Mumbai, March 27: The Reserve Bank of India (RBI) has unveiled fresh guidelines for supervisory review process (SRP) under the new capital adequacy framework, which is based on the Basel-II recommendations. The SRP guidelines ask banks to make provisions for risks relating to credit concentration, liquidity, settlement risk, reputation, strategy, and under-estimation of credit risk that were not specified earlier.

The central bank has set a deadline of June 30, 2008, or March 31, 2009 (for a certain category of banks) for submitting capital adequacy assessment and projections of capital requirement for the ensuing year, along with the plans and strategies for meeting the capital requirement. Thereafter, banks would be required to submit the internal capital adequacy assessment process (ICAAP) before March-end every year. “The RBI move is significant as the global financial system is still reeling under the impact of the US subprime crisis. The tighter norms will help banks to improve vigil,” said a banking source.

In its notification issued today, the RBI has asked banks to hold additional capital on account of both the possibility of under-estimation of risks under Pillar-I of Basel-II norms and the actual risk exposure of a bank vis-à-vis the quality of its risk management architecture. RBI has already issued two guidelines on minimum capital ratio and market disciplines for Basel-II norms, called Pillar I and Pillar III. While minimum capital ratio recognises three risks — credit, market and operational — the guidelines issued today specify new risks as well. Pillar I is the minimum capital ratio required by banks, while the other two are the supervisory review process (SRP) and market discipline respectively.

The objective of the SRP is to ensure that the banks have adequate capital to support all the risks in their business and encourage them to develop and use better risk management techniques for monitoring and managing their risks, the RBI said. The main aspects to be addressed under the SRP, and therefore under ICAAP, would include the risks that are not fully captured by the minimum capital ratio prescribed under Pillar-I, risks that are not at all taken into account by Pillar-I, and factors external to the bank.

This in turn would require a well-defined internal assessment process within the banks, through which they assure the RBI that adequate capital is indeed held towards the various risks to which they are exposed. The process of assurance might also involve an active dialogue between the bank and the RBI so that appropriate intervention can be made to either reduce the risk exposure of the bank or augment its capital. Thus, ICAAP is an important component of the SRP.

Foreign banks and those Indian banks that have operations outside the country have to implement the Basel-II norms from March 31, 2008, while for all other commercial banks, excluding the local area banks and regional rural banks, the rules will come into effect from March 31, 2009. With this, banks will be insulated against the risks that are not completely captured by the minimum capital adequacy ratio and caused by external factors.

Tighter Norms

•Now banks to hold additionalcapital on under-estimation of risks and actual risk exposure of a bank vis-à-vis quality of risk management architecture

•RBI has already issued two guidelines on minimum capital ratio and market disciplines for Basel II norms, called Pillar I and Pillar III

•SRP is meant to ensure that banks have adequate capital to support all the risks and encourage them to develop and use better risk management techniques for monitoring and managing their risks

•Deadline for foreign banks and those Indian banks that have operations outside the country is March 31, 2008, while for all other banks, excluding local area banks and regional rural banks, rules will be effective March 31, 2009