Description
This is a presentation about basel 1 and basel 2 and their impact on indian banks.
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Banks deal with depositors’ money. Soundness of banks is important. Stake in business is a measure of soundness as Capital is the shock absorber for losses.
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Total Capital Adequacy Ratio = Eligible total Capital funds / Credit Risk RWA + Market Risk RWA + Op Risk RWA Components of capital
? Tier 1 ? Tier 2
3
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Paid-up equity capital, statutory reserves, and other disclosed free reserves. Capital reserves representing surplus arising out of sale of proceeds of assets. Innovative perpetual debt instruments (IPDI) eligible for inclusion in Tier 1 capital in compliance with regulatory requirements (limited to 15% of total Tier 1 capital as on March 31 of the previous financial year). Perpetual Non-Cumulative Preference Shares (PNCPS) in compliance with regulatory requirements (Not exceeding 40% of total Tier 1 capital at any point of time). Any other type of instrument generally notified by RBI from time to time for inclusion in Tier 1 capital. IPDI / PNCPS in excess of the limit shall be eligible for inclusion under Tier 2, subject to limits prescribed for Tier 2 capital.
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Revaluation Reserves (at a discount of 55%) General Provisions and Loss reserves – general provisions on Standard assets, Floating Provisions, Provisions for Country Exposures, Investment Reserve Account and excess provisions which arise on account of sale of NPAs) – should not exceed 1.25% of total risk weighted assets Hybrid debt capital instruments – Upper Tier 2 capital – Perpetual Cumulative Preference Shares (PCPS), Redeemable Non-cumulative Preference Shares (RNCPS) and Redeemable Cumulative Preference Shares (RCPS) Subordinated debt – For inclusion in Tier 2 capital, the instrument should be fully paid-up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses, and should not be redeemable at the initiative of the holder or without the consent of RBI.
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IPDI in excess of 15% of Tier 1 capital PNCPS in excess of overall ceiling of 40% Limits on Tier 2 Capital Upper Tier 2 instruments along with other components of Tier 2 capital should not exceed 100% of Tier 1 capital. The above limit will be based on the amount of Tier 1 capital after deduction of Goodwill, DTA and other intangible asset but before deduction of investments.
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Intangible assets and losses in the current period and those brought forward from previous period to be deducted from Tier 1 capital. ? Deferred Tax Assets to be deducted from Tier 1 capital. ? Any gain on sale arising at the time of securitisation of standard assets, if recognized, should be deducted entirely from Tier 1 capital. ? Deduction of Securitisation exposure 50% from Tier 1 and 50% from Tier 2 capital. ? Investments in financial subsidiaries and associates – The entire investments in the paid-up equity of the financial entities (including insurance entities), which are not consolidated for capital purposes with the bank, where such investment exceed 30% of the paid up equity of such financial entities and entire investments in other instruments eligible for regulatory capital status of those entities, shall be deducted, at 50% from Tier 1 and 50% from Tier 2 capital.
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BCBS formed by Bank for International Settlement (BIS) in 1974 Members – Central banks of G-10 countries Countries / Banks do not have legal obligations to abide by the recommendations of the BCBS
8
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In 1998, Capital charge for Credit Risk was introduced. Risk weights prescribed -0% for all Sovereigns and 100% for all corporates (a broad brush approach) Through an amendment in 1996, capital charge for Market Risk was introduced.
9
Broad brush approach for Credit Risk. The factor that capital requirement of a bank also depends upon the effectiveness of managing risks was not considered. ? No capital charge for Operational Risk. To remove these shortcomings under Basel I, BCBS continued discussions for 5 years and issued a report ‘International Convergence of Capital Measurement and Capital Standards – A Revised framework’ – popularly known as Basel II. Basel II norms aim for stronger and more stable banking systems and fine tune the computational standards of minimum regulatory capital.
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10
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Pillar I - Minimum capital requirements
Classification of capital in 3 categories ? Tier 1 – Pure capital comprising paid up capital and free reserves (in other words Tangible Net Worth) ? Tier 2 – Supplementary Capital – those liabilities which will remain with the bank for long period and which also have qualities akin to equity e.g. hybrid debt ? Tier 3 – At present not allowed in India. These are also types of hybrid debts. Such capital will be allowed to be raised for covering capital charge for Operational Risk.
11
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CREDIT RISK (Methods for capital charge computation) Standardized Approach Risk weights rationalized (in comparison to Basel I) and made more risk-sensitive. Risk weights ranging from 0% to 150%. Prescribed risk weights for specified categories. External rating based risk weights for corporate exposure (exposure in excess of Rs. 5 crore). Asset category of Regulatory Retail introduced. Application of Credit Risk mitigation allowed i.e. certain securities are recognized for credit risk mitigation and are allowed to be deducted from exposure after application of haircuts and risk weight is applied on the amount net of credit risk mitigation.
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CREDIT RISK (Methods for capital charge computation) ? Internal Rating Based (IRB) Approaches ? Allows measurement of risk on the basis of internal rating by bank. The computation rests on 4 factors ? Probability of Default (PD) ? Loss Given Default (LGD) ? Exposure at Default (EAD) ? Under IRB (Foundation) Approach, PD to be assessed by bank and LGD & EAD to be provided by the Regulator. ? Under IRB (Advanced) Approach, all the factors are to be assessed by the bank.
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MARKET RISK (Methods for capital charge computation) Standardized Approach: Under this Approach capital charge is computed for Interest rate related instruments and equities in the Trading Book and ? Open Gold position limits ? Open foreign exchange limits ? Trading position in derivatives and ? Derivatives entered into for hedging trading book exposures ? For Interest rate related instruments & Equity two types of risk measures are computed Specific Risk and General Market Risk
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14
MARKET RISK (Methods for capital charge computation) ? Internal Models Approach: ? Under IMA, regulatory capital charge for Market Risk will have to be computed as per the following formula: ? Minimum Regulatory Capital (MRC) = Max {K* Average of 60 preceding days VaR (10 day VaR @ 99% confidence level), Last day VaR } + Stress VaR + Specific Risk
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OPERATIONAL RISK (Methods for capital charge computation) Basic Indicator Approach: Capital = 15% (Beta factor) of Average of positive annual Gross Income of the Bank over the previous 3 years. Gross Income of the bank is arrived at by using the following formula given by the RBI. Gross income = Net profit (+) Provisions & Contingencies (+) operating expenses (Schedule 16) (-) profit on sale of HTM investments (-) income from insurance (-) extraordinary / irregular item of income (+) loss on sale of HTM investments
16
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OPERATIONAL RISK (Methods for capital charge computation) Standardized Approach: Under this approach, banks will be required to divide bank’s activities into eight business lines. Within each business line the capital charge will be calculated by multiplying the Average Gross Income for that line by a “beta” factor for the line; the total capital charge would be the summation of regulatory capital changes across each of the business lines. Business Line Corporate Finance
Trading and sales Retail banking Commercial banking
Beta Factor 18%
18% 12% 15%
Business Line Payment and Settlement
Agency Services Asset Management Retail Brokerage
Beta Factor 18%
15% 12% 12%
17
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OPERATIONAL RISK (Methods for capital charge computation) Advanced Measurement Approach: Banks are allowed to develop their own model for assessing the regulatory capital requirement for operational risk. One common feature of all variants of AMA is their attempt to model the extreme tail part of the loss distribution i.e. a bank will have to figure out, to varying levels of granularity, the probability distribution of its operational loss amount and subsequently calculate its expected and unexpected losses at a given level of confidence (99.9% is recommended). Currently four methodologies are being used in various combinations. These are: Internal Measurement approach (IMA); Loss Distribution Approach (LDA); Scenario-based Advanced Measurement Approach (sb-AMA); Scorecard Approach (SA).
18
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Regulator to undertake Risk Based Supervision and assign Monitorable Action Plan (MAP) to banks if required. Banks to set up robust risk management systems and implement Risk Based Internal Audit. Banks to put in place Internal Capital Adequacy assessment Process (ICAAP), which prescribes capital charge for risks other than Credit, Market & Op Risk depending upon the risk appetite of the bank. Regulator to review the capital adequacy of the bank and that banks endeavour to keep higher CRAR than the MRC. Regulator to review the risk management processes and strategies of bank.
19
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A set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposure, risk assessment processes and hence the capital adequacy of the bank. RBI has given guidelines on the scope and frequency of disclosures, validation of disclosure, materiality of disclosure etc.
20
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Adoption of risk culture, sensitization across the institution Upgradation of
? Manpower skills,
? IT infrastructure and ? MIS
21
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The post Basel II era will belong to the banks who manage their risks effectively. The banks with proper risk management systems would not only gain competitive advantage by way of lower regulatory capital charge but also add value to the shareholders and other stakeholders by properly pricing their services, adequate provisioning and maintaining a robust financial health.
?
22
Thank You
23
doc_613087134.ppt
This is a presentation about basel 1 and basel 2 and their impact on indian banks.
1
? ? ?
Banks deal with depositors’ money. Soundness of banks is important. Stake in business is a measure of soundness as Capital is the shock absorber for losses.
2
?
?
?
Total Capital Adequacy Ratio = Eligible total Capital funds / Credit Risk RWA + Market Risk RWA + Op Risk RWA Components of capital
? Tier 1 ? Tier 2
3
? ? ?
?
? ?
Paid-up equity capital, statutory reserves, and other disclosed free reserves. Capital reserves representing surplus arising out of sale of proceeds of assets. Innovative perpetual debt instruments (IPDI) eligible for inclusion in Tier 1 capital in compliance with regulatory requirements (limited to 15% of total Tier 1 capital as on March 31 of the previous financial year). Perpetual Non-Cumulative Preference Shares (PNCPS) in compliance with regulatory requirements (Not exceeding 40% of total Tier 1 capital at any point of time). Any other type of instrument generally notified by RBI from time to time for inclusion in Tier 1 capital. IPDI / PNCPS in excess of the limit shall be eligible for inclusion under Tier 2, subject to limits prescribed for Tier 2 capital.
4
? ?
?
?
Revaluation Reserves (at a discount of 55%) General Provisions and Loss reserves – general provisions on Standard assets, Floating Provisions, Provisions for Country Exposures, Investment Reserve Account and excess provisions which arise on account of sale of NPAs) – should not exceed 1.25% of total risk weighted assets Hybrid debt capital instruments – Upper Tier 2 capital – Perpetual Cumulative Preference Shares (PCPS), Redeemable Non-cumulative Preference Shares (RNCPS) and Redeemable Cumulative Preference Shares (RCPS) Subordinated debt – For inclusion in Tier 2 capital, the instrument should be fully paid-up, unsecured, subordinated to the claims of other creditors, free of restrictive clauses, and should not be redeemable at the initiative of the holder or without the consent of RBI.
5
?
? ?
IPDI in excess of 15% of Tier 1 capital PNCPS in excess of overall ceiling of 40% Limits on Tier 2 Capital Upper Tier 2 instruments along with other components of Tier 2 capital should not exceed 100% of Tier 1 capital. The above limit will be based on the amount of Tier 1 capital after deduction of Goodwill, DTA and other intangible asset but before deduction of investments.
6
Intangible assets and losses in the current period and those brought forward from previous period to be deducted from Tier 1 capital. ? Deferred Tax Assets to be deducted from Tier 1 capital. ? Any gain on sale arising at the time of securitisation of standard assets, if recognized, should be deducted entirely from Tier 1 capital. ? Deduction of Securitisation exposure 50% from Tier 1 and 50% from Tier 2 capital. ? Investments in financial subsidiaries and associates – The entire investments in the paid-up equity of the financial entities (including insurance entities), which are not consolidated for capital purposes with the bank, where such investment exceed 30% of the paid up equity of such financial entities and entire investments in other instruments eligible for regulatory capital status of those entities, shall be deducted, at 50% from Tier 1 and 50% from Tier 2 capital.
?
7
? ? ?
BCBS formed by Bank for International Settlement (BIS) in 1974 Members – Central banks of G-10 countries Countries / Banks do not have legal obligations to abide by the recommendations of the BCBS
8
? ?
?
In 1998, Capital charge for Credit Risk was introduced. Risk weights prescribed -0% for all Sovereigns and 100% for all corporates (a broad brush approach) Through an amendment in 1996, capital charge for Market Risk was introduced.
9
Broad brush approach for Credit Risk. The factor that capital requirement of a bank also depends upon the effectiveness of managing risks was not considered. ? No capital charge for Operational Risk. To remove these shortcomings under Basel I, BCBS continued discussions for 5 years and issued a report ‘International Convergence of Capital Measurement and Capital Standards – A Revised framework’ – popularly known as Basel II. Basel II norms aim for stronger and more stable banking systems and fine tune the computational standards of minimum regulatory capital.
? ?
10
?
Pillar I - Minimum capital requirements
Classification of capital in 3 categories ? Tier 1 – Pure capital comprising paid up capital and free reserves (in other words Tangible Net Worth) ? Tier 2 – Supplementary Capital – those liabilities which will remain with the bank for long period and which also have qualities akin to equity e.g. hybrid debt ? Tier 3 – At present not allowed in India. These are also types of hybrid debts. Such capital will be allowed to be raised for covering capital charge for Operational Risk.
11
? ? ? ? ? ? ?
CREDIT RISK (Methods for capital charge computation) Standardized Approach Risk weights rationalized (in comparison to Basel I) and made more risk-sensitive. Risk weights ranging from 0% to 150%. Prescribed risk weights for specified categories. External rating based risk weights for corporate exposure (exposure in excess of Rs. 5 crore). Asset category of Regulatory Retail introduced. Application of Credit Risk mitigation allowed i.e. certain securities are recognized for credit risk mitigation and are allowed to be deducted from exposure after application of haircuts and risk weight is applied on the amount net of credit risk mitigation.
?
12
CREDIT RISK (Methods for capital charge computation) ? Internal Rating Based (IRB) Approaches ? Allows measurement of risk on the basis of internal rating by bank. The computation rests on 4 factors ? Probability of Default (PD) ? Loss Given Default (LGD) ? Exposure at Default (EAD) ? Under IRB (Foundation) Approach, PD to be assessed by bank and LGD & EAD to be provided by the Regulator. ? Under IRB (Advanced) Approach, all the factors are to be assessed by the bank.
?
13
MARKET RISK (Methods for capital charge computation) Standardized Approach: Under this Approach capital charge is computed for Interest rate related instruments and equities in the Trading Book and ? Open Gold position limits ? Open foreign exchange limits ? Trading position in derivatives and ? Derivatives entered into for hedging trading book exposures ? For Interest rate related instruments & Equity two types of risk measures are computed Specific Risk and General Market Risk
? ? ?
14
MARKET RISK (Methods for capital charge computation) ? Internal Models Approach: ? Under IMA, regulatory capital charge for Market Risk will have to be computed as per the following formula: ? Minimum Regulatory Capital (MRC) = Max {K* Average of 60 preceding days VaR (10 day VaR @ 99% confidence level), Last day VaR } + Stress VaR + Specific Risk
?
15
? ? ?
?
OPERATIONAL RISK (Methods for capital charge computation) Basic Indicator Approach: Capital = 15% (Beta factor) of Average of positive annual Gross Income of the Bank over the previous 3 years. Gross Income of the bank is arrived at by using the following formula given by the RBI. Gross income = Net profit (+) Provisions & Contingencies (+) operating expenses (Schedule 16) (-) profit on sale of HTM investments (-) income from insurance (-) extraordinary / irregular item of income (+) loss on sale of HTM investments
16
?
? ?
OPERATIONAL RISK (Methods for capital charge computation) Standardized Approach: Under this approach, banks will be required to divide bank’s activities into eight business lines. Within each business line the capital charge will be calculated by multiplying the Average Gross Income for that line by a “beta” factor for the line; the total capital charge would be the summation of regulatory capital changes across each of the business lines. Business Line Corporate Finance
Trading and sales Retail banking Commercial banking
Beta Factor 18%
18% 12% 15%
Business Line Payment and Settlement
Agency Services Asset Management Retail Brokerage
Beta Factor 18%
15% 12% 12%
17
? ? ?
?
? ? ? ?
OPERATIONAL RISK (Methods for capital charge computation) Advanced Measurement Approach: Banks are allowed to develop their own model for assessing the regulatory capital requirement for operational risk. One common feature of all variants of AMA is their attempt to model the extreme tail part of the loss distribution i.e. a bank will have to figure out, to varying levels of granularity, the probability distribution of its operational loss amount and subsequently calculate its expected and unexpected losses at a given level of confidence (99.9% is recommended). Currently four methodologies are being used in various combinations. These are: Internal Measurement approach (IMA); Loss Distribution Approach (LDA); Scenario-based Advanced Measurement Approach (sb-AMA); Scorecard Approach (SA).
18
? ? ?
? ?
Regulator to undertake Risk Based Supervision and assign Monitorable Action Plan (MAP) to banks if required. Banks to set up robust risk management systems and implement Risk Based Internal Audit. Banks to put in place Internal Capital Adequacy assessment Process (ICAAP), which prescribes capital charge for risks other than Credit, Market & Op Risk depending upon the risk appetite of the bank. Regulator to review the capital adequacy of the bank and that banks endeavour to keep higher CRAR than the MRC. Regulator to review the risk management processes and strategies of bank.
19
?
?
A set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposure, risk assessment processes and hence the capital adequacy of the bank. RBI has given guidelines on the scope and frequency of disclosures, validation of disclosure, materiality of disclosure etc.
20
?
?
Adoption of risk culture, sensitization across the institution Upgradation of
? Manpower skills,
? IT infrastructure and ? MIS
21
?
The post Basel II era will belong to the banks who manage their risks effectively. The banks with proper risk management systems would not only gain competitive advantage by way of lower regulatory capital charge but also add value to the shareholders and other stakeholders by properly pricing their services, adequate provisioning and maintaining a robust financial health.
?
22
Thank You
23
doc_613087134.ppt