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Part - IV

• Organization-wide scope. Basel II is set to influence all areas ranging from business processes and operations to organizational structure and strategy. As such, banks must establish a risk management methodology, a senior management audit and overview process, data collection and IT systems and disclosure processes, all of which are underpinned by the overall integration of risk into core business processes. To tackle operational risk management effectively, a proper integration of enterprise-wide risk management principles is of utmost necessity.

Basel II and Basel I - Relative Comparison

Basel I concentrated on credit risk alone being the biggest risk a bank assumes and arising out of its lending/investment operations. It prescribed risk weights for different loan assets essentially on the basis of security available after classifying the assets as standard or non-standard on the basis of payment record. Basel I did not draw a distinction for the purpose of capital allocation between loan assets based on the intrinsic risk in lending to individual counterparties. Security in the form of tangible assets and/or guarantees from governments/banks is the sole distinguishing factor. Credit extended on secured basis to a small-scale unit and to a large corporate was put in the same category in so far as minimum capital requirement was concerned. The higher probability of default in respect of a loan to, say, a proprietorship compared to the large professionally managed corporate did not get reflected in the capital requirement.

Basel II addresses this issue by factoring in the differential risk factor in loans made to different types of businesses, entities, markets, geographies, and so on, and allowing banks to have different levels of minimum capital taking into account intrinsic riskiness of the exposure. Three methods, increasing in sophistication, for assessing credit risks have been recommended for adoption. Assets are to be risk weighted based on a rational approach cleared in advance by the regulator and then aggregated to arrive at the minimum capital requirement. Higher the risk, higher the weightage, and more the capital allocation required. In the proposed scheme of things, weak credits can carry a weightage of up to 150 per cent.

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* Contributed by -
Vipul Mittal & Saurabh Singh,
Ist Year, MBA (Global),
Institute of Management Technology (IMT), Nagpur.