Post on 29-May-2018
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As far back as in October 1999, the
RBI had issued guidelines, with anintegrated approach, on risk
management in banks. Having regard
to diversity of banks, they wereadvised to design their own risk
management architecture, in tune with
their size, complexity of business, risk
philosophy, market perception and the
level of capital.
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HISTORY OF BASEL COMMITTEE
The Basel committee was constituted by central bank governors of the G
10 countries in 1974.The G-10 committee consists of members from Belgium, Canada, France,Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden,Switzerland, UK and US.
The committees secretariat is located at Bank for International Settlementsin Basel, Switzerland.
The present Chairman of this committee is Mr. Nout Wellink (President ofThe Netherlands Bank). The Secretary General of the Basel Committee is Mr.Stefan Walter.
This committee meets four times a year.
It provides forum for regular cooperation on banking supervisory matters.
This committee is best known for its international standards on capital
adequacy; the core principles of banking supervision and the concordat oncross-border banking supervision.
The Committee today consists of central bankers and supervisory regulatorsfrom 13 countries.
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GOALS OF BASEL NORMS
In the late eighties, there was a lot of cross
border lending particularly by Japanese banks.
Japanese banks grew enormously and gathered
market share, so western banks complained about
Japanese banks being regulated badly.
To standardise the regulation governing the global
banking industry Basel I was introduced.
Basel I norms defined the minimum required
equity capital.
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BASEL I
In July 1988 Basel committee came out with a set ofrecommendations, Also known as 1988 Basel Accord.
Basel I is a round of deliberations of the central banks
from all over the world.
In 1988 Basel committee in Basel, Switzerlandpublished a set of minimum capital requirements of
the bank and was enforced by law in G -10 countries.
It stated the minimum level of capital requirement
( single number calculated as a fraction of riskweighted assets) to be maintained by banks.
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CONTDu.
This is known as the capital adequacy ratio.
It was 8 % of their risk weighted assets.
Under Basel I assets of banks were classified into five
categories on the basis of credit risk carrying risk weights of0, 10, 20, 50 and upto 100 percent.
Different risk weights were specified for different categories
of exposure like 0 % for government bonds and 100 % for
corporate loans.
This CAR requirement reduced the high levels of leverage in
the banking industry.
Since 1988 this framework has been introduced in G-10
member countries comprising of 13 countries.
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BASEL II
It is more comprehensive than Basel I.
It was founded in 1999 with its final directive in 2003.
Basel II are the recommendations on banking
regulations and laws issued by Basel committee onBanking Supervision.
The purpose is to create an international standard
that banking regulators can use when creating
regulations about how much capital banks need to
put aside to guard against the types of financial and
operational risks banks face.
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BENEFITS OF BASEL IIThis will help in better pricing of loans in alignment with their actual
risks.This will enable customers with high credit worthiness to get cheaper
loans.
Higher risk sensitivity of the norms provide no incentive to lend to
borrowers with declining credit quality.Improving overall efficiency of banking and finance systems.
Takes global aspect into consideration for more rational decision
making, improving the decision matrix for banks.
Other important risk factors such as interest rate risks, foreignexchange risks and operational risk faced by a bank were not
addressed in Basel I.
In simple terms, it meant the greater risk to which the bank is
exposed, the greater the amount of capital the bank needs to hold to
safeguard its solvency and overall economic stability.
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BASEL II THREE PILLARS
Minimum capitalrequirement
-under the Basel II norms
bank should maintain 8 %
CAR but RBI requires it to
be maintained at 9 %.- Market risk
Same as Basel I accord.
- Credit risk
Three different approachesused for calculation.
- Operational risk
Not covered in Basel I
accord.
Supervisory review
- Assessment of overallcapital adequacy .
-review and evaluation of
banks internal capitaladequacy and strategies.
-to keep the capital at morethan the minimum ratio.
- To prevent capital falling
from below the minimumlevels.
Market discipline
-core and supplementarydisclosures to make marketdiscipline more efficient.
- Market signals
Responsiveness of banks orsupervisors to marketsignals.
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BASEL I BASEL II
Measurement of only one risk
(Credit Risk).
Measurement of all the three major risks faced by
the Bank e.g. Credit Risk, Market Risk and
Operational Risk.
Broad brush structure (e.g. all banks have 20% risk
weight and all corporates have 100% risk weight).
More risk sensitive (measurement of risk weights
for all individual banks and corporates).
Fixed method of calculation. Flexible Menu of approaches
Incentives in capital for adopting advanced and more
risk sensitive approaches.
One size fits all.
(9% for all banks irrespective of its risk management
capabilities).
Economic Capital will vary according to the assessed
loss on account of various risks. It takes care of risk
assessment and risk management capabilities of
each bank.
Structure depends only on one pillar.
Minimum Capital requirement.
There are three pillars
1. Minimum capital requirement.2. Supervisory Review
3. Market discipline (or the nature and extent of
disclosure).
Building up of adequate capital was the main
concern of banks management. Risk management
was not gaining importance as risk weight of various
assets were pre-determined.
Besides building up of capital, enhancing the skills
of management and staff in risk management
practices has gained momentous proportion.
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TERMS USED IN RISK MANAGEMENT
(1) PD or probability of default: is the likelihood that a loan
would not be repaid and will fall into default. It is
calculated for each individual client or a portfolio of clients
with similar attributes. The credit history and nature of
investment are taken into account.
(2) LGD or loss given default: is the fraction of EAD that will
not be recovered following a default. (most popular is gross
LGD where losses are divided by EAD)
(3) EAD or exposure at default: is the estimation of the extentto which a bank may be exposed to a counterparty in the
event of and at the time of its default.
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CAPITAL ADEQUACY RATIO
The amount of regulatory capital to be maintained by a bank to
account for various risks inherent in the banking system.
Also known as capital to risk weighted assets ratio.
The Capital Adequacy ratio is measured as;CAR = tier I capital + tier II capital
risk weighted assets
Regulatory capital is defined as the minimum capital, banks are
required to hold by the regulator, i.e. "The amount of capital abankmusthave". It is the summation of Tier I (core capital i.e.
equity capital and disclosed reserves)and Tier II (secondary bank
capital includes items such as undisclosed reserves etc.) capital.
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APPROACHES USED IN CALCULATION
OF CREDIT RISK
In this the banks uses rating of external credit ratingagencies to quantify required capital for credit risk.
Standardizedapproach
Under this banks can develop their own empiricalmodel to estimate PD (probability of default) forindividual clients or group of clients.
Banks can only used the prescribed LGD from theirregulators.
The total required capital is calculated as the fixed
percentage of the estimated RWA .
Foundation IRB
(internal ratings
based approach)
In this banks use their own quantitative model toestimate PD, EAD, LGD and other parametersrequired for calculating the RWA.
The total required capital is taken as a percentage ofestimated RWA.
Advanced IRB
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APPROACHES USED FOR
CALCULATION OF OPERATIONAL RISK
It is simpler as compared to other methods.
Capital to be kept aside for operational risk is theaverage of previous three years of fixed percentage ofannual gross income.
The fixed percentage alpha is usually 15 % of theannual gross income.
Basic indicator
approach
In this banks activities are divided into 8 lines.
The capital charge of each individual business line iscalculated by gross income by a factor denoted bybeta assigned to that business line.
The total capital charge is the three year average ofsimple summation of the regulatory capital charges
across each business line.
Standardized
approach
After fulfilling certain requirements as per Basel accorda bank can use its own empirical model to quantify
required capital for operational risk.
Advanced
measurement
approach
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APPROACHES USED IN CALCULATION
OF MARKET RISK
the most popular method is VaR i.e. value at risk.
It is defined with respect to specific portfolio of financial assets , at
a specified probability and a specified time horizon.
It estimates the probability of portfolio losses based on thestatistical analysis of historical price trends and volatilities.
Suppose a portfolio manager has a daily VaR equal to $1 million at
1 % . This means there is only one chance in 100 that a daily loss
bigger than $ 1 million occurs under normal market conditions.
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Different risk committees have been set up to monitor risk in different
areas such as market risk management, asset liability managementetc.
The bank works as per Basel II since 2006 and follows standardised
approach for credit risk, basic indicator approach for operational risk
and standardised duration method for market risk.
The bank uses several credit assessment models.
The bank conduct industry studies regarding the risk prevalent in each
industry to be considered in lending.
For close monitoring VaR is generated on a daily basis.
Stress testing of the portfolios are done under various scenerios.It uses the market related fund transfer pricing.
The bank manages operational risks through a comprehensive system
of internal control and systems.
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Highest net profit
during 2007-08.
Rs.6729 crores
Capital
Rs.631 crores
Return on assets
1.01 %
Net worth
(capital + reserves)
Rs.49033 crores
Capital adequacy
ratio
13.47 %
Net non
performing assets
1.78 %
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Every application thats used at ICICI bank is firstassessed for risk before it is deployed.
Its risk assessment programs are assessed against its
security policy framework.
The most significant credit risk is assessed by the credit
risk compliance & audit department.
The department performs various functions like credit
rating of companies, monitor adherence to RBI
guidelines, credit risk information system etc.
Web based system developed to provide information onvarious aspects of credit portfolio at ICICI bank.
Established a market risk compliance and audit
department.
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Profit during 2007-08
Rs.4158 crores
Capital
Rs.1463 crores
Return on assets
1.12 %
Net worth
(capital + reserves)
Rs.46820 crores
Capital adequacy ratio
13.97 %
Net NPA
1.55 %
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Risk management architecture consists of risk management structure,
policies and risk management implementation and monitoring systems.Several credit risk cells have been formed which worked together to
identify, measure, monitor and control the banks credit risk exposure.
(corporate research, portfolio and review cell)
Credit exposure ceilings have been set up (500 % of the banks capital
funds as per last year balance sheet)
Interest rate risk is measured through interest rate sensitivity gap
report and earning at risk.
ALCO and ALM manages the liquidity risk ensuring that the negative
liquidity gap does not indicate the tolerance levels.The bank is working upon new credit rating model to move to internal
rating based approach. It involves calculation ofPD and LGD.
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Profit during 2007-
08
Rs.1436 crores
Capital
Rs.366 crores
Return on assets0.89 %
Net worth
(capital + reserves)
Rs.11044 crores
Capital adequacy
ratio
12.91 %
Net NPA
0.47 %
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The bank has evolved a risk management frameworkcomprising of board level risk management committee.
(CRMC, ORMC, ALCO)
Each committee works towards measuring and monitoring
respective risks.The bank is in the implementation process of its technology
based MIS system covering all its branches and offices.
AS per the RBI guidelines the bank uses standardized
approach for credit risk and basic indicator approach for
operational risk.
With effect from march 2006 it applied standardized
duration approach for computing capital requirement for
market risks.
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Pr fit ri -
s. c res
Capital
s.44 cr res
et r assets.
Net w rth
(capital + reserves)
s. cr res
Capital a eq acy
rati. 4
Net NPA
0. 0
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BOTTLENECKS TO ACHIEVE EFFICIENT
RISK MANAGEMENT SYSTEM
Data adequacy
Lot of quantitative and qualitative historical data and
information related to credit, probability of customers
default, evaluation of recovery rates for the models like VaRis required.
Lack of efficiency
Most of the banks particularly nationalized banks does not
have appropriate data and efficient people to comprehend
and go forward for advance measurements as per Basel II.
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JUDGING A BANKS HEALTH
A banks health depends upon three critical parameters:(1) capital adequacy ratio
(2) Asset quality
(3) Earnings
As per the year 2007-08 data seven banks have more thanRs.10,000 crore worth with SBI having the highest net worth
followed by ICICI.
ICICI bank has the highest CAR 13.97 %, overall 30 banks
have CAR more than 12 %. The higher capital base showsthey are less leveraged and hence, strong.
a higher ratio indicates more safety.
Not a single bank has less then 9 % CAR.
Around 27 banks showed atleast 1 % return on assets.
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CONCLUSIONVijaya bank is the first in the bank in the public sector to initiate the
implementation of a enterprise wide integrated risk management
system project. (CAR 11.22 % )
As per a report by financial management services consultancy
provisions of the Indian banks are expected to increase to Rs.75,000
crore by 2013 from Rs.20,000 crore in 2008 given the tightening
economic conditions.In a volatile and dynamic market place for achieving sustainable
business growth and shareholders value, it is essential to develop a
link between risks and rewards of all products and services of the
bank.
Hence, the banks should have efficient risk management
framework to mitigate all internal and external risks.
In order to be competitive in the volatile and dynamic market a
bank needs to work towards a bank wide risk management
framework.
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India aims at attaining global standards in terms of financial health, safety ,
transparency through the implementation of Basel II accords by 2009.
Indian banks having overseas operations and foreign banks operating in India need
to comply with the Basel II norms by March 31,2008. All other commercial banks
excluding local area and regional rural banks are required to follow the frameworkby 2009.
RBI has come out with new guidelines which require the banks to keep funds for
non financial risks related to its own reputation, under estimation of credit risk
etc.
The objective of risk management is not to prohibit or prevent risk taking activitybut to ensure that the risks are consciously taken with full knowledge, clear
purpose and understanding so that it can be measured and mitigated.
Banks will have to restructure and adopt if they are to survive in the new
environment.