Banks are planning to go for a transformation in their capital structure within a short period from now. The Indian banks will adopt Basel II norms by March 2008 and the foreign banks will implement the same by 2009. Indian banks were puzzled when Basel I was implemented in the 1990s. But they successfully faced the challenges and converted the situation into an opportunity.

Basel I is a framework for calculating Capital to Risk- weighted Assets Ratio (CRAR). Through an amendment in 1996, market risk was incorporated in the weighting scheme of Basel I along with credit risk. The CRAR defines two types of bank capital. They are core capital (tier I), which consists of equity capital and disclosed reserves and tier II which includes hidden reserves, revaluation reserves,general provisioning, subordinated debt of maturity greater than five years and hybrid debt equity instrument, such as cumulative preference shares, and convertible bonds. Bank's asset should be weighted by five categories of corresponding risks to calculate CRAR. It is known as risk-weighted assets measure and it ranges from 0 to 100%. Claims on multilateral development banks such as World Bank, Asian Development Banks or claims collateralized by securities issued by these banks carry risks of 20%. Whereas claims on private sector companies will get 100% risk weight.

In 1996, Basel I system incorporated market risk element in the calculation of CRAR. To calculate market risk, banks were given two options. The first was a standardized approach and the second was an in-house approach, which allowed the banks to develop their own proprietary models to calculate capital charge for market risk by using the notion of value at risk. In the computation of the CRAR, the numerator will be the sum of the bank's tier I and tier II capital (tier II capital should be limited to a maximum of 100% of tier I capital), plus a tier III capital, introduced in the 1996 amendment to support market risk. It will consist of short-term subordinated debt, but with a minimum maturity of two years.

Basel I is considered as one-size-fits-all framework, which needed to be upgraded as each bank has its own way in measuring, managing and mitigating risk. The Basel II is of risk management which not only includes credit risk but the market and operational risk as well. Banks are capable of applying risk sensitive methodologies through Basel II norms.

Professional Banker Magazine, Basel II system, Indian Banking Sector, Capital to Risk weighted Assets Ratio , CRAR, World Bank, Private Sector Companies, Risk Assessment Methods, Export Credit Agencies, Credit Conversion Factors, Advanced Measurement Approach, Operational Management.