PROJECT REPORT ON
TREASURY MANAGEMENT IN BANKS
PREPARED BY
SOURAV BANDYOPADHYAY
ROLL NO 521020146
Sikkim Manipal University
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Contents
Page No.
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Treasury Management, needs and benefits Treasury functions Treasury Products Securities, Foreign Exchange Market Derivative Treasury Operations in bank Integrated Treasury Management Risk Management Risk management process Classification of risks Credit Risk Management Market Risk Management Operational Risk Management Extracts from RBI Master Circular Basel II Accord and Reserve Bank of India Asset Liability Management Remarks by Stefan Walter Treasury management and new age technology Speech by Dr. Nout Wellink on Basel II Case Study Gratitude Declaration Acknowledgement Examiner?s Certificate
03 04 05 06 07 08 08 09 10 10 13 14 14 15 22 33 35 42 43 50 55 56 57 58
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TREASURY MANAGEMENT
Treasury management is the process of managing and organizing the finance to optimize the economic growth in the organization. It is the process of planning, organizing and managing the organization?s holdings, corporate bonds, currencies, financial futures, options, derivatives, payment systems and associated risks.
“Treasury is the place of deposit reserved for storing treasures and disbursement of collected funds.” Teigen Lee E
Need:
Treasury management is mainly required to optimize the economy of the organization and provide an ability to manage financial risks.
Benefits:
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It increases the sales of the product. It provides better guidelines and methods to manage risks. It helps to optimize asset and debt performance while minimizing the needs for external funding. It enables the organization to analyze a variety of data which includes funds, transactions, foreign exchange rates, market data and third party information. Page | 3
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Risk Exposure
Treasury management is exposed to various risks in the organization.
Exposure
To Risks Financial Foreign Exchange
Currency
Commodity
Event
Treasury Functions
The traditional treasury functions can be depicted as below –
Treasury Functions
Cash Management
Currency Management
Fund Management
Corporate Finance
Risk Management
Cash Management: It deals with managing the collection and repayment of cash. Currency Management: It deals with foreign currency and exchange rate management.
Fund Management: It is the process of planning and outsourcing the short, medium and long term cash needs. Page | 4
Corporate Management:
It deals with achieving strategic financial goals.
Risk management:
It deals with balancing risks and returns thus optimizing profits and protecting assets.
Treasury Products:
Treasury products are the products available in the market and used for generating yields and manage the liquidity mismatch.
Treasury Products
Money Market
Securities Market
Foreign Exchange Market Derivative
Money Market:
According to RBI, money market is -“The centre for dealings, mainly short term character, in money assets; It meets the short-term requirements of borrowers and provides liquidity or cash to the lenders”
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Money Market Products
Call/ Notice Money Treasury Bills
Commercial Paper
Certificate Of Deposits
Commercial Bills
Repo/ Reverse Repo
Securities Market:
Securities market deals with all types of securities and ensures equal access to all investors through appropriate channels.
EQUITY S E C CAPITAL MARKET DEBT
PRIMARY SECONDARY Bonds, Debentures
IPO, Rights Issue, Preferential Issue Equity, Bonus, Rights
Government Securities U R I T I E S Foreign Exchange Derivatives Commodities OTC, Exchange Based and Futures Foreign Currency SWAPS, Options etc.
Participatory Notes ADR/GDR
M A R K E T Page | 6
Foreign Exchange Market:
Foreign exchange is a market where currencies of various countries are traded and it facilitates international trade and investments.
Derivative:
A stock derivative is a financial contract structured on an underlying asset which are equity, forex, or any other assets. The value of the derivative is dependent on the price of the underlying stock. These contracts help the investors to lessen the price risk, arising out of movement in prices of the underlying assets. A derivative contract helps to fix the price of the underlying asset on a future date.
Derivative contracts commonly used are –
1) Forward Contract: A forward contract is a derivative that has an agreement to buy or sell an asset on a predetermined future date at an agreed price.
2) Future Contracts: Future contracts are structures for the delivery of the underlying asset on an agreed future date. It is a transferable specific delivery forward contract. Futures can be interest rate futures, currency futures and index futures.
3) Option Contracts: These are contract between two parties where one party has the right to take delivery of an underlying asset but not the obligation, but the other party has the obligation to give or take delivery. Options provide the holder the right to buy (call) or sell (put) securities at a predetermined price within a specified period. The options can be on securities, commodities, index, currencies and futures.
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Treasury Operation in Banks
Currently, most of the Indian banks have classified their business into two primary segments viz. Banking Operations and Treasury Operations.
Treasury Operations in Banks
Foreign Rupee Treasury Exchange Treasury Derivatives
Integrated Treasury Management
Interest rate deregulation, liberalization of exchange control and development of foreign exchange market has necessitated the integration of foreign exchange dealings and domestic treasury operations.
Integrated Treasury Management Functions
Trading Activities
Liquidity Management
Risk and Asset Liability Management
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Trading Activities:
It deals with trading in Currencies, Securities, Derivatives and other Financial Instruments available in Money, Securities, Foreign Exchange Markets in order to contribute to bank?s profit.
Liquidity Management:
It is responsible for managing short term funds across currencies and also for complying with regulatory requirements prescribed by the Reserve Bank of India.
Liquidity Management Objectives:
1) To assure depositors of timely repayment of their deposits. 2) To assure borrowers of meeting their credit requirements. 3) To protect shareholders wealth from forced sale of assets
Liquidity Management Techniques:
Increasing Core Deposits Changing the interest rate on deposits. Maintaining CRR and SLR (RBI Guidelines) Maintaining CRAR (Basel II guidelines)
Risk Management:
Risk is defined as the exposure to an uncertain event which may have an adverse effect on bank?s capital and earnings. Risk may be Internal risk or External Risk and the business of banking is all about identifying, measuring, managing and accepting risks.
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Risk Management Process:
It basically is a five step process, which involves – a) b) c) d) e) Identification of risk Quantification of risk Policy formulation Strategy formulation Monitoring risks
Classification of Risks:
Credit Risk: Default Risk: It is the risk Exposure Risk: that arises in case the borrower defaults.
It is the risk that arises due to concentration of loans and advances to a particular borrower or business class. Market Risk: Liquidity Risk: It arises from funding long term assets by short term liabilities and vice versa. It may be as followsFunding Risk: It arises due to unanticipated outflows. Time Risk: It arises due to non receipt of expected inflow. Call Risk: It arises due to crystallization of contingent liabilities. Interest Rate Risk: It arises from adverse movement of interest rates during the period when asset or liability was held by the bank. It affects net interest margin or market value of equity. It may be categorized as followsGap Risk: It arises from holding assets and liabilities of different maturities. Basis Risk: It arises from change of interest rates on assets and liabilities, into different magnitudes.
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Embedded Option Risk: It arises from embedded call option for customer into an asset or liability. Net Interest Position Risk: It arises when bank has more interest sensitive assets than interest sensitive liabilities and interest rate declines. Yield Curve Risk: It arises when banks adopt two or more benchmark rates for different instruments in a floating rate situation. Reinvestment Risk: It arises from the uncertainty that the cash inflow from investment or loans and advances can be reinvested at a higher rate. Foreign Exchange Risk: Currency Risk: It arises due to fluctuation of prices of one currency in respect of other currency. Settlement Risk: It arises due to failure of counterparty to meet the settlement obligations on the date of settlement.
Country Risk: Currency Risk: Possibility that changes in exchange rate will affect the return on investments. Transfer Risk: remittances. Possibility of losses due to restriction on
Sovereign Risk: Associated with lending to government of a sovereign country or taking guarantee. Political Risk: Possibility that political environment will block the realization of asset or discharge of a liability. Cross Border Risk: Arises when the borrower is a resident of a country other than where the loans/advances have been disbursed.
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Operational Risk: People Risk: Arises due to human failure. Process Risk: Arises due to failure in processes. System Risk: Arises due to system & technological failure. Regulatory Risk: It arises due to changes in the prevailing legal Acts and the concerned Rules & Regulations. Environmental Risk: It arises due to changes in the Political, Economical, Social and Technological factors in the National or International environment.
Methods for Risk Measurement:
Credit Risk: A) B) C) D) E) Altman?s Z score method Credit Metrics Method Credit Risk+, a statistical method KMV method Mckinsey?s multi factor model
Liquidity Risk: a) b) Stock Approach: Ratio analysis Flow Approach: Time bucket analysis
Interest Rate Risk: GAP Analysis: a) Static Gap Analysis b) Dynamic Gap Analysis B) Simulation Method: a) Simulation of Net Interest Income b) Monte Carlo Simulation Foreign exchange Risk: Value at Risk Approach Operational Risk: a) Basic Indicator Approach b) Standardized Approach c) Advanced Measurement Approach A)
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Credit Risk Management:
Management of credit risk is done through the following processes – a) Selection of borrower through credit rating. b) Loan review mechanism c) Setting up exposure norms. Credit Rating: It is the independent assessment of credit worthiness of the borrower. It helps in measuring credit risk and facilitates loan pricing.
As per RBI guidelines banks may use the following domestic and international credit rating agencies for the purpose of risk weighting their capital for capital adequacy measurement –
Domestic Rating Agencies: a) CARE Ltd. b) CRISIL Ltd. c) ICRA Ltd. d) FITCH India International Rating Agencies: a) FITCH b) Moodys c) Standard & Poor?s Loan Review Mechanism:
Banks should put in place a proper Loan review mechanism as a part of their Loan Policy, as a proactive measure to identify loans which develop credit weakness, to evaluate portfolio quality and isolate potential problem areas.
Exposure Norms:
Banks should put in place single or group exposure limits, exposure to specific industry or sector as per the guidelines framed by RBI. Page | 13
Market Risk Management:
Market risk management involves the following processes –
a) Framing appropriate policies and guidelines for measuring, managing and reporting market risk. b) Ensuring sound financial models are used to measure market risk. c) Appointment of qualified and competent staff and independent market risk manager. d) Reviewing and monitoring to satisfy that the policies and guidelines are strictly adhered to.
Operational Risk Management:
Banks should take the following steps to ensure effective management of operational risk – a) Framing appropriate human resource policy and other operational policies and guidelines. b) Appointment of qualified and efficient staff. c) Continuous and ongoing training for the staff. d) Following job rotation, work allocation, mandatory leave and creation of second line officers. e) Mandatory staff meetings at regular intervals and participation of staff members. f) Proper housekeeping and early submission of control returns. g) Proper internal control system, regular inspection and compliance to Concurrent auditors/RBI inspections. h) Automation of processes and procedures. i) Strict adherence to banks policies, guidelines issued by RBI and other regulatory bodies. j) Follow up of manuals, circulars, master circulars, notices issued by RBI and other regulatory bodies. k) Proper maintenance of security stationery, fire safety and other security measures, timely renewal of licenses, insurance policies and following other statutory requirements. l) Proper security procedure to prevent physical access to hardware and software systems and access to database.EDP audit, system audit and compliance thereof.
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Extracts from RBI Master Circular N0. RBI/2011-12/50 DBOD. No.Ret. BC.13/12.01.001/2011-12 dated July 01, 2011
Master Circular - Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) A. Purpose - This master circular prescribes the broad details of the reserve requirements. B. Classification - A statutory guideline issued by the RBI under Section 35A of the BR Act, 1949. C. Previous Instructions - This master circular is a compilation of the instructions contained in the circulars issued by the Reserve Bank of India which is operational as on the date of this circular. D. Scope of Application - This master circular is applicable to all Scheduled Commercial Banks (SCBs) excluding Regional Rural Banks. E. Structure 1. Introduction With a view to monitoring compliance of maintenance of statutory reserve requirements viz. CRR and SLR by the SCBs, the Reserve Bank of India has prescribed statutory returns i.e. Form A return (for CRR) under Section 42 (2) of the RBI Act, 1934 and Form VIII return (for SLR) under Section 24 of the Banking Regulation Act, 1949. 1.1 CRR In terms of Section 42 (1) of the Reserve Bank of India Act, 1934 the Reserve Bank having regard to the needs of securing the monetary stability in the country, prescribes the CRR for SCBs without any floor or ceiling rate. 1.2 Maintenance of CRR At present, effective from the fortnight beginning April 24, 2010, the CRR is prescribed at 6.00 per cent of a bank's total of DTL adjusted for the exemptions discussed in Sections 1.11 and 1.12. 1.3 Incremental CRR In terms of Section 42(1-A) of RBI Act, 1934, the SCBs are required to maintain, in addition to the balances prescribed under Section 42(1) of the Act, an additional average daily balance, the amount of which shall not be less than the rate specified by the Reserve Bank in the notification published in the Gazette of India from time to time. Such additional balance will be calculated with reference to the excess of the total of DTL of the bank as shown in the Returns referred to in Section 42(2) of the Act, 1934 over the total of its DTL at the close of the business on the date specified in the notification. At present no incremental CRR is required to be maintained by the banks. 1.4 Computation of DTL Liabilities of a bank may be in the form of demand or time deposits or borrowings or other miscellaneous items of liabilities. As defined under Section 42 of the RBI Act, 1934, liabilities of a bank may be towards the banking system or towards others in the form of demand and time deposits or borrowings or other miscellaneous items of liabilities. The Reserve Bank of India has been authorized in terms of Section 42 (1C) of the RBI Act, 1934, to classify any particular liability and hence for any doubt regarding classification of a particular liability, banks are advised to approach the RBI for necessary clarification.
1.5 Demand Liabilities Demand Liabilities of a bank are liabilities which are payable on demand. These include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, outstanding
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Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand. Money at Call and Short Notice from outside the Banking System should be shown against liability to others. 1.6 Time Liabilities Time Liabilities of a bank are those which are payable otherwise than on demand. These include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held against letters of credit, if not payable on demand, deposits held as securities for advances which are not payable on demand and Gold deposits. 1.7 Other Demand and Time Liabilities (ODTL) ODTL include interest accrued on deposits, bills payable, unpaid dividends, suspense account balances representing amounts due to other banks or public, net credit balances in branch adjustment account, any amounts due to the banking system which are not in the nature of deposits or borrowing. Such liabilities may arise due to items like (i) collection of bills on behalf of other banks, (ii) interest due to other banks and so on. If a bank cannot segregate the liabilities to the banking system, from the total of ODTL, the entire ODTL may be shown against item II (c) 'Other Demand and Time Liabilities' of the return in Form 'A' and average CRR maintained on it by all SCBs . Participation Certificates issued to other banks, the balances outstanding in the blocked account pertaining to segregated outstanding credit entries for more than 5 years in inter-branch adjustment account, the margin money on bills purchased / discounted and gold borrowed by banks from abroad, also should be included in ODTL. Cash collaterals received under collateralized derivative transactions should be included in the bank’s DTL/NDTL for the purpose of reserve requirements as these are in the nature of ‘outside liabilities’. 1.8 Assets with the Banking System Assets with the banking system include balances with banks in current account, balances with banks and notified financial institutions in other accounts, funds made available to banking system by way of loans or deposits repayable at call or short notice of a fortnight or less and loans other than money at call and short notice made available to the banking system. Any other amounts due from banking system which cannot be classified under any of the above items are also to be taken as assets with the banking system. 1.9 Borrowings from abroad by banks in India Loans/borrowings from abroad by banks in India will be considered as 'liabilities to others' and will be subject to reserve requirements. Upper Tier II instruments raised and maintained abroad shall be reckoned as liability for the computation of DTL for the purpose of reserve requirements. 1.10 Arrangements with Correspondent Banks for Remittance Facilities When a bank accepts funds from a client under its remittance facilities scheme, it becomes a liability (liability to others) in its books. The liability of the bank accepting funds will extinguish only when the correspondent bank honours the drafts issued by the accepting bank to its customers. As such, the balance amount in respect of the drafts issued by the accepting bank on its correspondent bank under the remittance facilities scheme and remaining unpaid should be reflected in the accepting bank's books as liability under the head ' Liability to others in India' and the same should also be taken into account for computation of DTL for CRR/SLR purpose. The amount received by correspondent banks has to be shown as 'Liability to the Banking System' by them and not as 'Liability to others' and this liability could be netted off by the correspondent banks against the inter-bank assets. Likewise sums placed by banks issuing drafts/interest/dividend warrants are to be treated
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as 'Assets with banking system' in their books and can be netted off from their inter-bank liabilities. 1.11 Liabilities not to be included for DTL/NDTL computation The under-noted liabilities will not form part of liabilities for the purpose of CRR and SLR: a) Paid up capital, reserves, any credit balance in the Profit & Loss Account of the bank, amount of any loan taken from the RBI and the amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI; b) Net income tax provision; c) Amount received from DICGC towards claims and held by banks pending adjustments thereof; d) Amount received from ECGC by invoking the guarantee; e) Amount received from insurance company on ad-hoc settlement of claims pending judgment of the Court; f) Amount received from the Court Receiver; g) The liabilities arising on account of utilization of limits under Bankers Acceptance Facility (BAF); h) District Rural Development Agency (DRDA) subsidy of Rs.10, 000/- kept in Subsidy Reserve Fund account in the name of Self Help Groups; i) Subsidy released by NABARD under Investment Subsidy Scheme for Construction/Renovation/Expansion of Rural Godowns; j) Net unrealized gain/loss arising from derivatives transaction under trading portfolio; k) Income flows received in advance such as annual fees and other charges which are not refundable. l) Bill rediscounted by a bank with eligible financial institutions as approved by RBI and, (m) Provision not being a specific liability arising from contracting additional liability and created from profit and loss account. 1.12 Exempted Categories SCBs are exempted from maintaining CRR on the following liabilities: i. Liabilities to the banking system in India as computed under Clause (d) of the explanation to Section 42(1) of the RBI Act, 1934; ii. Credit balances in ACU (US$) Accounts; iii Demand and Time Liabilities in respect of their Offshore Banking Units (OBU);and iv SCBs are not required to include inter-bank term deposits/term borrowing liabilities of original maturities of 15 days and above and up to one year in "Liabilities to the Banking System" (item 1 of Form A return). Similarly banks should exclude their inter-bank assets of term deposits and term lending of original maturity of 15 days and above and up to one year in "Assets with the Banking System" (item III of Form A return) for the purpose of maintenance of CRR. The interest accrued on these deposits is also exempted from reserve requirements. 1.13 Loans out of FCNR (B) Deposits and IBFC Deposits Loans out of Foreign Currency Non–Resident Accounts (Banks), (FCNR Deposits Scheme) and Inter-Bank Foreign Currency (IBFC) deposits should be included as part of bank credit while reporting in Form ’A’ return. For the purpose of reporting, banks should convert their FCNR (B) deposits, overseas foreign currency assets and bank credit in India in foreign currency in 4 major currencies into rupees at FEDAI noon mean rate on the reporting Friday. 1.14 Procedure for Computation of CRR In order to improve cash management by banks, as a measure of simplification, a lag of one fortnight in the maintenance of stipulated CRR by banks has been introduced with effect from the fortnight beginning November 06, 1999. 1.15 Maintenance of CRR on Daily Basis
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With a view to providing flexibility to banks in choosing an optimum strategy of holding reserves depending upon their intra fortnight cash flows, all SCBs are required to maintain minimum CRR balances up to 70 per cent of the average daily required reserves for a reporting fortnight on all days of the fortnight with effect from the fortnight beginning December 28, 2002. 1.16 No Interest Payment on Eligible Cash Balances maintained by SCBs with RBI under CRR In view of the amendment carried out to RBI Act 1934, omitting sub-section (1B) of Section 42, the Reserve Bank does not pay any interest on the CRR balances maintained by SCBs with effect from the fortnight beginning March 31, 2007. 1.17 Fortnightly Return in Form A (CRR) Under Section 42 (2) of the RBI Act, 1934, all SCBs are required to submit to Reserve Bank a provisional Return in Form 'A' within 7 days from the expiry of the relevant fortnight which is used for preparing press communiqué. The final Form 'A' return is required to be submitted to RBI within 20 days from expiry of the relevant fortnight. Based on the recommendation of the Working Group on Money Supply: Analytics and Methodology of Compilation, all SCBs in India are required to submit from the fortnight beginning October 9, 1998, Memorandum to form 'A' return giving details about paid-up capital, reserves, time deposits comprising short-term (of contractual maturity of one year or less) and long-term (of contractual maturity of more than one year), certificates of deposits, NDTL, total CRR requirement etc., Annexure A to Form ‘A’ return showing all foreign currency liabilities and assets and Annexure B to Form ‘A’ return giving details about investment in approved securities, investment in non-approved securities, memo items such as subscription to shares /debentures / bonds in primary market and subscriptions through private placement. For reporting in Form 'A' return, banks should convert their overseas foreign currency assets and bank credit in India in foreign currency in four major currencies viz., US dollar, GBP, Japanese Yen and Euro into rupees at the Foreign Exchange Dealers Association of India's (FEDAI) noon mean rate on reporting Friday. The present practice of calculation of the proportion of demand liabilities and time liabilities by SCBs in respect of their savings bank deposits on the basis of the position as at the close of business on 30 September and 31 March every year (cf. RBI circular DBOD.No.BC.142/09.16.001/97-98 dated November 19, 1997) shall continue in the new system of interest application on savings bank deposits on a daily product basis. The average of the minimum balances maintained in each of the month during the half year period shall be treated by the bank as the amount representing the "time liability” portion of the savings bank deposits. When such an amount is deducted from the average of the actual balances maintained during the half year period, the difference would represent the "demand liability” portion. The proportions of demand and time liabilities so obtained for each half year shall be applied for arriving at demand and time liabilities components of savings bank deposits for all reporting fortnights during the next half year. 1.18 Penalties From the fortnight beginning June 24, 2006, penal interest will be charged as under in cases of default in maintenance of CRR by SCBs : (i) In case of default in maintenance of CRR requirement on a daily basis which is presently 70 per cent of the total CRR requirement, penal interest will be recovered for that day at the rate of three per cent per annum above the Bank Rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day and if the shortfall continues on the next succeeding day/s, penal interest will be recovered at the rate of five per cent per annum above the Bank Rate.
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(ii) In cases of default in maintenance of CRR on average basis during a fortnight, penal interest will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank of India Act, 1934. SCBs are required to furnish the particulars such as date, amount, percentage, reason for default in maintenance of requisite CRR and also action taken to avoid recurrence of such default. 2. Maintenance of Statutory Liquidity Ratio (SLR) Consequent upon amendment to the Section 24 of the Banking Regulation Act,1949 through the Banking Regulation (Amendment) Act, 2007 replacing the Regulation (Amendment) Ordinance, 2007, effective January 23, 2007, the Reserve Bank can prescribe the SLR for SCBs in specified assets. The value of such assets of a SCB shall not be less than such percentage not exceeding 40 per cent of its total DTL in India as on the last Friday of the second preceding fortnight as the Reserve Bank may, by notification in the Official Gazette, specify from time to time. SCBs can participate in the Marginal Standing Facility (MSF) scheme introduced by Reserve Bank with effect from May 09, 2011. Under this facility, the eligible entities may borrow overnight, up to one per cent of their respective NDTL outstanding at the end of the second preceding fortnight. Reserve Bank has specified vide notification DBOD.No.Ret.91/12.02.001/2010-11 dated May 09, 2011 that every SCB shall continue to maintain in India assets as detailed below, the value of which shall not, at the close of business on any day, be less than 24 per cent on the total net demand and time liabilities as on the last Friday of the second preceding fortnight as prescribed vide notification DBOD.No.Ret.BC.66/12.02.001/2010-11 dated December 16, 2010 valued in accordance with the method of valuation specified by the Reserve Bank of India from time to time: (a) Cash or (b) Gold valued at a price not exceeding the current market price, or (c) Investment in the following instruments which will be referred to as "Statutory Liquidity Ratio (SLR) securities": (i) Dated securities issued up to May 06, 2011 as listed in the Annex to Notification DBOD.No.Ret.91/12.02.001/2010-11 dated May 09, 2011. (ii) Treasury Bills of the Government of India; (iii) Dated securities of the Government of India issued from time to time under the market borrowing programme and the Market Stabilization Scheme; (iv) State Development Loans (SDLs) of the State Governments issued from time to time under the market borrowing programme; and (v) Any other instrument as may be notified by the Reserve Bank of India. Provided that the securities (including margin) referred to above, if acquired under the Reserve Bank- Liquidity Adjustment Facility (LAF), shall not be treated as an eligible asset for this purpose. Explanation: For the above purpose, "market borrowing programme" shall mean the domestic rupee loans raised by the Government of India and the State Governments from the public and managed by the Reserve Bank of India through issue of marketable securities, governed by the Government Securities Act, 2006 and the Regulations framed there under, through an auction or any other method, as specified in the Notification issued in this regard.
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2. Encumbered SLR securities shall not be included for the purpose of computing the percentage specified above. Provided that for the purpose of computing the percentage of assets referred to hereinabove, the following shall be included, namely: (i) securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against or availed of; and, (ii) securities offered as collateral to the Reserve Bank of India for availing liquidity assistance from Marginal Standing Facility (MSF) up to one percent of the total NDTL in India carved out of the required SLR portfolio of the bank concerned. 3. In computing the amount for the above purpose, the following shall be deemed to be cash maintained in India: (i) The deposit required under sub-section (2) of Section 11 of the Banking Regulation Act, 1949 to be made with the Reserve Bank by a banking company incorporated outside India; (ii) Any balances maintained by a scheduled bank with the Reserve Bank in excess of the balance required to be maintained by it under Section 42 of the Reserve Bank of India Act, 1934 (2 of 1934); and (iii) Net balances in current accounts with other scheduled commercial banks in India. Note: 1. With a view to disseminating information on the SLR status of a Government security, it has been decided that: (i) the SLR status of securities issued by the Government of India and the State Governments will be indicated in the Press Release issued by the Reserve Bank of India at the time of issuance of the securities; and, (ii) an updated and current list of the SLR securities will be posted on the Reserve Bank's website (www.rbi.org.in) under the link " Database on Indian Economy) 2. The cash management bill will be treated as Government of India Treasury Bill and accordingly shall be treated as SLR securities. 2.1 Procedure for Computation of SLR The procedure to compute total NDTL for the purpose of SLR under Section 24 (2) (B) of B.R. Act, 1949 is broadly similar to the procedure followed for CRR. The liabilities mentioned under Section 1.11 will not form part of liabilities for the purpose of SLR also. SCBs are required to include inter-bank term deposits / term borrowing liabilities of all maturities in ‘Liabilities to the Banking System’. Similarly, banks should include their inter-bank assets of term deposits and term lending of all maturities in ‘Assets with the Banking System’ for computation of NDTL for SLR purpose. 2.2 Classification and Valuation of Approved Securities for SLR As regards classification and valuation of approved securities, banks may be guided by the instructions contained in our Master Circular (as updated from time to time) on Prudential Norms for classification, valuation and operation of investment portfolio by banks. 2.3 Penalties If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to RBI in respect of that default, the penal interest for that day at the rate of three per cent per annum above the Bank Rate on the shortfall and if
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the default continues on the next succeeding working day, the penal interest may be increased to a rate of five per cent per annum above the Bank Rate for the concerned days of default on the shortfall. 2.4 Return in Form VIII (SLR) i) Banks should submit to the Reserve Bank before 20th day of every month, a return in Form VIII showing the amounts of SLR held on alternate Fridays during immediate preceding month with particulars of their DTL in India held on such Fridays or if any such Friday is a Public Holiday under the Negotiable Instruments Act, 1881, at the close of business on preceding working day. ii) Banks should also submit a statement as annexure to Form VIII return giving daily position of (a) value of securities held for the purpose of compliance with SLR, and (b) the excess cash balances maintained by them with RBI in the prescribed format. 2.5 Correctness of Computation of DTL to be certified by Statutory Auditors The Statutory Auditors should verify and certify that all items of outside liabilities, as per the bank’s books had been duly compiled by the bank and correctly reflected under DTL/NDTL in the fortnightly/monthly statutory returns submitted to Reserve Bank for the financial year.
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to Reserve Bank for the financial year.
BASEL II Accord and Reserve Bank of India
The Basel Committee, established by the central-bank Governors of the Group of Ten countries at the end of 1974, meets regularly four times a year. It has four main working groups which also meet regularly. The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank. The present chairman of the Committee is Mr Stefan Ingves, Governor of Sveriges Riksbank, who succeeded Mr Nout Wellink on 1 July 2011. The Committee does not possess any formal supranational supervisory authority, and its conclusions do not, and were never intended to, have legal force. Rather, it formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authorities will take steps to implement them through detailed arrangements - statutory or otherwise - which are best suited to their own national systems. In this way, the Committee encourages convergence towards common approaches and common standards without attempting detailed harmonization of member countries' supervisory techniques. The Committee reports to the central bank Governors and Heads of Supervision of its member countries. It seeks their endorsement for its major initiatives. These decisions cover a very wide range of financial issues. One important objective of the Committee's work has been to close gaps in international supervisory coverage in pursuit of two basic principles: that no foreign banking establishment should escape supervision; and that supervision should be adequate. To achieve this, the Committee has issued a long series of documents since 1975. In 1988, the Committee decided to introduce a capital measurement system commonly referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement framework with a minimum capital standard of 8% by end-1992. Since Page | 22
1988, this framework has been progressively introduced not only in member countries but also in virtually all other countries with internationally active banks. In June 1999, the Committee issued a proposal for a revised Capital Adequacy Framework. The proposed capital framework consists of three pillars: minimum capital requirements, which seek to refine the standardized rules set forth in the 1988 Accord; supervisory review of an institution's internal assessment process and capital adequacy; and effective use of disclosure to strengthen market discipline as a complement to supervisory efforts. Following extensive interaction with banks, industry groups and supervisory authorities that are not members of the Committee, the revised framework was issued on 26 June 2004. This text serves as a basis for national rule-making and for banks to complete their preparations for the new framework's implementation. Over the past few years, the Committee has moved more aggressively to promote sound supervisory standards worldwide. In close collaboration with many jurisdictions which are not members of the Committee, in 1997 it developed a set of " Core Principles for Effective Banking Supervision", which provides a comprehensive blueprint for an effective supervisory system. To facilitate implementation and assessment, the Committee in October 1999 developed the " Core Principles Methodology". The Core Principles and the Methodology were revised recently and released in October 2006. In response to the financial crisis of 2008, the Committee and its oversight body, the Group of Governors and Heads of Supervision, have developed a reform programme to address the lessons of the crisis, which delivers on the mandates for banking sector reforms established by the G20 at their 2009 Pittsburgh summit. Collectively, the new global standards to address both firm-specific and broader, systemic risks have been referred to as "Basel III". In order to enable a wider group of countries to be associated with the work being pursued in Basel, the Committee has always encouraged contacts and cooperation between its members and other banking supervisory authorities. It circulates to supervisors throughout the world published and unpublished papers. In many cases, supervisory authorities in non-member countries have seen fit publicly to associate themselves with the Committee's initiatives. Contacts have been further strengthened by International Conferences of Banking Supervisors (ICBS) which take place every two years. The last ICBS was held in Singapore in the autumn of 2010.
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The Committee's Secretariat is provided by the Bank for International Settlements in Basel. The 17 person Secretariat is mainly staffed by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it stands ready to give advice to supervisory authorities in all countries.
With a view to adopting the Basle Committee on Banking Supervision (BCBS) framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off-balance sheet business and also to strengthen the capital base of banks, Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure. Essentially, under the above system the balance sheet assets, non-funded items and other off-balance sheet exposures are assigned prescribed risk weights and banks have to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. Reserve Bank has issued guidelines to banks in June 2004 on maintenance of capital charge for market risks on the lines of „Amendment to the Capital Accord to incorporate market risks? issued by the BCBS in 1996.
The BCBS released the "International Convergence of Capital Measurement and Capital Standards: A Revised Framework" on June 26, 2004. The Revised Framework was updated in November 2005 to include trading activities and the treatment of double default effects and a comprehensive version of the framework was issued in June 2006 incorporating the constituents of capital and the 1996 amendment to the Capital Accord to incorporate Market Risk. The Revised Framework seeks to arrive at significantly more risk-sensitive approaches to capital requirements. The Revised Framework provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and financial markets.
The BASEL II Accord consists of three reinforcing pillars. They are – A) Minimum Capital Requirement B) Supervisory Review and Evaluation Process C) Market Discipline
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Pillar I: Minimum Capital Requirement:
The revised capital adequacy norms shall be applicable uniformly to all Commercial Banks (except Local Area Banks and Regional Rural Banks), both at the solo level (global position) as well as at the consolidated level. In terms of guidelines on preparation of consolidated prudential reports issued vide RBI circular DBOD. No.BP.BC.72/ 21.04.018/ 200102 dated February 25, 2003. A consolidated bank should maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) as applicable to a bank on an ongoing basis.
Capital Fund: Banks are required to maintain a minimum Capital to Risk Weighted Asset Ratio (CRAR) of 9% on an ongoing basis. Capital Fund consists of Tier I and Tier II capital. Tier I capital is the core capital and Tier II capital is noncore and less permanent in nature. Banks are required to maintain a Tier I CRAR of at least 6%.
Capital Charges: The Framework offers three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk. These options for credit and operational risks are based on increasing risk sensitivity and allow banks to select an approach that is most appropriate to the stage of development of bank's operations. The options available for computing capital for credit risk are Standardized Approach, Foundation Internal Rating Based Approach and Advanced Internal Rating Based Approach. The options available for computing capital for operational risk are Basic Indicator Approach, Standardized Approach and Advanced Measurement Approach. Keeping in view Reserve Bank?s goal to have consistency and harmony with international standards, it has been decided that all commercial banks in India (excluding Local Area Banks and Regional Rural Banks) shall adopt Standardized Approach (SA) for credit risk and Basic Indicator Approach (BIA) for operational risk. Banks shall continue to apply the Standardized Duration Approach (SDA) for computing capital requirement for market risks.
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Capital Charge for Credit Risk: Banks in India shall adopt the Comprehensive Approach, which allows fuller offset of collateral against exposures, by effectively reducing the exposure amount by the value ascribed to the collateral. Under this approach, banks, which take eligible financial collateral (e.g., cash or securities, more specifically defined below), are allowed to reduce their credit exposure to counterparty when calculating their capital requirements to take account of the risk mitigating effect of the collateral. Credit risk mitigation is allowed only on an account-byaccount basis. In the comprehensive approach, when taking collateral, banks will need to calculate their adjusted exposure to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral. Banks are required to adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either, occasioned by market movements. These adjustments are referred to as „haircuts?. The application of haircuts will produce volatility adjusted amounts for both exposure and Collateral. The volatility adjusted amount for the exposure will be higher than the exposure and the volatility adjusted amount for the collateral will be lower than the collateral, unless either side of the transaction is cash. In other words, the „haircut? for the exposure will be a premium factor and the „haircut? for the collateral will be a discount factor. It may be noted that the purpose underlying the application of haircut is to capture the market-related volatility inherent in the value of exposures as well as of the eligible financial collaterals. Since the value of credit exposures acquired by banks in the course of their banking operations, would not be subject to market volatility, (since the loan disbursal / investment would be a “cash” transaction) though the value of eligible financial collateral would be, the haircut stipulated by RBI would apply in respect of credit transactions only to the eligible collateral but not to the credit exposure of the bank. Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty.
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Capital Charge for Market Risk: Market risk is defined as the risk of losses in on-balance sheet and offbalance sheet positions arising from movements in market prices. The market risk positions subject to capital charge requirement are: (i) The risks pertaining to interest rate related instruments and equities in the trading book; and (ii) Foreign exchange risk (including open position in precious metals) throughout the bank (both banking and trading books).
The minimum capital requirement is expressed in terms of two separately calculated charges, (i) "specific risk" charge for each security, which is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer, both for short (short position is not allowed in India except in derivatives) and long positions, and (ii) "general market risk" charge towards interest rate risk in the portfolio, where long and short positions (which is not allowed in India except in derivatives) in different securities or instruments can be offset.
Capital Charge for Operational Risk: 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, which is 15% as set by BCBS) of positive annual gross income (Net Interest Income+ Net Non Interest 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.
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Pillar II: Supervisory Review and Evaluation Process:
The New Capital Adequacy Framework (NCAF), based on the Basel II Framework evolved by the Basel Committee on Banking Supervision, has been adapted for India vide RBI Circular DBOD.No.BP.BC 90/ 20.06.001/ 2006-07 dated April 27, 2007. In terms of paragraph 2.4 (iii) (c) of the Annex to the aforesaid circular banks were required to have a Board-approved policy on ICAAP and to assess the capital requirement as per ICAAP.
The objective of the SRP is to ensure that banks have adequate capital to support all the risks in their business as also to encourage them to develop and use better risk management techniques for monitoring and managing their risks. This in turn would require a well-defined internal assessment process within banks through which they assure the RBI that adequate capital is indeed held towards the various risks to which they are exposed. The process of assurance could also involve an active dialogue between the bank and the RBI so that, when warranted, appropriate intervention could be made to either reduce the risk exposure of the bank or augment / restore its capital.
Thus, ICAAP is an important component of the SRP.
The main aspects to be addressed under the SRP, and therefore, under the ICAAP, would include:
(a)
the risks that are not fully captured by the minimum capital ratio prescribed under Pillar 1; the risks that are not at all taken into account by the Pillar 1; and the factors external to the bank.
(b)
(c)
Banks were advised to develop and put in place, with the approval of their Boards, an ICAAP commensurate with their size, level of complexity, risk profile and scope of operations. Page | 28
The ICAAP, which would be in addition to a bank?s calculation of regulatory capital requirements under Pillar 1, was to be operationalised from March 31, 2009 by all other commercial banks, excluding the Local Area Banks and Regional Rural banks.
The ICAAP document should, inter alia, include the capital adequacy assessment and projections of capital requirement for the ensuing year, along with the plans and strategies for meeting the capital requirement.
The Basel II document of the Basel Committee also lays down the following four key principles in regard to the SRP envisaged under Pillar 2:
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.
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 the regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process.
Principle 3: Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.
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 and should require rapid remedial action if capital is not maintained or restored.
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The Pillar 2 (Supervisory Review Process - SRP) requires banks to implement an internal process, called the Internal Capital Adequacy Assessment Process (ICAAP), for assessing their capital adequacy in relation to their risk profiles as well as a strategy for maintaining their capital levels.
The Pillar 2 also requires the supervisory authorities to subject all banks to an evaluation process, hereafter called Supervisory Review and Evaluation Process (SREP), and to initiate such supervisory measures on that basis, as might be considered necessary.
An analysis of the foregoing principles indicates that the following broad responsibilities have been cast on banks and the supervisors:
Banks? responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels (Principle 1). b) Banks should operate above the minimum regulatory capital ratios (Principle 3).
Supervisors? responsibilities
a) Supervisors should review and evaluate a bank?s ICAAP. (Principle 2) b) Supervisors should take appropriate action if they are not satisfied with the results of this process. (Principle 2) c) Supervisors should review and evaluate a bank?s compliance with the regulatory capital ratios. (Principle 2) d) Supervisors should have the ability to require banks to hold capital in excess ofthe minimum. (Principle 3)
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e) Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels. (Principle 4) f) Supervisors should require rapid remedial action if capital is not maintained or restored. (Principle 4)
Thus, the ICAAP and SREP are the two important components of Pillar 2 and could be broadly defined as follows:
The ICAAP comprises a bank?s procedures and measures designed to ensure the following: a) An appropriate identification and measurement of risks; b) An appropriate level of internal capital in relation to the bank?s risk profile; and c) Application and further development management systems in the bank. of suitable risk
The SREP consists of a review and evaluation process adopted by the supervisor, which covers all the processes and measures defined in the principles listed above. Essentially, these include the review and evaluation of the bank?s ICAAP, conducting an independent assessment of the bank?s risk profile, and if necessary, taking appropriate prudential measures and other supervisory actions.
Through the SREP, the RBI would evaluate the adequacy and efficacy of the ICAAP of banks and assess the overall capital adequacy of a bank through a comprehensive evaluation that takes into account all relevant information.
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Pillar III: Market Discipline:
The purpose of Market discipline (detailed in Pillar 3) in the Revised Framework is to complement the minimum capital requirements and the supervisory review process.
The aim is to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.
Banks, including consolidated banks, should provide all Pillar 3 disclosures, both qualitative and quantitative, as at end March each year along with the annual financial statements. With a view to enhance the ease of access to the Pillar 3 disclosures, banks may make their annual disclosures both in their annual reports as well as their respective web sites.
Banks with capital funds of Rs.100 crore or more should make interim disclosures on the quantitative aspects, on a standalone basis, on their respective websites as at end September each year. Qualitative disclosures that provide a general summary of a bank?s risk management objectives and policies, reporting system and definitions may be published only on an annual basis.
In recognition of the increased risk sensitivity of the Revised Framework and the general trend towards more frequent reporting in capital markets, all banks with capital funds of Rs. 500 crore or more, and their significant bank subsidiaries, must disclose their Tier I capital, total capital, total required capital and Tier I ratio and total capital adequacy ratio, on a quarterly basis on their respective websites.
The disclosure on the websites should be made in a web page titled “Basel II Disclosures” and the link to this page should be prominently provided on the home page of the bank?s website.
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The following sections are the disclosure requirements under Pillar 3.
? ? ? ? ? ? ? ? ? ?
Scope of Application Capital Structure Capital Adequacy Credit Risk: General Disclosures for All Banks Credit Risk: Disclosures for Portfolios Subject to the Standardized Approach Credit Risk Mitigation: Disclosures for Standardized Approaches Securitization Exposures: Disclosure for Standardised Approach Market Risk in Trading Book Operational Risk Interest Rate Risk in Banking Book
Additional definitions and explanations are provided in a series of footnotes.
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Asset Liability Management
Asset Liability Management is a dynamic process of planning, organizing and controlling of assets and liabilities. The objective of ALM is to achieve perfect match between changes in present value of assets and liabilities of the bank. It aims in monitoring, measuring, and managing the Market Risk in banks. At the macro level, the ALM deals with the formulation of policies, capital allocation and pricing strategies. At this level, ALM aims at obtaining profit through price matching while ensuring liquidity through maturity matching. At the micro level, risk management is conducted by managers and individual departments.
Asset Liability Management is standing on three pillars –
Asset Liability Management ALM Information System
ALM Organisation
ALM Process
A) ALM Information System: a. Management Information System b. Availability, accuracy, adequacy and expediency of information.
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B) ALM Organization: a. ALCO: Asset Liability Committee comprises senior management team that decides the strategy and responsible for policy formulation and monitoring. b. Support Group: it consists of operating staff and responsible for managing maturity, currency and interest rate risk.
C) ALM Process: a. b. c. d. e. Liquidity Risk Management Market Risk Management Trading Risk Management Funding and Capital Planning Profit Planning and Growth Projection
The Reserve Bank of India prescribes for preparing the following statements/reports for controlling the risks –
A) Statement of B) Statement of C) Statement of D) GAP Analysis
Structural Liquidity Short Term Dynamic Liquidity Interest Rate Sensitivity Report
Liquidity Management: a. Stock Approach: Ratio Analysis b. Flow Approach: 1. Statement of Structural Liquidity 2. Statement of Short term dynamic liquidity Market Risk: a) Statement of Interest Rate sensitivity b) Gap analysis
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Basel II and Revisions to the Capital Requirements Directive
Remarks by Stefan Walter, Secretary General, Basel Committee on Banking Supervision, to the European Parliament Committee on Economic and Monetary Affairs on the BCBS's reform programme, 3 May 2010.
Introduction
The primary objective of the Basel Committee on Banking Supervision (BCBS) reform program is to raise the resilience of the banking sector, thus promoting more sustainable growth, both in the near term and over the long run. The over-riding objective of the Committee's reform agenda, as endorsed by the G20 and the FSB, is to deliver a banking and financial system that acts as a stabilizing force on the real economy. As we now know, this clearly was not the case leading up to the recent financial crisis. The pre-crisis financial system was characterized by the following weaknesses: a. too much leverage in the banking and financial system and not enough high quality capital to absorb losses; b. excessive credit growth based on weak underwriting standards and under pricing of liquidity and credit risk; c. insufficient liquidity buffers and overly aggressive maturity transformation, both direct and indirect (for example, through the shadow banking system); d. inadequate risk governance and poor incentives to manage risks towards prudent long term outcomes, including through poorly designed compensation systems; e. inadequate cushions in banks to mitigate the inherent procyclicality of financial markets and its participants; f. too much systemic risk, interconnectedness among financial players as well as common exposures to similar shocks, and inadequate oversight that should have served to mitigate the too-big-to fail problem. In particular, the depth and severity of the crisis was amplified by a financial system that entered the crisis with too much leverage, insufficient liquidity buffers and capital levels, and poor incentives for risk taking. The banking sector therefore was too vulnerable to shocks, Page | 36
whatever their source. During the most severe episode of the crisis, the market lost confidence in the solvency and liquidity of many banking institutions. The weaknesses in the banking sector were transmitted to the rest of the financial system and the real economy, resulting in a massive contraction of liquidity and credit availability. I feel certain that had regulatory standards been higher, as the BCBS is now proposing, the crisis would have been less severe and the burden on the public sector and taxpayers would have been lower.
Key elements of the BCBS reform programme
To remedy these fundamental shortcomings, the BCBS reforms promote the following objectives, which link directly to my analysis of pre-crisis shortcomings: a) ensure that all material risks are adequately integrated into and covered in computing the level of required capital (especially those related to trading activities, complex securitizations, and derivatives); b) assure that high quality capital is present to absorb losses arising from all risk exposures; c) introduce additional checks and balances into regulatory, supervisory and risk management frameworks. This includes strong emphasis on the three pillars of the Basel II framework, as well as moving over time to a credible Pillar 1 leverage ratio that serves as a backstop to the risk-based requirement and helps contain the build-up of banking sector wide leverage; d) promote forward looking provisioning and countercyclical capital buffers that raise the ability of the banking sector to absorb shocks when they inevitably come; e) introduce minimum global controlling liquidity risk; standards for measuring and
f) assure that regulation and supervision of systemically important banks is strong, forcing them to internalize the risks they create for the public at large; g) strengthen risk governance and management, building on the Pillar 2 supervisory review process; h) improve market discipline by enhancing Pillar 3 disclosure of firms' risk profile and capital adequacy; and i) promote practical approaches to improve the management of cross border bank resolutions. The BCBS reforms, integrating micro prudential and macro prudential elements are designed to be proportionate to the risks of individual banks' business models, as well as the broader risks that certain activities and institutions pose to the system. Page | 37
A significant proportion of the reforms are targeted at those firms and activities that are systemic in nature. In particular, capital requirements have been increased for trading book activities, counterparty credit risk, and complex securitizations and resecuritisations. Thus, under the newly proposed BCBS standards, systemically important banks will be subject to tougher standards. The BCBS has also put forward a set of proposals aimed at the systemic risks posed by derivative activities. Under these revisions, OTC derivative exposures will be subject to higher capital requirements based on stressed inputs and longer margining periods that reflect the liquidity. Moreover, derivatives exposures that are not cleared through central counterparties that meet the revised CPSS/IOSCO standards will be subject to higher capital requirements, thus increasing incentives to use such central counterparties. Also, exposures among major, interconnected financial institutions have a higher degree of correlation compared to exposures to the corporate sector and would therefore require relatively higher capital. Once the risk coverage of the capital framework has been improved to reflect different business models and different degrees of systemic risk, all banks need to back these exposures with higher quality capital that can absorb losses on a going and "gone concern" basis. In developing its proposals, the BCBS has paid particular attention to the unique circumstances of non-joint stock companies, including cooperatives and savings banks. Moreover, it is the expectation of the Committee that all banks will build buffers above the minimum in good times that can be used in times of stress. Having these countercyclical buffers will make the system more resilient to shocks and reduce the risk of spillover from the financial to the real economy.
Impact assessment, calibration, and implementation
In fashioning the reforms, the BCBS is paying close attention to the impact on the industry and the economy as a whole both during the transition and in the long run. This means putting in place a path to a safer and stronger financial system that keeps growth on track - enhancing welfare in the long run, while at the same time minimizing the economic costs in the short run. Banks have returned to pre-crisis levels of profitability. To a significant extent this is due to the unprecedented public support measures put in place during the crisis. With this in mind, it seems reasonable to expect Page | 38
that these profits will now be used to build capital and liquidity buffers, and not feed excessive bonuses, dividends, and leverage. The BCBS reforms, which the G20 has asked to be finalized by the end of this year, will provide clarity on the new resilience standards that banks should achieve. Moving towards these standards will increase confidence in the system. As history has shown time and again, a weak, undercapitalized banking sector cannot support sound, long-term real economic growth. Current minimum regulatory requirements remain unacceptably low and will not deter a renewed race to the bottom in which financial institutions end up undercapitalized, over-leveraged, and illiquid. For example, the current effective minimum capital requirement is just 2 percent common equity to risk-based assets. This is equivalent to riskweighted leverage of at least 50:1. However, it is based on a diluted definition of bank capital. If one were to use a more robust definition based on tangible common equity - which has become common practice among market participants - the leverage permissible under the current minimum would be even higher. In addition, there is no minimum global standard for liquidity whatsoever, even though poor liquidity at banks was one of the key amplifiers of the crisis. In response, the Committee has proposed internationally harmonized minimum liquidity standards to help ensure that banks can withstand a one-month period of acute stress and to promote banks' resilience over the longer term through incentives to support their activities with more stable sources of funding. The BCBS has put in place a rigorous process to assess the overall impact of its reforms with a view to ensuring that the new standards achieve the objective of greater banking sector resilience while they simultaneously promote maximum sustainable growth. These processes include the following: Public consultation: The December capital and liquidity reforms have been subject to rigorous public consultation. The Committee is now reviewing nearly 300 comments with an eye toward identifying any unintended consequences in either the design or calibration of the proposals. It is important to note that in many cases, higher requirements are being introduced - by design - which will affect those business lines and activities that posed substantial risk to banks and the system. The BCBS wants to make sure that it considers all major consequences of its reforms and the incentives they create. Impact assessment: The BCBS is conducting a comprehensive quantitative impact study to assess the impact of the reform package on individual banks and on the banking industry. The impact study will Page | 39
inform the calibration of the capital requirements and ensure an appropriate set of minimum standards across banks, countries, and business models. Similarly, the liquidity standards will be calibrated so that they promote sound liquidity buffers while allowing for prudently managed business models and sustainable maturity transformation in the banking system. Overall calibration: The Committee is engaging in an analysis to determine the calibration of the overall capital and liquidity requirements, factoring in the cumulative impact of all the individual reform measures, as well as what is necessary to achieve the resilience of the banking sector while ensuring prudent long term availability of credit. Macroeconomic impact assessment over the transition period: The FSB and the BCBS, in close collaboration with the BIS and IMF, are assessing the impact of the reforms over different possible transition periods to ensure that there is no threat to the economic recovery. Moreover, national macroeconomic models (subject to a common set of protocols) are being used to assess the link between higher capital standards, credit availability and costs, and broader economic growth. This framework therefore can accommodate differences in the role of the banking sector in national economies, where some are much more bank driven than others. Based on these four initiatives, by the end of this year the BCBS will develop a balanced set of reforms that promote greater banking sector resilience and maximum sustainable economic growth. The market and bank supervisors have already forced banks to raise their capital and liquidity buffers. However, when competitive pressures reassert themselves, significantly higher minimum requirements will help contain any return to the unacceptably low capital and liquidity levels which made the system so vulnerable to shocks the last time around. It therefore is critical that the calibration of the new standards be based on what is necessary to promote balanced and sustainable banking in the long run. Appropriate implementation time lines and transition arrangements will be used to make the transition to the new standards in a manner that does not jeopardize near term growth. Failure to set the right long run levels will undermine near-term confidence and jeopardize long-term financial stability. The BCBS is comprised of 27 countries and it conducts its work under the review of its oversight body, the Group of Central Bank Governors and Heads of Supervision of its member jurisdictions. The work of the Page | 40
Committee also is being reviewed closely by the Financial Stability Board. In addition to monitoring the consistency with the G20 reform mandates and the broader economic implications of the transition to the new standards, the FSB process will ensure that the BCBS reforms are integrated into a coherent overall set of reforms to strengthen global financial regulations. Consistent with the G-20's mandate, rigorous processes have been put in place to ensure that all countries implement the full set of international prudential standards. Consistent and timely implementation of standards by all jurisdictions is critical to promoting a global level playing field.
Conclusion
The Basel Committee is on schedule to deliver a fully calibrated package of global standards for capital and liquidity by the end of this year. It is conducting a wide range of analyses to ensure that the design of the reforms is appropriate and that they produce a more stable financial system and economy over the long run without jeopardizing growth in the near term. The BCBS reforms are intended to be forward looking, making the system more resilient to future crises, whatever their source. While certain banks and countries may not have "caused" the current crisis, everyone was affected. All countries and financial institutions benefited from the public sector interventions to stabilize the economy, the functioning of markets, and the resilience of counterparties. Moreover, past crises have emerged from all regions of the world, covering a wide range of products, and affecting all types of business models and asset classes (retail, commercial real estate, sovereign lending, corporate lending, trading activities, securitizations, and underwriting). While we cannot with certainty predict the source of the next crisis, we can however lay the groundwork to help mitigate or minimize the impact. It is therefore critical that all banks and countries strengthen banking sector resilience, particularly given the global and diverse nature of financial markets and the speed with which shocks are transmitted across countries. This and previous crises have shown that the deepest and most prolonged downturns arise when the banking sector gets into serious trouble and no longer has the capacity to perform its core credit intermediation function.
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Treasury Management and New Age Technology
With risk management becoming and increasing part of the corporate treasurer?s job and the development of technology, the technology is playing and ever more pivotal role. In this year?s of new age technology, the convergence between Treasury and Technology can be looked into three main areas- Currency, Capital and Foreign exchange. With the advent of internet banking, mobile banking, the frontiers are no barrier now – transaction may flow from anywhere around the world. Trading in securities, commodities, foreign exchange are just a click away now. This has made the job of the treasurers much more difficult. Portfolio management, Liquidity management and maintaining the margin has become more technology oriented. Every organization must have a sound technological base and to keep pace with the advancement of technology to survive. Here are some technology providers in India, who provide modern technological support for treasury management – a) TATA Consultancy Services – TCS BaNCS Treasury Solutions website: www.tcs.com b) Genesis Software: www.genesissoftware.co.in
c) Surya Software Systems: ALM, Credit Risk, Capital Adequacy, Transfer Pricing, Corporate Treasury website: www.suryasoft.com d) Techno Brain India Pvt. Ltd.: Integrated Treasury Management System
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Speech by Dr. Nout Wellink, Chairman of the BCBS on Basel II
Nout Wellink: Global banking supervision in a changing financial environment
Formal opening address by Dr Nout Wellink, President of the Netherlands Bank and Chairman of the Basel Committee on Banking Supervision, at the 14th International Conference of Banking Supervisors, Mérida, Mexico, 4 October 2006. Introduction Good morning. It is an honour and a privilege for me to officially open the proceedings of the 14th International Conference of Banking Supervisors. This is my first formal address as Chairman of the Basel Committee on Banking Supervision, and I can’t imagine a more appropriate venue for my first speech than here with my colleagues from the international banking supervisory community. In addition, this year’s ICBS is the first to be held in Latin America, and I’m very pleased that we have at long last gathered in this rapidly growing and dynamic region. Since we gather at the ICBS to bring together our varied views and experiences, it is appropriate that we are here in the beautiful city of Mérida, which reflects the diverse influences of Europe, the Caribbean and the local Mayan culture. I would especially like to extend my sincerest thanks to Jonathan Davis and his staff at the Mexican National Banking and Securities Commission for their warm and generous hospitality. Not only have they put together what I expect will be a very thought-provoking programme of speakers and working groups, but they have also arranged a fascinating programme of events to better acquaint us with the colourful history and culture of Mexico and its Yucatán region. Before I begin, let me acknowledge one of our colleagues who was supposed to be joining us here. As you are no doubt aware, Andrei Kozlov, first deputy chairman of the Central Bank of Russia, was recently and tragically slain. We will remember Mr Kozlov for his tireless efforts to promote the safety, soundness and integrity of the banking system. His death is a great loss to the international supervisory community. In my remarks this morning, I would like to touch on several key themes. First, I will briefly review the work that has taken place since we last gathered two years ago in Madrid. I would then like to share some thoughts on developments in financial markets and the banking sector, and on how these developments influence the types of issues that both supervisors and the industry face. Finally, I will end with thoughts on the future agenda of the Basel Committee. In particular, I will emphasise our commitment to Basel II implementation, the need to monitor and assess the broad impact of the new capital standard, and the importance in all our work of minimising any unwarranted burden on the industry. Octavio Paz, the Nobel Prize winning Mexican poet and author, once said that “wisdom lies neither in fixity nor in change, but in the dialectic between the two”. As I will discu ss shortly, we are in a time of rapid change, and we must continue to adapt. But at the same time, we must not lose sight of the fundamental elements of banking supervision. I believe that, as supervisors, we need to evolve to keep pace with changing developments, while also making sure that we retain the basic lessons that have served us well over the years. My hope going forward is that we all benefit from the wisdom of striking the correct balance between change and stability. Recent supervisory developments As I think ahead, I am greatly encouraged that the Committee’s recent work – under the steady guidance of my predecessor, Jaime Caruana – demonstrates an awareness of the need to strike this balance. Supervisors face an ever growing challenge of devising appropriate prudential structures for a financial industry that is in a constant state of change. In recent years, for example, we have witnessed an ongoing revolution in banks’ risk management practices. More and more, banks are taking a firm-wide approach to risk management that considers a broader array of risks, across a wider range of product lines and regions. Risk managers have become increasingly more disciplined
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in their approaches, harnessing both technology and advanced quantitative techniques in the process. Such changes require that supervisors design flexible standards and regulations that ensure a safe and sound banking system while still allowing for continued innovation in bank practices. The Basel II framework is designed to achieve this balance. It represents a fundamental paradigm shift in how we think about capital regulation. The advanced approaches to credit and operational risk rely on banks’ own assessments of risk as inputs to capital calculations, a recognition that banks are best positioned to understand and measure the risks that they face. In addition, because the quantitative and qualitative parameters for using the advanced approaches are intended as a baseline of sound practices, they can accommodate continued innovation by firms. And since the advanced approaches are driven by rigorous internal processes for risk measurement and management, they are clearly well suited for today’s sophisticated global banks. Indeed, the results of our fifth Quantitative Impact Study reveal that virtually every global bank intends to implement one of the advanced approaches. In combination with the role assigned to supervisory review and market discipline, these features of the new framework represent a more forward-looking approach to capital regulation, with the flexibility to evolve over time. A similar approach is evident in the new capital rules for certain exposures in the trading book, published in July 2005. Among other things, these rules update the trading book capital framework to better reflect the growth in traded credit products. The rules directly recognise the realities and complexities of today’s markets, and demonstrate that, even in the face of such complexity, greater harmonisation of regulations across sectors is possible. The Basel Committee has also strengthened its collaboration with banking supervisors throughout the world. This cooperation is particularly important for the success of Basel II, which raises many challenging questions regarding the roles and responsibilities of home and host supervisors. As one example, the Basel Committee’s recent paper on Home-host information sharing for effective Basel II implementation was developed jointly with a group of supervisors from a range of other countries. Likewise, 19 countries from outside the Committee submitted data to the fifth Quantitative Impact Study, allowing for a fuller understanding of the likely impact of the new framework on overall capital levels. Our commitment to working closely with non-member countries on Basel II implementation is also evident in their representation in the technical subgroups of the Accord Implementation Group. The Basel Committee also worked closely with supervisors from around the world on the updates to the Core Principles for Effective Banking Supervision. In what was truly a global effort, we have all succeeded in designing a practical yet flexible framework. It recognises not only the changes in financial markets and supervisory practices since the Core Principles were first published in 1997, but also that these changes have not occurred evenly across jurisdictions. The outcome of our effort, I believe, will allow for the application of the Principles to less sophisticated financial systems, without sacrificing their relevance for assessments of more complex systems. International accounting and auditing standards have also evolved rapidly in recent years. As supervisors, we are keenly interested in ensuring that banks’ accounting practices promote sound risk management practices, reinforce the safety and soundness of the banking system, and support market discipline through transparency. Where objectives of accounting standard setters diverge from those of bank supervisors, supervisors may have to put in place additional safeguards. Likewise, when audit reliability is called into question, supervisors may need to take steps to encourage greater reliability. Given these interests, the Basel Committee has taken an active role in the debate on changes to the framework for international accounting standards and promoting stronger global auditing oversight. As we look back on our accomplishments since we last assembled, I believe we have much to be proud of. In our completion of the Basel II rules, our attention to Basel II implementation issues, and our updates to the Core Principles, we have pursued approaches that have the flexibility to accommodate the continued evolution of bank and supervisory practices. We have also recognised the critical contributions that the broader supervisory community, the industry and other standard-setting bodies can and must make. All these efforts amount to significant contributions to ensuring the robustness of the financial system in the face of any future shocks.
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Evolving financial markets and emerging risks At the same time, however, the pace of innovation in financial markets shows no sign of slowing. Thus, even as we look back, we must look forward to ensure that our work remains appropriately focused on the most relevant risks. In this process, an important first step is considering market developments that affect how we view risk in the banking sector. This is the second topic of my remarks this morning. The role of banks is changing. As we know, banks have historically been the primary source of financial intermediation in most economies, with the loans they originated serving as their primary assets. Now, however, banks increasingly originate loans and other types of credit instruments with the intent of securitising them and selling them to other market participants. While it may be the case that banks in the end hold fewer credits on their balance sheets, I believe that it would be wrong to say that banks now play a less important role in credit markets. Banks, as well as securities firms, are at the centre of a new risk intermediation landscape that is increasingly based on traded products. In this new landscape, banks and securities firms are actively involved in origination, securitisation and active management of credit exposures. This shift to capital markets-based distribution of risk has been accompanied by increased velocity in intermediation, aided by new technologies that allow for greater automation and standardisation. And the greater role of capital markets in intermediation also implies that many of the risks once held by banks are now held by other types of market participants. The greater reliance on capital markets in credit origination and distribution has also served to unlock the creative potential of market participants. We see this, for example, in products that not only bundle loans with similar characteristics prior to sale, but also then structure the resulting securities into tranches with different risk profiles. We have also witnessed explosive growth in over-the-counter derivative products that give exposure to, and provide hedging vehicles for, a growing array of new and increasingly complex risks. To give some sense of the volume of this activity, the International Swaps and Derivatives Association recently estimated that the gross notional amount of outstanding credit derivatives was $26 trillion, a growth of over 50% in just six months. While I believe that these changes have made the banking system more resilient, these developments also pose a range of risks that both supervisors and the industry need to monitor closely. In a very broad sense, many of the challenges that we face stem from the mismatch between rapid market innovation and risk management infrastructure. The rapid growth in the markets for new financial products, and the entry of a diversity of participants into these markets, frequently strain the capacity of banks to manage the associated risks. If not addressed promptly and appropriately, these circumstances can have significant consequences for financial market stability. It is therefore imperative that we explore the extent to which the management of risks such as counterparty credit risk, market risk, liquidity risk and operational risk evolve in the face of market innovation. Globalisation is another important trend in the banking industry. A combination of liberalisation of financial markets over the past two decades and business opportunities in rapidly growing economies has led to an increasing proportion of global bank activities in foreign countries. This is particularly the case in capital markets, but also in areas such as retail where the presence of global banks in local markets continues to grow. As a result of cross-border mergers and acquisitions, an increasing number of banking markets now have a significant foreign bank presence. In general, I would argue that the scale of foreign banks operating in emerging markets allows them to bring expertise and financial resources that might not otherwise be available. They can also introduce more sophisticated risk management tools that may have been developed for the larger financial group. While these benefits are significant, the scale of foreign banks’ presence can have implications for host countries. For example, a local financial system could be disproportionately dependent on the safety and soundness of a small handful of foreign banks. This has potentially significant implications for how banks in these markets are supervised. It is one of the great challenges of our work that as many banks’ operations and risk management frameworks become more global, the supervisory structure remains national. Thus, as we work to address the issues I have highlighted, supervisors must also solve problems of cross-border information sharing and coordination, and clearly define those areas where supervisory responsibilities overlap and those where they diverge. Our recent updates to the Basel Core Principles show that we have been up to these challenges. The process of updating the Principles was a truly global supervisory effort and demonstrated our capacity to cooperate and seek a common understanding on many important issues. And the result – a global standard whose local application
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can be scaled in proportion to local risks and financial market realities – demonstrates our ability to work effectively within the constraints imposed by using national structures to supervise global institutions. Future work of the Basel Committee Given the developments that I’ve just cited, where do we go from here? How do we strike the appropriate balance between change and stability? My third topic this morning is to share some ideas on where I see the importance of work in the supervisory community over the next several years. I will focus my remarks on three key areas: our commitment to Basel II implementation; the importance of assessing and monitoring the impact of Basel II; and the need for proportionality in supervisory efforts relative to underlying risks in order to minimise the regulatory burden on the industry whenever possible. Basel II implementation Let me begin with Basel II implementation, which remains the key item on the C ommittee’s agenda. As I mentioned at the outset, Basel II represents a fundamental paradigm shift in the supervisory approach to capital regulation. This new approach is entirely necessary if capital standards are to keep pace with rapid innovation in financial products as well as in risk measurement and management techniques, and the ever increasing complexity of firms’ risk profiles. As such, the new framework is absolutely critical to the health and stability of the banking system. Given the importance of Basel II, I am pleased to report that implementation is fully under way. For example, implementing legislation or regulation is either in place or in process in markets such as the European Union and Japan. Likewise, supervisory agencies in the United States recently issued their notice of proposed rulemaking. Meanwhile, banks are continuing their discussions with supervisors on their specific Basel II plans, in many cases with a goal of implementation next year. Let me not, though, gloss over the difficulties involved in successful implementation. For example, it is clear that home-host issues remain among the most challenging for both supervisors and the industry. In addressing these issues, we should strive to achieve as much cross-border consistency as possible on key elements of the framework. At the same time, we should also recognise that both home and host supervisors have legitimate interests that need to be met and national implementation will vary in relation to local needs. Indeed, the tension inherent in applying a global standard within national supervisory regimes will never fully dissipate. Issues must often be resolved on a case by case basis, seeking pragmatic solutions that recognise the limits of what can be accomplished. Going forward, we must extract lessons and principles from specific cases and apply them back to our overall Basel II work. This is an iterative process, and one that will help to maximise consistency in implementation across banks and jurisdictions. In this regard, the Committee’s Accord Implementation Group, or AIG, is working to share information and thereby promote greater consistency in implementation across countries. As we address the challenges of Basel II implementation, we must remember that Basel II is more than a one-off exercise in getting the details and the numbers right. More than anything, it is a flexible framework that supports innovation over time, and provides appropriate incentives for improvements to risk management, supervision and disclosure. Basel II is as much about this long-term process, and the beneficial dialogue it has spurred between banks and supervisors, as it is about the more micro-level details of implementation. It provides the medium for interaction with the industry on a number of complex issues, and for thinking about how risk management and supervisory practices are likely to evolve over time. I encourage all of us not to lose sight of this important aspect of Basel II. The impact of Basel II I would also like to address the importance of understanding the impact of Basel II on banks and markets. Many banks, and market participants more broadly, have voiced concerns that the new framework could have unintended consequences on banks’ risk -taking and capital allocation in both the short and the long term. These consequences could occur across different dimensions, for example firm size, risk profile and jurisdiction. There could also be consequences for banks’ activities relative to those of securities firms.
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The Committee has been sensitive to the potential impacts of Basel II throughout its development, and this will not change as we move into implementation. I believe that shorter-term consequences, such as those related to so-called “gap year” issues arising from different implementation dates, will ultimately resolve themselves as these gaps disappear over time. This will be easier if there is constructive dialogue during this transitional period with the industry and among supervisors from jurisdictions with varying implementation dates about how best to address these short-term challenges. Some of the longer-term consequences, however, may be more difficult to predict but in many instances are likely to be the natural result of a more risk-sensitive framework. So as a first step in any discussion of longer-term consequences of Basel II, supervisors and banks should distinguish between those that reflect the closer alignment of regulatory and economic capital, and those that are indeed unintended and undesirable. Indeed, where regulatory and economic capital are more closely aligned, I expect that this will have a levelling effect on the playing field by eliminating any competitive distortions caused by Basel I. In addition, as is currently the case, I expect that banks’ decisio ns will be driven more strongly by assessments of risk and return than by regulatory capital considerations. Nevertheless, we must closely monitor and assess the impact of Basel II to mitigate the possibility of any competitive distortions. Failure to do so would undermine much of what is innovative and beneficial in the new framework. While I do not currently expect that it will be necessary, the Committee remains prepared to revisit aspects of the rules where there is clear evidence during the coming transition years of unintended consequences for risk-taking and capital allocation. We must also be attuned to the risk that these consequences can result from inconsistent application across banks or sectors, particularly for rules related to risk assessment and quantification. This is an area where the AIG and its subgroups will continue to actively exchange information on observed industry and national supervisory practices. I would like to highlight what I believe is a major accomplishment in this regard. Earlier in my remarks I mentioned the new trading book rules, which were developed jointly with our colleagues from the International Organization of Securities Commissions. Through this cooperative effort, we have developed a common framework for the convergence of capital requirements for banks and securities firms, which is a significant step towards providing a more level playing field.
Proportionality of supervisory efforts As an important guiding principle for future supervisory areas of focus, we need to ensure that the scope and scale of any work we undertake is commensurate with the risks we seek to address. The realities of today’s banking industry and financial markets argue for more measured and flexible approaches. In an environment of continuous innovation and growing competition within and across sectors, it is important that regulators assess the appropriate balance between formal regulatory responses, enhancements to supervisory tools, industry solutions and market discipline. In the years to come, it is inevitable that the Committee will choose to develop guidance aimed at strengthening supervisory practices or highlighting necessary improvements to banks’ risk management. However, I anticipate that there will be many more instances where we decide to limit our work to stocktaking exercises and information exchange, or defer work altogether so that industry and national supervisory initiatives have the time and flexibility to run their course. As we consider the trade-offs of these types of approaches, we will continue to seek industry input on the intersection of market developments, the robustness of risk management practices, and the adequacy of supervision and regulations. In doing so, we will be able to build on the excellent dialogue that has existed around Basel II. Guided by this principle of proportionality, I would like to explore some broad aspects of the Committee’s agenda. These include cross-border information sharing, banks’ risk management practices, supervisory techniques and cross-sector coordination. My goal is not to provide specific details on potential projects, but to give you some sense of how the Committee perceives its role in the international supervisory community.
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Cross-border information sharing Looking first at information sharing, one of the main challenges I see going forward relates to the tension, if you will, between regulatory structures and market realities. A trend that we see is that banks increasingly manage risk on a global basis. This poses a challenge to us as supervisors since we generally operate within national regulatory structures (for very sound reasons, I might add). Supervisors will need to depend ever more on information provided by their colleagues in other jurisdictions, and will need to set up the appropriate mechanisms for doing so in ways that do not impose a burden on one another, or on the industry. In particular, we need to consider how supervisory information sharing and coordination can be deepened and broadened. Risk management practices We will also need to stay abreast of the latest developments in risk management and be attentive to the possibility that these developments may, as they have on occasions in the past, lag innovations in financial products and markets. Where such lags between financial innovations and risk management practices arise, the Committee will consider the merits of issuing guidance that conveys to banks and supervisors the sound practices that institutions should be following. Moreover, there is significant value in supervisors providing the industry with transparency about the range of practices they see in areas where financial innovation and risk management practices are evolving rapidly. For example, I think the Committee might usefully explore industry practices in areas such as counterparty credit risk, liquidity risk management and techniques for assessing economic capital. We will also continue our important work in the accounting sphere, to ensure that accounting and sound risk management practices are properly aligned. Moreover, ongoing changes in the accounting framework can have important implications for valuations, capital, and disclosure practices, and the Committee will continue to monitor developments in this area closely. Supervisory techniques The sharing of information on emerging supervisory practices will remain a fundamental role of the Basel Committee. It is not uncommon for national supervisors to pursue different approaches when adapting to changes in industry practices and market structures. Given the dynamic nature of the financial industry, diversity in supervisory practices is to be expected, and even encouraged in instances where our methods and processes continue to evolve. As best supervisory practices emerge, however, we have a strong interest in ensuring that these practices are clearly articulated and widely disseminated. Doing so will help to raise the level of global supervision, reduce any competitive distortions resulting from differing practices, and ultimately contribute to the resilience of the financial system. Cross-sector coordination In these and other efforts, it is equally important that we work closely with our fellow supervisors in the securities and insurance sectors, as firms in the three sectors increasingly compete across a range of products and markets. I have already mentioned our joint work with IOSCO on the trading book, and I am encouraged that securities regulators remain involved in our continued exploration of trading book issues, an area of growing importance as credit products become increasingly and actively traded. We will also continue to work closely with securities regulators and insurance supervisors under the auspices of the Joint Forum, which focuses on issues common to the three sectors, including the supervision of financial conglomerates and areas such as risk concentrations and management of complex retail products. Enhancing dialogue In all of our work, one of my key goals as Basel Committee Chairman is to maintain and enhance the dialogue with the wider supervisory community. For example, I earlier discussed the growth of crossborder banking and the challenges this poses for both home and host supervisors. This makes it essential that the Committee have a keen understanding of these challenges from both a home and a host supervisor perspective. In recent years, the Committee has strengthened its outreach through, for example, more frequent meetings with chairs of regional groups of banking supervisors and with the Committee’s Core Principles Liaison Group, which includes representatives from 16 non -G10 countries. This dialogue has been absolutely essential and must continue and be strengthened.
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Concluding thoughts In closing, as I mentioned earlier in my remarks, over the past several years we have tried to design flexible, principles-based standards that foster greater resilience in the banking sector while allowing for continued innovation on the part of banks. Looking at the pace of innovation in financial markets, the changing role of banks and the more globally interlinked banking industry, we must continue to respond in kind. Going forward, I expect the Committee will continue moving full speed ahead with Basel II implementation, assessing the impact of Basel II, and maintaining a sense of proportionality so as not to overly burden the industry and ourselves. Moreover, while we will probably continue to issue supervisory guidance as necessary in the future, we will also focus on some of the “basics” such as cross-border information sharing, understanding bank risk management practices and supervisory techniques, cross-sector coordination, and dialogue with the industry and among bank supervisors. In adapting to a changing world, we must not lose sight of the basic supervisory tools that have served us so well over the years. We should continue to encourage the development of sophisticated tools for better risk management, but we should also continue to emphasise simple but vitally important concepts such as sound corporate governance. We should strive to understand the increasingly complex quantitative models that banks increasingly rely upon, but not lose sight of the importance of sound judgment on the part of bankers as well as supervisors. I hope that you find the next several days in Mérida enlightening, challenging, energising and even, dare I say, fun. Thank you very much, and I look forward to exchanging views not just during this ICBS, but over the coming years as well.
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CASE STUDY
A study carried on an Urban Cooperative Bank shows that the principles of treasury management applied following the guidelines issued by RBI can make a bank to stand on a sound financial base and to grow safe.
Name of the bank :The Baidyabati Sheoraphuli Cooperative Bank Limited Address : 6, Kalahata Lane, Sheoraphuli, Hooghly Pin – 712223
Balance Sheet as on 31.03.2011 (Audited) Sources Amount
(Rs. In lac) Share Capital Reserves & Surplus Deposits: SB CA Term Deposit Interest payable on deposit Bills payable Bills for collection Sundry Liabilities Overdue Interest Suspense Profit & Loss Appropriation Total Applications Cash Balances with other banks CA SB Term Deposits Investments Advances (NPA=439.44) Bills receivable Interest Receivable Fixed Assets Sundry Assets Total
Amount
(Rs.In lac) 134.31 1198.51
3266.25 58.48 2674.01
5998.74 69.13 2.80 37.00 328.90 138.23 1134.51 9042.13 29.47
: 281.41 14.88 1717.17 2013.46 2511.67 3677.96 37.00 468.78 31.80 271.99 9042.13
We shall apply the Asset Liability Management techniques and Basel II norms to find out the financial soundness and the strength of the capital to stand against the risks. Page | 50
Basel II applications: Risk Weighted Assets
Particulars
Cash in hand Cash at bank:CA Investments: Govt. Securities Commercial Banks Non-SLR investments Advances: Loan agst LIC/KVP/Dep Loan to Staff House Building Loan Personal Loan Gold Loan Others Premises, Furniture & Fixture Other Assets Interest due on Govt. Securities Interest due from banks Interest due from AIFI Bonds Interest due on housing/gold loan Interest due on staff loan Interest due on loan agst NSC/KVP Interest due on other loans Other Assets TOTAL
Book value
29.47 281.41 1979.18 1732.05 532.49 54.85 6.69 157.62 95.23 413.16 2950.41 31.80 13.03 312.72 4.80 31.30 0.02 6.66 100.25 271.99 9005.13
Risk weight%
0.00 20.00 2.50 20.00 102.50 0.00 20.00 50.00 125.00 50.00 100.00 100.00 0.00 20.00 102.50 50.00 20.00 0.00 100.00 100.00
RWA
0.00 56.28 49.48 346.41 545.80 0.00 1.34 78.81 119.04 206.58 2950.41 31.80 0.00 62.54 4.92 15.65 0.00 0.00 100.25 271.99 4841.30
Capital Fund A.Tier I Capital Fund Paid up Capital Reserves & Surplus Statutory Reserve Special Reserve Profit & Loss Appropriation B.Tier II Capital Investment Fluctuation Reserve General Provisions TOTAL CAPITAL FUND TOTAL RWA Tier I Capital to RWA CRAR Other Assets TOTAL
Rs.in lac
Rs.in lac
134.31
Rs.in lac
256.97 61.03 1134.51
1452.51
1586.82
110.00 61.82
171.82 1758.64 4841.30 32.78% 36.33% 271.99 4841.30
271.99 9005.13
100.00
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The Baidyabati Sheoraphuli Cooperative Bank Limited Statement of Structural Liquidity as on 31.03.2011 Outflow
Share Capital Reserves & Surplus Deposits SB & CA Term Deposit Interest Payable on Deposit Bills Payable Bills for Collection Sundry Liabilities Overdue Interest Suspense Profit & Loss Appropriation TOTAL(A) Inflow Cash Bank Balances CA & SB Term Deposits Investments SLR Others Advances Standard NPA Bills Receivable Interest Receivable Fixed Assets Sundry Assets TOTAL(B) Mismatch Cumulative mismatch Mismatch %
1-14 days
15-28 days
29-90 days
3-6 months
Up to 1 year
1-3 year
3-5 year
Above 5 year
134.31 1198.51
Total
134.31 1198.51
831.18 75.69 69.13 2.80 37.00 49.34
24.33
219.54
313.93
416.88
2493.55 1182.18
275.69
165.77
3324.73 2674.01 69.13 2.80 37.00
279.56 138.23
328.90 138.23
1134.51 1065.14 29.47 296.29 30.73 226.72 1011.98 322.21 37.00 45.10 6.08 24.33 219.54 313.93 416.88 3675.73 275.69 3050.89
1134.51 9042.13 29.47 296.29 1717.17 2511.67 1499.69 1011.98 3677.96 3238.52 439.44 37.00 468.78 31.80 271.99 9042.13
27.47 54.89
218.00 78.48
718.98 104.22
721.21 918.93 68.92
0.78 41.45
325.62
609.92
647.10
803.90
309.25
220.52 439.44
15.02
15.98
75.32
131.00
119.52
32.14
34.70 31.80 271.99 820.16 -2230.73 00
1999.50 934.36 934.36
346.72 322.39 1256.75
708.26 488.72 1745.47
1018.90 704.97 2450.44
1758.10 1341.22 3791.66
2068.91 -1606.82 2184.84
321.58 45.89 2230.73
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The Baidyabati Sheoraphuli Cooperative Bank Limited Statement of Interest Rate Sensitivity as on 31.03.2011 Outflow
Share Capital Reserves & Surplus Deposits SB & CA Term Deposit Interest Payable on Deposit Bills Payable Bills for Collection Sundry Liabilities Overdue Interest Suspense Profit & Loss Appropriation TOTAL(A) Inflow Cash Bank Balances CA & SB Term Deposits Investments SLR Others Advances Standard NPA Bills Receivable Interest Receivable Fixed Assets Sundry Assets TOTAL(B) Mismatch Cumulative mismatch Mismatch %
1-28 days
29-90 days
3-6 months
Up to 1 year
1-3 year
3-5 year
Above 5 year
Non Total Sensitive
134.31 1198.51 134.31 1198.51
100.02
219.54
3266.25 313.93
58.48 416.88 1182.18 275.69 165.77 69.13
3324.73 2674.01 69.13
2.80 37.00 328.90 138.23
2.80 37.00 328.90 138.23
1134.51 100.02 219.54 3580.18 416.88 1182.18 275.69 165.77 3101.87 29.47 14.88 218.00 78.48 281.41 718.98 104.22 721.21 918.93 68.92 0.78 41.45
1134.51 9042.13 29.47 296.29 1717.17 2511.67
30.73 232.80 1011.98 647.83
27.47 54.89
3677.96 609.92 647.10 803.90 309.25 220.52 439.44 37.00 468.78 31.80 271.99 1559.89 -1541.98 00 37.00 468.78 31.80 271.99 9042.13
1923.34 1823.32 1823.32
692.28 472.74 2296.06
958.46 -2621.72 -325.66
1627.10 1210.22 884.56
1949.39 767.21 1651.77
289.44 13.75 1665.52
42.23 -123.54 1541.98
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The Baidyabati Sheoraphuli Cooperative Bank Limited Statement of Short Term Dynamic Liquidity as on 31.03.2011
Outflow Net increase in advances Net increase in investments Inter bank commitments Off balance sheet items Others TOTAL Inflow Net cash position Net increase in deposits Interest on investments Inter bank claims Off balance sheet items others TOTAL Mismatch Cumulative mismatch Mismatch %
1-14 days 58.00 6.00
15-28 days 58.00 6.00
29-90 days 230.00 25.00
Total 346.00 37.00
4.00 68.00 10.25 49.00 45.10
4.00 68.00 10.25 49.00 15.02
16.00 271.00 31.00 195.00 15.98
24.00 407.00 51.50 293.00 76.10
104.35 36.35 36.35
74.27 6.27 42.62
241.98 -29.02 13.60
420.60 13.60 00
Analysis:
1) From the analysis of the Statement of Structural Liquidity, we find that there is no negative cumulative mismatch in any time bucket, which confirms that the bank has sufficient amount of surplus liquid assets. 2) From the analysis of the Statement of Short Term Dynamic Liquidity, we can say that the bank will not suffer from any liquidity crisis in the near short term, as there is no negative cumulative mismatch in any time bucket. 3) From the analysis of the CRAR (Basel II), we can find that the bank stands on a very sound financial base. The capital fund of the bank is much higher than the prescribed international norm of minimum 6% for Tier I Capital and 9% for total Capital fund.
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To whom it may concern
I hereby declare that the project report titled “ Treasury Management in Banks” submitted in partial fulfillment of the requirement of the degree of MBA from Sikkim Manipal University, India is my original work and not submitted for the award of any other degree, diploma, fellowship or any similar title or prizes.
Signature Place: Sheoraphuli Date: Name: Sourav Bandyopadhyay Registration No. 5521020146
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ACKNOWLEDGEMENT
I would like to extend my deep gratitude and obligation to them who have helped me in the field to complete the project.
I am grateful to Dr. Arunava Sinha (CED, SMU Learning CentreSerampore) for his kind inspiration, guidance and valuable suggestion during the course of my project work.
I also express my gratitude and obligation to Dr. Arunava Sinha (CED, SMU Learning Centre – Serampore), Mr. Kunal Paul and Miss Debarati Roy and my friends and staff of Institute of Information Technology ( Study Centre of Sikkim Manipal University, Serampore, Hooghly) for their help in different aspects.
I also thank to all those people without the support of them it was impossible for me to complete this project.
Name of Centre: Institute of Information Technology Centre Code: 00199
Signature Place: Sheoraphuli Date: Name: Sourav Bandyopadhyay Registration No. 5521020146
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Examiner?s Certificate
The Project Report of Sri Sourav Bandyopadhyay titled “Treasury Management in Banks” approved and acceptable in quality and form.
Internal Examiner Name: Dr. Arunava Sinha Qualification: MBA, PhD (CS), JU Designation: CED, SMU LC
External Examiner Name: Mr. Rituparna Thakur Qualification: MBA (Finance) Designation: Senior executive
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Gratitude:
1) 2)
SMU Learning Centre, Serampore
The Chief Manager, The Baidyabati Sheoraphuli Bank Limited
Cooperative
3)
Reserve Bank of India official website: www.rbi.gov.in
4)
The Institute of Chartered Accountants of India www.icai.org.in
website:
5)
Official website of Bank of International Settlement website: www.bis.org
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doc_281387158.docx
TREASURY MANAGEMENT IN BANKS
PREPARED BY
SOURAV BANDYOPADHYAY
ROLL NO 521020146
Sikkim Manipal University
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Contents
Page No.
? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?
Treasury Management, needs and benefits Treasury functions Treasury Products Securities, Foreign Exchange Market Derivative Treasury Operations in bank Integrated Treasury Management Risk Management Risk management process Classification of risks Credit Risk Management Market Risk Management Operational Risk Management Extracts from RBI Master Circular Basel II Accord and Reserve Bank of India Asset Liability Management Remarks by Stefan Walter Treasury management and new age technology Speech by Dr. Nout Wellink on Basel II Case Study Gratitude Declaration Acknowledgement Examiner?s Certificate
03 04 05 06 07 08 08 09 10 10 13 14 14 15 22 33 35 42 43 50 55 56 57 58
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TREASURY MANAGEMENT
Treasury management is the process of managing and organizing the finance to optimize the economic growth in the organization. It is the process of planning, organizing and managing the organization?s holdings, corporate bonds, currencies, financial futures, options, derivatives, payment systems and associated risks.
“Treasury is the place of deposit reserved for storing treasures and disbursement of collected funds.” Teigen Lee E
Need:
Treasury management is mainly required to optimize the economy of the organization and provide an ability to manage financial risks.
Benefits:
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It increases the sales of the product. It provides better guidelines and methods to manage risks. It helps to optimize asset and debt performance while minimizing the needs for external funding. It enables the organization to analyze a variety of data which includes funds, transactions, foreign exchange rates, market data and third party information. Page | 3
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Risk Exposure
Treasury management is exposed to various risks in the organization.
Exposure
To Risks Financial Foreign Exchange
Currency
Commodity
Event
Treasury Functions
The traditional treasury functions can be depicted as below –
Treasury Functions
Cash Management
Currency Management
Fund Management
Corporate Finance
Risk Management
Cash Management: It deals with managing the collection and repayment of cash. Currency Management: It deals with foreign currency and exchange rate management.
Fund Management: It is the process of planning and outsourcing the short, medium and long term cash needs. Page | 4
Corporate Management:
It deals with achieving strategic financial goals.
Risk management:
It deals with balancing risks and returns thus optimizing profits and protecting assets.
Treasury Products:
Treasury products are the products available in the market and used for generating yields and manage the liquidity mismatch.
Treasury Products
Money Market
Securities Market
Foreign Exchange Market Derivative
Money Market:
According to RBI, money market is -“The centre for dealings, mainly short term character, in money assets; It meets the short-term requirements of borrowers and provides liquidity or cash to the lenders”
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Money Market Products
Call/ Notice Money Treasury Bills
Commercial Paper
Certificate Of Deposits
Commercial Bills
Repo/ Reverse Repo
Securities Market:
Securities market deals with all types of securities and ensures equal access to all investors through appropriate channels.
EQUITY S E C CAPITAL MARKET DEBT
PRIMARY SECONDARY Bonds, Debentures
IPO, Rights Issue, Preferential Issue Equity, Bonus, Rights
Government Securities U R I T I E S Foreign Exchange Derivatives Commodities OTC, Exchange Based and Futures Foreign Currency SWAPS, Options etc.
Participatory Notes ADR/GDR
M A R K E T Page | 6
Foreign Exchange Market:
Foreign exchange is a market where currencies of various countries are traded and it facilitates international trade and investments.
Derivative:
A stock derivative is a financial contract structured on an underlying asset which are equity, forex, or any other assets. The value of the derivative is dependent on the price of the underlying stock. These contracts help the investors to lessen the price risk, arising out of movement in prices of the underlying assets. A derivative contract helps to fix the price of the underlying asset on a future date.
Derivative contracts commonly used are –
1) Forward Contract: A forward contract is a derivative that has an agreement to buy or sell an asset on a predetermined future date at an agreed price.
2) Future Contracts: Future contracts are structures for the delivery of the underlying asset on an agreed future date. It is a transferable specific delivery forward contract. Futures can be interest rate futures, currency futures and index futures.
3) Option Contracts: These are contract between two parties where one party has the right to take delivery of an underlying asset but not the obligation, but the other party has the obligation to give or take delivery. Options provide the holder the right to buy (call) or sell (put) securities at a predetermined price within a specified period. The options can be on securities, commodities, index, currencies and futures.
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Treasury Operation in Banks
Currently, most of the Indian banks have classified their business into two primary segments viz. Banking Operations and Treasury Operations.
Treasury Operations in Banks
Foreign Rupee Treasury Exchange Treasury Derivatives
Integrated Treasury Management
Interest rate deregulation, liberalization of exchange control and development of foreign exchange market has necessitated the integration of foreign exchange dealings and domestic treasury operations.
Integrated Treasury Management Functions
Trading Activities
Liquidity Management
Risk and Asset Liability Management
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Trading Activities:
It deals with trading in Currencies, Securities, Derivatives and other Financial Instruments available in Money, Securities, Foreign Exchange Markets in order to contribute to bank?s profit.
Liquidity Management:
It is responsible for managing short term funds across currencies and also for complying with regulatory requirements prescribed by the Reserve Bank of India.
Liquidity Management Objectives:
1) To assure depositors of timely repayment of their deposits. 2) To assure borrowers of meeting their credit requirements. 3) To protect shareholders wealth from forced sale of assets
Liquidity Management Techniques:
Increasing Core Deposits Changing the interest rate on deposits. Maintaining CRR and SLR (RBI Guidelines) Maintaining CRAR (Basel II guidelines)
Risk Management:
Risk is defined as the exposure to an uncertain event which may have an adverse effect on bank?s capital and earnings. Risk may be Internal risk or External Risk and the business of banking is all about identifying, measuring, managing and accepting risks.
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Risk Management Process:
It basically is a five step process, which involves – a) b) c) d) e) Identification of risk Quantification of risk Policy formulation Strategy formulation Monitoring risks
Classification of Risks:
Credit Risk: Default Risk: It is the risk Exposure Risk: that arises in case the borrower defaults.
It is the risk that arises due to concentration of loans and advances to a particular borrower or business class. Market Risk: Liquidity Risk: It arises from funding long term assets by short term liabilities and vice versa. It may be as followsFunding Risk: It arises due to unanticipated outflows. Time Risk: It arises due to non receipt of expected inflow. Call Risk: It arises due to crystallization of contingent liabilities. Interest Rate Risk: It arises from adverse movement of interest rates during the period when asset or liability was held by the bank. It affects net interest margin or market value of equity. It may be categorized as followsGap Risk: It arises from holding assets and liabilities of different maturities. Basis Risk: It arises from change of interest rates on assets and liabilities, into different magnitudes.
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Embedded Option Risk: It arises from embedded call option for customer into an asset or liability. Net Interest Position Risk: It arises when bank has more interest sensitive assets than interest sensitive liabilities and interest rate declines. Yield Curve Risk: It arises when banks adopt two or more benchmark rates for different instruments in a floating rate situation. Reinvestment Risk: It arises from the uncertainty that the cash inflow from investment or loans and advances can be reinvested at a higher rate. Foreign Exchange Risk: Currency Risk: It arises due to fluctuation of prices of one currency in respect of other currency. Settlement Risk: It arises due to failure of counterparty to meet the settlement obligations on the date of settlement.
Country Risk: Currency Risk: Possibility that changes in exchange rate will affect the return on investments. Transfer Risk: remittances. Possibility of losses due to restriction on
Sovereign Risk: Associated with lending to government of a sovereign country or taking guarantee. Political Risk: Possibility that political environment will block the realization of asset or discharge of a liability. Cross Border Risk: Arises when the borrower is a resident of a country other than where the loans/advances have been disbursed.
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Operational Risk: People Risk: Arises due to human failure. Process Risk: Arises due to failure in processes. System Risk: Arises due to system & technological failure. Regulatory Risk: It arises due to changes in the prevailing legal Acts and the concerned Rules & Regulations. Environmental Risk: It arises due to changes in the Political, Economical, Social and Technological factors in the National or International environment.
Methods for Risk Measurement:
Credit Risk: A) B) C) D) E) Altman?s Z score method Credit Metrics Method Credit Risk+, a statistical method KMV method Mckinsey?s multi factor model
Liquidity Risk: a) b) Stock Approach: Ratio analysis Flow Approach: Time bucket analysis
Interest Rate Risk: GAP Analysis: a) Static Gap Analysis b) Dynamic Gap Analysis B) Simulation Method: a) Simulation of Net Interest Income b) Monte Carlo Simulation Foreign exchange Risk: Value at Risk Approach Operational Risk: a) Basic Indicator Approach b) Standardized Approach c) Advanced Measurement Approach A)
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Credit Risk Management:
Management of credit risk is done through the following processes – a) Selection of borrower through credit rating. b) Loan review mechanism c) Setting up exposure norms. Credit Rating: It is the independent assessment of credit worthiness of the borrower. It helps in measuring credit risk and facilitates loan pricing.
As per RBI guidelines banks may use the following domestic and international credit rating agencies for the purpose of risk weighting their capital for capital adequacy measurement –
Domestic Rating Agencies: a) CARE Ltd. b) CRISIL Ltd. c) ICRA Ltd. d) FITCH India International Rating Agencies: a) FITCH b) Moodys c) Standard & Poor?s Loan Review Mechanism:
Banks should put in place a proper Loan review mechanism as a part of their Loan Policy, as a proactive measure to identify loans which develop credit weakness, to evaluate portfolio quality and isolate potential problem areas.
Exposure Norms:
Banks should put in place single or group exposure limits, exposure to specific industry or sector as per the guidelines framed by RBI. Page | 13
Market Risk Management:
Market risk management involves the following processes –
a) Framing appropriate policies and guidelines for measuring, managing and reporting market risk. b) Ensuring sound financial models are used to measure market risk. c) Appointment of qualified and competent staff and independent market risk manager. d) Reviewing and monitoring to satisfy that the policies and guidelines are strictly adhered to.
Operational Risk Management:
Banks should take the following steps to ensure effective management of operational risk – a) Framing appropriate human resource policy and other operational policies and guidelines. b) Appointment of qualified and efficient staff. c) Continuous and ongoing training for the staff. d) Following job rotation, work allocation, mandatory leave and creation of second line officers. e) Mandatory staff meetings at regular intervals and participation of staff members. f) Proper housekeeping and early submission of control returns. g) Proper internal control system, regular inspection and compliance to Concurrent auditors/RBI inspections. h) Automation of processes and procedures. i) Strict adherence to banks policies, guidelines issued by RBI and other regulatory bodies. j) Follow up of manuals, circulars, master circulars, notices issued by RBI and other regulatory bodies. k) Proper maintenance of security stationery, fire safety and other security measures, timely renewal of licenses, insurance policies and following other statutory requirements. l) Proper security procedure to prevent physical access to hardware and software systems and access to database.EDP audit, system audit and compliance thereof.
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Extracts from RBI Master Circular N0. RBI/2011-12/50 DBOD. No.Ret. BC.13/12.01.001/2011-12 dated July 01, 2011
Master Circular - Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) A. Purpose - This master circular prescribes the broad details of the reserve requirements. B. Classification - A statutory guideline issued by the RBI under Section 35A of the BR Act, 1949. C. Previous Instructions - This master circular is a compilation of the instructions contained in the circulars issued by the Reserve Bank of India which is operational as on the date of this circular. D. Scope of Application - This master circular is applicable to all Scheduled Commercial Banks (SCBs) excluding Regional Rural Banks. E. Structure 1. Introduction With a view to monitoring compliance of maintenance of statutory reserve requirements viz. CRR and SLR by the SCBs, the Reserve Bank of India has prescribed statutory returns i.e. Form A return (for CRR) under Section 42 (2) of the RBI Act, 1934 and Form VIII return (for SLR) under Section 24 of the Banking Regulation Act, 1949. 1.1 CRR In terms of Section 42 (1) of the Reserve Bank of India Act, 1934 the Reserve Bank having regard to the needs of securing the monetary stability in the country, prescribes the CRR for SCBs without any floor or ceiling rate. 1.2 Maintenance of CRR At present, effective from the fortnight beginning April 24, 2010, the CRR is prescribed at 6.00 per cent of a bank's total of DTL adjusted for the exemptions discussed in Sections 1.11 and 1.12. 1.3 Incremental CRR In terms of Section 42(1-A) of RBI Act, 1934, the SCBs are required to maintain, in addition to the balances prescribed under Section 42(1) of the Act, an additional average daily balance, the amount of which shall not be less than the rate specified by the Reserve Bank in the notification published in the Gazette of India from time to time. Such additional balance will be calculated with reference to the excess of the total of DTL of the bank as shown in the Returns referred to in Section 42(2) of the Act, 1934 over the total of its DTL at the close of the business on the date specified in the notification. At present no incremental CRR is required to be maintained by the banks. 1.4 Computation of DTL Liabilities of a bank may be in the form of demand or time deposits or borrowings or other miscellaneous items of liabilities. As defined under Section 42 of the RBI Act, 1934, liabilities of a bank may be towards the banking system or towards others in the form of demand and time deposits or borrowings or other miscellaneous items of liabilities. The Reserve Bank of India has been authorized in terms of Section 42 (1C) of the RBI Act, 1934, to classify any particular liability and hence for any doubt regarding classification of a particular liability, banks are advised to approach the RBI for necessary clarification.
1.5 Demand Liabilities Demand Liabilities of a bank are liabilities which are payable on demand. These include current deposits, demand liabilities portion of savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash certificates and cumulative/recurring deposits, outstanding
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Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for advances which are payable on demand. Money at Call and Short Notice from outside the Banking System should be shown against liability to others. 1.6 Time Liabilities Time Liabilities of a bank are those which are payable otherwise than on demand. These include fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held against letters of credit, if not payable on demand, deposits held as securities for advances which are not payable on demand and Gold deposits. 1.7 Other Demand and Time Liabilities (ODTL) ODTL include interest accrued on deposits, bills payable, unpaid dividends, suspense account balances representing amounts due to other banks or public, net credit balances in branch adjustment account, any amounts due to the banking system which are not in the nature of deposits or borrowing. Such liabilities may arise due to items like (i) collection of bills on behalf of other banks, (ii) interest due to other banks and so on. If a bank cannot segregate the liabilities to the banking system, from the total of ODTL, the entire ODTL may be shown against item II (c) 'Other Demand and Time Liabilities' of the return in Form 'A' and average CRR maintained on it by all SCBs . Participation Certificates issued to other banks, the balances outstanding in the blocked account pertaining to segregated outstanding credit entries for more than 5 years in inter-branch adjustment account, the margin money on bills purchased / discounted and gold borrowed by banks from abroad, also should be included in ODTL. Cash collaterals received under collateralized derivative transactions should be included in the bank’s DTL/NDTL for the purpose of reserve requirements as these are in the nature of ‘outside liabilities’. 1.8 Assets with the Banking System Assets with the banking system include balances with banks in current account, balances with banks and notified financial institutions in other accounts, funds made available to banking system by way of loans or deposits repayable at call or short notice of a fortnight or less and loans other than money at call and short notice made available to the banking system. Any other amounts due from banking system which cannot be classified under any of the above items are also to be taken as assets with the banking system. 1.9 Borrowings from abroad by banks in India Loans/borrowings from abroad by banks in India will be considered as 'liabilities to others' and will be subject to reserve requirements. Upper Tier II instruments raised and maintained abroad shall be reckoned as liability for the computation of DTL for the purpose of reserve requirements. 1.10 Arrangements with Correspondent Banks for Remittance Facilities When a bank accepts funds from a client under its remittance facilities scheme, it becomes a liability (liability to others) in its books. The liability of the bank accepting funds will extinguish only when the correspondent bank honours the drafts issued by the accepting bank to its customers. As such, the balance amount in respect of the drafts issued by the accepting bank on its correspondent bank under the remittance facilities scheme and remaining unpaid should be reflected in the accepting bank's books as liability under the head ' Liability to others in India' and the same should also be taken into account for computation of DTL for CRR/SLR purpose. The amount received by correspondent banks has to be shown as 'Liability to the Banking System' by them and not as 'Liability to others' and this liability could be netted off by the correspondent banks against the inter-bank assets. Likewise sums placed by banks issuing drafts/interest/dividend warrants are to be treated
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as 'Assets with banking system' in their books and can be netted off from their inter-bank liabilities. 1.11 Liabilities not to be included for DTL/NDTL computation The under-noted liabilities will not form part of liabilities for the purpose of CRR and SLR: a) Paid up capital, reserves, any credit balance in the Profit & Loss Account of the bank, amount of any loan taken from the RBI and the amount of refinance taken from Exim Bank, NHB, NABARD, SIDBI; b) Net income tax provision; c) Amount received from DICGC towards claims and held by banks pending adjustments thereof; d) Amount received from ECGC by invoking the guarantee; e) Amount received from insurance company on ad-hoc settlement of claims pending judgment of the Court; f) Amount received from the Court Receiver; g) The liabilities arising on account of utilization of limits under Bankers Acceptance Facility (BAF); h) District Rural Development Agency (DRDA) subsidy of Rs.10, 000/- kept in Subsidy Reserve Fund account in the name of Self Help Groups; i) Subsidy released by NABARD under Investment Subsidy Scheme for Construction/Renovation/Expansion of Rural Godowns; j) Net unrealized gain/loss arising from derivatives transaction under trading portfolio; k) Income flows received in advance such as annual fees and other charges which are not refundable. l) Bill rediscounted by a bank with eligible financial institutions as approved by RBI and, (m) Provision not being a specific liability arising from contracting additional liability and created from profit and loss account. 1.12 Exempted Categories SCBs are exempted from maintaining CRR on the following liabilities: i. Liabilities to the banking system in India as computed under Clause (d) of the explanation to Section 42(1) of the RBI Act, 1934; ii. Credit balances in ACU (US$) Accounts; iii Demand and Time Liabilities in respect of their Offshore Banking Units (OBU);and iv SCBs are not required to include inter-bank term deposits/term borrowing liabilities of original maturities of 15 days and above and up to one year in "Liabilities to the Banking System" (item 1 of Form A return). Similarly banks should exclude their inter-bank assets of term deposits and term lending of original maturity of 15 days and above and up to one year in "Assets with the Banking System" (item III of Form A return) for the purpose of maintenance of CRR. The interest accrued on these deposits is also exempted from reserve requirements. 1.13 Loans out of FCNR (B) Deposits and IBFC Deposits Loans out of Foreign Currency Non–Resident Accounts (Banks), (FCNR Deposits Scheme) and Inter-Bank Foreign Currency (IBFC) deposits should be included as part of bank credit while reporting in Form ’A’ return. For the purpose of reporting, banks should convert their FCNR (B) deposits, overseas foreign currency assets and bank credit in India in foreign currency in 4 major currencies into rupees at FEDAI noon mean rate on the reporting Friday. 1.14 Procedure for Computation of CRR In order to improve cash management by banks, as a measure of simplification, a lag of one fortnight in the maintenance of stipulated CRR by banks has been introduced with effect from the fortnight beginning November 06, 1999. 1.15 Maintenance of CRR on Daily Basis
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With a view to providing flexibility to banks in choosing an optimum strategy of holding reserves depending upon their intra fortnight cash flows, all SCBs are required to maintain minimum CRR balances up to 70 per cent of the average daily required reserves for a reporting fortnight on all days of the fortnight with effect from the fortnight beginning December 28, 2002. 1.16 No Interest Payment on Eligible Cash Balances maintained by SCBs with RBI under CRR In view of the amendment carried out to RBI Act 1934, omitting sub-section (1B) of Section 42, the Reserve Bank does not pay any interest on the CRR balances maintained by SCBs with effect from the fortnight beginning March 31, 2007. 1.17 Fortnightly Return in Form A (CRR) Under Section 42 (2) of the RBI Act, 1934, all SCBs are required to submit to Reserve Bank a provisional Return in Form 'A' within 7 days from the expiry of the relevant fortnight which is used for preparing press communiqué. The final Form 'A' return is required to be submitted to RBI within 20 days from expiry of the relevant fortnight. Based on the recommendation of the Working Group on Money Supply: Analytics and Methodology of Compilation, all SCBs in India are required to submit from the fortnight beginning October 9, 1998, Memorandum to form 'A' return giving details about paid-up capital, reserves, time deposits comprising short-term (of contractual maturity of one year or less) and long-term (of contractual maturity of more than one year), certificates of deposits, NDTL, total CRR requirement etc., Annexure A to Form ‘A’ return showing all foreign currency liabilities and assets and Annexure B to Form ‘A’ return giving details about investment in approved securities, investment in non-approved securities, memo items such as subscription to shares /debentures / bonds in primary market and subscriptions through private placement. For reporting in Form 'A' return, banks should convert their overseas foreign currency assets and bank credit in India in foreign currency in four major currencies viz., US dollar, GBP, Japanese Yen and Euro into rupees at the Foreign Exchange Dealers Association of India's (FEDAI) noon mean rate on reporting Friday. The present practice of calculation of the proportion of demand liabilities and time liabilities by SCBs in respect of their savings bank deposits on the basis of the position as at the close of business on 30 September and 31 March every year (cf. RBI circular DBOD.No.BC.142/09.16.001/97-98 dated November 19, 1997) shall continue in the new system of interest application on savings bank deposits on a daily product basis. The average of the minimum balances maintained in each of the month during the half year period shall be treated by the bank as the amount representing the "time liability” portion of the savings bank deposits. When such an amount is deducted from the average of the actual balances maintained during the half year period, the difference would represent the "demand liability” portion. The proportions of demand and time liabilities so obtained for each half year shall be applied for arriving at demand and time liabilities components of savings bank deposits for all reporting fortnights during the next half year. 1.18 Penalties From the fortnight beginning June 24, 2006, penal interest will be charged as under in cases of default in maintenance of CRR by SCBs : (i) In case of default in maintenance of CRR requirement on a daily basis which is presently 70 per cent of the total CRR requirement, penal interest will be recovered for that day at the rate of three per cent per annum above the Bank Rate on the amount by which the amount actually maintained falls short of the prescribed minimum on that day and if the shortfall continues on the next succeeding day/s, penal interest will be recovered at the rate of five per cent per annum above the Bank Rate.
th st
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(ii) In cases of default in maintenance of CRR on average basis during a fortnight, penal interest will be recovered as envisaged in sub-section (3) of Section 42 of Reserve Bank of India Act, 1934. SCBs are required to furnish the particulars such as date, amount, percentage, reason for default in maintenance of requisite CRR and also action taken to avoid recurrence of such default. 2. Maintenance of Statutory Liquidity Ratio (SLR) Consequent upon amendment to the Section 24 of the Banking Regulation Act,1949 through the Banking Regulation (Amendment) Act, 2007 replacing the Regulation (Amendment) Ordinance, 2007, effective January 23, 2007, the Reserve Bank can prescribe the SLR for SCBs in specified assets. The value of such assets of a SCB shall not be less than such percentage not exceeding 40 per cent of its total DTL in India as on the last Friday of the second preceding fortnight as the Reserve Bank may, by notification in the Official Gazette, specify from time to time. SCBs can participate in the Marginal Standing Facility (MSF) scheme introduced by Reserve Bank with effect from May 09, 2011. Under this facility, the eligible entities may borrow overnight, up to one per cent of their respective NDTL outstanding at the end of the second preceding fortnight. Reserve Bank has specified vide notification DBOD.No.Ret.91/12.02.001/2010-11 dated May 09, 2011 that every SCB shall continue to maintain in India assets as detailed below, the value of which shall not, at the close of business on any day, be less than 24 per cent on the total net demand and time liabilities as on the last Friday of the second preceding fortnight as prescribed vide notification DBOD.No.Ret.BC.66/12.02.001/2010-11 dated December 16, 2010 valued in accordance with the method of valuation specified by the Reserve Bank of India from time to time: (a) Cash or (b) Gold valued at a price not exceeding the current market price, or (c) Investment in the following instruments which will be referred to as "Statutory Liquidity Ratio (SLR) securities": (i) Dated securities issued up to May 06, 2011 as listed in the Annex to Notification DBOD.No.Ret.91/12.02.001/2010-11 dated May 09, 2011. (ii) Treasury Bills of the Government of India; (iii) Dated securities of the Government of India issued from time to time under the market borrowing programme and the Market Stabilization Scheme; (iv) State Development Loans (SDLs) of the State Governments issued from time to time under the market borrowing programme; and (v) Any other instrument as may be notified by the Reserve Bank of India. Provided that the securities (including margin) referred to above, if acquired under the Reserve Bank- Liquidity Adjustment Facility (LAF), shall not be treated as an eligible asset for this purpose. Explanation: For the above purpose, "market borrowing programme" shall mean the domestic rupee loans raised by the Government of India and the State Governments from the public and managed by the Reserve Bank of India through issue of marketable securities, governed by the Government Securities Act, 2006 and the Regulations framed there under, through an auction or any other method, as specified in the Notification issued in this regard.
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2. Encumbered SLR securities shall not be included for the purpose of computing the percentage specified above. Provided that for the purpose of computing the percentage of assets referred to hereinabove, the following shall be included, namely: (i) securities lodged with another institution for an advance or any other credit arrangement to the extent to which such securities have not been drawn against or availed of; and, (ii) securities offered as collateral to the Reserve Bank of India for availing liquidity assistance from Marginal Standing Facility (MSF) up to one percent of the total NDTL in India carved out of the required SLR portfolio of the bank concerned. 3. In computing the amount for the above purpose, the following shall be deemed to be cash maintained in India: (i) The deposit required under sub-section (2) of Section 11 of the Banking Regulation Act, 1949 to be made with the Reserve Bank by a banking company incorporated outside India; (ii) Any balances maintained by a scheduled bank with the Reserve Bank in excess of the balance required to be maintained by it under Section 42 of the Reserve Bank of India Act, 1934 (2 of 1934); and (iii) Net balances in current accounts with other scheduled commercial banks in India. Note: 1. With a view to disseminating information on the SLR status of a Government security, it has been decided that: (i) the SLR status of securities issued by the Government of India and the State Governments will be indicated in the Press Release issued by the Reserve Bank of India at the time of issuance of the securities; and, (ii) an updated and current list of the SLR securities will be posted on the Reserve Bank's website (www.rbi.org.in) under the link " Database on Indian Economy) 2. The cash management bill will be treated as Government of India Treasury Bill and accordingly shall be treated as SLR securities. 2.1 Procedure for Computation of SLR The procedure to compute total NDTL for the purpose of SLR under Section 24 (2) (B) of B.R. Act, 1949 is broadly similar to the procedure followed for CRR. The liabilities mentioned under Section 1.11 will not form part of liabilities for the purpose of SLR also. SCBs are required to include inter-bank term deposits / term borrowing liabilities of all maturities in ‘Liabilities to the Banking System’. Similarly, banks should include their inter-bank assets of term deposits and term lending of all maturities in ‘Assets with the Banking System’ for computation of NDTL for SLR purpose. 2.2 Classification and Valuation of Approved Securities for SLR As regards classification and valuation of approved securities, banks may be guided by the instructions contained in our Master Circular (as updated from time to time) on Prudential Norms for classification, valuation and operation of investment portfolio by banks. 2.3 Penalties If a banking company fails to maintain the required amount of SLR, it shall be liable to pay to RBI in respect of that default, the penal interest for that day at the rate of three per cent per annum above the Bank Rate on the shortfall and if
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the default continues on the next succeeding working day, the penal interest may be increased to a rate of five per cent per annum above the Bank Rate for the concerned days of default on the shortfall. 2.4 Return in Form VIII (SLR) i) Banks should submit to the Reserve Bank before 20th day of every month, a return in Form VIII showing the amounts of SLR held on alternate Fridays during immediate preceding month with particulars of their DTL in India held on such Fridays or if any such Friday is a Public Holiday under the Negotiable Instruments Act, 1881, at the close of business on preceding working day. ii) Banks should also submit a statement as annexure to Form VIII return giving daily position of (a) value of securities held for the purpose of compliance with SLR, and (b) the excess cash balances maintained by them with RBI in the prescribed format. 2.5 Correctness of Computation of DTL to be certified by Statutory Auditors The Statutory Auditors should verify and certify that all items of outside liabilities, as per the bank’s books had been duly compiled by the bank and correctly reflected under DTL/NDTL in the fortnightly/monthly statutory returns submitted to Reserve Bank for the financial year.
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to Reserve Bank for the financial year.
BASEL II Accord and Reserve Bank of India
The Basel Committee, established by the central-bank Governors of the Group of Ten countries at the end of 1974, meets regularly four times a year. It has four main working groups which also meet regularly. The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. Countries are represented by their central bank and also by the authority with formal responsibility for the prudential supervision of banking business where this is not the central bank. The present chairman of the Committee is Mr Stefan Ingves, Governor of Sveriges Riksbank, who succeeded Mr Nout Wellink on 1 July 2011. The Committee does not possess any formal supranational supervisory authority, and its conclusions do not, and were never intended to, have legal force. Rather, it formulates broad supervisory standards and guidelines and recommends statements of best practice in the expectation that individual authorities will take steps to implement them through detailed arrangements - statutory or otherwise - which are best suited to their own national systems. In this way, the Committee encourages convergence towards common approaches and common standards without attempting detailed harmonization of member countries' supervisory techniques. The Committee reports to the central bank Governors and Heads of Supervision of its member countries. It seeks their endorsement for its major initiatives. These decisions cover a very wide range of financial issues. One important objective of the Committee's work has been to close gaps in international supervisory coverage in pursuit of two basic principles: that no foreign banking establishment should escape supervision; and that supervision should be adequate. To achieve this, the Committee has issued a long series of documents since 1975. In 1988, the Committee decided to introduce a capital measurement system commonly referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement framework with a minimum capital standard of 8% by end-1992. Since Page | 22
1988, this framework has been progressively introduced not only in member countries but also in virtually all other countries with internationally active banks. In June 1999, the Committee issued a proposal for a revised Capital Adequacy Framework. The proposed capital framework consists of three pillars: minimum capital requirements, which seek to refine the standardized rules set forth in the 1988 Accord; supervisory review of an institution's internal assessment process and capital adequacy; and effective use of disclosure to strengthen market discipline as a complement to supervisory efforts. Following extensive interaction with banks, industry groups and supervisory authorities that are not members of the Committee, the revised framework was issued on 26 June 2004. This text serves as a basis for national rule-making and for banks to complete their preparations for the new framework's implementation. Over the past few years, the Committee has moved more aggressively to promote sound supervisory standards worldwide. In close collaboration with many jurisdictions which are not members of the Committee, in 1997 it developed a set of " Core Principles for Effective Banking Supervision", which provides a comprehensive blueprint for an effective supervisory system. To facilitate implementation and assessment, the Committee in October 1999 developed the " Core Principles Methodology". The Core Principles and the Methodology were revised recently and released in October 2006. In response to the financial crisis of 2008, the Committee and its oversight body, the Group of Governors and Heads of Supervision, have developed a reform programme to address the lessons of the crisis, which delivers on the mandates for banking sector reforms established by the G20 at their 2009 Pittsburgh summit. Collectively, the new global standards to address both firm-specific and broader, systemic risks have been referred to as "Basel III". In order to enable a wider group of countries to be associated with the work being pursued in Basel, the Committee has always encouraged contacts and cooperation between its members and other banking supervisory authorities. It circulates to supervisors throughout the world published and unpublished papers. In many cases, supervisory authorities in non-member countries have seen fit publicly to associate themselves with the Committee's initiatives. Contacts have been further strengthened by International Conferences of Banking Supervisors (ICBS) which take place every two years. The last ICBS was held in Singapore in the autumn of 2010.
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The Committee's Secretariat is provided by the Bank for International Settlements in Basel. The 17 person Secretariat is mainly staffed by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it stands ready to give advice to supervisory authorities in all countries.
With a view to adopting the Basle Committee on Banking Supervision (BCBS) framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off-balance sheet business and also to strengthen the capital base of banks, Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure. Essentially, under the above system the balance sheet assets, non-funded items and other off-balance sheet exposures are assigned prescribed risk weights and banks have to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. Reserve Bank has issued guidelines to banks in June 2004 on maintenance of capital charge for market risks on the lines of „Amendment to the Capital Accord to incorporate market risks? issued by the BCBS in 1996.
The BCBS released the "International Convergence of Capital Measurement and Capital Standards: A Revised Framework" on June 26, 2004. The Revised Framework was updated in November 2005 to include trading activities and the treatment of double default effects and a comprehensive version of the framework was issued in June 2006 incorporating the constituents of capital and the 1996 amendment to the Capital Accord to incorporate Market Risk. The Revised Framework seeks to arrive at significantly more risk-sensitive approaches to capital requirements. The Revised Framework provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and financial markets.
The BASEL II Accord consists of three reinforcing pillars. They are – A) Minimum Capital Requirement B) Supervisory Review and Evaluation Process C) Market Discipline
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Pillar I: Minimum Capital Requirement:
The revised capital adequacy norms shall be applicable uniformly to all Commercial Banks (except Local Area Banks and Regional Rural Banks), both at the solo level (global position) as well as at the consolidated level. In terms of guidelines on preparation of consolidated prudential reports issued vide RBI circular DBOD. No.BP.BC.72/ 21.04.018/ 200102 dated February 25, 2003. A consolidated bank should maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) as applicable to a bank on an ongoing basis.
Capital Fund: Banks are required to maintain a minimum Capital to Risk Weighted Asset Ratio (CRAR) of 9% on an ongoing basis. Capital Fund consists of Tier I and Tier II capital. Tier I capital is the core capital and Tier II capital is noncore and less permanent in nature. Banks are required to maintain a Tier I CRAR of at least 6%.
Capital Charges: The Framework offers three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk. These options for credit and operational risks are based on increasing risk sensitivity and allow banks to select an approach that is most appropriate to the stage of development of bank's operations. The options available for computing capital for credit risk are Standardized Approach, Foundation Internal Rating Based Approach and Advanced Internal Rating Based Approach. The options available for computing capital for operational risk are Basic Indicator Approach, Standardized Approach and Advanced Measurement Approach. Keeping in view Reserve Bank?s goal to have consistency and harmony with international standards, it has been decided that all commercial banks in India (excluding Local Area Banks and Regional Rural Banks) shall adopt Standardized Approach (SA) for credit risk and Basic Indicator Approach (BIA) for operational risk. Banks shall continue to apply the Standardized Duration Approach (SDA) for computing capital requirement for market risks.
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Capital Charge for Credit Risk: Banks in India shall adopt the Comprehensive Approach, which allows fuller offset of collateral against exposures, by effectively reducing the exposure amount by the value ascribed to the collateral. Under this approach, banks, which take eligible financial collateral (e.g., cash or securities, more specifically defined below), are allowed to reduce their credit exposure to counterparty when calculating their capital requirements to take account of the risk mitigating effect of the collateral. Credit risk mitigation is allowed only on an account-byaccount basis. In the comprehensive approach, when taking collateral, banks will need to calculate their adjusted exposure to a counterparty for capital adequacy purposes in order to take account of the effects of that collateral. Banks are required to adjust both the amount of the exposure to the counterparty and the value of any collateral received in support of that counterparty to take account of possible future fluctuations in the value of either, occasioned by market movements. These adjustments are referred to as „haircuts?. The application of haircuts will produce volatility adjusted amounts for both exposure and Collateral. The volatility adjusted amount for the exposure will be higher than the exposure and the volatility adjusted amount for the collateral will be lower than the collateral, unless either side of the transaction is cash. In other words, the „haircut? for the exposure will be a premium factor and the „haircut? for the collateral will be a discount factor. It may be noted that the purpose underlying the application of haircut is to capture the market-related volatility inherent in the value of exposures as well as of the eligible financial collaterals. Since the value of credit exposures acquired by banks in the course of their banking operations, would not be subject to market volatility, (since the loan disbursal / investment would be a “cash” transaction) though the value of eligible financial collateral would be, the haircut stipulated by RBI would apply in respect of credit transactions only to the eligible collateral but not to the credit exposure of the bank. Where the volatility-adjusted exposure amount is greater than the volatility-adjusted collateral amount (including any further adjustment for foreign exchange risk), banks shall calculate their risk-weighted assets as the difference between the two multiplied by the risk weight of the counterparty.
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Capital Charge for Market Risk: Market risk is defined as the risk of losses in on-balance sheet and offbalance sheet positions arising from movements in market prices. The market risk positions subject to capital charge requirement are: (i) The risks pertaining to interest rate related instruments and equities in the trading book; and (ii) Foreign exchange risk (including open position in precious metals) throughout the bank (both banking and trading books).
The minimum capital requirement is expressed in terms of two separately calculated charges, (i) "specific risk" charge for each security, which is designed to protect against an adverse movement in the price of an individual security owing to factors related to the individual issuer, both for short (short position is not allowed in India except in derivatives) and long positions, and (ii) "general market risk" charge towards interest rate risk in the portfolio, where long and short positions (which is not allowed in India except in derivatives) in different securities or instruments can be offset.
Capital Charge for Operational Risk: 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, which is 15% as set by BCBS) of positive annual gross income (Net Interest Income+ Net Non Interest 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.
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Pillar II: Supervisory Review and Evaluation Process:
The New Capital Adequacy Framework (NCAF), based on the Basel II Framework evolved by the Basel Committee on Banking Supervision, has been adapted for India vide RBI Circular DBOD.No.BP.BC 90/ 20.06.001/ 2006-07 dated April 27, 2007. In terms of paragraph 2.4 (iii) (c) of the Annex to the aforesaid circular banks were required to have a Board-approved policy on ICAAP and to assess the capital requirement as per ICAAP.
The objective of the SRP is to ensure that banks have adequate capital to support all the risks in their business as also to encourage them to develop and use better risk management techniques for monitoring and managing their risks. This in turn would require a well-defined internal assessment process within banks through which they assure the RBI that adequate capital is indeed held towards the various risks to which they are exposed. The process of assurance could also involve an active dialogue between the bank and the RBI so that, when warranted, appropriate intervention could be made to either reduce the risk exposure of the bank or augment / restore its capital.
Thus, ICAAP is an important component of the SRP.
The main aspects to be addressed under the SRP, and therefore, under the ICAAP, would include:
(a)
the risks that are not fully captured by the minimum capital ratio prescribed under Pillar 1; the risks that are not at all taken into account by the Pillar 1; and the factors external to the bank.
(b)
(c)
Banks were advised to develop and put in place, with the approval of their Boards, an ICAAP commensurate with their size, level of complexity, risk profile and scope of operations. Page | 28
The ICAAP, which would be in addition to a bank?s calculation of regulatory capital requirements under Pillar 1, was to be operationalised from March 31, 2009 by all other commercial banks, excluding the Local Area Banks and Regional Rural banks.
The ICAAP document should, inter alia, include the capital adequacy assessment and projections of capital requirement for the ensuing year, along with the plans and strategies for meeting the capital requirement.
The Basel II document of the Basel Committee also lays down the following four key principles in regard to the SRP envisaged under Pillar 2:
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.
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 the regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process.
Principle 3: Supervisors should expect banks to operate above the minimum regulatory capital ratios and should have the ability to require banks to hold capital in excess of the minimum.
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 and should require rapid remedial action if capital is not maintained or restored.
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The Pillar 2 (Supervisory Review Process - SRP) requires banks to implement an internal process, called the Internal Capital Adequacy Assessment Process (ICAAP), for assessing their capital adequacy in relation to their risk profiles as well as a strategy for maintaining their capital levels.
The Pillar 2 also requires the supervisory authorities to subject all banks to an evaluation process, hereafter called Supervisory Review and Evaluation Process (SREP), and to initiate such supervisory measures on that basis, as might be considered necessary.
An analysis of the foregoing principles indicates that the following broad responsibilities have been cast on banks and the supervisors:
Banks? responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels (Principle 1). b) Banks should operate above the minimum regulatory capital ratios (Principle 3).
Supervisors? responsibilities
a) Supervisors should review and evaluate a bank?s ICAAP. (Principle 2) b) Supervisors should take appropriate action if they are not satisfied with the results of this process. (Principle 2) c) Supervisors should review and evaluate a bank?s compliance with the regulatory capital ratios. (Principle 2) d) Supervisors should have the ability to require banks to hold capital in excess ofthe minimum. (Principle 3)
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e) Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels. (Principle 4) f) Supervisors should require rapid remedial action if capital is not maintained or restored. (Principle 4)
Thus, the ICAAP and SREP are the two important components of Pillar 2 and could be broadly defined as follows:
The ICAAP comprises a bank?s procedures and measures designed to ensure the following: a) An appropriate identification and measurement of risks; b) An appropriate level of internal capital in relation to the bank?s risk profile; and c) Application and further development management systems in the bank. of suitable risk
The SREP consists of a review and evaluation process adopted by the supervisor, which covers all the processes and measures defined in the principles listed above. Essentially, these include the review and evaluation of the bank?s ICAAP, conducting an independent assessment of the bank?s risk profile, and if necessary, taking appropriate prudential measures and other supervisory actions.
Through the SREP, the RBI would evaluate the adequacy and efficacy of the ICAAP of banks and assess the overall capital adequacy of a bank through a comprehensive evaluation that takes into account all relevant information.
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Pillar III: Market Discipline:
The purpose of Market discipline (detailed in Pillar 3) in the Revised Framework is to complement the minimum capital requirements and the supervisory review process.
The aim is to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes, and hence the capital adequacy of the institution.
Banks, including consolidated banks, should provide all Pillar 3 disclosures, both qualitative and quantitative, as at end March each year along with the annual financial statements. With a view to enhance the ease of access to the Pillar 3 disclosures, banks may make their annual disclosures both in their annual reports as well as their respective web sites.
Banks with capital funds of Rs.100 crore or more should make interim disclosures on the quantitative aspects, on a standalone basis, on their respective websites as at end September each year. Qualitative disclosures that provide a general summary of a bank?s risk management objectives and policies, reporting system and definitions may be published only on an annual basis.
In recognition of the increased risk sensitivity of the Revised Framework and the general trend towards more frequent reporting in capital markets, all banks with capital funds of Rs. 500 crore or more, and their significant bank subsidiaries, must disclose their Tier I capital, total capital, total required capital and Tier I ratio and total capital adequacy ratio, on a quarterly basis on their respective websites.
The disclosure on the websites should be made in a web page titled “Basel II Disclosures” and the link to this page should be prominently provided on the home page of the bank?s website.
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The following sections are the disclosure requirements under Pillar 3.
? ? ? ? ? ? ? ? ? ?
Scope of Application Capital Structure Capital Adequacy Credit Risk: General Disclosures for All Banks Credit Risk: Disclosures for Portfolios Subject to the Standardized Approach Credit Risk Mitigation: Disclosures for Standardized Approaches Securitization Exposures: Disclosure for Standardised Approach Market Risk in Trading Book Operational Risk Interest Rate Risk in Banking Book
Additional definitions and explanations are provided in a series of footnotes.
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Asset Liability Management
Asset Liability Management is a dynamic process of planning, organizing and controlling of assets and liabilities. The objective of ALM is to achieve perfect match between changes in present value of assets and liabilities of the bank. It aims in monitoring, measuring, and managing the Market Risk in banks. At the macro level, the ALM deals with the formulation of policies, capital allocation and pricing strategies. At this level, ALM aims at obtaining profit through price matching while ensuring liquidity through maturity matching. At the micro level, risk management is conducted by managers and individual departments.
Asset Liability Management is standing on three pillars –
Asset Liability Management ALM Information System
ALM Organisation
ALM Process
A) ALM Information System: a. Management Information System b. Availability, accuracy, adequacy and expediency of information.
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B) ALM Organization: a. ALCO: Asset Liability Committee comprises senior management team that decides the strategy and responsible for policy formulation and monitoring. b. Support Group: it consists of operating staff and responsible for managing maturity, currency and interest rate risk.
C) ALM Process: a. b. c. d. e. Liquidity Risk Management Market Risk Management Trading Risk Management Funding and Capital Planning Profit Planning and Growth Projection
The Reserve Bank of India prescribes for preparing the following statements/reports for controlling the risks –
A) Statement of B) Statement of C) Statement of D) GAP Analysis
Structural Liquidity Short Term Dynamic Liquidity Interest Rate Sensitivity Report
Liquidity Management: a. Stock Approach: Ratio Analysis b. Flow Approach: 1. Statement of Structural Liquidity 2. Statement of Short term dynamic liquidity Market Risk: a) Statement of Interest Rate sensitivity b) Gap analysis
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Basel II and Revisions to the Capital Requirements Directive
Remarks by Stefan Walter, Secretary General, Basel Committee on Banking Supervision, to the European Parliament Committee on Economic and Monetary Affairs on the BCBS's reform programme, 3 May 2010.
Introduction
The primary objective of the Basel Committee on Banking Supervision (BCBS) reform program is to raise the resilience of the banking sector, thus promoting more sustainable growth, both in the near term and over the long run. The over-riding objective of the Committee's reform agenda, as endorsed by the G20 and the FSB, is to deliver a banking and financial system that acts as a stabilizing force on the real economy. As we now know, this clearly was not the case leading up to the recent financial crisis. The pre-crisis financial system was characterized by the following weaknesses: a. too much leverage in the banking and financial system and not enough high quality capital to absorb losses; b. excessive credit growth based on weak underwriting standards and under pricing of liquidity and credit risk; c. insufficient liquidity buffers and overly aggressive maturity transformation, both direct and indirect (for example, through the shadow banking system); d. inadequate risk governance and poor incentives to manage risks towards prudent long term outcomes, including through poorly designed compensation systems; e. inadequate cushions in banks to mitigate the inherent procyclicality of financial markets and its participants; f. too much systemic risk, interconnectedness among financial players as well as common exposures to similar shocks, and inadequate oversight that should have served to mitigate the too-big-to fail problem. In particular, the depth and severity of the crisis was amplified by a financial system that entered the crisis with too much leverage, insufficient liquidity buffers and capital levels, and poor incentives for risk taking. The banking sector therefore was too vulnerable to shocks, Page | 36
whatever their source. During the most severe episode of the crisis, the market lost confidence in the solvency and liquidity of many banking institutions. The weaknesses in the banking sector were transmitted to the rest of the financial system and the real economy, resulting in a massive contraction of liquidity and credit availability. I feel certain that had regulatory standards been higher, as the BCBS is now proposing, the crisis would have been less severe and the burden on the public sector and taxpayers would have been lower.
Key elements of the BCBS reform programme
To remedy these fundamental shortcomings, the BCBS reforms promote the following objectives, which link directly to my analysis of pre-crisis shortcomings: a) ensure that all material risks are adequately integrated into and covered in computing the level of required capital (especially those related to trading activities, complex securitizations, and derivatives); b) assure that high quality capital is present to absorb losses arising from all risk exposures; c) introduce additional checks and balances into regulatory, supervisory and risk management frameworks. This includes strong emphasis on the three pillars of the Basel II framework, as well as moving over time to a credible Pillar 1 leverage ratio that serves as a backstop to the risk-based requirement and helps contain the build-up of banking sector wide leverage; d) promote forward looking provisioning and countercyclical capital buffers that raise the ability of the banking sector to absorb shocks when they inevitably come; e) introduce minimum global controlling liquidity risk; standards for measuring and
f) assure that regulation and supervision of systemically important banks is strong, forcing them to internalize the risks they create for the public at large; g) strengthen risk governance and management, building on the Pillar 2 supervisory review process; h) improve market discipline by enhancing Pillar 3 disclosure of firms' risk profile and capital adequacy; and i) promote practical approaches to improve the management of cross border bank resolutions. The BCBS reforms, integrating micro prudential and macro prudential elements are designed to be proportionate to the risks of individual banks' business models, as well as the broader risks that certain activities and institutions pose to the system. Page | 37
A significant proportion of the reforms are targeted at those firms and activities that are systemic in nature. In particular, capital requirements have been increased for trading book activities, counterparty credit risk, and complex securitizations and resecuritisations. Thus, under the newly proposed BCBS standards, systemically important banks will be subject to tougher standards. The BCBS has also put forward a set of proposals aimed at the systemic risks posed by derivative activities. Under these revisions, OTC derivative exposures will be subject to higher capital requirements based on stressed inputs and longer margining periods that reflect the liquidity. Moreover, derivatives exposures that are not cleared through central counterparties that meet the revised CPSS/IOSCO standards will be subject to higher capital requirements, thus increasing incentives to use such central counterparties. Also, exposures among major, interconnected financial institutions have a higher degree of correlation compared to exposures to the corporate sector and would therefore require relatively higher capital. Once the risk coverage of the capital framework has been improved to reflect different business models and different degrees of systemic risk, all banks need to back these exposures with higher quality capital that can absorb losses on a going and "gone concern" basis. In developing its proposals, the BCBS has paid particular attention to the unique circumstances of non-joint stock companies, including cooperatives and savings banks. Moreover, it is the expectation of the Committee that all banks will build buffers above the minimum in good times that can be used in times of stress. Having these countercyclical buffers will make the system more resilient to shocks and reduce the risk of spillover from the financial to the real economy.
Impact assessment, calibration, and implementation
In fashioning the reforms, the BCBS is paying close attention to the impact on the industry and the economy as a whole both during the transition and in the long run. This means putting in place a path to a safer and stronger financial system that keeps growth on track - enhancing welfare in the long run, while at the same time minimizing the economic costs in the short run. Banks have returned to pre-crisis levels of profitability. To a significant extent this is due to the unprecedented public support measures put in place during the crisis. With this in mind, it seems reasonable to expect Page | 38
that these profits will now be used to build capital and liquidity buffers, and not feed excessive bonuses, dividends, and leverage. The BCBS reforms, which the G20 has asked to be finalized by the end of this year, will provide clarity on the new resilience standards that banks should achieve. Moving towards these standards will increase confidence in the system. As history has shown time and again, a weak, undercapitalized banking sector cannot support sound, long-term real economic growth. Current minimum regulatory requirements remain unacceptably low and will not deter a renewed race to the bottom in which financial institutions end up undercapitalized, over-leveraged, and illiquid. For example, the current effective minimum capital requirement is just 2 percent common equity to risk-based assets. This is equivalent to riskweighted leverage of at least 50:1. However, it is based on a diluted definition of bank capital. If one were to use a more robust definition based on tangible common equity - which has become common practice among market participants - the leverage permissible under the current minimum would be even higher. In addition, there is no minimum global standard for liquidity whatsoever, even though poor liquidity at banks was one of the key amplifiers of the crisis. In response, the Committee has proposed internationally harmonized minimum liquidity standards to help ensure that banks can withstand a one-month period of acute stress and to promote banks' resilience over the longer term through incentives to support their activities with more stable sources of funding. The BCBS has put in place a rigorous process to assess the overall impact of its reforms with a view to ensuring that the new standards achieve the objective of greater banking sector resilience while they simultaneously promote maximum sustainable growth. These processes include the following: Public consultation: The December capital and liquidity reforms have been subject to rigorous public consultation. The Committee is now reviewing nearly 300 comments with an eye toward identifying any unintended consequences in either the design or calibration of the proposals. It is important to note that in many cases, higher requirements are being introduced - by design - which will affect those business lines and activities that posed substantial risk to banks and the system. The BCBS wants to make sure that it considers all major consequences of its reforms and the incentives they create. Impact assessment: The BCBS is conducting a comprehensive quantitative impact study to assess the impact of the reform package on individual banks and on the banking industry. The impact study will Page | 39
inform the calibration of the capital requirements and ensure an appropriate set of minimum standards across banks, countries, and business models. Similarly, the liquidity standards will be calibrated so that they promote sound liquidity buffers while allowing for prudently managed business models and sustainable maturity transformation in the banking system. Overall calibration: The Committee is engaging in an analysis to determine the calibration of the overall capital and liquidity requirements, factoring in the cumulative impact of all the individual reform measures, as well as what is necessary to achieve the resilience of the banking sector while ensuring prudent long term availability of credit. Macroeconomic impact assessment over the transition period: The FSB and the BCBS, in close collaboration with the BIS and IMF, are assessing the impact of the reforms over different possible transition periods to ensure that there is no threat to the economic recovery. Moreover, national macroeconomic models (subject to a common set of protocols) are being used to assess the link between higher capital standards, credit availability and costs, and broader economic growth. This framework therefore can accommodate differences in the role of the banking sector in national economies, where some are much more bank driven than others. Based on these four initiatives, by the end of this year the BCBS will develop a balanced set of reforms that promote greater banking sector resilience and maximum sustainable economic growth. The market and bank supervisors have already forced banks to raise their capital and liquidity buffers. However, when competitive pressures reassert themselves, significantly higher minimum requirements will help contain any return to the unacceptably low capital and liquidity levels which made the system so vulnerable to shocks the last time around. It therefore is critical that the calibration of the new standards be based on what is necessary to promote balanced and sustainable banking in the long run. Appropriate implementation time lines and transition arrangements will be used to make the transition to the new standards in a manner that does not jeopardize near term growth. Failure to set the right long run levels will undermine near-term confidence and jeopardize long-term financial stability. The BCBS is comprised of 27 countries and it conducts its work under the review of its oversight body, the Group of Central Bank Governors and Heads of Supervision of its member jurisdictions. The work of the Page | 40
Committee also is being reviewed closely by the Financial Stability Board. In addition to monitoring the consistency with the G20 reform mandates and the broader economic implications of the transition to the new standards, the FSB process will ensure that the BCBS reforms are integrated into a coherent overall set of reforms to strengthen global financial regulations. Consistent with the G-20's mandate, rigorous processes have been put in place to ensure that all countries implement the full set of international prudential standards. Consistent and timely implementation of standards by all jurisdictions is critical to promoting a global level playing field.
Conclusion
The Basel Committee is on schedule to deliver a fully calibrated package of global standards for capital and liquidity by the end of this year. It is conducting a wide range of analyses to ensure that the design of the reforms is appropriate and that they produce a more stable financial system and economy over the long run without jeopardizing growth in the near term. The BCBS reforms are intended to be forward looking, making the system more resilient to future crises, whatever their source. While certain banks and countries may not have "caused" the current crisis, everyone was affected. All countries and financial institutions benefited from the public sector interventions to stabilize the economy, the functioning of markets, and the resilience of counterparties. Moreover, past crises have emerged from all regions of the world, covering a wide range of products, and affecting all types of business models and asset classes (retail, commercial real estate, sovereign lending, corporate lending, trading activities, securitizations, and underwriting). While we cannot with certainty predict the source of the next crisis, we can however lay the groundwork to help mitigate or minimize the impact. It is therefore critical that all banks and countries strengthen banking sector resilience, particularly given the global and diverse nature of financial markets and the speed with which shocks are transmitted across countries. This and previous crises have shown that the deepest and most prolonged downturns arise when the banking sector gets into serious trouble and no longer has the capacity to perform its core credit intermediation function.
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Treasury Management and New Age Technology
With risk management becoming and increasing part of the corporate treasurer?s job and the development of technology, the technology is playing and ever more pivotal role. In this year?s of new age technology, the convergence between Treasury and Technology can be looked into three main areas- Currency, Capital and Foreign exchange. With the advent of internet banking, mobile banking, the frontiers are no barrier now – transaction may flow from anywhere around the world. Trading in securities, commodities, foreign exchange are just a click away now. This has made the job of the treasurers much more difficult. Portfolio management, Liquidity management and maintaining the margin has become more technology oriented. Every organization must have a sound technological base and to keep pace with the advancement of technology to survive. Here are some technology providers in India, who provide modern technological support for treasury management – a) TATA Consultancy Services – TCS BaNCS Treasury Solutions website: www.tcs.com b) Genesis Software: www.genesissoftware.co.in
c) Surya Software Systems: ALM, Credit Risk, Capital Adequacy, Transfer Pricing, Corporate Treasury website: www.suryasoft.com d) Techno Brain India Pvt. Ltd.: Integrated Treasury Management System
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Speech by Dr. Nout Wellink, Chairman of the BCBS on Basel II
Nout Wellink: Global banking supervision in a changing financial environment
Formal opening address by Dr Nout Wellink, President of the Netherlands Bank and Chairman of the Basel Committee on Banking Supervision, at the 14th International Conference of Banking Supervisors, Mérida, Mexico, 4 October 2006. Introduction Good morning. It is an honour and a privilege for me to officially open the proceedings of the 14th International Conference of Banking Supervisors. This is my first formal address as Chairman of the Basel Committee on Banking Supervision, and I can’t imagine a more appropriate venue for my first speech than here with my colleagues from the international banking supervisory community. In addition, this year’s ICBS is the first to be held in Latin America, and I’m very pleased that we have at long last gathered in this rapidly growing and dynamic region. Since we gather at the ICBS to bring together our varied views and experiences, it is appropriate that we are here in the beautiful city of Mérida, which reflects the diverse influences of Europe, the Caribbean and the local Mayan culture. I would especially like to extend my sincerest thanks to Jonathan Davis and his staff at the Mexican National Banking and Securities Commission for their warm and generous hospitality. Not only have they put together what I expect will be a very thought-provoking programme of speakers and working groups, but they have also arranged a fascinating programme of events to better acquaint us with the colourful history and culture of Mexico and its Yucatán region. Before I begin, let me acknowledge one of our colleagues who was supposed to be joining us here. As you are no doubt aware, Andrei Kozlov, first deputy chairman of the Central Bank of Russia, was recently and tragically slain. We will remember Mr Kozlov for his tireless efforts to promote the safety, soundness and integrity of the banking system. His death is a great loss to the international supervisory community. In my remarks this morning, I would like to touch on several key themes. First, I will briefly review the work that has taken place since we last gathered two years ago in Madrid. I would then like to share some thoughts on developments in financial markets and the banking sector, and on how these developments influence the types of issues that both supervisors and the industry face. Finally, I will end with thoughts on the future agenda of the Basel Committee. In particular, I will emphasise our commitment to Basel II implementation, the need to monitor and assess the broad impact of the new capital standard, and the importance in all our work of minimising any unwarranted burden on the industry. Octavio Paz, the Nobel Prize winning Mexican poet and author, once said that “wisdom lies neither in fixity nor in change, but in the dialectic between the two”. As I will discu ss shortly, we are in a time of rapid change, and we must continue to adapt. But at the same time, we must not lose sight of the fundamental elements of banking supervision. I believe that, as supervisors, we need to evolve to keep pace with changing developments, while also making sure that we retain the basic lessons that have served us well over the years. My hope going forward is that we all benefit from the wisdom of striking the correct balance between change and stability. Recent supervisory developments As I think ahead, I am greatly encouraged that the Committee’s recent work – under the steady guidance of my predecessor, Jaime Caruana – demonstrates an awareness of the need to strike this balance. Supervisors face an ever growing challenge of devising appropriate prudential structures for a financial industry that is in a constant state of change. In recent years, for example, we have witnessed an ongoing revolution in banks’ risk management practices. More and more, banks are taking a firm-wide approach to risk management that considers a broader array of risks, across a wider range of product lines and regions. Risk managers have become increasingly more disciplined
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in their approaches, harnessing both technology and advanced quantitative techniques in the process. Such changes require that supervisors design flexible standards and regulations that ensure a safe and sound banking system while still allowing for continued innovation in bank practices. The Basel II framework is designed to achieve this balance. It represents a fundamental paradigm shift in how we think about capital regulation. The advanced approaches to credit and operational risk rely on banks’ own assessments of risk as inputs to capital calculations, a recognition that banks are best positioned to understand and measure the risks that they face. In addition, because the quantitative and qualitative parameters for using the advanced approaches are intended as a baseline of sound practices, they can accommodate continued innovation by firms. And since the advanced approaches are driven by rigorous internal processes for risk measurement and management, they are clearly well suited for today’s sophisticated global banks. Indeed, the results of our fifth Quantitative Impact Study reveal that virtually every global bank intends to implement one of the advanced approaches. In combination with the role assigned to supervisory review and market discipline, these features of the new framework represent a more forward-looking approach to capital regulation, with the flexibility to evolve over time. A similar approach is evident in the new capital rules for certain exposures in the trading book, published in July 2005. Among other things, these rules update the trading book capital framework to better reflect the growth in traded credit products. The rules directly recognise the realities and complexities of today’s markets, and demonstrate that, even in the face of such complexity, greater harmonisation of regulations across sectors is possible. The Basel Committee has also strengthened its collaboration with banking supervisors throughout the world. This cooperation is particularly important for the success of Basel II, which raises many challenging questions regarding the roles and responsibilities of home and host supervisors. As one example, the Basel Committee’s recent paper on Home-host information sharing for effective Basel II implementation was developed jointly with a group of supervisors from a range of other countries. Likewise, 19 countries from outside the Committee submitted data to the fifth Quantitative Impact Study, allowing for a fuller understanding of the likely impact of the new framework on overall capital levels. Our commitment to working closely with non-member countries on Basel II implementation is also evident in their representation in the technical subgroups of the Accord Implementation Group. The Basel Committee also worked closely with supervisors from around the world on the updates to the Core Principles for Effective Banking Supervision. In what was truly a global effort, we have all succeeded in designing a practical yet flexible framework. It recognises not only the changes in financial markets and supervisory practices since the Core Principles were first published in 1997, but also that these changes have not occurred evenly across jurisdictions. The outcome of our effort, I believe, will allow for the application of the Principles to less sophisticated financial systems, without sacrificing their relevance for assessments of more complex systems. International accounting and auditing standards have also evolved rapidly in recent years. As supervisors, we are keenly interested in ensuring that banks’ accounting practices promote sound risk management practices, reinforce the safety and soundness of the banking system, and support market discipline through transparency. Where objectives of accounting standard setters diverge from those of bank supervisors, supervisors may have to put in place additional safeguards. Likewise, when audit reliability is called into question, supervisors may need to take steps to encourage greater reliability. Given these interests, the Basel Committee has taken an active role in the debate on changes to the framework for international accounting standards and promoting stronger global auditing oversight. As we look back on our accomplishments since we last assembled, I believe we have much to be proud of. In our completion of the Basel II rules, our attention to Basel II implementation issues, and our updates to the Core Principles, we have pursued approaches that have the flexibility to accommodate the continued evolution of bank and supervisory practices. We have also recognised the critical contributions that the broader supervisory community, the industry and other standard-setting bodies can and must make. All these efforts amount to significant contributions to ensuring the robustness of the financial system in the face of any future shocks.
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Evolving financial markets and emerging risks At the same time, however, the pace of innovation in financial markets shows no sign of slowing. Thus, even as we look back, we must look forward to ensure that our work remains appropriately focused on the most relevant risks. In this process, an important first step is considering market developments that affect how we view risk in the banking sector. This is the second topic of my remarks this morning. The role of banks is changing. As we know, banks have historically been the primary source of financial intermediation in most economies, with the loans they originated serving as their primary assets. Now, however, banks increasingly originate loans and other types of credit instruments with the intent of securitising them and selling them to other market participants. While it may be the case that banks in the end hold fewer credits on their balance sheets, I believe that it would be wrong to say that banks now play a less important role in credit markets. Banks, as well as securities firms, are at the centre of a new risk intermediation landscape that is increasingly based on traded products. In this new landscape, banks and securities firms are actively involved in origination, securitisation and active management of credit exposures. This shift to capital markets-based distribution of risk has been accompanied by increased velocity in intermediation, aided by new technologies that allow for greater automation and standardisation. And the greater role of capital markets in intermediation also implies that many of the risks once held by banks are now held by other types of market participants. The greater reliance on capital markets in credit origination and distribution has also served to unlock the creative potential of market participants. We see this, for example, in products that not only bundle loans with similar characteristics prior to sale, but also then structure the resulting securities into tranches with different risk profiles. We have also witnessed explosive growth in over-the-counter derivative products that give exposure to, and provide hedging vehicles for, a growing array of new and increasingly complex risks. To give some sense of the volume of this activity, the International Swaps and Derivatives Association recently estimated that the gross notional amount of outstanding credit derivatives was $26 trillion, a growth of over 50% in just six months. While I believe that these changes have made the banking system more resilient, these developments also pose a range of risks that both supervisors and the industry need to monitor closely. In a very broad sense, many of the challenges that we face stem from the mismatch between rapid market innovation and risk management infrastructure. The rapid growth in the markets for new financial products, and the entry of a diversity of participants into these markets, frequently strain the capacity of banks to manage the associated risks. If not addressed promptly and appropriately, these circumstances can have significant consequences for financial market stability. It is therefore imperative that we explore the extent to which the management of risks such as counterparty credit risk, market risk, liquidity risk and operational risk evolve in the face of market innovation. Globalisation is another important trend in the banking industry. A combination of liberalisation of financial markets over the past two decades and business opportunities in rapidly growing economies has led to an increasing proportion of global bank activities in foreign countries. This is particularly the case in capital markets, but also in areas such as retail where the presence of global banks in local markets continues to grow. As a result of cross-border mergers and acquisitions, an increasing number of banking markets now have a significant foreign bank presence. In general, I would argue that the scale of foreign banks operating in emerging markets allows them to bring expertise and financial resources that might not otherwise be available. They can also introduce more sophisticated risk management tools that may have been developed for the larger financial group. While these benefits are significant, the scale of foreign banks’ presence can have implications for host countries. For example, a local financial system could be disproportionately dependent on the safety and soundness of a small handful of foreign banks. This has potentially significant implications for how banks in these markets are supervised. It is one of the great challenges of our work that as many banks’ operations and risk management frameworks become more global, the supervisory structure remains national. Thus, as we work to address the issues I have highlighted, supervisors must also solve problems of cross-border information sharing and coordination, and clearly define those areas where supervisory responsibilities overlap and those where they diverge. Our recent updates to the Basel Core Principles show that we have been up to these challenges. The process of updating the Principles was a truly global supervisory effort and demonstrated our capacity to cooperate and seek a common understanding on many important issues. And the result – a global standard whose local application
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can be scaled in proportion to local risks and financial market realities – demonstrates our ability to work effectively within the constraints imposed by using national structures to supervise global institutions. Future work of the Basel Committee Given the developments that I’ve just cited, where do we go from here? How do we strike the appropriate balance between change and stability? My third topic this morning is to share some ideas on where I see the importance of work in the supervisory community over the next several years. I will focus my remarks on three key areas: our commitment to Basel II implementation; the importance of assessing and monitoring the impact of Basel II; and the need for proportionality in supervisory efforts relative to underlying risks in order to minimise the regulatory burden on the industry whenever possible. Basel II implementation Let me begin with Basel II implementation, which remains the key item on the C ommittee’s agenda. As I mentioned at the outset, Basel II represents a fundamental paradigm shift in the supervisory approach to capital regulation. This new approach is entirely necessary if capital standards are to keep pace with rapid innovation in financial products as well as in risk measurement and management techniques, and the ever increasing complexity of firms’ risk profiles. As such, the new framework is absolutely critical to the health and stability of the banking system. Given the importance of Basel II, I am pleased to report that implementation is fully under way. For example, implementing legislation or regulation is either in place or in process in markets such as the European Union and Japan. Likewise, supervisory agencies in the United States recently issued their notice of proposed rulemaking. Meanwhile, banks are continuing their discussions with supervisors on their specific Basel II plans, in many cases with a goal of implementation next year. Let me not, though, gloss over the difficulties involved in successful implementation. For example, it is clear that home-host issues remain among the most challenging for both supervisors and the industry. In addressing these issues, we should strive to achieve as much cross-border consistency as possible on key elements of the framework. At the same time, we should also recognise that both home and host supervisors have legitimate interests that need to be met and national implementation will vary in relation to local needs. Indeed, the tension inherent in applying a global standard within national supervisory regimes will never fully dissipate. Issues must often be resolved on a case by case basis, seeking pragmatic solutions that recognise the limits of what can be accomplished. Going forward, we must extract lessons and principles from specific cases and apply them back to our overall Basel II work. This is an iterative process, and one that will help to maximise consistency in implementation across banks and jurisdictions. In this regard, the Committee’s Accord Implementation Group, or AIG, is working to share information and thereby promote greater consistency in implementation across countries. As we address the challenges of Basel II implementation, we must remember that Basel II is more than a one-off exercise in getting the details and the numbers right. More than anything, it is a flexible framework that supports innovation over time, and provides appropriate incentives for improvements to risk management, supervision and disclosure. Basel II is as much about this long-term process, and the beneficial dialogue it has spurred between banks and supervisors, as it is about the more micro-level details of implementation. It provides the medium for interaction with the industry on a number of complex issues, and for thinking about how risk management and supervisory practices are likely to evolve over time. I encourage all of us not to lose sight of this important aspect of Basel II. The impact of Basel II I would also like to address the importance of understanding the impact of Basel II on banks and markets. Many banks, and market participants more broadly, have voiced concerns that the new framework could have unintended consequences on banks’ risk -taking and capital allocation in both the short and the long term. These consequences could occur across different dimensions, for example firm size, risk profile and jurisdiction. There could also be consequences for banks’ activities relative to those of securities firms.
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The Committee has been sensitive to the potential impacts of Basel II throughout its development, and this will not change as we move into implementation. I believe that shorter-term consequences, such as those related to so-called “gap year” issues arising from different implementation dates, will ultimately resolve themselves as these gaps disappear over time. This will be easier if there is constructive dialogue during this transitional period with the industry and among supervisors from jurisdictions with varying implementation dates about how best to address these short-term challenges. Some of the longer-term consequences, however, may be more difficult to predict but in many instances are likely to be the natural result of a more risk-sensitive framework. So as a first step in any discussion of longer-term consequences of Basel II, supervisors and banks should distinguish between those that reflect the closer alignment of regulatory and economic capital, and those that are indeed unintended and undesirable. Indeed, where regulatory and economic capital are more closely aligned, I expect that this will have a levelling effect on the playing field by eliminating any competitive distortions caused by Basel I. In addition, as is currently the case, I expect that banks’ decisio ns will be driven more strongly by assessments of risk and return than by regulatory capital considerations. Nevertheless, we must closely monitor and assess the impact of Basel II to mitigate the possibility of any competitive distortions. Failure to do so would undermine much of what is innovative and beneficial in the new framework. While I do not currently expect that it will be necessary, the Committee remains prepared to revisit aspects of the rules where there is clear evidence during the coming transition years of unintended consequences for risk-taking and capital allocation. We must also be attuned to the risk that these consequences can result from inconsistent application across banks or sectors, particularly for rules related to risk assessment and quantification. This is an area where the AIG and its subgroups will continue to actively exchange information on observed industry and national supervisory practices. I would like to highlight what I believe is a major accomplishment in this regard. Earlier in my remarks I mentioned the new trading book rules, which were developed jointly with our colleagues from the International Organization of Securities Commissions. Through this cooperative effort, we have developed a common framework for the convergence of capital requirements for banks and securities firms, which is a significant step towards providing a more level playing field.
Proportionality of supervisory efforts As an important guiding principle for future supervisory areas of focus, we need to ensure that the scope and scale of any work we undertake is commensurate with the risks we seek to address. The realities of today’s banking industry and financial markets argue for more measured and flexible approaches. In an environment of continuous innovation and growing competition within and across sectors, it is important that regulators assess the appropriate balance between formal regulatory responses, enhancements to supervisory tools, industry solutions and market discipline. In the years to come, it is inevitable that the Committee will choose to develop guidance aimed at strengthening supervisory practices or highlighting necessary improvements to banks’ risk management. However, I anticipate that there will be many more instances where we decide to limit our work to stocktaking exercises and information exchange, or defer work altogether so that industry and national supervisory initiatives have the time and flexibility to run their course. As we consider the trade-offs of these types of approaches, we will continue to seek industry input on the intersection of market developments, the robustness of risk management practices, and the adequacy of supervision and regulations. In doing so, we will be able to build on the excellent dialogue that has existed around Basel II. Guided by this principle of proportionality, I would like to explore some broad aspects of the Committee’s agenda. These include cross-border information sharing, banks’ risk management practices, supervisory techniques and cross-sector coordination. My goal is not to provide specific details on potential projects, but to give you some sense of how the Committee perceives its role in the international supervisory community.
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Cross-border information sharing Looking first at information sharing, one of the main challenges I see going forward relates to the tension, if you will, between regulatory structures and market realities. A trend that we see is that banks increasingly manage risk on a global basis. This poses a challenge to us as supervisors since we generally operate within national regulatory structures (for very sound reasons, I might add). Supervisors will need to depend ever more on information provided by their colleagues in other jurisdictions, and will need to set up the appropriate mechanisms for doing so in ways that do not impose a burden on one another, or on the industry. In particular, we need to consider how supervisory information sharing and coordination can be deepened and broadened. Risk management practices We will also need to stay abreast of the latest developments in risk management and be attentive to the possibility that these developments may, as they have on occasions in the past, lag innovations in financial products and markets. Where such lags between financial innovations and risk management practices arise, the Committee will consider the merits of issuing guidance that conveys to banks and supervisors the sound practices that institutions should be following. Moreover, there is significant value in supervisors providing the industry with transparency about the range of practices they see in areas where financial innovation and risk management practices are evolving rapidly. For example, I think the Committee might usefully explore industry practices in areas such as counterparty credit risk, liquidity risk management and techniques for assessing economic capital. We will also continue our important work in the accounting sphere, to ensure that accounting and sound risk management practices are properly aligned. Moreover, ongoing changes in the accounting framework can have important implications for valuations, capital, and disclosure practices, and the Committee will continue to monitor developments in this area closely. Supervisory techniques The sharing of information on emerging supervisory practices will remain a fundamental role of the Basel Committee. It is not uncommon for national supervisors to pursue different approaches when adapting to changes in industry practices and market structures. Given the dynamic nature of the financial industry, diversity in supervisory practices is to be expected, and even encouraged in instances where our methods and processes continue to evolve. As best supervisory practices emerge, however, we have a strong interest in ensuring that these practices are clearly articulated and widely disseminated. Doing so will help to raise the level of global supervision, reduce any competitive distortions resulting from differing practices, and ultimately contribute to the resilience of the financial system. Cross-sector coordination In these and other efforts, it is equally important that we work closely with our fellow supervisors in the securities and insurance sectors, as firms in the three sectors increasingly compete across a range of products and markets. I have already mentioned our joint work with IOSCO on the trading book, and I am encouraged that securities regulators remain involved in our continued exploration of trading book issues, an area of growing importance as credit products become increasingly and actively traded. We will also continue to work closely with securities regulators and insurance supervisors under the auspices of the Joint Forum, which focuses on issues common to the three sectors, including the supervision of financial conglomerates and areas such as risk concentrations and management of complex retail products. Enhancing dialogue In all of our work, one of my key goals as Basel Committee Chairman is to maintain and enhance the dialogue with the wider supervisory community. For example, I earlier discussed the growth of crossborder banking and the challenges this poses for both home and host supervisors. This makes it essential that the Committee have a keen understanding of these challenges from both a home and a host supervisor perspective. In recent years, the Committee has strengthened its outreach through, for example, more frequent meetings with chairs of regional groups of banking supervisors and with the Committee’s Core Principles Liaison Group, which includes representatives from 16 non -G10 countries. This dialogue has been absolutely essential and must continue and be strengthened.
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Concluding thoughts In closing, as I mentioned earlier in my remarks, over the past several years we have tried to design flexible, principles-based standards that foster greater resilience in the banking sector while allowing for continued innovation on the part of banks. Looking at the pace of innovation in financial markets, the changing role of banks and the more globally interlinked banking industry, we must continue to respond in kind. Going forward, I expect the Committee will continue moving full speed ahead with Basel II implementation, assessing the impact of Basel II, and maintaining a sense of proportionality so as not to overly burden the industry and ourselves. Moreover, while we will probably continue to issue supervisory guidance as necessary in the future, we will also focus on some of the “basics” such as cross-border information sharing, understanding bank risk management practices and supervisory techniques, cross-sector coordination, and dialogue with the industry and among bank supervisors. In adapting to a changing world, we must not lose sight of the basic supervisory tools that have served us so well over the years. We should continue to encourage the development of sophisticated tools for better risk management, but we should also continue to emphasise simple but vitally important concepts such as sound corporate governance. We should strive to understand the increasingly complex quantitative models that banks increasingly rely upon, but not lose sight of the importance of sound judgment on the part of bankers as well as supervisors. I hope that you find the next several days in Mérida enlightening, challenging, energising and even, dare I say, fun. Thank you very much, and I look forward to exchanging views not just during this ICBS, but over the coming years as well.
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CASE STUDY
A study carried on an Urban Cooperative Bank shows that the principles of treasury management applied following the guidelines issued by RBI can make a bank to stand on a sound financial base and to grow safe.
Name of the bank :The Baidyabati Sheoraphuli Cooperative Bank Limited Address : 6, Kalahata Lane, Sheoraphuli, Hooghly Pin – 712223
Balance Sheet as on 31.03.2011 (Audited) Sources Amount
(Rs. In lac) Share Capital Reserves & Surplus Deposits: SB CA Term Deposit Interest payable on deposit Bills payable Bills for collection Sundry Liabilities Overdue Interest Suspense Profit & Loss Appropriation Total Applications Cash Balances with other banks CA SB Term Deposits Investments Advances (NPA=439.44) Bills receivable Interest Receivable Fixed Assets Sundry Assets Total
Amount
(Rs.In lac) 134.31 1198.51
3266.25 58.48 2674.01
5998.74 69.13 2.80 37.00 328.90 138.23 1134.51 9042.13 29.47
: 281.41 14.88 1717.17 2013.46 2511.67 3677.96 37.00 468.78 31.80 271.99 9042.13
We shall apply the Asset Liability Management techniques and Basel II norms to find out the financial soundness and the strength of the capital to stand against the risks. Page | 50
Basel II applications: Risk Weighted Assets
Particulars
Cash in hand Cash at bank:CA Investments: Govt. Securities Commercial Banks Non-SLR investments Advances: Loan agst LIC/KVP/Dep Loan to Staff House Building Loan Personal Loan Gold Loan Others Premises, Furniture & Fixture Other Assets Interest due on Govt. Securities Interest due from banks Interest due from AIFI Bonds Interest due on housing/gold loan Interest due on staff loan Interest due on loan agst NSC/KVP Interest due on other loans Other Assets TOTAL
Book value
29.47 281.41 1979.18 1732.05 532.49 54.85 6.69 157.62 95.23 413.16 2950.41 31.80 13.03 312.72 4.80 31.30 0.02 6.66 100.25 271.99 9005.13
Risk weight%
0.00 20.00 2.50 20.00 102.50 0.00 20.00 50.00 125.00 50.00 100.00 100.00 0.00 20.00 102.50 50.00 20.00 0.00 100.00 100.00
RWA
0.00 56.28 49.48 346.41 545.80 0.00 1.34 78.81 119.04 206.58 2950.41 31.80 0.00 62.54 4.92 15.65 0.00 0.00 100.25 271.99 4841.30
Capital Fund A.Tier I Capital Fund Paid up Capital Reserves & Surplus Statutory Reserve Special Reserve Profit & Loss Appropriation B.Tier II Capital Investment Fluctuation Reserve General Provisions TOTAL CAPITAL FUND TOTAL RWA Tier I Capital to RWA CRAR Other Assets TOTAL
Rs.in lac
Rs.in lac
134.31
Rs.in lac
256.97 61.03 1134.51
1452.51
1586.82
110.00 61.82
171.82 1758.64 4841.30 32.78% 36.33% 271.99 4841.30
271.99 9005.13
100.00
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The Baidyabati Sheoraphuli Cooperative Bank Limited Statement of Structural Liquidity as on 31.03.2011 Outflow
Share Capital Reserves & Surplus Deposits SB & CA Term Deposit Interest Payable on Deposit Bills Payable Bills for Collection Sundry Liabilities Overdue Interest Suspense Profit & Loss Appropriation TOTAL(A) Inflow Cash Bank Balances CA & SB Term Deposits Investments SLR Others Advances Standard NPA Bills Receivable Interest Receivable Fixed Assets Sundry Assets TOTAL(B) Mismatch Cumulative mismatch Mismatch %
1-14 days
15-28 days
29-90 days
3-6 months
Up to 1 year
1-3 year
3-5 year
Above 5 year
134.31 1198.51
Total
134.31 1198.51
831.18 75.69 69.13 2.80 37.00 49.34
24.33
219.54
313.93
416.88
2493.55 1182.18
275.69
165.77
3324.73 2674.01 69.13 2.80 37.00
279.56 138.23
328.90 138.23
1134.51 1065.14 29.47 296.29 30.73 226.72 1011.98 322.21 37.00 45.10 6.08 24.33 219.54 313.93 416.88 3675.73 275.69 3050.89
1134.51 9042.13 29.47 296.29 1717.17 2511.67 1499.69 1011.98 3677.96 3238.52 439.44 37.00 468.78 31.80 271.99 9042.13
27.47 54.89
218.00 78.48
718.98 104.22
721.21 918.93 68.92
0.78 41.45
325.62
609.92
647.10
803.90
309.25
220.52 439.44
15.02
15.98
75.32
131.00
119.52
32.14
34.70 31.80 271.99 820.16 -2230.73 00
1999.50 934.36 934.36
346.72 322.39 1256.75
708.26 488.72 1745.47
1018.90 704.97 2450.44
1758.10 1341.22 3791.66
2068.91 -1606.82 2184.84
321.58 45.89 2230.73
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The Baidyabati Sheoraphuli Cooperative Bank Limited Statement of Interest Rate Sensitivity as on 31.03.2011 Outflow
Share Capital Reserves & Surplus Deposits SB & CA Term Deposit Interest Payable on Deposit Bills Payable Bills for Collection Sundry Liabilities Overdue Interest Suspense Profit & Loss Appropriation TOTAL(A) Inflow Cash Bank Balances CA & SB Term Deposits Investments SLR Others Advances Standard NPA Bills Receivable Interest Receivable Fixed Assets Sundry Assets TOTAL(B) Mismatch Cumulative mismatch Mismatch %
1-28 days
29-90 days
3-6 months
Up to 1 year
1-3 year
3-5 year
Above 5 year
Non Total Sensitive
134.31 1198.51 134.31 1198.51
100.02
219.54
3266.25 313.93
58.48 416.88 1182.18 275.69 165.77 69.13
3324.73 2674.01 69.13
2.80 37.00 328.90 138.23
2.80 37.00 328.90 138.23
1134.51 100.02 219.54 3580.18 416.88 1182.18 275.69 165.77 3101.87 29.47 14.88 218.00 78.48 281.41 718.98 104.22 721.21 918.93 68.92 0.78 41.45
1134.51 9042.13 29.47 296.29 1717.17 2511.67
30.73 232.80 1011.98 647.83
27.47 54.89
3677.96 609.92 647.10 803.90 309.25 220.52 439.44 37.00 468.78 31.80 271.99 1559.89 -1541.98 00 37.00 468.78 31.80 271.99 9042.13
1923.34 1823.32 1823.32
692.28 472.74 2296.06
958.46 -2621.72 -325.66
1627.10 1210.22 884.56
1949.39 767.21 1651.77
289.44 13.75 1665.52
42.23 -123.54 1541.98
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The Baidyabati Sheoraphuli Cooperative Bank Limited Statement of Short Term Dynamic Liquidity as on 31.03.2011
Outflow Net increase in advances Net increase in investments Inter bank commitments Off balance sheet items Others TOTAL Inflow Net cash position Net increase in deposits Interest on investments Inter bank claims Off balance sheet items others TOTAL Mismatch Cumulative mismatch Mismatch %
1-14 days 58.00 6.00
15-28 days 58.00 6.00
29-90 days 230.00 25.00
Total 346.00 37.00
4.00 68.00 10.25 49.00 45.10
4.00 68.00 10.25 49.00 15.02
16.00 271.00 31.00 195.00 15.98
24.00 407.00 51.50 293.00 76.10
104.35 36.35 36.35
74.27 6.27 42.62
241.98 -29.02 13.60
420.60 13.60 00
Analysis:
1) From the analysis of the Statement of Structural Liquidity, we find that there is no negative cumulative mismatch in any time bucket, which confirms that the bank has sufficient amount of surplus liquid assets. 2) From the analysis of the Statement of Short Term Dynamic Liquidity, we can say that the bank will not suffer from any liquidity crisis in the near short term, as there is no negative cumulative mismatch in any time bucket. 3) From the analysis of the CRAR (Basel II), we can find that the bank stands on a very sound financial base. The capital fund of the bank is much higher than the prescribed international norm of minimum 6% for Tier I Capital and 9% for total Capital fund.
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To whom it may concern
I hereby declare that the project report titled “ Treasury Management in Banks” submitted in partial fulfillment of the requirement of the degree of MBA from Sikkim Manipal University, India is my original work and not submitted for the award of any other degree, diploma, fellowship or any similar title or prizes.
Signature Place: Sheoraphuli Date: Name: Sourav Bandyopadhyay Registration No. 5521020146
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ACKNOWLEDGEMENT
I would like to extend my deep gratitude and obligation to them who have helped me in the field to complete the project.
I am grateful to Dr. Arunava Sinha (CED, SMU Learning CentreSerampore) for his kind inspiration, guidance and valuable suggestion during the course of my project work.
I also express my gratitude and obligation to Dr. Arunava Sinha (CED, SMU Learning Centre – Serampore), Mr. Kunal Paul and Miss Debarati Roy and my friends and staff of Institute of Information Technology ( Study Centre of Sikkim Manipal University, Serampore, Hooghly) for their help in different aspects.
I also thank to all those people without the support of them it was impossible for me to complete this project.
Name of Centre: Institute of Information Technology Centre Code: 00199
Signature Place: Sheoraphuli Date: Name: Sourav Bandyopadhyay Registration No. 5521020146
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Examiner?s Certificate
The Project Report of Sri Sourav Bandyopadhyay titled “Treasury Management in Banks” approved and acceptable in quality and form.
Internal Examiner Name: Dr. Arunava Sinha Qualification: MBA, PhD (CS), JU Designation: CED, SMU LC
External Examiner Name: Mr. Rituparna Thakur Qualification: MBA (Finance) Designation: Senior executive
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Gratitude:
1) 2)
SMU Learning Centre, Serampore
The Chief Manager, The Baidyabati Sheoraphuli Bank Limited
Cooperative
3)
Reserve Bank of India official website: www.rbi.gov.in
4)
The Institute of Chartered Accountants of India www.icai.org.in
website:
5)
Official website of Bank of International Settlement website: www.bis.org
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