India
is known for excellent policies and their poor implementation.
Indian plan documents, known for excellent analysis of
economic problems and their remedies, are the finest examples
of gaps between intention and execution. In banking, too,
we have a plethora of well-intentioned guidelines, policy
documents, committee reports and circulars, but the ground
realty is a testimony to the gaps. By Ashok K Nag,
senior vice president of risk management firm, Riskraft
Consulting Ltd.
The
Basel II guidelines on risk management framework that
the Reserve Bank has rightly asked Indian banks to implement
is likely to meet a similar fate, given the state of confusion
that prevails within the Indian banking industry with
regard to its implementation roadmap.
Indian
banks appear to be uncertain about the actual intent of
Basel II guidelines. Is it a technology that can be bought
off the shelf or does it involve business process re-engineering
or is it merely a new way of calculating a bank''s risk
profile?
In
recent times a number of Indian public sector banks have
come up with tender documents requesting vendor responses
to either Basel II consulting services or risk management
software solutions. Some banks have even asked for an
enterprise-wide risk management solution, while other
have asked for solutions in a specific area like credit
risk.
A
careful study of these tender documents shows that the
banks are completely in the dark about the true import
of Basel II norms. For example, one public sector bank
has identified data gap as the foremost problem with regard
to Basel II implementation.
Per
se, the bank is absolutely right on this point. But it
appears to be interested in identifying data gaps only
for risk calculation. Apparently its main objective is
to work out regulatory capital under Basel II norms and
nothing more.
Does
it mean that as long as the bank is able to calculate
its probability of default it can legitimately migrate
to an advanced internal rating-based approach? Like the
proverbial four blind men the bank has been able to appreciate
only a part, albeit a very important part of the Basel
II elephant.
Another
public sector bank first floated a tender for an enterprise-wide
risk management software solution followed, after a gap
of two months, with another tender for pre-qualification
of risk management consultants.
Presumably,
the consultants will have to advice within the framework
of the software already selected.
The
bank would have been better served with the domain advice
of the software solution provider. If the consultant to
be appointed is not required to advice on the optimal
solution with regard to bank''s specific requirement, what
services would the bank like to get from the person?
Yet
another bank wants its consultant for an integrated risk
management system to advise it on almost all possible
activities that can be thought of in banking in general
like product pricing of deposit and advances, transfer
pricing policy, future business strategy, economic and
political impact on the bank''s balance sheet!
Apart from the mandatory menu of probability of default
calculation, etc, all the advice has to be delivered within
six months a tall order indeed.
In
this era of the internet and with Microsoft''s largesse
in providing ctrl+C and ctrl+V functionalities, preparation
of such tender documents is all a matter of a day''s work.
It is obvious that these banks have not done their required
homework in training their personnel to understand the
issues involved in Basel II to articulate their bank''s
specific requirements. Evidently, regulatory pressure
is the only thing driving these last minute rush activities.
The
main point that all Indian banks and particularly those
in the public sector are missing is that Basel II is more
about the risk governance structure of a bank and risk
calculation is only an intermediate step towards building
that structure.
No
doubt data gap is extremely important and without bridging
that gap nothing concrete can be achieved.
But
data gap must be analysed and mapped with regard to certain
objectives, which should be establishing a risk governance
structure, and within it all necessary calculations should
be incorporated. This governance structure must be built
on the foundation of each bank''s overall risk management
strategy and appetite. The strategy must be spelt out
and adopted as a mission goal by the top management.
There
is no evidence that many of these banks have made any
effort in this respect. More importantly there is no evidence
of any appreciation of the Pillar 2 and Pillar 3 norms
of Basel II guidelines.
It
is these two pillars that completely differentiate this
new international guideline from its predecessors. Banks
are falling over each other to buy some piece of software
that would throw the risk numbers.
But
what guarantee is ther that these numbers will meet supervisory
approval and whether these numbers are accurate.
Since
the banks have totally ignored the need for building the
internal expertise to decipher the intricate methodology
that goes behind these numbers, how are they going to
convince the supervisors about the soundness of their
methodology? In fact, there are cases of banks having
purchased risk management software without really evaluating
the methodology or even, more preposterously, without
being even provided with the underlying methodological
documents.
In
one case that this author knows of, the vendor has refused
to provide the methodological document unless the bank
issues the user acceptance certificate!
One
private sector bank is keen to implement the advanced
measurement approach for operation risk without establishing
a workflow within the organisation for identifying potential
risk events and a proper operational risk assessment process
across its various business lines.
This
particular bank feels that what it requires is merely
a calculation engine and nothing else to derive substantial
regulatory capital advantage.
No
doubt shrewd marketing teams of software vendors have
done a marvelous job for their companies but let us hope
that the Basel II euphoria does not turn out to be a grand
marketing opportunities for software vendors only.
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