, a marginal stretching beyond this date cannot be ruled out in view of latest indications of the state of preparedness. though the basel ii framework provides various options for implementation, special attention was given to the differences in degrees of sophistication and development of the

the government ’ s 2 % target for cpi inflation. despite missing the target for much of the past five years, i ’ ve no doubt that the credible nominal anchor it provided served our economy well during the crisis. indeed, without that credibility it wouldn ’ t have been possible to loosen monetary policy as aggressively as we did in order to support output and jobs. as we have seen, the good news is that inflation has fallen sharply over the past few months and the 2 % target is now in sight for the first time in over 4 years. but this isn ’ t a time for complacency. to repeat, inflation has been above the 2 % target for most of the past five years. there are good reasons why policy wasn ’ t tightened in order to bring inflation back to target more quickly. but ultimately, the mpc will be judged by the success of our actions, not the elegance of our arguments. we need to demonstrate our commitment to bring inflation back to target and to keep it there. but we have also needed to trade off the speed with which we bring inflation back to target against the support that monetary policy can provide to the recovery. the mpc ’ s forward guidance gives greater clarity about our view of the appropriate trade - off. more important for us today, our guidance is rooted in the recognition that it ’ s a long way back to the economy being fully recovered. the damage and losses associated with the financial crisis and the years of frustration and disappointment that followed won ’ t be reversed simply by one or two quarters of strong growth. our guidance makes clear that we intend to maintain the current exceptionally stimulative stance of monetary policy until we ’ ve bis central bankers ’ speeches seen a sustained period of strong growth and the margin of slack in the economy has narrowed significantly, as long as this does not pose risks to either price or financial stability. as you may know, our guidance was framed in terms of so - called thresholds and knockouts. the mpc intends not to raise bank rate or reduce the stock of asset purchases at least until the unemployment rate reaches a threshold of 7 %, subject to three knockouts designed to guard against risks to price and financial stability. but abstracting from the details of these thresholds and knockouts, our message to you – the businessmen and women driving this recovery – is clear. you can plan for the future in the knowledge that the mpc intends to keep interest rates low until we have seen a prolonged period of