Adequate capital backup, to take care of unexpected losses, has become the real license to conduct and expand banking business, especially in the case of asset portfolio. The Indian banking system is better prepared to adopt Basel II than it was for Basel I. Nevertheless, the task is daunting enough, requiring more rigor and improvement in risk management systems, especially credit risk measurement and related database. The past trends indicate that to maintain the present 12% level of Capital to Risk Weighted Assets Ratio), even in March 2007, banks in India may fall short of capital by Rs. 30,000-Rs. 57,000 cr. Owing to an estimated increase of risk weighted assets by 15-30%, mainly on account of operational and market risk (if not credit risk) during Basel II era, nationalized banks and private sector banks seem to be more vulnerable when compared to the State Bank group and foreign banks in accomplishing such task. The size of bank being a helpful factor to improve the risk-bearing capacity, consolidation through orderly mergers and acquisition may be necessary. Asset expansion through proper risk management culture is another important strategic dimension in the Basel II context with matching supervision, audit and vigilance systems, which should encourage capturing business rather than driving it away. Degovernmentalization of public sector banks, through managerial autonomy, will ensure prompt organizational responses to the fast changing market developments. Draft guidelines issued by RBI in February 2005 on Basel II implementation clearly indicate a phased approach, without putting undue pressure on the banking system and, at the same time, aiming to reach international standards and best practices. Basel II transition should further strengthen the banks to play a crucial role in ensuring that the fruits of economic reforms, especially the financial sector reforms, are in the reach of the vast and vulnerable sections of the society.

Banking, in the classical intermediary sense, has been defined as accepting deposits to lend money as per the national economic policy. However, in the event of market economy assuming prominence, the nature and role of intermediation is undergoing a radical change. One can say that a bank intermediates the differing liquidity needs of depositors as well as borrowers. It tries to guarantee the depositors the return of principal plus interest at the end of the contracted period, sometimes even before that, if the depositor wishes to prematurely withdraw without any corresponding degree ofguarantee of such repayment from the borrowers, and in the process, undertakes both liquidity and credit risk. In fact, in a way, all worries of a banker are on account of such one-sided guarantee to the depositors. Further, apart from paying the rent for using the depositor’s money, the banker compensates the depositor for the loss of purchasing power due to inflation in the form of interest. A banker also undertakes intermediation between wholesale and retail customers, thus assuming the denomination risk. Market risk in the bank’s assets and liabilities is a major risk to be taken care of, especially after transition from the fixed price or administered price regime to free-market or deregulated interest rate regime. In other words, a banker is basically an underwriter of financial risk in the process of the above said intermediation. Who should be given the license to undertake such financial risk intermediation? Obviously, those institutions that have the ability to understand, gauge, and profitably undertake such risks and possess sufficient capacity to absorb the shocks inherent in the process should be preferred. One of the methods adopted by the banking regulators all over the world to judge such capacity to absorb shocks is the capital adequacy position.