Basel
II has proposed a different treatment for the assessment
of capital for market risk and for investment securities
in both trading and banking books. Indian banks hold
more than 75% of the investment in government or semi-government
securities, and assigning specific risk weight according
to Basel II is a major challenge. Though they might
need more capital they have sufficient cushion as
they hold around 1.8% as investment fluctuation reserve
and 2.5% as additional capital charge for market risk. But
before adopting Basel II they need to develop an advanced
skill set as a bank's internal system is the principal
tool for the measurement of interest rate risk in
the banking book and in the supervisory response.
The
proposed new Basel Capital Accord (Basel II) prescribes
a separate treatment for the trading book and the
banking book in the assessment of the capital for
market risk in the banks' books. For the trading book,
specific risk capital charges for government paper,
specific risk rules for unrated debt securities and
specific risk capital charges for position hedged
by credit derivatives are prescribed. As per the third
consultative document released by the Basel Committee
in July 2003, specific risk capital charges for government
paper will be linked to their external credit assessment
as well as the residual term to the final maturity
and shall vary between 0% to 8%.
As
regards the banking book, the interest rate risk falls
under Pillar II of the new framework, i.e., the Supervisory
Review. If supervisors determine that banks are not
holding capital commensurate with the level of the
interest rate risk, they must require the bank to
reduce its risk, or to hold a specific additional
amount of capital, or some combination of the two.
Supervisors should be particularly attentive to the
sufficiency of capital in the "outlier banks"
where economic value declines by more than 20% of
the sum of Tier-1 and Tier-2 capitals as a result
of a standardized interest rate shock (200 basis points),
or 1st and 99th percentile of
the observed interest rate changes using a one year
(240 working days) holding period and a minimum of
five years of observations. |
