Basel II accord is based on three pillars : – First Pillar : Minimum Capital Requirements. There is no change in the definition of 'Capital fund', however, the accord asks for modification in the method of calculating risk weighted assets so as to factor 'market risk' and 'operational risk' in addition to 'credit risk'. Capital requirement on account of 'credit risk' depends on whether calculation is based on 'Standardised approach' or 'Internal Ratings Based (IRB)' approach ? Under standardised approach, credit risk is externally assessed whereas under IRB approach, banks can use their own internal estimates. The Internal Rating Based (IRB) approach suggested by the Committee warrants a specially effective supervisory review process to assess the adequacy of capital, based on a thorough evaluation of the assets it has created with attendant risks. In the New Accord, bank management continues to bear responsibility for ensuring adequate capital on continuing basis : (i) for supporting the current risks (ii) for supporting risks beyond the core minimum requirements. Risk Weights for Banks : Two options have been clearly spelt out for the banks. Under the first option, all banks incorporated in a given country will be assigned a risk weight one category lower than that assigned to claims on the sovereign of incorporation. However, there will be cap of a 100% risk weight. For the banks incorporated in the countries rated below B, the risk weight will be capped at 150%. The second option for banks is the risk weighting on the external credit assessment of the bank itself. Under this option, a preferential risk weight that is one category higher than the risk weight shown in the table below, may be applied to claims with an original maturity of 3 months or less, subject to floor of 20%. This treatment will be available to both the rated and the unrated banks' claims, excluding banks risk weighted at 150%. The inter-banks short-term claims get preferential treatment; these are defined as having an original maturity of three months or less. Their risk weights are as shown in the table reproduced below : Risk Weights for Different Credit Ratings Exposures AAA to A + to A – BBB + BB + to B – Below B – Unrated AA – to BBB – Sovereigns 0% 20% 50% 100% 150% 100% Banks-Option 1 20% 50% 100% 100% 100% 150% Banks-Option 2 20% 50% 50% 100% 150% 50% Short-Term Claims 20% 20% 20% 50% 150% Corporates 20% 50% 100% – 150% 100% (BBB + (below to BB –) BB –) Risk Weights for Corporates : The unrated corporates are assigned 100% risk weight as compared to 150% risk weight assigned for corporates rated bb– to below. The above risk weights are based on recognition of the fact that majority of corporates do not require a rating in order to fund their activities. Non-rating of a Corporate (or a corporate borrower) does not necessarily indicate low credit quality.
The Committee does not wish to cause an unwarranted increase in the cost of funding for small and 207 medium-sized businesses, which, in most countries, are a primary source of job creation and economic growth. Due to the above reasons, a 100% risk weight has been assigned to un-rated corporates; the same risk weight was assigned to such corporate exposures under the 1988 accord. Operational Risk is the risk of loss (direct/indirect) increasing due to inadequate/failed internal systems, procedures and people, e.g., Internal Fraud, Safety Rules, Labour Rules & Practices, etc. There are three methods of measuring operational risk, namely Basic Indicator approach, Standardised approach and advanced Measurement approach. Second Pillar : Supervisory Review Process New accord has laid down four basic principles : – (i) Bank should have an overall capital adequacy assessment process as per its own risk profile. (ii) Bank should have a system of monitoring and maintaining its internal capital adequacy assessment vis-a-vis extant regulatory norms. (iii) Bank must operate above and maintain capital in excess of minimum regulatory requirements. (iv) Bank supervisors should intervene, whenever needed, at an early stage to prevent capital from falling below minimum requirement level. Third Pillar : Market discipline Based II accord prescribes a set of disclosures that will allow market participants to assess risk and minimum capital requirement : (i) Qualitative disclosures on annual basis, (ii) Information on risk exposure on quarterly basis, and (iii) Capital adequacy & components disclosures on quarterly basis. Risk Based Internal Audit Policy is based on Reserve Bank of India guidelines and was approved by the Board in August 2005. From 1st January 2006, the audit for all purposes will be conducted as per Risk Based system only. Risk assessment will be based on risk rating of the branch as per last on-site audit and assessment of risk direction through off-site audit. The on-site audit of the branches would be undertaken as per annual audit plan for assessment of business risk, control risk and overall risk rating of the branch. Controlling offices would submit information to ZAOs on a prescribed format termed as 'Business Profile of the branch' which contains past three years data of the branch on all important parameters like composition and quality of deposit, advances, off balance-sheet items, audit reports' compliances, control returns, visit reports of controlling authorities etc. The periodicity for submission 'Business Profile' would be : o Extremely High, Very High and High Risk branches - Quarterly o Medium risk branches - Half Yearly o Low risk branches - Yearly Direction of the risk would be assessed by comparing the information with risk rating of the branch from last on-site audit in terms of : o Increasing, o Stable, or o Decreasing In case of alarming signals, a snap audit may be conducted. 208
On-site Audit (Risk Assessment) Business risk In assessment of business risk the emphasis is on business growth and quality aspects of the business rather than the volume of business. o Credit risk 400 * Quality of Credit Portfolio 100 * Extent ofmigration in existing rated accounts 50 * Gross NPA to total Advances 60 * Restructured accounts – trend of slippage 40 * Quick mortality cases 30 * Credit concentration Segmentwise 30 Borrowerwise 30 * Advances to sensitive Sector 30 * Invoked / Develved BG / LC 30 o Operational risk 300 * Deposit mobilized under new products / schemes 40 * Cash Ratio 60 * Computerization 60 * Business Continuity status 80 * Outstanding of services 60 o Earning risk 300 * Business Growth Deposits 20 Low cost deposit 20 Credit (Fund Based / Non Fund Based) 30 PS Credit etc. 20 * CD Ratio 20 * Achievement of profit budget 20 * Forex turnover 15 * Achievement of Retail Lending budget 15 * Av. Cost of deposits 20 * Av. Return on advances 20 * Growth in fee-based income 30 * Business per employee 20 * Profit per employee 20 * Revenue Leakage 20 * Reduction in controllable expenses 10 Total 1000 Risk categories : Low : up to 30%, Medium : > 30-60%, High : > 60-75% and Very High : > 75% score. 209 Control Risk : o Business Management 300 * Credit Functions 200 * Non-Credit Functions 100 600 o Compliances * Closure of Previous inspection / audit reports 100 * Sumission of Control Returns 45 * Efficiency in communication and reporting 30 * Customer Service (complaint redressal) 50 * Regulatory / legal Compliances 25 250 o Branch Management * Branch Management (Manpower Utilisation) * Job Knowledge of Staff 18 * Up-keep of brnach premises 25
* Expenditures 05 * Punctuality / discipline 18 * Duty rotation & placement 14 80 * Security Audit * Security Infrastructure 25 * Security Manpower 08 * Security Equipment 12 * Security Procedure 13 * Fire Safety 12 70 Total 1000 Risk Categories Low : up to 20%, Medium : > 20 – 45%, High : > 45 – 70%, and Very High : > 70% score. Overall Risk : Overall risk (VH – Unsatisfactory, H – Satisfactory, M – Good, L – Very Good) is assessed as per risk matrix as under : H H VH EH M H H VH MMHH LMMH L M H VH VH H M L 20 35 50 60 40 20 0 Control Risk Business Risk 210 Bank has also identified 55 Fraud Sensitive Items (FSI) including 18 Zero Tolerance Level Items (ZTL) with the provision that in case any irregularity is reported in I.R. in these areas (within 12 broad major operation heads), the same should be rectified within 10 days and 3 days respectively.
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The Committee does not wish to cause an unwarranted increase in the cost of funding for small and 207 medium-sized businesses, which, in most countries, are a primary source of job creation and economic growth. Due to the above reasons, a 100% risk weight has been assigned to un-rated corporates; the same risk weight was assigned to such corporate exposures under the 1988 accord. Operational Risk is the risk of loss (direct/indirect) increasing due to inadequate/failed internal systems, procedures and people, e.g., Internal Fraud, Safety Rules, Labour Rules & Practices, etc. There are three methods of measuring operational risk, namely Basic Indicator approach, Standardised approach and advanced Measurement approach. Second Pillar : Supervisory Review Process New accord has laid down four basic principles : – (i) Bank should have an overall capital adequacy assessment process as per its own risk profile. (ii) Bank should have a system of monitoring and maintaining its internal capital adequacy assessment vis-a-vis extant regulatory norms. (iii) Bank must operate above and maintain capital in excess of minimum regulatory requirements. (iv) Bank supervisors should intervene, whenever needed, at an early stage to prevent capital from falling below minimum requirement level. Third Pillar : Market discipline Based II accord prescribes a set of disclosures that will allow market participants to assess risk and minimum capital requirement : (i) Qualitative disclosures on annual basis, (ii) Information on risk exposure on quarterly basis, and (iii) Capital adequacy & components disclosures on quarterly basis. Risk Based Internal Audit Policy is based on Reserve Bank of India guidelines and was approved by the Board in August 2005. From 1st January 2006, the audit for all purposes will be conducted as per Risk Based system only. Risk assessment will be based on risk rating of the branch as per last on-site audit and assessment of risk direction through off-site audit. The on-site audit of the branches would be undertaken as per annual audit plan for assessment of business risk, control risk and overall risk rating of the branch. Controlling offices would submit information to ZAOs on a prescribed format termed as 'Business Profile of the branch' which contains past three years data of the branch on all important parameters like composition and quality of deposit, advances, off balance-sheet items, audit reports' compliances, control returns, visit reports of controlling authorities etc. The periodicity for submission 'Business Profile' would be : o Extremely High, Very High and High Risk branches - Quarterly o Medium risk branches - Half Yearly o Low risk branches - Yearly Direction of the risk would be assessed by comparing the information with risk rating of the branch from last on-site audit in terms of : o Increasing, o Stable, or o Decreasing In case of alarming signals, a snap audit may be conducted. 208
On-site Audit (Risk Assessment) Business risk In assessment of business risk the emphasis is on business growth and quality aspects of the business rather than the volume of business. o Credit risk 400 * Quality of Credit Portfolio 100 * Extent ofmigration in existing rated accounts 50 * Gross NPA to total Advances 60 * Restructured accounts – trend of slippage 40 * Quick mortality cases 30 * Credit concentration Segmentwise 30 Borrowerwise 30 * Advances to sensitive Sector 30 * Invoked / Develved BG / LC 30 o Operational risk 300 * Deposit mobilized under new products / schemes 40 * Cash Ratio 60 * Computerization 60 * Business Continuity status 80 * Outstanding of services 60 o Earning risk 300 * Business Growth Deposits 20 Low cost deposit 20 Credit (Fund Based / Non Fund Based) 30 PS Credit etc. 20 * CD Ratio 20 * Achievement of profit budget 20 * Forex turnover 15 * Achievement of Retail Lending budget 15 * Av. Cost of deposits 20 * Av. Return on advances 20 * Growth in fee-based income 30 * Business per employee 20 * Profit per employee 20 * Revenue Leakage 20 * Reduction in controllable expenses 10 Total 1000 Risk categories : Low : up to 30%, Medium : > 30-60%, High : > 60-75% and Very High : > 75% score. 209 Control Risk : o Business Management 300 * Credit Functions 200 * Non-Credit Functions 100 600 o Compliances * Closure of Previous inspection / audit reports 100 * Sumission of Control Returns 45 * Efficiency in communication and reporting 30 * Customer Service (complaint redressal) 50 * Regulatory / legal Compliances 25 250 o Branch Management * Branch Management (Manpower Utilisation) * Job Knowledge of Staff 18 * Up-keep of brnach premises 25
* Expenditures 05 * Punctuality / discipline 18 * Duty rotation & placement 14 80 * Security Audit * Security Infrastructure 25 * Security Manpower 08 * Security Equipment 12 * Security Procedure 13 * Fire Safety 12 70 Total 1000 Risk Categories Low : up to 20%, Medium : > 20 – 45%, High : > 45 – 70%, and Very High : > 70% score. Overall Risk : Overall risk (VH – Unsatisfactory, H – Satisfactory, M – Good, L – Very Good) is assessed as per risk matrix as under : H H VH EH M H H VH MMHH LMMH L M H VH VH H M L 20 35 50 60 40 20 0 Control Risk Business Risk 210 Bank has also identified 55 Fraud Sensitive Items (FSI) including 18 Zero Tolerance Level Items (ZTL) with the provision that in case any irregularity is reported in I.R. in these areas (within 12 broad major operation heads), the same should be rectified within 10 days and 3 days respectively.
doc_693034249.doc