Capital Management

WELCOME TO THE VIRTUAL CLASS – MODULE

D CAPITAL MANAGEMENT

AND PROFIT PLANNING.

SIMON PHILIPVICE PRINCIPALBANK OF INDIA

MANAGEMENT DEV. INSTT.CBD BELAPUR.

BASEL I ACCORD FOR THE FIRST TIME PROVIDED

FRAMEWORK FOR CAPITAL ADEQUACY. DEFINED COMPONENTS OF CAPITAL. ALLOTTED RISK WEIGHTS TO ASSETS. PRONOUNCED THE MINIMUM RATIO OF

CAPITAL TO SUM TOTAL OF RW ASSETS. INITIALLY COVERED ONLY CREDIT RISK AND

SUBSEQUENTLY MARKET RISK.

BASEL II ACCORD. IMPLEMENTATION: FOR BANKS HAVING GLOBAL

PRESENCE AND FOREIGN BANKS IN INDIA FROM MARCH, 2008.

FOR OTHER BANKS FROM MARCH, 2009.

BASEL II ACCORD REVISED FRAMEWORK COVERING

OPERATIONAL RISK. BASED ON THREE PILLARS.

1. MINIMUM CAPITAL REQUIREMENTS.

2. SUPERVISORY REVIEW PROCESS.

3. MARKET DISCIPLINE.

MINIMUM CAPITAL REQUIREMENT.

CREDIT RISK:

1. STANDARDISED APPROACH.

2. INTERNAL RATING BASED APPROACH.- FOUNDATION.

3. INTERNAL RATING BASED APPROACH- ADVANCED.


MARKET RISK:


(A) MATURITY, (B) DURATION.

2. INTERNAL MODELS METHOD.


OPERATIONAL RISK:

1. BASIC INDICATOR APPROACH.


3. ADVANCED MEASUREMENT APPROACH.

SUPERVISORY REVIEW PROCESS

TO ENSURE ROBUST INTERNAL PROCESSES FOR RISK MANAGEMENT FOR ADEQUACY OF CAPITAL.

EVALUATION OF RISK ASSESSMENT. PRESCRIBE DIFFERENTIAL CAPITAL

WHEREVER NECESSARY.

MARKET DISCIPLINE DISCLOSURE NORMS ABOUT RISK

MANAGEMENT PRACTICES AND ALLOCATION OF REGULATORY CAPITAL.

TO ENHANCE DISCLOSURES.- CORE AND DISCRETIONARY.

TIMELY DISCLOSURES.

REGULATORY CAPITAL 1. TIER I

2. TIER II

3. TIIER III

TIER I- CORE CAPITAL CAPITAL FREE RESERVES UNALLOCATED SURPLUSES LESS

SPECIFIED DEDUCTIONS.

TIER II- SUPPLEMENTARY CAPITAL. SUBORDINATED DEBT OF MORE THAN 5

YEARS MATURITY. LOAN LOSS RESERVES. REVALUATION RESERVES. INVESTMENT FLUCTUATION RESERVES. LIMITED LIFE PREFERENTIAL SHARES. (TIER II CAPITAL IS RESTRICTED TO 100% OF

TIER I CAPITAL AND LONG TERM SUB DEBT NOT TO EXCEED 50% OF TIER I CAPITAL)

TIER III CAPITAL SHORT TERM SUBORDINATED DEBT. FOR THE SOLE PURPOSE OF MEETING A

PROPORTION OF THE CAPITAL REQUIREMENT FOR MARKET RISK.

SHORT TERM BOND MUST HAVE AN ORIGIANL MATURITY OF ATLEAST 2 YEARS

TIER 3 CAPITAL WILL BE LIMITED TO 250% OF A BANK’S TIER I CAPITAL REQUIRED TO SUPPORT MARKET RISK OF THE BANK

CAPITAL ADEQUACY ANY CAPITAL REQUIREMENT ARISING

IN RESPECT OF CREDIT RISK OR COUNTER PARTY RISK MUST BE MET BY TIER I & II CAPITAL.

MINIMUM OF 28.5% OF MARKET RISK NEEDS TO BE SUPPORTED BY TIER I CAPITAL.

CREDIT RISK AND CAR RATING METHODOLOGY

1. EXTERNAL AGENCY.

2. INTERNAL ASSESSMENT. FOR CREDIT RATING OF SOVEREIGN

THE COUNTRY SCORES OF EXPORT CREDIT AGENCY MAY BE RECOGNISED.

CREDIT RATING OF COMMERCIAL BANKS.

ALL BANKS IN A GIVEN COUNTRY WILL BE ASSIGNED A RW- ONE BELOW THE RW ASSSIGNED TO THAT SOVEREIGN.

HOWEVER, FOR CLAIMS ON BANKS IN COUNTRIES WITH SOVEREIGN RATING BB+ TO B- AND BANKS IN RATED COUNTRIES RW WILL BE CAPPED AT 100%

CREDIT RATING OF COMMERCIAL BANKS

BASES THE RISK WEIGHTING ON THE EXTERNAL CREDIT ASSESSMENT OF THE BANK ITSELF. UNRATED BANKS WILL HAVE A RW OF 50%

RISK WEIGHTS OF SOVEREIGN AND THEIR CENTRAL BANKS.

Credit rating of sovereigns

RW of sovereigns

RW for banks in that country

AAA to AA- 0% 20%

A+ to A- 20% 50%

BBB+ to BBB- 50% 100%

BB+ to B- 100% 100%

Below B- 150% 150%

Unrated 100% 100%

VARIOUS RISK WEIGHTS RETAIL AND SME EXPOSURE S ATTRACT

RISK WEIGHT OF 75%. LENDING FULLY SECURED BYMORTGAGE

ON RESIDENTIAL PROPERTY : RW 35% LOAN SECUREEDBY COMMERCIAL

PROPERTY: RW 100% PAST DUE LOANS: 150% WHEN SPECIFIC

PROVISIONS ARE LESS THAN 20% OF THE LOAN AMT.AND 100% IF HIGHER PROVIS.

VARIOUS RISK WEIGHTS IN CASE OF PAST DUE HOUSING

LOANS: 100% IF PROVISIONING IS BELOW 20%. 50% IF HIGHER PROV.

FOR OFF B/S ITEMS, CREDIT CONVERSION FACTOR IS USED.

NETTING OF THE SECURITIES FROM THE OUTSTANDING EXPOSURE IS PERMITTED.

RISK WEIGHTS WHEN THE CLAIM AMOUNT IS

GUARANTEED BY ANOTHER PARTY/ AGENCY WITH A BETTER RATING , THE RW WOULD REDUCE ACCORDINGLY.

SIMPLIFIED STANDARDISED APPROACH

For sovereign exposures rating, one being used by Export Credit Agency.

Risk weight for the corporates is flat 100%, since ratings are not used.

Reduced risk weights of 75% and 35% for retail and housing portfolio.

IRB APPROACH. CAPITAL CHARGE COMPUTATION IS

DEPENDENT ON THE FOLLOWING PARAMETERS:

PD: PROBABILITY OF DEFAULT. LGD: LOSS GIVEN AT DEFAULT. ED: EXPOSURE AT DEFAULT. M: EFFECTIVE MATURITY.

IRB APPROACH. COMPUTES CAPITAL REQUIREMENT

OF EACH EXPOSURE DIRECTLY. CATEGORISATION OF ASSETS AS

CORPORATE, SOVEREIGNS, BANKS, RETAIL AND EQUITY ETC.

BANKS PROVIDE THEIR OWN ESTIMATES OF PD,LGD,EAD,M.

CAPITAL CHARGE FOR MARKET RISK.

MARKET RISK IS DEFINED AS THE RISK OF LOSSES IN ON BALANCE SHEET AND OFF BALANCE SHEET POSITIONS ARISING FROM MOVEMENTS IN THE MARKET PRICES.

MARKET RISK THE MARKET RISK POSITIONS WHICH

REQUIRE CAPITAL CHARGE ARE : (I) INTEREST RATE RELATED INSTRUMENTS

IN TRADING BOOK. (II) EQUITIES IN TRADING BOOK. (III) FOREIGN EXCHANGE OPEN POSITIONS

(INCLUDING POSITIONS IN PRECIOUS METALS) THROUGHOUT THE BANK (BOTH BANKING AND TRADING BOOKS)

MARKET RISK A TRADING BOOK CONSISITS OF

FINANCIAL INSTRUMENTS AND COMMODITIES HELD EITHER WITH TRADING INTENT OR IN ORDER TO HEDGE OTHER ELEMENTS IN TRADING BOOK.

THE POSITIONS NEED TO BE VALUED FREQUENTLY AND ACCURATELY.

MARKET RISK IN INDIAN SCENARIO THE TRADING BOOKS

COMPRISES OF: SECURITIES UNDER HELF FOR TRDG. SECURITIES UNDER AVAILABLE FOR SALE. OPEN FOREX POSITIONS OPEN GOLD POSITIONS TRADING POSITIONS IN DERIVATIVES DERIVATIVES FOR HEDGING TRADING

POSITIONS.

CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS.

CLAIMS ON GOVT.

GOVT.SECU.

OTHER APPROVED SEC.GTD.BY GOVT.

MATURITY

ALL

ALL

SPECIFIC CAPITAL CHARGE% OF EXPOSURE

0%

0%

CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS

CLAIMS ON GOVT.

Other apprvd. Sec. not gtd. By government.

Other non appr.

Sec. gtd. By government./claims on Banks

MATURITY

all

all

CAPITAL CHARGE % OF EXPOSURE

1.8%

1.8%

CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS

CLAIMS ON GOVT.

Claims on banks for residual term /other Tier II bonds.

Tier II bonds/ claims on others

Mortgage

All others

MATURITY

Upto 6 m

6 m to 24 m

>24 m

All

All

All

CAPITAL CHARGE.

0.3%

1.125%

1.8%

9%

4.5%

9%

CAPITAL CHARGE FOR MARKET RISK: TOTAL OF 4 COMPONENTS NET POSITION IN THE TRADING BOOK A SMALL PORTION OF THE MATCHED

POSITION IN EACH TIME BAND (VERTICAL DISALLOWANCE)

A LARGER PORTION OF THE MATCHED POSITION ACROSS DIFFERENT TIME BANDS (HORIZONTAL DISALLOWANCE)

A NET CHANGE FOR POSITION IN OPTION.

CAPITAL CHARGE FOR EQUITIES IN THE TRADING BOOK FOR SPECIFIC RISK: 9%. SPECIFIC RISK IS

COMPUTED ON THE BANK’S GROSS EQUITY POSITION.

GENERAL MARKET RISK CHARGE:9% ON THE GROSS EQUITY POSITION.

FE OPEN POSITION & GOLD OPEN POSITION: 9%

THE OPEN POSITION WOULD BE THE LIMIT OR ACTUAL WHICHEVER IS HIGHER.

OPERATIONAL RISK OPERATIONAL RISK IS DEFINED AS

THE RISK OF LOSS RESULTING FROM INADEQUATE OR FAILED INTERNAL PROCESSES, PEOPLE AND SYSTEMS OR FROM EXTERNAL EVENTS. IT INCLUDES LEGAL RISK BUT EXCLUDES STRATEGIES AND REPUTATIONAL RISK.

CAPITAL CHARGE FOR O.R. 1. BASIC INDICATOR APPROACH.


3. ADVANCE MEASUREMENT APPROACH.

BASIC INDICATOR APPROACH EQUAL TO THE AVERAGE OVER THE PREVIOUS 3

YEARS OF A FIXED PERCENTAGE. DENOTED BY ALPHA OF POSITIVE ANNUAL GROSS

INCOME. THE AMOUNT SHOULD BE GROOS OF ANY PROVISION. SHOULD BE GROSS OF OPERATING EXPENSES. SHOULD EXCLUDE REALISED PROFITS/LOSSES FROM

SALE OF INVESTMENT. SHOULD EXCLUDE EXTRA ORDINARY OR IRREGULAR

ITEMS AND INCOME DERIVED FROM INSURANCE.

STANDARDISED APPROACH BANK’S ACTIVITIES DIVIDED IN TO 8

BUSINESS LINES. 1. CORPORATE FINANCE: 18% 2. TRADING/SALES : 18% 3. RETAIL BANKING : 12% 4. COMMERCIAL BKG. : 15% 5. PAYMENTS/SETTLMTS : 18% 6. AGENCY BUSINESS : 15% 7. ASSETS MGMT. : 12% 8. RETAIL BROKERING : 12%

STANDARDISED APPROACH WITHIN EACH BUSINESS LINE, GROSS

INCOME IS A BROAD INDICATOR FOR OPERATIONAL RISK EXPOSURE.

THE CAPITAL CHARGE FOR EACH B/L IS COMPUTED BY MULTIPLYING GROSS INCOME BY A FACTOR CALLED BETA, ASSIGNED TO THAT B/L.

THE TOTAL CHARGE IS THE THREE YEAR AVERAGE OF THE SIMPLE SUMMATION OF THE REGULATORY CAPITAL CHARGES FOR EACH OF THE B/L.

ADVANCE MESUREMENT APPRAOCH.

Bank’s internal operational risk measurement system is used which is to be vetted by the Central Bank.

The regulatory capital requirement will equal the risk measure generated by the Bank’s internal OR measurement system using qualitative and quantitative criteria for the AMA.

QUALITATIVE STANDARDS Bank must have independent OR

management function. Integration of ORM system with the day to

day RM process. Regular reporting of OR exposure and loss

experience. Documentation of ORM system.

QUALITATIVE STANDARDS Regular review by internal/external

auditors. Validation of ORM system by supervisory

authorities.

QUANTITATIVE STANDARDS Consistency in the system. Bank should calculate regulatory capital

and the sum of Expected Loss (EL) and unexpected Loss (UL)

The measurement system must be sufficiently granular to capture major events of OR.

QUANTITATIVE STANDARDS. System for determining co-relations mustbe

sound and the bank must validate the co relation assumptions.

The system must have key elements that meet with Supervisory standards.

A Bank needs to have a credible, transparent, well documented and verifiable approach for weighing fundamental elements in the RM system.

QUANTITATIVE STANDARDS Internally generated measures must be

based on a minimum 5 years observation period of internal loss data.

To use relevant external data. Bank must use scenario analysis of expert

opinion in conjunction with external data to evaluate its exposure to high severity events.

VARIOUS OTHER ASPECTS PERSONNEL SELECTION. WORK CULTURE. ORGANISATIONAL STRUCTURE. SYSTEM REVIEW/REVISION.

EXTERNAL CREDIT ASSESSMENT INSTITUTE: CRITERIA

OBJECTIVITY INDEPENDENCE INTERNAL ACCESS TRANSPARENCY. DISCLOSURES. RESOURCES. CREDIBILITY.

SUPERVISORY REVIEW TO ENSURE THAT BANKS HAVE

ADEQUATE CAPITAL TO SUPPORT ALL RISKS INTHEIR BUSINESS.

TO ENCOURAGE BANKS TO DEVELOP AND USE BETTER RISK MANAGEMENT TECHNIQUES IN MONITORING AND MITIGATING THEIR RISKS.

SUPERVISORS NEED TO CONCENTRATE: RISK CONSIDERED UNDER PILLAR 1 BUT

NOT FULLY CAPTURED SUCH AS CREDIT CONCENTRATION RISK.

FACTORS THAT ARE NOT ADDRESSED IN PILLAR 1 PROCESS SUCH AS STRATEGIC RISK OR INTEREST RATE RISK IN THE BANKING BOOK.

FACTORS EXTERNAL TO THE BANK E.G. BUSINESS CYCLE EFFECTS.

PRINCIPLES: SUPERVISORY REVIEW BANKS SHOULD HAVE A PROCESS FOR

ASSESSING THEIR CAPITAL ADEQUACY IN RELATION TO THEIR RISK PROFILE AND A STRATEGY FOR MAINTAINING THEIR CAPITAL LEVELS.

SUPERVISORS SHOULD REVIEW AND EVALUATE BANK’S INTERNAL CAPITAL ADEQUACY ASSESSMENT/STRATEGIES .

PRINCIPLES: SUPERVISORY REVIEW SUPERVISORS SHOULD EXPECT BANKS

TO OPERATE ABOVE THE MINIMUM REGULATORY CAPITAL RATIOSAND SHOULD HAVE THE ABILITY TO REQUIRE BANKS TO HOLD CAPITAL IN EXCESS OFTHE MINIMUM.

SUPERVISORS SHOULD INTERVENE AT AN EARLY STAGE TO PREVENT CAPITAL FALL.

MARKET DISCIPLINE IT IS IN SUPPORT TO PILLAR 1 AND 2. DISCLOSURES FOR ALLOWING PUBLIC

TO ASSESSKEYINFORMATION AND THERBY MAKE INFORMED DECISIONS.

PROFIT PLANNING

FACTORS AFFECTING PROFITABILITY 1. TRUSTEE FOR DEPOSITORS AND

NEED TO GIVE ATTRACTIVE RETURNS TO DEPOSITIORS.

2. RESPONSIBILITY TOWARDS SHAREHOLDERS NEEDS MAXIMIATION OF PROFIT.

PROFIT PLANNING INVOLVES BALANCE SHEET MANAGEMENT

COVERING: 1. CREDIT. 2. INVESTMENT AND NON FUND BASED

INCOME. 3. INCOME COMES FROM INTEREST ON

ADVANCES, FEE BASED INCOME AND TREASURY OPERATIONS.

TOTAL INVESTMENT

I II III IVA) Investment in Govt. Securities with yield 6% and risk weightage of 0%

1000 400 300 300

b) Lending to AAA rated customers with yield 8% p.a.& risk weightagof 20%

0 600 300 300

c) Lending to AA rated customers with yield of 10% p.a. & risk weightage of 50%

0 0 400 200

d) Lending to A rated customers with yield of 12% p.a. and risk weightage of 100%

0 0 0 200

Total investment 1000 1000 1000 1000

YIELD ON INVESTMENT

Yield I II III IVa) 6% 60 24 18 18

b)8% 0 48 24 24

c)10% 0 0 40 20

d)12% 0 0 0 24

Total Yield 60 72 82 86

Rate 6.00% 7.20% 8.20% 8.60%

Risk Weighted Assets I II III IV

a) 0 0 0 0

b) 0 120 60 60

c) 0 0 200 100

d) 0 0 0 200

RWA 0 120 260 360

Capital Required (at 8% CRAR)

0 9.6 20.8 28.8

LENDING TO LOWER RATED CUSTOMERS RISK GETS ENHANCED NEEDING MORE CAPITAL BUT ALSO GIVES IMPROVED YIELD ON THE ASSETS.

THE EFFECT OF NPA. (I) NO INCOME (II) PROVISIONING AND

(III) ADDITIONAL CAPITAL

FEE BASED INCOME REDUCING INCOME FROM

TRADITIONAL SERVICES. NEW TECHNOLOGICAL SERVICE LIKE

DEPOSITORY SERVICES, INTERNET BANKING, E COMMERCE.

THIRD PARTY PRODUCTS. CROSS SELLING OF PRODUCTS.

TREASURY INCOME TRADING IN SECURITIES, FOREIGN

EXCHANGE, EQUITIES, BULLION, COMMODITIES, DERIVATIVES.

EXPENDITURE SIDE INTEREST EXPENSES. OPERATING EXPENSES.

04/10/23 Simon Philip, MDI, CBD Belapur 61

.ThankYou and All the .ThankYou and All the BestBest

Capital Management

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