The Hindu Business Line : There's reward in risk

Opportunities for IT companies exist in Basel II implementation in banks, mainly in the areas of operational risks, which include technology support for internal ratings.

It is considered to be the next big opportunity for the infotech industry after Y2K. While it is yet to evolve completely, the industry has started humming about it. Software services companies, operating in the BFSI space have started gearing up to encash it by setting up separate lines of practices to tap this opportunity. While a certain section of the industry is gung ho about the opportunities that are set to unfold, few players are waiting to watch how it is going to evolve. It is not only the biggies like Infosys and iflex but even the smaller companies like Ivega have also jumped the fray. Various estimates indicate that the opportunity is likely to be in the region of $18 billion to $80 billion.

But what exactly is Basel II?

The exponential growth in use of technology by the financial system over the last few decades has seen certain issues cropping up regarding operational risks, especially that of risk management and capital adequacy. The growing inter-linkages between financial market participants across the globe also adds up to the increased scrutiny of operational risks by regulators. Addressing these risk related issues is on top of mind for financial regulators today.

Events such as the collapse of Barings Bank and Daiwa Bank, the Y2K Bug scare, the WTC tragedy and, more recently, the Enron bankruptcy and rogue trading losses at AllFirst Bank have heightened the perception of `other' risks.

In a bid to avoid collapses, the Basel Committee was established by the Central bank Governors of G-10 countries mainly to formulate broad supervisory standards and recommend statements of best practice for national banking supervisors.

Basel in Switzerland is the headquarters of IBS. In 1988, the Basel Committee introduced a capital measurement system commonly referred to as the Basel Accord providing for a credit risk measurement framework with a minimum capital standard of 8 per cent. This framework has since been progressively introduced not only in member countries but also in virtually all other countries with active international banks.

Basel II refers to the proposed revised accord among the members of the Basel Committee on Banking Supervision, bringing about more risk sensitivity into capital charges computation. The Basel Committee now proposes a New Capital Adequacy Framework to replace the 1988 Accord. A consultative document has been issued in January 2001 and extensive interaction with banks and industry groups is on. While the work is in progress, the first draft of Basel II framework would be ready by December this year. The committee proposes to release its final draft accord during 2003 and the implementation is set to begin by December 2006. However, some international banks like the Standard Chartered Bank seem to have gone ahead with the implementation.

Scope for IT companies

Opportunities for IT companies exist mainly in the areas of operational risks in terms of technology support for internal ratings based credit and operational risk approach, database technology and integration with front-office decisioning tools, areas of data collection, tracking and monitoring, analysis and reporting, risk management system, asset and liability management system, cash liquidity management and business intelligence engine.

"Implementing Basel II requirements would require fresh investments in IT by banks and banking product companies, as it involves developing new solutions and enhancing existing solutions," says H.R. Rajashekar, Senior Consultant, i-flex consulting. "It will also require a higher level of integration between different systems, for example, applications such as credit decisioning, application processing, risk rating, transaction systems, collateral management — all need to integrate to be able to meet the Basel II requirements," he adds.

The Basel II framework revolves around three support pillars mainly relating to the minimum capital requirements, supervisory review and disclosure of risk assessment methods and capital adequacy calculations. "From the IT perspective, opportunities exists in the I and II pillars, that is minimum capital requirements and supervisory review," says Girish Vaidya, Senior Vice-President and Head, Banking Business Unit, Infosys Technologies.

Among the reasons for existence of Basel II are to bring competitive advantage to those financial institutions that can reshape their operations, optimise the capital structure and allocations and align the internal processes with the external compliance standards. "The effect of implementing Basel II would not only improve the shareholder perception and values but also enhance the reputation and image of the banks," says Rohan Joshi, Chief Marketing Officer, Ivega.

Basel II is more complicated because it implies implementing a new set of rules along with old rules and the old rules, says Joshi. The opportunities here are more than that of the Euro implementation project and less than Y2K. Already banks, especially in the US, have started with the diagnosis of the problem.

Comparision with Y2K not accurate

"Sections of the IT industry has been comparing Basel II with Y2K. However, comparison with the Y2K is not accurate, as Y2K was a technology problem, which required a solution purely from a technology perspective," says Rajashekar. Basel II is about the regulatory approach to risk measurement and capital adequacy of banks. While Y2K was driven by the IT departments, being a technology risk, Basel II will be driven by the business, as it focuses on business risks, such as market risks, credit risks and operational risks.

However, some similarity exists in terms of extremely large size of the implementation work that needs to be done in order to comply with the Basel II proposals and also the fact that Basel II gets implemented globally over a period of time just as Y2K, says Rohan Joshi of Ivega. "Unless you start analysing the problem, one will not know how deep the problem is," he says, adding that almost all the companies are in the pre-diagnosis space creating a team.

In Basel II, however, each country will set its own standards and schedule for compliance. "Basel Committee expects banks to use the same risk management systems for both internal management decision-making and regulatory compliance; therefore a bank cannot only implement a separate system for compliance," says Rajashekar.

Companies such as Infosys, i-flex and Ivega have been closely following the developments with regard to the revision in Basel accord and are trying to develop their expertise and sharpen their focus in a bid to tap this new global opporunity. Almost all these companies have set up a practice line within their consulting division focussing on the Basel II requirements. While i-flex has a couple of consultants working on Basel II, Ivega has about 10 people, which it plans to increase to about 40 over the next few years. i-flex consulting has assisted a large bank in Japan to design its overall credit risk solutions architecture as a part of its roadmap for Basel II compliance.

"i-flex has just begun a project for a large organisation in Europe for designing, developing and implementing Basel II rating solution," says Rajashekar, adding that the pace at which this accord is implemented will determine the size of the revenue. While the Meridien Research estimates the revenue potential at $18 billion, several committees at IBS estimate it to be around $80 billion. "There have been some delays in arriving at a consensus, however we do expect the pace to pick up with Germany recently giving its nod to the revised specification," he adds.

In conclusion, given the nature of Basel II requirements, there will be no single software solution for all kinds and sizes of banks. The opportunities are definitely large and only those companies who understand the domain well are going to be there for the long haul. It is not about one more go at plain vanilla IT services.

vishwa@thehindu.co.in

Send this article to Friends by E-Mail

Stories in this Section
It works out real cheap

Making tech registers ring

There's reward in risk

A push for quicker drug discovery

Chatting away

Redoing the colour setting

Starting Internet information server

Internet connectivity

Course in animation

e-mail as the green channel

A blueprint for e-seva

Customer cool is crucial

Cyber Quest

Cartoon