Description
It gives history of Basel Accord, explanation of Basel 1, major changes and scope of Basel 2 with respect to basel 1, major changes and scope of Basel 3 and proposed time schedule of implementation.
Types of Risk for a Bank
• • • • • Liquidity Risk Credit Risk Market Risk Operational Risk Other Risks [e.g. Strategic Risk, Reputational Risk]
Relationship among the Risks
Liquidity Risk
Credit Risk
Other Risks
Banking Risks
Market Risk
Operational Risk
Liquidity Risk: Types / Sources
• Term Liquidity risk: Unexpected delays in repayment by borrowers
• Withdrawal / Call Risk: Run off for cash
• Structural / Funding Liquidity Risk: Necessary funding transactions cannot be carried out or can be carried out at a higher cost • Contingent Liquidity Risk: Difficulty in replacing maturing liabilities with the new ones • Marker Liquidity Risk: Difficulty in selling the positions in securities/derivatives
Liquidity Risk: Management
• Management of Liquidity Risk: Asset Liability Management (ALM)
– Matching the term period of Assets and Liabilities (arising out of the Lending and Deposit Mobilization operations) – Identification of Time Buckets: (Day 1, 2-7 days, 8-14 days, 15-28 days, 29-90 days, 91-365 days, 1-3 years, 3-5 years, over 5 years) – Asset Liability Management Committee (ALCO) is established which takes care of ALM. – ALCO designs Liquidity Policy with the approval of the Board of Directors. – Generally, ALCO also handles FOREX and other risks.
• Tools of Liquidity Management
– The Working Funds Approach – The Ratios Approach – Cash Flow Approach
• Gap should be identified for each time bucket based on behavioral estimate. • Gap should not exceed: Day 1 (5%), 2-7 days (10%), 8-14 days (15%), 15-28 days (20%)
– Stress Testing Process
Market Risk: Types / Sources
• Interest Rate Risk (IRR): Change in portfolio value due to change in interest rates. – Re-pricing Risk – Yield Curve Risk – Basis Risk – Optionality Risk • Equity Price Risk: Fluctuations in market price of equity investments due to general market related factors. • Currency / FOREX Risk: Fluctuations in exchange rates.
Operational Risk: Types / Sources
• Documentation Risk • Legal Risk
• Frauds: Internal & External
• Disruptions and business system failures, etc.
The Basel Accord: History
• Bank for International Settlements (BIS), Basel, Switzerland (established in 1930) to serve as bank of central banks set up a committee of central bank governors of G10 countries in 1974 called the Basel Committee on Banking Supervision (BCBS). The main role of BCBS is to provide a regulatory framework for better risk management in banks. It, in itself, does not possess regulatory power. It can only recommend to the member countries for implementing the desired risk management frameworks. In 1988, the Basel Accord was signed by G10 nations, which stipulated a risk management framework. Later on many other nations adopted it. In 1990 the Basel Accord was accepted as a world standard with more than 100 countries adopting the framework.
•
• •
•
•
It mainly stipulated the capital adequacy related requirements with focus on Credit Risk.
Later on, the Market Risk was also brought into the supervisory framework.
Basel –I : Major Prescriptions
• Capital Adequacy Ratio prescribed: – Internationally active banks in G10 countries to hold capital equal to at least 8% of a basket of assets measured in accordance with their risk profiles. This is called Capital to Risk-weighted Assets Ratio (CRAR). The CRAR of minimum 8% was supposed to be attained by end of 1992. – ‘Capital’ divided into two parts. • Core Capital called Tier 1 capital • Non-core part called Tier 2 capital ‘Assets’ classified into two categories. – Non-risky Assets: Risk weight being zero for this category, no capital was required to support this category of assets. – Risky Assets: For identifying Risky Assets, the focus was on Credit Risk. Accordingly, Risky Assets were classified into four groups for deciding the required support of the capital. The capital support required for the assets held (i.e. On-Balance Sheet Credit Exposure) in each different groups were: 10%, 20%, 50%, and 100% in the order of increasing riskiness. – It was recognized that Off-Balance Sheet credit exposures would also require capital support. Credit Conversion Factors were decided. Like, Standby Letter of Credit and Bank Guarantee: 100%, Commercial Letters of Credit and Performance Bonds: 50%, Undrawn limit on CC: 20%, etc.
•
Basel –II : Major Changes: Scope
• Basel-I mainly confided to the aspect of ‘Capital Adequacy’.
• Basel-II is more broad-based. It identifies THREE PILLARS on which BASEL-II is built up.
– Pillar –I: Capital Adequacy – Pillar –II: Supervisory Review Process [Only the capital should not be regarded as a substitute for addressing fundamentally inadequate control or risk management processes. Principles set for Supervisory
Review and Evaluation Process (SREP) by RBI and Internal Capital Adequacy Assessment Process (ICAAP) by the bank]
– Pillar –III: Market Discipline [Public reporting]
Basel –II : Major Changes (Contd.)
• Types of risk covered:
– Basel-I focuses on Credit Risk; but later on, also covered the Market Risk. – Basel-II covers all the three major types of risks, namely, Credit Risk, Market Risk, and Operational Risk.
• Specification of Approach for Risk Management:
– Basel-I took ‘One Size Fits All’ Approach. – Basel-II provides for more flexibility and specifies different approaches starting with the most simple approach and going up to the Advanced Approach. It also provides for capital incentives for better risk management. It places more weight on Risk Mitigation.
Basel –II : Regulatory Capital [as per RBI]
• • CRAR must not be less than 8% as per Basel-II. Against this, RBI mandates for 9%. RBI may selectively increase this for those banks who do not have prudent risk management processes. Tier 1 (Core) Capital:
• • • • • • Paid up equity share capital. Statutory Reserves Other Disclosed Free Reserves Capital Reserves representing surplus arising out of sale proceeds of assets Innovative Perpetual Debt Instruments (IPDI) [Maximum 15%] Perpetual Non-cumulative Preference Shares (PNCPS) [Total of PNCPS and IPDI must not exceed 40%. Any excess on the count of PNCPS to be added to Tier 2 Capital.]
•
Tier 2 (Supplementary) Capital: [This should be limited to 100% of the Tier 1 capital]
• • • • • Undisclosed reserves Revaluation Reserves [to be considered with 55% discount on it] General Provisions and Loan Loss Reserves [Limited to 1.25% of the total risk-weighted assets] Hybrid Debt Capital Instruments [If they display close similarities to equity] Subordinated Term Loans [Instruments with initial maturity of less than 5 years and/or with remaining maturity of 1 year cannot be included. Progressive 20% discount to be applied for each year less than five year maturity]
•
Deductions from Tier 1 Capital:
• • • • • • Intangible assets like goodwill to be deducted from Tier 1 Capital Investments in subsidies not consolidated in national system to be deducted from Tier 1 Capital ‘Gain on Sale’ of securitization of standard assets Minority interests 50% of investments in excess of 10% of capital of other banks. [Remaining 50% to be deducted from Tier 2 Capital.] Secularization exposure [50% from Tier 1 Capital and 50% from Tier 2 Capital.]
Basel –II : Approaches for Risk Measurement
• Credit Risk:
– The Standardized (External Rating Based) Approach [RBI] – The Internal Rating Based Approach (IRB)
• Foundation IRB (FIRB) • Advanced IRB (AIRB)
• Market Risk:
– Standardized Maturity Approach – Standardized Duration Approach [RBI] – Internal Models Approach (IMA)
• Operational Risk:
– Basic Indicator Approach [RBI] – Standardized Approach – Advanced Measurement Approach (AMA)
Credit Risk: The Standardized (External Rating Based) Approach
Market Risk: Capital Charges for Capital Adequacy: An Illustrative Table
Interest Rate Risk: Management
• Strategic Approach: Effecting changes in portfolio • Maturity and Duration based Gaps
• Interest Rate Derivatives
(Only for Hedging; not for creating naked positions)
• • • • • Swaps Interest Rate Futures Forward Rate Agreements (FRA) Interest Rate Options Swaptions
Operational Risk: The Basic Indicator Approach
Under the Basic Indicator Approach, banks must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted as alpha) of positive annual gross income.
Basel –III : Major Changes
• Scope:
– Basel-II focuses on only Micro Prudential (Firm Specific ) Measures. – Basel-III will include Macro Prudential Measures to additionally address the Systemic Risks faced by banks and their interconnectedness.
• Types of Risk Aspects Covered:
– Basel-II mainly focuses on the quantitative aspects of capital. – Basel-III will include issues like quality of capital, etc.
• Capital Adequacy Requirements:
– Basel-II specifies CRAR of 8%, with equity capital of at least 2%. – Basel-III undertakes to increase the equity capital to at least 7%.
• Robustness of Models Used:
– Though Basel-II asks for stress testing of models, detailed prescriptions are not made towards that. – Basel-III seeks to make detailed prescriptions on Stress Testing of Models. It also envisages to bring more sophisticated models in use.
Basel –III : Proposed Time Schedule of Implementation
doc_618404620.ppt
It gives history of Basel Accord, explanation of Basel 1, major changes and scope of Basel 2 with respect to basel 1, major changes and scope of Basel 3 and proposed time schedule of implementation.
Types of Risk for a Bank
• • • • • Liquidity Risk Credit Risk Market Risk Operational Risk Other Risks [e.g. Strategic Risk, Reputational Risk]
Relationship among the Risks
Liquidity Risk
Credit Risk
Other Risks
Banking Risks
Market Risk
Operational Risk
Liquidity Risk: Types / Sources
• Term Liquidity risk: Unexpected delays in repayment by borrowers
• Withdrawal / Call Risk: Run off for cash
• Structural / Funding Liquidity Risk: Necessary funding transactions cannot be carried out or can be carried out at a higher cost • Contingent Liquidity Risk: Difficulty in replacing maturing liabilities with the new ones • Marker Liquidity Risk: Difficulty in selling the positions in securities/derivatives
Liquidity Risk: Management
• Management of Liquidity Risk: Asset Liability Management (ALM)
– Matching the term period of Assets and Liabilities (arising out of the Lending and Deposit Mobilization operations) – Identification of Time Buckets: (Day 1, 2-7 days, 8-14 days, 15-28 days, 29-90 days, 91-365 days, 1-3 years, 3-5 years, over 5 years) – Asset Liability Management Committee (ALCO) is established which takes care of ALM. – ALCO designs Liquidity Policy with the approval of the Board of Directors. – Generally, ALCO also handles FOREX and other risks.
• Tools of Liquidity Management
– The Working Funds Approach – The Ratios Approach – Cash Flow Approach
• Gap should be identified for each time bucket based on behavioral estimate. • Gap should not exceed: Day 1 (5%), 2-7 days (10%), 8-14 days (15%), 15-28 days (20%)
– Stress Testing Process
Market Risk: Types / Sources
• Interest Rate Risk (IRR): Change in portfolio value due to change in interest rates. – Re-pricing Risk – Yield Curve Risk – Basis Risk – Optionality Risk • Equity Price Risk: Fluctuations in market price of equity investments due to general market related factors. • Currency / FOREX Risk: Fluctuations in exchange rates.
Operational Risk: Types / Sources
• Documentation Risk • Legal Risk
• Frauds: Internal & External
• Disruptions and business system failures, etc.
The Basel Accord: History
• Bank for International Settlements (BIS), Basel, Switzerland (established in 1930) to serve as bank of central banks set up a committee of central bank governors of G10 countries in 1974 called the Basel Committee on Banking Supervision (BCBS). The main role of BCBS is to provide a regulatory framework for better risk management in banks. It, in itself, does not possess regulatory power. It can only recommend to the member countries for implementing the desired risk management frameworks. In 1988, the Basel Accord was signed by G10 nations, which stipulated a risk management framework. Later on many other nations adopted it. In 1990 the Basel Accord was accepted as a world standard with more than 100 countries adopting the framework.
•
• •
•
•
It mainly stipulated the capital adequacy related requirements with focus on Credit Risk.
Later on, the Market Risk was also brought into the supervisory framework.
Basel –I : Major Prescriptions
• Capital Adequacy Ratio prescribed: – Internationally active banks in G10 countries to hold capital equal to at least 8% of a basket of assets measured in accordance with their risk profiles. This is called Capital to Risk-weighted Assets Ratio (CRAR). The CRAR of minimum 8% was supposed to be attained by end of 1992. – ‘Capital’ divided into two parts. • Core Capital called Tier 1 capital • Non-core part called Tier 2 capital ‘Assets’ classified into two categories. – Non-risky Assets: Risk weight being zero for this category, no capital was required to support this category of assets. – Risky Assets: For identifying Risky Assets, the focus was on Credit Risk. Accordingly, Risky Assets were classified into four groups for deciding the required support of the capital. The capital support required for the assets held (i.e. On-Balance Sheet Credit Exposure) in each different groups were: 10%, 20%, 50%, and 100% in the order of increasing riskiness. – It was recognized that Off-Balance Sheet credit exposures would also require capital support. Credit Conversion Factors were decided. Like, Standby Letter of Credit and Bank Guarantee: 100%, Commercial Letters of Credit and Performance Bonds: 50%, Undrawn limit on CC: 20%, etc.
•
Basel –II : Major Changes: Scope
• Basel-I mainly confided to the aspect of ‘Capital Adequacy’.
• Basel-II is more broad-based. It identifies THREE PILLARS on which BASEL-II is built up.
– Pillar –I: Capital Adequacy – Pillar –II: Supervisory Review Process [Only the capital should not be regarded as a substitute for addressing fundamentally inadequate control or risk management processes. Principles set for Supervisory
Review and Evaluation Process (SREP) by RBI and Internal Capital Adequacy Assessment Process (ICAAP) by the bank]
– Pillar –III: Market Discipline [Public reporting]
Basel –II : Major Changes (Contd.)
• Types of risk covered:
– Basel-I focuses on Credit Risk; but later on, also covered the Market Risk. – Basel-II covers all the three major types of risks, namely, Credit Risk, Market Risk, and Operational Risk.
• Specification of Approach for Risk Management:
– Basel-I took ‘One Size Fits All’ Approach. – Basel-II provides for more flexibility and specifies different approaches starting with the most simple approach and going up to the Advanced Approach. It also provides for capital incentives for better risk management. It places more weight on Risk Mitigation.
Basel –II : Regulatory Capital [as per RBI]
• • CRAR must not be less than 8% as per Basel-II. Against this, RBI mandates for 9%. RBI may selectively increase this for those banks who do not have prudent risk management processes. Tier 1 (Core) Capital:
• • • • • • Paid up equity share capital. Statutory Reserves Other Disclosed Free Reserves Capital Reserves representing surplus arising out of sale proceeds of assets Innovative Perpetual Debt Instruments (IPDI) [Maximum 15%] Perpetual Non-cumulative Preference Shares (PNCPS) [Total of PNCPS and IPDI must not exceed 40%. Any excess on the count of PNCPS to be added to Tier 2 Capital.]
•
Tier 2 (Supplementary) Capital: [This should be limited to 100% of the Tier 1 capital]
• • • • • Undisclosed reserves Revaluation Reserves [to be considered with 55% discount on it] General Provisions and Loan Loss Reserves [Limited to 1.25% of the total risk-weighted assets] Hybrid Debt Capital Instruments [If they display close similarities to equity] Subordinated Term Loans [Instruments with initial maturity of less than 5 years and/or with remaining maturity of 1 year cannot be included. Progressive 20% discount to be applied for each year less than five year maturity]
•
Deductions from Tier 1 Capital:
• • • • • • Intangible assets like goodwill to be deducted from Tier 1 Capital Investments in subsidies not consolidated in national system to be deducted from Tier 1 Capital ‘Gain on Sale’ of securitization of standard assets Minority interests 50% of investments in excess of 10% of capital of other banks. [Remaining 50% to be deducted from Tier 2 Capital.] Secularization exposure [50% from Tier 1 Capital and 50% from Tier 2 Capital.]
Basel –II : Approaches for Risk Measurement
• Credit Risk:
– The Standardized (External Rating Based) Approach [RBI] – The Internal Rating Based Approach (IRB)
• Foundation IRB (FIRB) • Advanced IRB (AIRB)
• Market Risk:
– Standardized Maturity Approach – Standardized Duration Approach [RBI] – Internal Models Approach (IMA)
• Operational Risk:
– Basic Indicator Approach [RBI] – Standardized Approach – Advanced Measurement Approach (AMA)
Credit Risk: The Standardized (External Rating Based) Approach
Market Risk: Capital Charges for Capital Adequacy: An Illustrative Table
Interest Rate Risk: Management
• Strategic Approach: Effecting changes in portfolio • Maturity and Duration based Gaps
• Interest Rate Derivatives
(Only for Hedging; not for creating naked positions)
• • • • • Swaps Interest Rate Futures Forward Rate Agreements (FRA) Interest Rate Options Swaptions
Operational Risk: The Basic Indicator Approach
Under the Basic Indicator Approach, banks must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted as alpha) of positive annual gross income.
Basel –III : Major Changes
• Scope:
– Basel-II focuses on only Micro Prudential (Firm Specific ) Measures. – Basel-III will include Macro Prudential Measures to additionally address the Systemic Risks faced by banks and their interconnectedness.
• Types of Risk Aspects Covered:
– Basel-II mainly focuses on the quantitative aspects of capital. – Basel-III will include issues like quality of capital, etc.
• Capital Adequacy Requirements:
– Basel-II specifies CRAR of 8%, with equity capital of at least 2%. – Basel-III undertakes to increase the equity capital to at least 7%.
• Robustness of Models Used:
– Though Basel-II asks for stress testing of models, detailed prescriptions are not made towards that. – Basel-III seeks to make detailed prescriptions on Stress Testing of Models. It also envisages to bring more sophisticated models in use.
Basel –III : Proposed Time Schedule of Implementation
doc_618404620.ppt