Credit Risk Management is a comprehensive package for protecting the Banks from risk of failure as credit risk covers 90% of the total risk of any Bank. But, CRM does not appear to be the foolproof solution for credit risk. Numerous Banks have been bankrupted though there was a credit risk management system. As banks gives loan to the client from the depositors’ money, failure of bank harms the depositors directly. Though there is a credit management system is place in almost every bank of the world, there is no set standard for CRM. Credit facilities were given to customers with no ability to repay. Malpractice, fraud and other irregularities are also responsible for giving loan to defaulters. To solve this problem and to insulate the depositors from losses the concept of capital adequacy has been give birth to.
Capital adequacy is define as the minimum level of capital, which is require to protect a bank from portfolio losses. However, debate on the quantum of minimum level of capital seems to be never ending. Though different methods and approaches were adopt in different points in time. They were insufficient to capture new dimensions and magnitudes of risk emanated from the continuous innovations in the domestic and international business. Consequently experienced many uncertainties and volatilities that caused serious banking problems. The approach that a bank’s capital should be link to a fix ratio of its time and demand liabilities went under strong criticism on the ground that bank’s major risk is derived from the riskiness of its assets.
Basel I: Basel I was an international accord to set minimum levels of capital for banks. Building societies and other deposit taking institutions. It was design to create a level playing field for lenders from different countries and to ensure. That lenders were sufficiently well capitalize to protect depositors and the financial system.
Two fundamental objectives of the Accord were
- Strengthen the soundness and stability of the international banking system.
- Obtain a high degree of consistency in its application to banks in different countries with a view to diminishing an existing source of competitive inequality among international banks.
- The accord requires that banks meet a minimum capital ratio that must be equal to at least 8 percent of total risk-weighted assets. Though at first only credit risk was incorporate, in 1996 market risk was also incorporate in this accord.
Basel II: The Basel Committee tried to address some of these criticisms over the years. Is the result of such efforts. The primary objective of the New Accord is to make it more risk-sensitive. So that financial institutions will be able to sustain even in periods of financial crisis. Consequently, the new proposal moves ahead of the “one-size-fit-all” approach. Another objective of the Accord is to continue to enhance competitive equality among the internationally active banks throughout the world.