basel ppt

MET League of Colleges-PG 2004-06

The BASEL Capital Accord

Introduction to BASEL Capital Accord

Shift towards risk-centric bank management

Basel Capital Accord 1988 (Basel I)

0 % for Governments

20 % for Banks

100 % for Corporates

Rationale for a new Accord

The existing Accord (Basel I)

The proposed new Accord (Basel II)

Focus on a single risk measure

Emphasis on banks’ own internal

methodologies

One size fits all Menu of approaches

Broad brush structure More risk sensitivity

Promote safety and soundness in the financial system

Continue to enhance competitive equality

Complete recognition of all types of risk

Orientation on the bank’sindividual risk profile

Focus on internationally active banks

Principles suitable for applicationon smaller banks

What?

How?

Who?

The Three Pillars of BASEL II

minimum capital requirement

supervisory review process

market discipline

Calculation of minimum capital requirements

The total capital ratio must be no lower than 8%

Tier 2 capital is limited to 100% of Tier 1 capital

A Bird’s eye view of BASEL II

Minimum 8% unchange

d

Capital Ratio = Total Capital

Credit risk + Market Risk + Operational Risk

No Change

New capital charges called for

RWA Calculations revised

Credit Risk

Credit Risk Calculations

Standardized Approach

Internal Ratings Based (IRB) Advanced Approach

Internal Ratings Based (IRB) Foundation Approach

Standardized Approach

Overview

External credit assessment institution (ECAI)

Who decides?

Eligibility criteria for ECAIs

Objectivity Disclosure

Independence Resources

International access

Credibility

Claims on sovereigns

Credit *

Assessment

AAA to

AA-

A+

to A-

BBB+ to

BBB-

BB+

to B-

Below B-

Unrated

Risk Weight

0% 20% 50% 100% 150% 100%

* Notations used are followed by Standard & Poor’s

Claims on banks

Option 1

Credit

Assessment

AAA to

AA-

A+

to A-

BBB+ to

BBB-

BB+

to B-

Below B-

Unrated

Risk Weight

20% 50% 100% 100%

(cap)

150%

(cap)

100%

(cap)

Claims on banks

Credit assessment

of Banks

AAA to

AA-

A+

to A-

BBB+ to

BBB-

BB+

to B-

Below B-

Unrated

Risk weight under

Option 2

20% 50% 50% 100% 150% 50%

(cap)

Risk weight for

short-term

Claims under

Option 2

20% 20% 20% 50% 150%

(N.A.)

20%

Option 2

Claims on MDBs

Option 2 for banks w/o preferential treatment for short-term claims

0% risk weight will be applied to claims on highly rated MDBs such as IFC, IBRD, ADB…

Claims secured by mortgages on residential property

Claims secured by mortgages on residential property that is or will be occupied by the borrower will be risk-weighted @ 35 %

Supervisory discretion

Claims secured by commercial real estate

100 % weightage

Exceptional cases – 50 % weight for lower of

50 % of MV of loan or

60 % of LTV

Credit Risk – the IRB approach

Foundation Advanced

IRB approach

IRB Approach - Parameters

Probability of Default (PD)

Exposure at Default (EAD)

Maturity (M)

Loss given Default (LGD)

Criteria Standardized Approach

Internal Ratings Based (IRB) Approach

Foundation Advanced

Rating External Internal Internal

Risk Weight Caiberated on the basis of external ratings

Function of PD, EAD, LGD and M


Probability of Default (PD):

tied to

risk weights based on

external ratings

Provided by bank based

on own estimates


on own estimates

Exposure of Default (EAD):

tied to


external ratings

Supervisory values set by

the Basel Committee

Provided by bank based on

own estimates

Loss Given Default (LGD):

tied to


external ratings

Supervisory values set

the Basel Committee


own estimates; extensive

process and internal control

requirements

Maturity Implicit recognition Supervisory values set by the

Basel Committee


own estimates



Foundation Advanced

Rating External Internal Internal

Risk Weight Caiberated on the basis of external ratings



Probability of Default (PD):

Tied to


external ratings


on own estimates


on own estimates

Exposure of Default (EAD):

Tied to


external ratings

Supervisory values set by

the Basel Committee

Provided by bank based on own estimates

Loss Given Default (LGD):

Tied to


external ratings

Supervisory values set

the Basel Committee

Provided by bank based on own estimates;

extensive process and internal control

requirements

Maturity Implicit recognition Supervisory values set by the

Basel Committee

Provided by bank based on own estimates



Foundation Advanced

Data Requirements

Provision dates

Default events

Exposure data

Customer segmentation

External ratings

Collateral data

Rating data

Default events

Historical data to

PDs (5 years)

Collateral data

Same as IRB Foundation, plus:

Historical loss data to estimate LGD (7 years)

Historical exposure data to estimate EAD (7 years)

Process Requirements

Provisioning process

Same as Standardized, plus minimum requirements to ensure quality of internal ratings and PD estimation and their use in the risk management process

Same as IRB Foundation, plus minimum requirements to ensure quality of estimation of all parameters

Categorization of exposures

Banking book exposuresBanking book exposures

CorporateCorporate

SovereignSovereign

BankBank

Retail Retail

EquityEquity

Market Risk

The BIS defines market risk as

“ the risk that the value of on-or off-balance-sheet positions will be adversely affected by movements in equity and interest rate markets, currency exchange rates and commodity prices “

Market Risk

Introduction

Asset-Liability Management Committee (ALCO)

Liquidity Risk Management

Interest Rate Risk (IRR) Management

Foreign Exchange Risk Management

Treatment of Market Risk in the Proposed Basel Capital Accord

Risk weight of 2.5 % for Investment in G-Secs

Risk weight of 100 % on open positions in forex and gold

Operational Risk

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events

This definition includes legal risk which includes exposure to fines, penalties, or punitive damages resulting from supervisory actions, as well as private settlements

Operational Risk – Menu of Approaches

Operational Risk Calculations

Basic Indicator Approach

Standardised Approach

Advanced MeasurementApproaches (AMA)

Basic Indicator Approach

capital for operational riskequal to the average over the previous three years of a fixed percentage (denoted alpha) of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average

The charge may be expressed as follows:KBIA = [Σ(GI1…n x α)] /n

WhereKBIA = the capital charge under the Basic Indicator ApproachGI = annual gross income, where positive, over the previous three yearsn = number of the previous three years for which gross income is positiveα = 15%, which is set by the Committee

agency agency servicesservices


retail bankingretail banking

commercial bankingcommercial banking

payment &payment &settlementsettlement

retail retail brokeragebrokerage

corporate corporate financefinance

trading & Salestrading & Sales

asset asset managementmanagement

Banks’ Activities :


Within each biz. line regulatory charge is calculated and is indicative of operational risk exposure within these lines

KTSA={Σ years 1-3 max[Σ(GI1-8 x β1-8),0]} / 3

Where:KTSA = the capital charge under the Standardised ApproachGI1-8 = annual gross income in a given year, as defined above in the Basic IndicatorApproach, for each of the eight business lines

β1-8 = a fixed percentage, set by the Committee, relating the level of required capital to the level of the gross income for each of the eight business lines.

Business Lines Beta Factors

Corporate finance (β1)

18%

Trading and sales (β2)

18%

Retail banking (β3)

12%

Commercial banking (β4)

15%

Business Lines

Beta Factors

Payment and settlement (β5)

18%

Agency services (β6)

15%

Asset management (β7)

12%

Retail brokerage (β8)

12%

Internal loss data– minimum five-year

observation period – captures all material

activities and exposures from all appropriate sub-systems and geographic locations

– gross loss amounts, date of the event, any recoveries of gross loss amounts , drivers or causes of the loss event

External data– either public data

and / or pooled industry data

– when there is reason to believe that the bank is exposed to infrequent, yet potentially severe, losses

Expected Loss & Unexpected Loss

Advanced Measurement Approach

Probability of Loss

Level of LossExpected Loss

Unexpected Loss

Stress Loss

Covered by Provisions Covered by

Economic Capital

Confidence level 99 %

Prudential Norms

Non-performing Assets - A credit facility wherein the repayment of

the installment of principal and/or interest has remained due for specified period of time (90 days)

When consider NPA?

Term loan- > 90 Days

Overdraft/cash credit – i) O/s bal Continuously in excess of sanctioned limitii)No credits continuously for 90 days

Bills purchased and discounted – > 90 Days

Agricultural Advance –i) Short duration crops: Two crop seasonii) Long duration crops: One crop season

Any other credit facility

Income Recognition

When received not on accrual basis

Asset Classification of NPA’s

Sub-standard Assets- NPA for less than or equal to 12 months

Doubtful Assets- Remained in sub-standard category for 12 months

Loss Assets- Loss is identified by bank,auditors or the RBI inspection but amount is not w/off wholly

Treatment for various assets

Accounts with temporary deficiency

– not an NPA

Upgradation of loans classified as NPA

- Arrears of Interest and principal paid

Accounts Regularised near b/s date

– deemed NPA

Asset classification borrower-wise & not facility-wise

- Except advances to PACS under on-lending system

Treatment continued…

Advances under consortium- NPA if remittances not parted to member banks

Accounts where there is erosion in the value of security- treated as NPA

Advances against Term deposits,NSCs..- not treated as NPA

Loans with moratorium for payment of Interest

Provisioning For NPAs

Take out finance

Post shipment Suppliers credit

Export project finance

Provision Norms

Loss Assets- w/off or 100% of outstanding

Doubtful Assets- 100% if uncovered - 20% to 100% of secured portion

Sub-standard Assets- General Provision of 10% when secured

- Additional 10% for unsecured exposures i.e 20%

Doubtful Assets

Period for which the advance has remained in doubtful category

Provision requirement (%)

Upto 1 year 20%

One to Three years 30%

More than Three years 60% (4th year)

75% (5th year)

100%(6th year onwards)


The Second Pillar – Supervisory Review Process

•risks considered under Pillar 1 that are not fully captured by the Pillar 1 process

•those factors not taken into account by the Pillar 1 process factors external to the bank

Importance of Supervisory Review

Risk management techniques

Evaluation of capital in relation to risk

Principle 1: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels.

Board and Senior Management oversight

Sound capital assessment

Comprehensive assessment of risks

Monitoring and Reporting

Internal control review

Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios.

on-site examinations or inspections

off-site review

discussions with bank management

review of work done by external auditors

periodic reporting

Principle 3: Supervisors should expect banks to operate above the minimumregulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.

Creditworthiness

Fluctuations in overall capital ratio

Raising additional capital

Minimum regulatory capital

Risks not taken into consideration

Principle 4: Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required to support the risk characteristics of a particular bank

intensifying the monitoring of the bank

restricting the payment of dividends

prepare and implement a satisfactory capital adequacy restoration plan

requiring the bank to raise additional capital immediately

Pillar 3 – Market Discipline

Achieving appropriate disclosure

Interaction with accounting disclosures

Materiality

Frequency

Proprietary and confidential information

Scope of application

General qualitative disclosure requirementFor each separate risk area

strategies and processes of risk mgmnt;the structure and organization of the relevant risk management function;the scope and nature of risk reporting and/or measurement systems;policies for hedging and/or mitigating risk strategies and processes for monitoring the effectiveness of hedges/mitigants.


Implementation of Basel II in Advanced Countries

•High Cost lending and Reduced lending to Emerging Economies

•The Vicious Circle of Curtailment of Credit to Emerging Countries•Higher Interest Costs & Competitive advantage of corporate borrowers•Impact on Infrastructure development

Implementation of Basel II in Advanced Countries

Shorter Term to maturity of lending

Impact on capital flows

Impact on Companies

Implementation of Basel II in Emerging Economies

Standardised Approach and External Credit Rating Problems

Difficulties in Implementation of IRB based Credit Risk ManagementApproach

Costs of Implementation: IT spending & Training Costs

Multiple Supervisory bodies

Impacts of Basel II

Improved Risk Management & Capital Adequacy Curtailment of Credit to Infrastructure ProjectsPreference for Mortgage Credit to Consumer Credit Basel II: Advantage Big Banks IT spending: Advantage Indian IT companies Consolidation in the banking Industries Non-implementation could impact Sovereign rating

Recommendations

Incorporation of Anti Cyclical measures

Stronger Equity Markets & regulatory environment

Clear Roadmap for implementation

Capitalisation & depreciation of IT expenditure

Revision of Curricula to incorporate Risk Management & retraining

Consolidation within Banking Industry

Thank you!!

A humble effort by :

Ruby Mohan 04138

Sweta Vaishnav 04170

Nidhi Agarwal 04178

» PGeMBA Finance 2004-06

» Under the guidance of Prof. Paradkar

basel ppt

Documents