BASEL-ii IMPACT IN CREDIT RISK MANAGEMENT

Basel-II implementation is challenging. For such event, banking sector needs services of techno- human resources. Why? The reply is to combat multiple risks facing the financial sector. In order to address high tech information technology, Complex business transactions, derivatives and various swaps has been significantly increasing the risk in banking sector.
One important aim of Basel-II initiatives is international convergence of Capital standard. Capital is very important for banks as it is a business not on money of the people. Capital is a cushion against their business loss, it promotes public confidence and measures soundness and stability. Since 2oo3, Bangladesh Bank introduced risk management practices focusing on five Core risk areas such as Credit risk, asset and liability balance sheet risk, foreign exchange risk, Internal Control and Compliance risk and money laundering risk and Information Technology risk. The simple fact is that banks are doing Business with depositor’s money which is repayable 100 percent. Fund is invested in risky investments. Therefore, in order to Judge the financial health of the bank, it is necessary to see whether banks are investing the money cautiously or not. All stakeholders including regulators and depositors are interested to know how the banks are performing.

The Basel-II accord came into effect in our Country- from January, 2009 alongside the Basel-I to Consolidate Capital base of the Banks. The banks were allowed to follow both Basel-II and Basel-I frameworks in 2009 to Calculate their Capital adequacy. But the Banks are implementing Basel-II framework from January, 2010. The year 2009 was considered a trial period for the banks for improving their efficiencies to implement Basel-II accord from 2010.

Our banking sector, in Bangladesh, started parallel run of Basel-II on January 01, 2009 and a full-fledged run of Basel-II is going on from January 01,2010.

Basel-II accord describes three-tier concept with a view to complying with the requirements which are designed to encourage the banks to strengthen their capital positions considering their risk, supervisory review process and market discipline. In Basel II accord, the total capital of a banking company has been segregated as tier-one capital, tier-two capital and tier-three capital.

Tier-one capital, also considered as core capital, mainly comprises of highest quality capital elements which include the amount of funds contributed by the owners of the banking company in exchange for shares or stock as paid-up capital, share premium account that represents the excess value of a share of stock above its par (face) value and which is non-repayable in nature, statutory reserve which is kept at least 20% of pre-tax profit as per sec.24 of BCA, 1991 until the reserve e along with share premium account becomes equal to bank's paid-up capital, the balance of general reserve, the amount of earnings which has been retained in the bank as un-distributable portion of profit or retained earnings after making payment of appropriation items including dividend, the bank's minority interest in subsidiaries that represents the bank's ownership shares in the related business, non-cumulative irredeemable preference shares which pay a fixed rate of dividend and dividend equalization account which is maintained to insure payment of dividend each year at a certain rate.
Tier-two capital, also called supplementary capital, covers some items which fall short of some of the features of the core capital in terms of readiness and supporting quality of the capital. Tier-two capital includes general provision of unclassified loans and advances, special mention account and off-balance exposures, 50% of asset revaluation reserves which represent the difference between the book value and the re-valued amount of land and buildings of the bank, all other preference shares except ones listed under core capital, subordinated debt that does not have liquidity date or is perpetual in nature and limited to use up to 30% of tier-one capital exchange equalization account which arises from exchange gain due to devaluation of local currency with foreign currencies and up to 50% of revaluation reserve of securities which holds for transaction motive.

Tier-three capital, another sort of supplementary capital, is essential for meeting partial capital requirements of market risk of a banking company which may arise from trading book. This sort of capital consists of short term subordinated debt. Subordinated debt means and unsecured debt mainly extended to the borrowers by its sponsors subordinated to the claim against the borrowers and documented by a formal subordination agreement between the providers and the borrowers. Subordinated debt-holders have a prior claim over common and preference shareholders against the bank's earnings and assets.

The sum of the above mentioned three tiers of capital shall be at least 10 per cent of risk weighted assets of on-balance sheet and off-balance sheet items of a bank. This amount of capital is termed as adequate capital of a bank. In addition, to manage adequate capital, a banking company is to follow a number of constraints in its capital structure. First the ratio of core capital (Tier-one) to risk weighted assets must be at least 5.0 per cent. Second, the total of tier-two and tier-three capital shall not exceed the total of tier-one capital. Third, a minimum of about 20% of market risk needs to be supported by tier-one capital. Fourth, supporting of market risk from tier-three capital shall be limited up to a maximum of 20% of a bank's tier-one capital that is available after meeting credit risk capital requirements.

However, to determine each bank's total eligible regulatory capital, banks are required to make deductions from Tier-1 capital some additional items including book value of goodwill, shortfall in provisions required against classified assets, and remaining deficit on account of revaluation of investments in securities after netting off any other surplus on the securities. The banks must meet minimum capital requirements because capital plays some important roles in supporting the daily operations and ensuring the long-term viability of a financial institution. Capital provides a cushion against the risk of failure by absorbing financial and operating losses until management can address the bank’s problems and restore the bank’s profitability. Capital provides the funds needed to get the bank chartered, organized and operating before deposits come flowing in. A new bank needs start-up funding to acquire land, build a new structure, and equip its facilities etc., even before opening day.

Capital promotes public confidence in a bank and reassures its creditors /depositors of its financial strength. So, it must be strong enough to reassure borrowers that the bank will be able to meet their needs. Capital provides funds for the organization’s growth and development of new services and facilities.

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