Basel II - A wake up call for the financial sector

Developed economies are governed by prudential norms and regulatory bodies. As markets and products mature, so does governance. And eventually, even those organisations or countries which resist the initial frameworks are nudged into compliance by others that adopt the revised policies.

The early stages of this change are being played out with respect to the Basel II prudential norms for financial service providers. The changes are intended to improve the resilience of global financial markets and deepen the understanding of risk in loans and other instruments based on credit. In addition to this is the introduction of operational risk as a category to be measured, understood and, over time, aligned with standard allocation of capital towards risk at financial institutions.

We see this as a significant step towards deepening the understanding and management of risk in financial transactions. Associating regulatory compliance and capital allocation with operational risk will require banks to examine their operational processes in detail and invest in solutions and technologies that automate and enhance operations, that monitor statistics and norms, allow automation of transaction workflow and perform monitoring of deviation requests for transactions.

The challenge for solution providers is to build this into their solution offerings early, before they are deemed non-compliant with the emerging framework.

Given the Basel II framework, in the credit assessment arena we foresee a shift of trends from historical credit analysis (credit-based model) to more predictive (actuarial model) credit analysis. We expect to see data warehouses of historical data extended to integrate with credit scorecards and decision support tools at the application capture stage.

Banks are expected to predict the risk in their different loan portfolios and they will turn to improved technology solutions to meet this demand.

As always, the early adopters will learn early, make their early mistakes and be well ahead of the followers. This will allow them to enjoy better global risk ratings and make more efficient use of capital. Too soon to tell, but it is likely that the laggards will be potential takeover targets of the leaders, given the better capital utilisation of the latter.

Arvind Joshi is chief operating officer of ICICI Infotech

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