basel 1and 2 new

8/8/2019 Basel 1and 2 New

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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


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


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


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.

basel 1and 2 new

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