Basel II is aimed at not just sensitizing capital to the risks assumed by banks but also aligning the strategies and policies of the banks to Risk Management. Various economy cycles, market volatility, corporate irregularities and troubled capital markets have shaken the banking industry number of times and highlighted the dangers of poor risk management. With the increasing globalization and technology driven distribution channels, the traditional risk management systems appear to be inadequate to capture inter-linkages between various types of risks across geographies, customer segments and business lines.

One of the most significant factors, which concern financial institutions, is the Credit Risk. Credit Risk can be defined as probability that a borrower will not repay all or a portion of a loan on time. In other terms Credit Risk is the possibility that a bond issuer will default, by failing to repay principal and interest in a timely manner. It is also called as Default Risk.

Credit Risk can be regarded as an inherent component of the banking business. The introduction of customized banking products and services has made the task of judging the risk impact of credit decisions even more challenging. The increasing inter-linkages amongst various financial institutions since late 1980s have ensured that any risk event experienced by one institution has the potential to impact others also and the financial system in general, which is termed as Domino effect.

All the above reaffirms that an appropriate and robust Risk Management system is required for any organization to mitigate the risks-emerging out of business lines and inherent in their processing mechanisms. In order to have uniform standards internationally among banks, the Bank for International Settlements (BIS) formed a committee known as Basel Committee on Banking Supervision (BCBS). The committee made several efforts in laying down the minimum capital standards and in 1988 it came out with an accord, which is known as Basel Capital Accord (also known as Basel I), to ensure a level playing field in terms of capital required to be maintained by internationally active banks.

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