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Basel II framework to restrict credit to businesses

DUBAI — The implementation of the Basel II accord in the UAE will have major implications on the local businesses with bank credit lines expected to get more restricted and regulated, financial analysts point out.

Currently, in the absence of any reliable credit rating agencies, businesses in the region are able to avail of facilities from various banks without their credit worthiness being thorughly scrutinised. But, with Basel II, corporate and personal borrowers will have to face stringent procedures and controls as credit risk management of the banks will become more supervised and regularised, analysts point out.

"However, it also will be a win-win situation for both the banks and customers as such measures will reduce the instances of failures in businesses," says Sushil Malhotra, Chartered Accountant and Partner in AGN MAK.

"Banks will become more competitive and capital efficient, which will lead to increase in shareholders' returns. At the same time, the customer will take risk of over exposure to interest burden and debt as per his capacity which will balance the entrepreneurial spirit in the economy in the right direction," he said.

The accord, an extension of Basel I, aimed at reducing instances of bank failures, will lead the executive management to risk management initiatives to assess and strengthen Risk Management Systems and Controls relating to adequacy of capital, operational risk, credit risk, market risk and other supervisory related regulatory compliances, thus giving a new dimension of adjusted risk based return on capital for the banking sector.

Malhotra said the new supervision-based regulation will have to be implemented in the local banking sector from end of 2006. It will have a major revision on bank’s capital adequacy over the previous requirements introduced in 1988 and would ensure that the banks maintain levels of capital that are in line with their risk exposures.

The new accord will prompt banks to control risk effectively and efficiently and to justify the risks they have taken. "The regulation will thus have an enormous impact on the day-to-day operations of the banks as well as their long-term operational investment and growth strategies," he said.

Banks are required to have ongoing risk management system to address the constantly changing operational risks with more active involvement of senior management and board. The regulators feel that compliance and disclosures of relevant information would improve and make overall risk management more effective which would help mitigate risks, enhance financial stability and enhance market discipline.

With Basel II, there will be increased disclosures and increased supervisory review for the banks in UAE in general and given the flexibility of determining 'Internal Ratings Based - IRBs' advanced approaches, the banks will have to thoroughly review the current existing processes, controls and risk management methodologies for the transition to the new Accord. Credit ratings, whether external rating agencies for corporate portfolio or personal borrowings, will play a major role in the future which will be useful for the banks as a central repository database and will reduce the risk exposure of the banks as well.

Basel II addresses how to adopt more risk sensitive approaches to risk management for preventing disaster in banking sector and ultimately it will increase the risk adjusted return on capital and shareholder value. Dr Khalid Maniar - Managing Partner of AGN MAK, said Basel II Accord will further improve corporate governance and supervised controls in the banking sector. "With the WTO regime round the corner and talks of FTA agreement between UAE and USA gathering momentum, banks in UAE will have to gear up to meet the challenges of Basel II and at the same time seize the opportunity to consolidate the growth in the robust economy in UAE," Malhotra pointed out. Since most of UAE banks are well covered with capital requirements stipulated in Basel II, the new regulation will have no major impact.

Dr Khalid pointed out that it is also an opportunity for the banks to review the capitalisation as in the event of over capatilisation, the banks may also reconsider levels of capital adequacy ratio to be maintained which may also further increase the bank's revenue lines.