Trend

Basel II: banks struggle to meet deadline

Big Indian banks are gearing up to comply with international standards by adopting Basel II, but smaller institutions are struggling to cope, finds Megha Banduni.

RBI’s deadline for Indian banks to comply with Basel II is March 2007. That’s just four months away, and by the looks of it, banks are struggling to meet this deadline.

Complying with Basel II will mean a complete changeover of a bank’s IT systems. For instance, two of the features that these banks need to put in place are anti-money laundering and digitisation of records. That means good business for vendors who are providing these solutions.

Earlier, regulations in the banking sector were focussed on credit and market risk. Basel II encourages banks to ensure that their risk management capabilities are commensurate with the risks that they face as they go about doing business. Basel II specifies that banks must follow a standardised approach and an Internal Ratings-Based (IRB) approach. At present, all banks are following a standardised approach.

According to Robin Roy, Principal Consultant, PricewaterhouseCoopers (PwC), “Banks are at different stages of preparedness. Most of them are seriously evaluating Basel II and have started or completed the relevant procedures. A few have moved a step ahead of the standard approach.” This though is happening only at the top 10 or so banks in India. There are about 100 banks in the country, all told.

To comply with RBI guidelines for Basel II, banks need to deploy a suitable solution. Such deployments require a handsome outlay for internal systems will have to be replaced and processes overhauled. Scepticism runs high among analysts as to whether banks will be able to achieve this state of preparedness by the deadline, with the RBI hinting that the deadline may be extended.

The immediate beneficiaries are the vendors who have the hassled bankers knocking on their doors.

Says Amit Sheth, MD, AurionPro Solutions, “There are two approaches associated with Basel II. One is the standardised approach, which the banks are following, and the other is the advanced approach, which banks will look at by 2009-2010. The standard approach means that banks are creating uniform structured data, redefining processes, and so on. In the advanced approach, the central bank has asked banks to define risk models for themselves.”

Adds Venkatesh Srinivasan, Senior Vice-president, Head of Treasury and Risk Management, Corporate Banking, Polaris, “Indian banks are rushing to buy packaged software to comply with RBI guidelines. In the long run, a package covering all three models—standard, foundation and advanced—is the optimal solution for a bank; it is also cost-effective. Banks can implement the above models in steps and by configuring the package without having to invest in upgrades and enhancements.”

What is bothering analysts is the ability of smaller banks to deploy the desired IT systems as they will have to make substantial investments. “Top-tier and newer banks have adopted or are adopting Basel II, but small banks are not ready largely because they don’t have the financial resources to do so. However, the requirements of small and large banks remain the same. Minor issues like training, flexibility in adoption, and criticality in roll-out might differ. Small banks lack the readiness to accept new things easily,” notes Sheth.

One way to deal with this is to have modular solutions. Aurovision has customers like Kotak Mahindra, Yes Bank and HDFC Bank. The company’s expertise lies in providing solutions for market risk. According to Devakumar Sanyasi, EVP, Corporate Relations, Aurovision, “In the case of Yes we went and found what products they were dealing with in terms of financial instruments…they shared their data formats with us and we analysed this data. Later, we customised the process of computing risk indicators depending on the type of data that a bank had on its systems. Testing is the next step, after which we put all the data into systems and automate and manage it.”

Data collection: the focus area

"One thing to keep in mind is that apart from Basel II, a lot of internal improvements are needed" - Aruna Rao Business Head Corporate Banking, Products & Services Polaris

The key aspect of Basel II is to accurately collect, analyse, manage and digitise data. This is one of the challenges that software providers face. Banks must redefine processes, segregate data in a standardised form, and keep Basel II as a backbone for this. “Indian banks are taking care of market and credit risk, but the banking sector is still at a nascent stage when it comes to operational risk. Indian banks will go slow on this front,” says Roy, continuing, “Solutions for data capture, warehousing, creating data marts, standardising data, and conducting data analysis are in demand. These initiatives are encouraging enterprise-wide initiatives and BI.”

Cautions Aruna Rao, Business Head, Corporate Banking, Products and Services, Polaris: “One thing to keep in mind is that apart from Basel II, a lot of internal improvements are required. For example, standardisation of data.” Polaris has a product called Intellect Integrator which allows users to cobble systems together to get data into one place, say, a warehouse. They also have a product called Asset-Liability Management which caters to liquidity, interest rate and reputation risk.

"Credit risk is a concept that has been floating around for years, but operational risk is just starting to gain ground in India" - Vishnu Dusad Managing Director Nucleus Software

According to Vishnu Dusad, Managing Director of Nucleus Software, “The top requirement of any bank is to collect data; this includes data analysis, deriving meaning from it, and digitising the same. Credit risk is a concept that has been floating around for years, but operational risk is just starting to gain ground in India. Not all banks will attain Basel II by 2007; still, banks are in process of preparation.”

Comments Roy: “A trend that we see is that banks are adopting data warehousing solutions. Data pooling is one approach that banks should undertake to cut costs and improve output. Some case studies show that data pooling results in costs being pared down to one-fifth of what they were.” This makes sense for smaller banks which cannot invest and also do not need a dedicated IT department since their IT needs are managed by a third-party.

Solutions available

Advises Roy, “Before going in for a solution, banks should find out what type of systems they have in place and the capabilities of these systems. For instance, not more than 40 to 50 percent of core banking system capabilities are being utilised by Indian banks.”

Sheth says that “all the modules which are required in standard approach are in demand. There is considerable demand for risk management modules from all banks after RBI announced the deadline.”

Aurovision launched a product called Market Risk System (MRS) which plays a key role in helping banks to monitor and manage their market exposures to securities, derivatives and options open positions on a daily basis. MRS helps banks integrate data from their treasury and trading activities. It has been developed on RBI’s recommended ‘standardised duration method’ to arrive at the capital charge. The product provides comprehensive security measures, log reports and audit trials. Some banks using this solution are HDFC Bank, Kotak Mahindra Bank and Yes Bank.

Then there is AurionPro, which has a product called riskPro that helps banks in the computation of credit, market and operational risk. The riskPro suite offers solutions for the standardised IRB and advanced IRB approach. The modular approach adopted by riskPro lets a bank build on its existing infrastructure, leverage what is already present, and add new functionality as and when needed. AurionPro is currently approaching leading private and public sector banks in India with its riskPro suite of offerings.

Big banks are ready

Basel II is helpful to all banks, especially those which desire to go global. That’s the reason why most large banks in India are preparing themselves to adhere to these norms. One of the principal objectives of Basel II is to reduce risk—both market and operational—in the financial system by aligning each bank’s capital requirement so that the bank can accurately reflect its credit risk. According to Srinivasan, “Indian banks have started taking care of operational risk. Many banks have taken steps towards Basel II, and are concentrating on risk management practices.” He feels that the deadline to comply with Basel II may be extended because many banks are not prepared and will require more time. To which Sanyasi adds, “Small banks have realised the benefits of Basel II and are on track to implement solutions. The average implementation period for our product is three months. It’s not too late for smaller banks to look at Basel II even now.”

From here to Basel II

Migrating from the standard approach to the advanced one is on the cards. Adopting the advanced approach will require superior technology and information systems that will help a bank improve its data collection and analysis.

RBI has decreed that after adequate skills are developed, banks might be allowed to migrate to an IRB approach. As of now, all banks are focussing on a standardised approach for credit risk and operational risk. Once this is through, some banks may be allowed to migrate to an IRB approach.