A Study on Basel II Framework
-
Upload
rahulmangalca9997 -
Category
Documents
-
view
215 -
download
0
Transcript of A Study on Basel II Framework
-
8/8/2019 A Study on Basel II Framework
1/61
1 1
study on Basel IIFramework
-
8/8/2019 A Study on Basel II Framework
2/61
2
Contents
-
8/8/2019 A Study on Basel II Framework
3/61
3
Basel II - Introduction
Basel II is the second of the Basel Accords issued bythe Basel Committee on Banking Supervision
(BCBS).
Objective: Ensuring that capital allocation is more risk sensitive;
Separating operational risk from credit risk, and
quantifying both;
Attempting to align economic and regulatory capital
more closely
In India, implemented w.e.f. March 31, 2009
-
8/8/2019 A Study on Basel II Framework
4/61
4
Comparison with Basel-I
Basel I Basel IIFocused on Single riskMeasure
More emphasis on banks own internal riskmanagement methodologies, supervisoryreview and market discipline
Broad Brush structure More risk sensitive; Menu of approaches;Capital incentive for better riskmanagement; Granularity in the RW of assets
-
8/8/2019 A Study on Basel II Framework
5/61
5
Scope
Applicable to all Commercial Banks
Except Local Area Banks and RRBs
Applicable at both solo & consolidated level
Consolidated bank include all group entities
except :
Insurance
Business not pertaining to financial services
-
8/8/2019 A Study on Basel II Framework
6/61
6
Based on Three Pillars
-
8/8/2019 A Study on Basel II Framework
7/61
7 7
PILLAR - 1PILLAR - 1MINIMUM CAPITAL REQUIREMENTMINIMUM CAPITAL REQUIREMENT
-
8/8/2019 A Study on Basel II Framework
8/61
8
Pillar - 1
-
8/8/2019 A Study on Basel II Framework
9/61
9
Timelines
All banks (except Local Area Banks & RRB) to migrate tothe approaches prescribed by March 31, 2009.
Time schedule for the advanced approaches
-
8/8/2019 A Study on Basel II Framework
10/61
10
CRAR
Total CRAR =Eligible total capital fundsCredit Risk RWA + Market Risk RWA +
Operational Risk RWAMinimum 9% Tier 1 CRAR =
Eligible total capital fundsCredit Risk RWA + Market Risk RWA +Operational Risk RWA
Minimum 6%
-
8/8/2019 A Study on Basel II Framework
11/61
11
Elements of Tier I Capital
Paid-up equity capital, statutory reserves, andother disclosed free reserves
Capital reserves representing surplus arising out
of sale proceeds of assets Innovative perpetual debt instruments (IPDI)
Limited to 15% of total Tier I Capital
Perpetual Non-Cumulative Pref. Shares (PNCPS) Limited to 40% of total Tier I capital along with
innovative instruments
-
8/8/2019 A Study on Basel II Framework
12/61
12
Elements of Tier II Capital
Revaluation Reserves (at a discount of 55%) General Provisions & Loss Reserves Hybrid Debt Capital Instruments
Subordinated Debt Subjected to progressive discount as per their
maturity Limited to 50% of Tier I Capital
IPDI & PNCPS in excess of limit under Tier I
Tier II capital shall not exceed Tier I capital
-
8/8/2019 A Study on Basel II Framework
13/61
13
Capital Funds Deductions
Intangible assets & losses from Tier I Capital DTA:
Associated with accumulated losses
Balance DTA net of DTL If DTL > DTA, it cannot be adjusted/ added
Gain on sale arising due to securitization of standard assets, if recognized (from Tier I)
Securitization exposures, if unrated or rated B & below 50% from Tier I and 50% from Tier II
-
8/8/2019 A Study on Basel II Framework
14/61
14
Investment in financial entities (FE)
Consolidated Not -Consolidated
tain CRAR at consolidated levelInvt. > 30% of the paid up equityInvt.
-
8/8/2019 A Study on Basel II Framework
15/61
15 15
PILLAR - 1PILLAR - 1MINIMUM CAPITAL REQUIREMENTMINIMUM CAPITAL REQUIREMENTCREDIT RISK
OPERATIONAL RISK
MARKET RISK
-
8/8/2019 A Study on Basel II Framework
16/61
16
Credit Risk Approaches
Banks in India currently follow standardized approach
StandardizedApproach
StandardizedApproach
Foundation InternalRatings
Based Approach
Foundation InternalRatings
Based Approach
Advanced InternalRatings Based
Approach
Advanced InternalRatings Based
ApproachI N
C RE A
S E
D S OP HI S T I C AT I ON
R E D U C E D C A P I T A L R E Q U I R E M E N T
Risk weights are based onassessment by external creditrating agencies
Banks use internalestimations of probability of default (PD) to calculate riskweights for exposure classes.Other risk components arestandardized.
Banks use internalestimations of PD, lossgiven default (LGD)and exposure atdefault (EAD) tocalculate risk weightsfor exposure classes
PILLAR 1 FOR CREDIT RISK
-
8/8/2019 A Study on Basel II Framework
17/61
17
Risk Weights
Domestic Sovereigns - zero risk weight
Foreign Sovereigns - Risk weights as per the
rating
Exposures to Domestic Corporates/ Domestic
PSEs/ Primary Dealers
RW as per rating
Only solicited ratings can be used
Foreign Corporates / PSEs will be risk weighed as
per foreign ratings
-
8/8/2019 A Study on Basel II Framework
18/61
18
Provisions related to NBFC
Capital requirement against exposure to AFCs /
IFCs will depend on risk rating
Incentive for higher credit ratings
In case of AFCs, claims that attract RW of 150%
as per rating will be risk weighed at 100% only
Claims on other NBFC-ND-SI to be uniformly risk
weighed at 100%
-
8/8/2019 A Study on Basel II Framework
19/61
19
Risk Weights
Retail - Risk weight of 75%, in case:
Total customer exposure is
-
8/8/2019 A Study on Basel II Framework
20/61
20
Risk Weights Real Estate
-
8/8/2019 A Study on Basel II Framework
21/61
21
Risk Weights
Venture Capital Funds RW of 150% Invt. in equity of non-financial entities:
RW of 125%
Consumer credit (excl. Education loan) &
Capital market exposure RW of 125% or higher
Provide capital against all securitizationexposure As per risk rating of the issue
-
8/8/2019 A Study on Basel II Framework
22/61
22
Risk Weights for NPAs
The unsecured portion of NPA, net of specificprovisions will be risk-weighted as follows:
For the purpose of calculating secured portion, eligible
collateral will be the same as recognized for credit
risk mitigation purpose
Specific provisions RW Res.
Property
RW-Others
< 20% of the o/s amt. of the NPA
100% 150%> = 20% of the o/s amt. of the NPA
75% 100%> = 50% of the o/s amt. of the NPA
50% 50%
-
8/8/2019 A Study on Basel II Framework
23/61
23
Off-balance sheet items
Market related Non-market relatedIncludes interest ratecontracts & foreignexchange contracts
Credit equivalentamountis determinedusing current exposuremethod
Current exposureincludes:1) Current credit exposure MTM value of thecontract2) Future credit exposure
Includes direct creditsubstitutes, trade & performance related
contingent items,commitments withcertain drawdown, etc.Amount needs to be
multiplied with CreditConversion Factor (CCF)
-
8/8/2019 A Study on Basel II Framework
24/61
24
Credit Risk Mitigation
Allowed mitigants: Eligible financial securities & guarantees
Eligible financial securities:
Cash, fixed deposits, KVP/NSC, gold, central/stategovt. securities, Life Insurance policies (at surrender
value), debt instruments rated BBB- or better, units
of MF
Banks must conduct a sufficient legal review
Credit quality & collateral should not be positively
correlated
-
8/8/2019 A Study on Basel II Framework
25/61
25
Haircuts
Adjustments made for market movements:
For Exposure Works as a Premium factor
For Collateral Works as a Discount factor
Additional haircut, if exposure & collateral are
held in different currencies
Banks in India to use standard supervisory
haircuts set by Basel committee
-
8/8/2019 A Study on Basel II Framework
26/61
26
Credit Risk Mitigation - Guarantees
Only direct, unconditional, irrevocable and explicitguarantees are eligible
Protected portion of the counterparty exposure is
assigned RW of the guarantor Guarantor TreatmentCentral Govt. RW 0%State Govt. RW 20%
Corporate (only if minimum rating of AA)
RW as applicableto guarantor
PersonalGuarantees
Not eligible
-
8/8/2019 A Study on Basel II Framework
27/61
27
Maturity Mismatch
Occurs if residual maturity of collateral is less thanthat of underlying exposure
CRM not recognized, if maturity mismatch and: CRM has original maturity of < 1 year CRM has residual maturity of < = 3 months
In other cases, partial recognition as follows: Pa = P X (t-0.25) (T-0.25)
Where, Pa = Adjusted Credit protectionP = Credit protection
t = min (T, residual maturity of protection)
T = min (5, residual maturity of exposure)
-
8/8/2019 A Study on Basel II Framework
28/61
28
Calculation of Capital requirement
E* = max {0, [E x (1 + H e ) - C x (1 - H c - H fx )]}where:
E* = the exposure value after risk mitigation
E = current value of the exposure
He = haircut appropriate to the exposure
C = the current value of the collateral received
Hc = haircut appropriate to the collateral
Hfx = haircut appropriate for currency mismatch between the collateral and
exposure
Risk weighted asset (RWA) = E* x RW
Minimum Capital = RWA x 9%
-
8/8/2019 A Study on Basel II Framework
29/61
29
Internal Ratings based (IRB) approach
Banks rely on their own internal estimates of riskcomponents
Approach based on measure of expected losses(EL) & unexpected losses (UL)
The capital base is required to absorb the UL, asand when they arise.
Factors affecting credit risk:
Exposure at default (EAD) Probability of default (PD) Loss given default (LGD) Effective Maturity (M)
-
8/8/2019 A Study on Basel II Framework
30/61
30
IRB Approach
Categorise banking-book exposures into broad classes of assets with different underlying risk characteristics
Key elements Risk components
Risk weight functions Minimum requirement
Foundation approach Banks provide their own estimate of PD
Rely on supervisory estimates for other risk components Advanced approaches
Banks provide more of their own estimates of PD, LGD andEAD
-
8/8/2019 A Study on Basel II Framework
31/61
31 31
PILLAR - 1PILLAR - 1
MINIMUM CAPITAL REQUIREMENTMINIMUM CAPITAL REQUIREMENTCREDIT RISK
OPERATIONAL RISK
MARKET RISK
-
8/8/2019 A Study on Basel II Framework
32/61
32
Operational risk
Risk of loss resulting from inadequate or failed internalprocesses, people and systems or from external events
Banks in India to begin with Basic Indicator approachKBIA = [ (GI 1n x )]/n
Where:
KBIA = the capital charge under the Basic Indicator Approach
GI = annual gross income, where positive, over the previous
three yearsn = number of the previous three years for which gross
income is positive
= 15 per cent, which is set by the BCBS
-
8/8/2019 A Study on Basel II Framework
33/61
33
Operational Risk Other Approaches
The Standardised Approach: Banks activities are divided into 8 business lines
Capital charge is calculated separately for each business line
using separate factors
Advanced Measurement Approach:
Banks are allowed to develop their own empirical model to
quantify required capital for operational risk
Use of statistical methods like VaR, Monte Carlo, etc.
-
8/8/2019 A Study on Basel II Framework
34/61
34 34
PILLAR - 1PILLAR - 1
MINIMUM CAPITAL REQUIREMENTMINIMUM CAPITAL REQUIREMENTCREDIT RISK
OPERATIONAL RISK
MARKET RISK
-
8/8/2019 A Study on Basel II Framework
35/61
35
Market Risk
Risk of losses due to market price movements
ted instruments & equities in the trading book Foreign Exchange risk Trading & Bankin
Specific Risk General Market Risk
ments - defined as % of exposure based on issuer & maturityts 9% capital charge
Standardised method Internal models metho
Maturity method Duration method
-
8/8/2019 A Study on Basel II Framework
36/61
36
General Market Risk Standardised method
-
8/8/2019 A Study on Basel II Framework
37/61
37
General Market Risk Internal Models Method
Qualitative Criteria: Independent Risk Control Unit responsible for design and
implementation of Banks risk management systems
Regular Back-Testing
Initial and on-going Validation of Internal Model
Model must be integrated into Management decisions
To be used in conjunction with Trading and Exposure Limits.
Stress Testing
Well documented
Independent review by internal audit
Board and senior management should be actively involved
-
8/8/2019 A Study on Basel II Framework
38/61
38
General Market Risk Internal Models Method
Quantitative Criteria: Banks can use their own VaR models as basis for capital
requirement for Market Risk
VaR computation be based on following inputs : Holding period of 10 Trading days
99% confidence level
Observation period at least 1 year historical data
Recognise correlation within Categories as well as across
categories
General Market Risk charge shall be Higher of previous
days VaR or Avg VaR over last 60 business days X
Multiplier factor K (absolute floor of 3)
-
8/8/2019 A Study on Basel II Framework
39/61
39 39
PILLAR - 2PILLAR - 2SUPERVISORY REVIEW OF CAPITAL ADEQUACYSUPERVISORY REVIEW OF CAPITAL ADEQUACYINTERNAL CAPITAL ADEQUACY ASSESSMENT PROCESS (ICAAP)
-
8/8/2019 A Study on Basel II Framework
40/61
40
Supervisory Review & Evaluation Process
Objective Ensure that banks have adequate capital to support all
the risks Develop and use better risk management techniques
Main aspects: Risks that are not fully captured under Pillar I Risks that are not taken into account by Pillar I Factors external to the bank
Risks not covered by Pillar-I Residual risk, concentration risk, liquidity risk,
reputation risk, strategic risk, interest rate risk in thebanking book
-
8/8/2019 A Study on Basel II Framework
41/61
41
ICAAP Principles
Every bank must have a process for assessing its capitaladequacy relative to its risk profile
Should comprise a complete process with proper oversightand controls
Decisions regarding the design and operation of the ICAAPshould reflect sound risk management
The institutions capital policy should be fully documented,and the management body should take responsibility for the
ICAAP. The ICAAP should form an integral part of the management
process and decision making culture of the institution. The ICAAP should be forward looking and reviewed regularly
-
8/8/2019 A Study on Basel II Framework
42/61
42
ICAAP Maturity Ladder
-
8/8/2019 A Study on Basel II Framework
43/61
43
ICAAP - Benefits
Provides holistic view of the underlying risks Enhances Managements ability to understand
how much capital flexibility exists
Enhances banks reputation
Builds and supports linkage between risk &
capital and ties performance to both
Move to a regime in which internal models will
be relied upon by the regulators.
-
8/8/2019 A Study on Basel II Framework
44/61
44 44
PILLAR - 3PILLAR - 3MARKET DISCIPLINEMARKET DISCIPLINE
-
8/8/2019 A Study on Basel II Framework
45/61
45
Guidelines for disclosures
Disclosures in line with how senior management & theBoard assess and manage the risks of the bank
To have a formal Board approved disclosure policy
Implement a process for assessing theappropriateness of the disclosures
Applies at the top consolidated level of the banking
group
Apply materiality concept in determining which
disclosures are relevant
Format prescribed by RBI
-
8/8/2019 A Study on Basel II Framework
46/61
46 46
IMPACT STUDYIMPACT STUDY
-
8/8/2019 A Study on Basel II Framework
47/61
47
Challenges in implementation
Advanced approaches require lot of historical data Use of sophisticated models
IT challenges
Embedding risk management practices into day today business processes
Human resources with required skill sets
Robust legal systems Capital requirement may increase
-
8/8/2019 A Study on Basel II Framework
48/61
48
Basel I Vs Basel II HDFC Bank
-
8/8/2019 A Study on Basel II Framework
49/61
49
Basel I Vs Basel II ICICI Bank
-
8/8/2019 A Study on Basel II Framework
50/61
50
Basel I Vs Basel II SBI Bank
-
8/8/2019 A Study on Basel II Framework
51/61
51 51
COMPARISON WITH NBFCCOMPARISON WITH NBFC
-
8/8/2019 A Study on Basel II Framework
52/61
52
Capital Adequacy- Banks Vs NBFC
Particulars Banks NBFCCRAR 9% 12% by Mar,
2010 15% byMar, 2011Credit Risk
mitigation
A wider range of
credit riskmitigants allowed
Limited
Capitalrequirement forOperational Risk
Applicable Not applicable
Capitalrequirement forMarket Risk
Applicable Not applicable
ICAAP Required Not required
Indicates lower capital requirement for NBFC
Indicates higher capital requirement for NBFC
-
8/8/2019 A Study on Basel II Framework
53/61
53
Capital Adequacy- Banks Vs NBFC
Particulars Banks NBFCRisk Weightage 1) Use of credit
ratings to defineRW
2) Retail 75%RW can be higherthan 100% inselect exposuresLoans to staff 20% / 75%Investment in nonFE RW of 125%
1) RW defined asper asset classes2) Mostly 100%
for all assetclassesLoans to staff 0%
-
8/8/2019 A Study on Basel II Framework
54/61
54
THANK YOU
-
8/8/2019 A Study on Basel II Framework
55/61
55
Risk Weights
Long termCRISIL ICRA FITCH CARE Short termCRISIL ICRA FITCH CARE Risk-weight
AAA LAAA AAA (ind) CARE AAA P1+ A1+ F1+(ind)
PR1+ 20%
AA LAA AA (ind) CARE AA P1 A1 F1(ind)
PR1 30%
A LA A(ind)
CARE A P2 A2 F2(ind)
PR2 50%
BBB LBBB BBB(ind) CAREBBB P3 A3 F3(ind) PR3 100%
BB+/ LBB+/ BB+(ind)/ CARE BB+ or below, including D P4/ P5/ A4/ A5/ F4(ind)/ F5(ind)/ PR4/ PR5 150%
Unrated 100%
For unrated, risk weight can be higher than 100% if warranted
-
8/8/2019 A Study on Basel II Framework
56/61
56
Securitisation Exposure
Risk weight mapping to Long-Term Ratings
Commercial Real Estate Securitization Exposure Risk
weight mapping to Long Term Ratings
* Deduction 50% each from Tier I & Tier II
-
8/8/2019 A Study on Basel II Framework
57/61
57
Calculation of capital requirement
Details of a corporate borrower rated by External Ratingagency as A
Nature Out standing
Cash Credit 600
Term Loan 500LC 200
Collateral SeNature
-
8/8/2019 A Study on Basel II Framework
58/61
58
Calculation of capital requirement
Adjustment for the collateral valueFacility Amt. CCF
Haircut
ConvertedExposure
CollateralType Amt.
Haircut
Adj.value of collateral
Netexposure
1 2 3 4 5=(2*3)+4 6 7 8 9=7-(8*7)
5-9
CC 600 NA NA 600 FDR 50 NA 50 55
TL 500 NA NA 500 AA ratedbond
300 8% 276 22
LC 200 100% NA 200 20
Total 1300 350 326 97
Amt. O/s aft
-
8/8/2019 A Study on Basel II Framework
59/61
59
General Market Risk Standardized Approach
Duration method Time Bands & Assumed changes in yield
-
8/8/2019 A Study on Basel II Framework
60/61
60
General Market Risk Standardized Approach
Horizontal Disallowances
-
8/8/2019 A Study on Basel II Framework
61/61
General Market Risk Standardized Approach