A PROJECT REPORT ON

OPTIMIZATION OF CAPITAL

IN BANKS TREASURY

AT

STATE BANK OF INDIA

Submitted by:

Ravi Ranjan Kumar Singh

Roll No: 40

Batch 2

In partial fulfilment of the requirement for the degree of

Post Graduate Diploma in Management

XAVIER INSTITUTE OF MANAGEMENT

ANDENTREPRENEURSHIP, KOCHI

ACKNOWLEDGEMENT

I thank Almighty God for helping me to complete this project fruitfully.

At the end of summer internship programme I feel obliged and thank everyone who made this

possible. The two months of internship has been an enriching experience, in terms of learning

and application of theory in practice. The real time experience that I have received is

something which cannot be emulated in classroom scenario and will be highly helpful for my

professional growth.

I would like to express my deepest regards & gratitude to my coordinator, Mr Shrinivas

Sharad Narvilkar and my mentors, Mr Om Prakash Shivapriya and Mr Rajesh Kumar

Gupta for their continuous motivation, guidance and support in this process. I would also like

to thank all the other employees of State Bank of India for being supportive, cooperative and

encouraging throughout my journey. This research would not be possible without their

valuable inputs.

I would like to thank my college, XAVIER INSTITUTE OF MANAGEMENT AND

ENTREPRENEURSHIP, for providing me with this opportunity. This endeavour would not

have been possible without the continuous guidance and encouragement by my professors

and my friends.

I would also like to thanks Assistant dean Mr. Amitabh Satapathy, my internal faculty

guide for timely guidance and support.

I acknowledge with profound gratitude and reverence the help and guidance of STATE

BANK OF INDIA and I thank this organisation for providing me with this opportunity of

learning and growth.

Last but not the least; my heartfelt love for my parents, whose constant support and blessings

helped me throughout this project.

EXECUTIVE SUMMARY

This paper aims to give a summarized view about all the experts speak about optimization of

capital in banks treasury. It explains the different method used by the banking sector to

mitigate its risk arising from Counterparty Credit Risk (CCR), Credit Value Adjustment

(CVA), Risk-Weighted Assets (RWA), etc. It begins by showing an overall perspective of

risk management and optimization of capital by different ways and then moves on the

guidelines prescribed by the Reserve Bank of India (RBI), Basel Committee on Banking

Supervision (BCBS), Banking for International Settlement (BIS) to save banks risk arising

from Risk-Weighted Assets, liquidity etc. The primary data is collected from State Bank of

India (SBI) regarding their internal regulatory and operational policies on optimization of

capital. The secondary data collected from various articles on the public domain by the

consulting companies which measures banks need to use for capital optimization such as

Standardized Method, Advanced Internal Rating Based Approach Method, and Internal

Model Method etc.

This paper shows how CVA capital charge is optimize by adopting Internal Model Method

and also how the following Advanced IRB approach can give banks clear idea about

“Return on Capital” on particular investment comparable to standardized method.

This paper shows how bank can use operational measure, tactical measure, and strategic

measure to make its day-to-day activity plan, short term plan and long term plan to get a

competitive edge over its competitor. Further its shows the way to overcome from liquidity

problems.

This paper also shows about the importance of reducing derivative transactions and benefits

arising from changing its business model. Further it depicts the importance of room for client

management for achieving customer satisfaction and higher customer life time value.

Towards the end, it shows the active approach can be taken by banks for balance sheet (off

and on) management.

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1. INTRODUCTION

In the recent times when the service industry is attaining greater importance compared to

manufacturing industry, banking has evolved as a prime sector providing financial

services to growing needs of the economy.

Banking industry has undergone a paradigm shift from providing ordinary banking

services in the past to providing such complicated and crucial services like, merchant

banking, housing finance, bill discounting etc. This sector has become more active with

the entry of new players like private and foreign banks. It has also evolved as a prime

builder of the economy by understanding the needs of the same and encouraging the

development by way of giving loans, providing infrastructure facilities and financing

activities for the promotion of entrepreneurs and other business establishments.

For a fast developing economy like ours, presence of a sound financial system to mobilize

and allocate savings of the public towards productive activities is necessary. Commercial

banks play a crucial role in this regard.

The Banking sector in recent years has incorporated new products in their businesses,

which are helpful for growth. The banks have started to provide fee-based services like,

treasury operations, managing derivatives, options and futures, acting as bankers to the

industry during the public offering, providing consultancy services, acting as an

intermediary between two-business entities etc. At the same time, the banks are reaching

out to other end of customer requirements like, insurance premium payment, tax payment

etc. It has changed itself from transaction type of banking into relationship banking, where

you find friendly and quick service suited to your needs. This is possible with

understanding the customer needs their value to the bank, etc. This is possible with the

help of well-organized staff, computer based network for speedy transactions, products

like credit card, debit card, health-card, ATM etc. These are the present trend of services.

The customers at present ask for convenience of banking transactions, like 24 hours

banking, where they want to utilize the services whenever there is a need. The relationship

banking plays a major and important role in growth, because the customers now have

enough number of opportunities, and they choose according to their satisfaction of

responses and recognition they get. So the banks have to play cautiously, else they may

lose out the place in the market due to competition, where slightest of opportunities are

captured fast.

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Another major role played by banks is in transnational business, transactions and

networking. Many leading Indian banks have spread out their network to other countries,

which help in currency transfer and earn exchange over it.

Another emerging change happening all over the banking industry is consolidation

through mergers and acquisitions. This helps the banks in strengthening their empire and

expanding their network of business in terms of volume and effectiveness.

If the recent scenario of Greece is taken into consideration, the crisis has forced most of

the economies to opt austerity measures which in turn has increased the importance of

banks, as these economies would now turn to saving rather than investing or spending. In

case of India, the new and stable government has raised the hopes of investors and also the

market sentiment. Also, the Union Budget 2015-16 was considered as a pro-growth

budget. The Corporate tax reduction, repo rate cut, Jan Dhan Yojana, Pension plans and

many more initiatives, all point in the same direction – growth of the banking sector. The

growth of the banking sector is clearly visible if we take a look at the increase in the total

amount of loans and deposits of various banks with a view to expand and withstand the

growing competition. But, this expansion has also lead to a great deal of increase in the

amount of NPAs. The reasons behind this increase could be the rising demand for loans

and improper follow-up.

This entire banking sector scenario portrays a single message – an increase in the business

of a sector for increasing its profits would increase the amount of risk involved in it. The

BASEL Committee on Banking Supervision (BCBS) has issued the BASEL guidelines

with a view to curb these kinds of risks by asking the banks to maintain a certain amount

of minimum capital in proportion with these risks. These guidelines are a type of an

external regulation towards risk management. The internal regulation of such risk is done

through the risk control department of a bank.

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1.1. THE STRUCTURE OF INDIAN BANKING

1.2. COMPANY PROFILE

Founded in 1806, Bank of Calcutta was the first Bank established in India and over a

period of time evolved into SBI. SBI represents a sterling legacy of over 200 years. It is

the oldest commercial Bank in the Indian subcontinent, strengthening the nation’s trillion-

dollar economy and serving the aspirations of its vast population. The Bank is India’s

largest commercial Bank in terms of assets, deposits, profits, branches, number of

Nationalized

Banks SBI and its

Associates

Schedule Urban co-

operative Banks

Schedule state co-

operative Banks

Reserve Bank of

India

(Central Bank)

Schedule Banks

Scheduled

Commercial Banks

Scheduled

Cooperative Banks

Public Sector

Banks

Private Sector

Banks Foreign Banks

Regional Rural

Banks

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Customers and employees, enjoying the continuing faith of millions of customers across

the social spectrum.

Not only many financial institution in the world today can claim the antiquity and majesty

of the State Bank Of India founded nearly two centuries ago with primarily intent of

imparting stability to the money market, the bank from its inception mobilized funds for

supporting both the public credit of the companies governments in the three presidencies

of British India and the private credit of the European and India merchants from about

1860s when the Indian economy book a significant leap forward under the impulse of

quickened world communications and ingenious method of industrial and agricultural

production the Bank became intimately in valued in the financing of practically and

mining activity of the Sub- Continent Although large European and Indian merchants and

manufacturers were undoubtedly thee principal beneficiaries, the small man never ignored

loans as low as Rs.100 were disbursed in agricultural districts against gold ornaments.

Added to these the bank till the creation of the Reserve Bank in 1935 carried out numerous

Central – Banking functions.

Adaptation world and the needs of the hour has been one of the strengths of the Bank, in

the post-depression. For instance – when business opportunities become extremely

restricted, rules laid down in the book of instructions were relined to ensure that good

business did not go post. Yet seldom did the bank contravenes its value as depart from

sound banking principles to retain as expand its business. An innovative array of office,

unknown to the world then, was devised in the form of branches, sub branches, treasury

pay office, pay office, sub pay office and out students to exploit the opportunities of an

expanding economy. New business strategy was also evaded way back in 1937 to render

the best banking service through prompt and courteous attention to customers.

A highly efficient and experienced management functioning in a well-defined

organizational structure did not take long to place the bank an executed pedestal in the

areas of business, profitability, internal discipline and above all credibility An impeccable

financial status consistent maintenance of the lofty traditions if banking an observation of

a high standard of integrity in its operations helped the bank gain a pre- eminent status. No

wonders the administration for the bank was universal as key functionaries of India

successive finance minister of independent India Resource Bank of governors and

representatives of chamber of commercial showered economics on it.

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Modern day management techniques were also very much evident in the good old day’s

years before corporate governance had become a puzzled the banks bound functioned with

a high degree of responsibility and concerns for the shareholders. An unbroken records of

profits and a fairly high rate of profit and fairly high rate of dividend all through ensured

satisfaction, prudential management and asset liability management not only protected the

interests of the Bank but also ensured that the obligations to customers were not met. The

traditions of the past continued to be upheld even to this day as the State Bank years itself

to meet the emerging challenges of the millennium.

The bank provides a full range of corporate, commercial and retail banking and treasury

operation services.

1.3. MISSION, VISION AND VALUES

VISION STATEMENT

To retain the Bank’s position as premiere Indian Financial Service Group, with world

class standards and significant global committed to excellence in customer, shareholder

and employee satisfaction and to play a leading role in expanding and diversifying

financial service sectors while containing emphasis on its development banking rule. SBI

also speaks about my SBI, my customer first and first in customer satisfaction.

MISSION STATEMENT

We will be prompt, polite and proactive with our customers.

We will speak the language of young India.

We will create products and services that help our customers achieve their goals.

We will go beyond the call of duty to make our customers feel valued.

We will be of service even in the remotest part of our country.

We will offer excellence in services to those abroad as much as we do in India.

We will imbibe state-of-the-art technology to drive excellence

VALUES

Excellence in customer service

Profit orientation

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Belonging commitment to bank

Fairness in all dealings and relations

Risk taking and innovative

Team playing

Learning and renewal

Integrity

Transparency and Discipline in policies and systems.

1.4. CORPORATE CENTRE ORGANIZATIONAL CHART

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1.5. PRODUCTS AND SERVICES

PRODUCTS State Bank of India renders varieties of services to customers through the following

products:

SBI TERM DEPOSITS

SBI RECURRING DEPOSITS

SBI HOUSING LOAN

SBI CAR LOAN

SBI EDUCATIONAL LOAN

SBI PERSONAL LOAN

SBI LOAN FOR PENSIONERS

LOAN AGAINST MORTGAGE OF PROPERTY

LOAN AGAINST SHARES & DEBENTURES

SERVICES

DOMESTIC TREASURY

SBI VISHWA YATRA FOREIGN TRAVEL CARD

BROKING SERVICES

REVISED SERVICE CHARGES

ATM SERVICES

INTERNET BANKING

E-PAY

E-RAIL

SAFE DEPOSIT LOCKER

GIFT CHEQUES

FOREIGN INWARD REMITTANCES

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2. LITERATURE REVIEW

A number of articles by the various consultancy group such as Accenture, Cognizant, and

E & Y etc. has made valuable contribution regarding optimization of bank capital

according to Basel III norms. There are also many regulatory frameworks provided by

Banking Committee on Basel Supervision (BCBS), Banking for International Settlement

(BIS), Reserve Bank of India (RBI) to work to optimize Risk-Weighted Assets (RWA)

and calculation of Counterparty Credit Risk (CCR) and Credit Value Adjustment (CVA)

etc.

2.1. BASEL REGULATORY CHANGES

After the financial crisis of 2008, BCBS came with a new accord as BASEL III,

which gave a strong foundation to banking sector to avoid liquidity problems in

stress scenarios and it shows the banking industry a way to avoid pitfall in their

approach for calculation of CCR and CVA.

There are following changes made by BCBS which are explained below;

Pillar 1 - Quality and level of capital; Greater focus on common equity. The

minimum will be raised to 4.5% of risk-weighted assets, after deductions. Capital

loss absorption at the point of non-viability; contractual terms of capital

instruments will include a clause that allows – at the discretion of the relevant

authority – write-off or conversion to common shares if the bank is judged to be

non-viable. This principle increases the contribution of the private sector to

resolving future banking crises and thereby reduces moral hazard. Capital

conservation buffer; comprising common equity of 2.5% of risk-weighted assets,

bringing the total common equity standard to 7%. Constraint on a bank’s

discretionary distributions will be imposed when banks fall into the buffer range.

Countercyclical buffer; imposed within a range of 0-2.5% comprising common

equity, when authority’s judge credit growth is resulting in an unacceptable build-up

of systematic risk. Securitization; strengthens the capital treatment for certain

complex securitizations. Requires banks to conduct more rigorous credit analyses of

externally rated securitization exposures. Trading book; significantly higher capital

for trading and derivatives activities, as well as complex securitizations held in the

trading book. Introduction of a stressed value-at-risk framework to help mitigate

procyclicality. A capital charge for incremental risk that estimates the default and

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migration risks of unsecuritised credit products and takes liquidity into account.

Counterparty credit risk; substantial strengthening of the counterparty credit risk

framework. Includes: more stringent requirements for measuring exposure; capital

incentives for banks to use central counterparties for derivatives; and higher capital

for inter-financial sector exposures. Bank exposures to central counterparties

(CCPs); the Committee has proposed that trade exposures to a qualifying CCP will

receive a 2% risk weight and default fund exposures to a qualifying CCP will be

capitalized according to a risk-based method that consistently and simply estimates

risk arising from such default fund. Leverage ratio; a non-risk-based leverage ratio

that includes off-balance sheet exposures will serve as a backstop to the risk-based

capital requirement. Also helps contain system wide build-up of leverage. It should

be more than or equal to 3%.

Pillar 2 - Supplemental Pillar 2 requirements; Address firm-wide governance

and risk management; capturing the risk of off-balance sheet exposures and

securitization activities; managing risk concentrations; providing incentives for

banks to better manage risk and returns over the long term; sound compensation

practices; valuation practices; stress testing; accounting standards for financial

instruments; corporate governance; and supervisory colleges.

Pillar 3 – Revised Pillar 3 disclosures requirements; the requirements introduced

relate to securitization exposures and sponsorship of off-balance sheet vehicles.

Enhanced disclosures on the detail of the components of regulatory capital and their

reconciliation to the reported accounts will be required, including a comprehensive

explanation of how a bank calculates its regulatory capital ratios.

Liquidity – Liquidity coverage ratio; the liquidity coverage ratio (LCR) will

require banks to have sufficient high-quality liquid assets to withstand a 30-day

stressed funding scenario that is specified by supervisors. It should be more than or

equal to 100%. Net stable funding ratio; the net stable funding ratio (NSFR) is a

longer-term structural ratio designed to address liquidity mismatches. It covers the

entire balance sheet and provides incentives for banks to use stable sources of

funding. It should be more than or equal to 100%. Principles for Sound Liquidity

Risk Management and Supervision; the Committee’s 2008 guidance Principles for

Sound Liquidity Risk Management and Supervision takes account of lessons learned

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during the crisis and is based on a fundamental review of sound practices for

managing liquidity risk in banking organizations. Supervisory monitoring; the

liquidity framework includes a common set of monitoring metrics to assist

supervisors in identifying and analyzing liquidity risk trends at both the bank and

system-wide level.

Systemically important financial institutions (SIFIs) – In addition to meeting the

Basel III requirements, global systemically important financial institutions

(SIFIs) must have higher loss absorbency capacity to reflect the greater risks that

they pose to the financial system. The Committee has developed a methodology that

includes both quantitative indicators and qualitative elements to identify global

systemically important banks (SIBs). The additional loss absorbency requirements

are to be met with a progressive Common Equity Tier 1 (CET1) capital requirement

ranging from 1% to 2.5%, depending on a bank’s systemic importance. For banks

facing the highest SIB surcharge, an additional loss absorbency of 1% could be

applied as a disincentive to increase materially their global systemic importance in

the future. A consultative document was published in cooperation with the Financial

Stability Board, which is coordinating the overall set of measures to reduce the

moral hazard posed by global SIFIs.

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2.2. CENTRAL COUNTERPARTY (CCP)

While the financial crisis caused massive fallout on bilateral traded over-the-counter

(OTC) sides, exchange traded and centrally cleared derivatives escaped with barely a

scratch. As 90% of global derivatives volumes are purportedly being conducted in

the OTC markets, it is clear why regulators and governments are concerned.

Buy

Sell

Figure 1: Counterparty Risk – Bilateral Settlement

OTC derivatives: The default of a firm A in OTC derivatives transactions has a

possible contagion effect. It doesn’t only affect firm B, it leaves all connected

trading counterparties from firm A to E potentially at risk.

Figure 2: Counterparty Risk – Central Clearing

Bank A

Bank B

Bank CBank D

Bank E

Bank A Bank B

Bank C Bank E

Bank D

CCP

12

In this scenario, the CCP stands between firms A to E in the transactions. If firm D

defaults, positions are closed out or transferred to other members. The effect of

default is contained, but there is no contagion.

In simple term, CCP is an intermediary. In other term we can say that, CCPs place

themselves between the buyer and seller of an original trade, leading to a less

complex web of exposures. CCPs effectively guarantee the obligations under the

contract agreed between the two counterparties, both of which would be participants

of the CCP. If one counterparty fails, the other is protected via the default

management procedures and resources of the CCP. (Or) any position taken on with

one counterparty is always offset by an opposite position taken on with a second

counterparty.

2.2.1. OBJECTIVE OF CENTRAL COUNTERPARTY (CCP)

There are following objectives of CCP which have taken into consideration

after financial crisis to increase market safety and integrity, which are

following;

Reduce the probability of a counterparty defaulting with help of the

“Novation” Process ( In this process, two new contracts are created between

the CCP and the buyer and the CCP and the seller to replace the single,

original contracts between the two parties thus, transferring counterpart risk to

the clearing house).

Central clearers have put effective lines of defense in place ensuring multilevel

security. So they are well protected against default.

Set their margin requirement at levels that are expected to cover estimated

market moves of normal market conditions for the interval between the time of

last collection of margin and transfer (or) close out of positions.

During the risk management process the CCP nets all offsetting open

derivatives contracts of each trading parties. Such multilateral netting decrease

the gross risk exposure to a much higher degree than in the OTC-derivatives

segments which utilize only bilateral netting. Therefore, the CCPs own risk is

reduced and is manageable by means of appropriate margins and capital

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deposits to prevent damages which arises as a result of any member’s default

burdening the CCP.

Participants in a bilateral environment are not able to gain as comprehensive a

picture of their counterparties’ derivatives trading risks as CCPs are, since

their knowledge is limited to their own positions vis-à-vis their counterparties.

The effects of this uncertainty on market confidence in periods of market

turmoil can be devastating. By contrast, CCPs are uniquely poised to swiftly

understand the positions of all market participants which they serve as a

central counterparty and are in a stronger position for managing risks for a

clearing member in distress. This may necessitate increasing collateral and – if

needed – unwinding open positions. Well-established CCP processes for

unwinding the positions of a defaulting member further foster market

confidence.

The introduction of clearing houses into the mix promises to correct these

asymmetries because only the clearing house knows which counterparty is on

the other side of a trade. This anonymity may encourage increased trading

activity on the part of both buy-side and sell-side users.

Reduces complexity by reducing the number of counterparty relations and

increases efficiency by establishing minimum financial and operational criteria

as well as margin and collateral requirements for its members, centralizing the

necessary calculations, automatically collecting or paying the respective

amounts and preventing disputes (e.g. over the amount and quality of

collateral).

CCPs address operational risks by means of adequate auditing procedures (i.e.

compliance with technical infrastructure requirements) that ensure the

necessary operational know-how of their current and potential members.

Requires less regulatory capital from clearing members due to CCPs’ capacity

to mutualize losses through the use of default funds. Many analyst suggested a

remarkable cost advantage if there is no equity capital cost due to the zero

capital weighting.

Higher collateral cost results from the precautionary measures taken by CCPs

as compared with typical OTC derivatives trading– such as higher quality

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requirements for eligible collateral and overall level of collateralization

required. However these are partially offset by equity capital savings.

2.2.2. REQUIREMENT OF CCP FOR CCR

Basel II regulations made requirements related to counterparty risk on market

transactions;

Capital calculation related to over the counter (OTC) and Securities financing

transactions (SFT) such as asset loans and repo, and reverse repo agreements

with exposures implied by the potential one year horizon counterparty default.

The assessment of counterparty risks on market transactions is directly linked

to the evaluation of the amount of exposure considered appropriate for a

market transaction. Basel II provided two main approaches to estimate this;

The fixed price version (current exposure method or CEM) is based on a

market price valuation, offering a hybrid measure between exposure and

volume.

EAD (Exposure at default) = [(RC + add-on) – Volatility adjusted collateral)]

Where, RC = Replacement Cost

Add- on = is the estimated amount of Potential Future Exposure

Volatility adjusted collateral = is the value of collateral as specified

The “internal models” version was created to enable banks to simulate mark-

to-market future variations, with the objective of using such simulations both

for their internal risk monitoring and for calculating regulatory capital.

The implementation of IMM is much more demanding in terms of

documentation and approval. IMM approach may help to provide regulatory

capital saving opportunities compared to Credit Exposure Method (CEM).

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2.2.3. NEW REQUIRED MEASUREMENT FOR CCR

There are following measures introduced related to counterparty credit risk;

Calibration of diffusion parameters in stressed Effective Expected

Positive Exposure (EEPE) calculations: EEPE measure is completed by a

“stressed” EEPE calculation based on the calibration of diffusion model

parameters over a period of three years including a period of rapid increases in

credit spreads. The parameters are then recalibrated and used in current market

situations for calculating the mark-to-future and stressed EEPE. The risk-

weighted assets (RWA) calculation is made twice, using both non-stressed and

stressed parameters. The final measure appearing in the regulatory report is the

highest one observed between non-stressed RWA and stressed RWA.

Introduction of an additional capital charge to cover the risk of change in

Credit Value Adjustment (CVA) of a trading portfolio: The adjustment of

CVA materializes the market value of CCR on the market transaction of the

trading portfolio. The CVA charge represents a new capital add-on for

potential mark-to-market losses associated with deterioration in the credit

worthiness of counterparty. Two methods for assessing this charge are

proposed by the Basel Committee on Banking Supervision:

For portfolio valued using the standard method formula; The only eligible

hedges that can be included in calculating the advanced CVA risk capital

charge are, a) Single-name credit default swaps (CDSs) or other equivalent

hedging instruments referencing the counterparty directly . Index CDSs,

provided that the basis between any individual counterparty spread and the

spreads of index CDS hedges is reflected, to the satisfaction of the competent

authority, in the Value-at-Risk (VaR).

For portfolios valued using IMM (and in the case of banks already using

an internal model for interest rate VaR), the method is based on applying

the VaR model used for bonds to the regulatory CVA.

The difference in terms of capital requirements between the standard and the

CVA VaR approach can be very material, thus encouraging many market

players to use the Internal Model Approach. The CVA risk capital can lead to

a significant increase in the risk weighted assets.

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As for exceptions, a bank is not required to include in its capital charge the

following: Transactions with a central counterparty (CCP) and a client’s

transaction with a clearing member, when the clearing member is acting as an

intermediary between the client and a qualifying central counterparty and the

trading transactions expose the clearing member to a qualifying central

counterparty and securities financing transactions (SFT), unless the bank’s

supervisor determines that the loss exposures arising from SFT transactions

are material. Details explanation of CVA has given below.

Specific Wrong Way Risk (WWR): Also called unfavorable correlation. It

quantifies the negative correlation between the risk exposure to counterparty

and its credit quality (for instance a put option purchase on a counterparty

legally bound to the counterparty issuing the underlying instrument).

Transactions carrying specific WWR with unfavorable correlation will have to

be identified, isolated from the overall compensation node of origin and

assigned to a particular computational processing to calculate their

exposure at default (EAD).

General Wrong Way Risk: Macroeconomic factors. For e.g. Increase in oil

prices will lead to probability of airlines companies as the value of some their

exposures increase. Banks will not have to implement a particular action or a

differentiated capital allocation for this type of risk, but nevertheless would

have to identify such exposures through scenario analysis of market

tensions, in order to identify the risk factors correlated with the credit quality

of the counterparties.

Increase of the Margin Period of Risk (MPR): The margin period of risk

(MPR) is the time period overseeing the last exchange of collateral used to

cover netting transactions with a defaulting counterpart and the closing out of

the counterparty and the resulting market risk is re-hedged. With this indicator

it is possible to model the change in market value of the collateral exchanged

during a theoretical date of collateral exchange and the calculation date of

subsequent exposure. In some situations, for all “illiquid” netting sets, banks

will have to move from 10 days (the Basel II requirement) to 20 days of the

regulatory threshold (with the possible doubling of this threshold if at least two

17

disputes on the same set of compensation have been observed over the last six

months).

Collateral Management: Implementation of collateral management.

Monitoring, reporting and analyzing received and paid collateral including

categories of collateralized assets, the amount of margin calls exchanged, and

the concentration, disputes, re-hypothecations and other elements.

Application of a coefficient of correlation between assets value for large

financial institutions: It requires the use of a correlation factor greater than

1.25 times the one used in calculating the Basel II regulatory capital for

institutions of significant size (e.g., those with a trading book exposure over

$100 billion).

Central Counterparty Clearing (CCP) houses: A bank is required to use a

minimum risk weighting of 2% of the exposure value of all its trade

exposures with the CCP. These counterparties are to serve as intermediaries

between buyers and sellers of products and thus help reduce counterparty risk.

Cleared derivatives contracts will tend to increase liquidity needs through

initial and variation margins callable by clearing houses.

Back-testing credit counterparty risk modules: Requires performing initial

and on-going valuation of credit counterparty risk exposure models with a

focus on; a) Carrying out back-testing at , Risk Factor Level, Pricing Model

Level, CCR exposure Module. b) Considering a number of distinct prediction

time horizons out to last one year.

2.2.4. QUALIFYING CENTRAL COUNTERPARTIES (QCCP)

It is an entity that is licensed to operate as a CCP (including a license granted

by way of confirming an exemption), and is permitted by the appropriate

regulator / overseer to operate as such with respect to the products offered.

This is subject to the provision that the CCP is based and prudentially

supervised in a jurisdiction where the relevant regulator/overseer has

established, and publicly indicated that it applies to the CCP on an ongoing

basis, domestic rules and regulations that are consistent with the CPSS-IOSCO

Principles for Financial Market Infrastructures.

In India following four corporations have got status as QCCP:

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National Securities Clearing Corporation Limited (NSCCL)

Indian Clearing Corporation Limited (ICCL)

MCX-SX Clearing Corporation Limited (MCX-SXCCL)

Clearing Corporation of India Ltd. (CCIL)

2.2.5. CAPITAL REQUIREMENTS FOR EXPOSURES TO CCPS

Capital requirements will be dependent on the nature of CCPs viz. Qualifying

CCPs (QCCPs) and non-Qualifying CCPs.

Regardless of whether a CCP is classified as a QCCP or not, a bank retains the

responsibility to ensure that it maintains adequate capital for its exposures.

Bank should consider whether it might need to hold capital in excess of the

minimum capital requirements if, for example, (i) its dealings with a CCP give

rise to more risky exposures or (ii) where, given the context of that bank’s

dealings, it is unclear that the CCP meets the definition of a QCCP.

Banks may be required to hold additional capital against their exposures to

QCCPs, if in the opinion of RBI, it is necessary to do so.

Where the bank is acting as a clearing member, the bank should assess through

appropriate scenario analysis and stress testing whether the level of capital

held against exposures to a CCP adequately addresses the inherent risks of

those transactions.

The trades with a former QCCP may continue to be capitalized as though they

are with a QCCP for a period not exceeding three months from the date it

ceases to qualify as a QCCP. After that time, the bank’s exposures with such a

central counterparty must be capitalized according to rules applicable for non-

QCCP.

2.2.6. EXPOSURES TO QUALIFYING CCPS (QCCPS)

A. Trade Exposures:

Clearing member exposure to QCCPs:

Where a bank acts as a clearing member of a QCCP for its own purposes,

risk weight of 2% must be applied to the bank’s trade exposure to the QCCP

19

in respect of OTC derivatives transactions, exchange traded derivatives

transactions and SFTs.

The exposure amount for such trade exposure will be calculated in accordance

with the Current Exposure Method (CEM) for derivatives and rules as

applicable for capital adequacy for Repo / Reverse Repo-style transactions.

Clearing member exposures to clients: The clearing member will always

capitalize its exposure (including potential CVA risk exposure) to clients as

bilateral trades, irrespective of whether the clearing member guarantees the

trade or acts as an intermediary between the client and the QCCP. However, to

recognize the shorter close-out period for cleared transactions, clearing

members can capitalize the exposure to their clients by multiplying the EAD

by a scalar which is not less than 0.71(A margin period of risk at least 5 days).

(If a margin period of risk will be 6 days = 0.77, 7 days = 0.84, 8 days = 0.89,

9 days = 0.95, and 10 days = 1)

Client bank exposures to clearing members: Where a client is not protected

from losses in the case that the clearing member and another client of the

clearing member jointly default or become jointly insolvent, but all other

conditions mentioned above are met and the concerned CCP is a QCCP, risk

weight of 4% will apply to the client’s exposure to the clearing member.

Treatment of posted collateral: Any assets or collateral posted must, from

the perspective of the bank posting such collateral, receive the risk weights

that otherwise applies to such assets or collateral under the capital adequacy

framework, regardless of the fact that such assets have been posted as

collateral. Thus collateral posted from Banking Book will receive Banking

Book treatment and collateral posted from Trading Book will receive Trading

Book treatment.

Collateral posted by the clearing member (including cash, securities, other

pledged assets, and excess initial or variation margin, also called over-

collateralization), held by a custodian, and is bankruptcy remote from the

20

QCCP, is not subject to a capital requirement for counterparty credit risk

exposure to such bankruptcy remote custodian.

Collateral posted by a client, that is held by a custodian, and is bankruptcy

remote from the QCCP, the clearing member and other clients, is not subject to

a capital requirement for counterparty credit risk.

If the collateral is held at the QCCP on a client’s behalf and is not held on a

bankruptcy remote basis, 2% risk weight will be applied to the collateral.

Risk weight of 4% will be made applicable if a client is not protected from

losses in the case that the clearing member and another client of the clearing

member jointly default or become jointly insolvent.

B. Default Fund Exposures to QCCPs: If default fund is shared between

products or types of business with settlement risk only (e.g. equities and

bonds) and products or types of business which give rise to counterparty credit

risk, all of the default fund contributions will receive the risk weight

determined according to the formulae and methodology, without

apportioning to different classes or types of business or products.

2.2.7. EXPOSURES TO NON-QUALIFYING CCPS

Banks must apply the Standardized Approach for credit risk according to the

category of the counterparty, to their trade exposure to a non-qualifying CCP.

Banks apply Risk Weight of 1250 % to their default fund to a non-QCCPs.

Default Fund = Funded + Unfunded contribution.

If liability for unfunded contributions, the national supervisor (In case of India,

its RBI) should determine the amount of unfunded commitments to which

Risk weight of 1250 % should apply to.

The exposures of banks on account of derivative trading and securities and

financing to CCP including those attached stock exchanges for settlement of

exchange traded derivatives, are assigned zero exposure value for CCR.

Credit Conversion factor (CCF) of 100% are applied to the securities

posted as collaterals with CCPs. 20% for Clearing Corporation of India

Limited (CCIL), and as per the external ratings for other CCPs.

21

Deposits kept by banks with the CCPs, 20% Risk Weights for CCIL and as

per the external ratings for other CCPs.

Illustration: A Real Estate Company entering into an IRS contracts via a CCP

Company asks bank to ‘Swap’ its

Floating-rate loan Interest payments

For fixed-rate payments.

Floating-Rate Payments Floating-Rate Payments

Fixed Rate Payments Fixed Rate Payments

Assume if Broker Dealer B defaults before the end of the 3 year contract, and

unable to make obligation to offer fixed rate payments in return for floating

ones. The CCP must manage this exposure. For instance, it may use an auction

process to find another counterparty to take on the swap contract. In this event,

the collateral pledged to the CCP by Broker Dealer B could be used to cover

losses the CCP might incur while arranging this.

2.2.8. DEFAULT WATERFALL (HOW CCPS CAN MANAGE IN CASE OF

DEFAULT)

In taking on the obligations of each side to a transaction, a CCP has equal and

opposite contracts. That is, payments owed by the CCP to a member on one

trade are exactly matched by payments due to the CCP from the member on

the matching trade. But if one member defaults, the CCP needs resources to

draw on to continue meeting its obligations to surviving members. This is

Commercial Bank

A

(Member of CCP)

Real Estate Company

CCP Broker Dealer B

(Member of

CCP)

22

sometimes achieved through an ‘auction’ of the defaulter’s position among

surviving members. In terms of resources to cover its obligations, CCPs

typically have access to financial resources provided by the defaulting party,

the CCP itself and the other, non-defaulting members of the CCP. The order in

which these are drawn down helps to create appropriate incentives for all

parties (members and CCPs) to manage the risks they take on. These funds are

collectively known as the CCP’s ‘default waterfall’.

Figure 3: Default waterfall

If the collateral posted by the defaulter to the CCP is insufficient to meet the

amount owed, the CCP can then draw on the defaulting party’s contribution to

the CCP’s ‘default fund’. Usually, all members are required to contribute to

this fund in advance of using a CCP. A key feature of CCPs is that losses

exceeding those initial sums provided by the defaulter are effectively shared

(mutualized) across all other members of the CCP.

Before using the default fund contributions of surviving members the CCP

may contribute some of its own equity resources towards the loss (shown in

Defaulting member’s initial margin and default

fund contribution

Surviving members default fund-contributions

Part of CCPs Equity

CCPs remaining equity

Right of assessment

CCP insolvent in the absence of a mechanism to

allocate the residual loss

23

the second row of Figure 3). This incentivizes the CCP to ensure that losses

are, as far as possible, limited to the resources provided by the defaulting

member rather than being passed on to other members.

If the CCP’s own contribution is fully utilized, the CCP then mutualizes

outstanding losses across all the other (non-defaulting) members. First, the

CCP draws on default fund contributions from non-defaulting members (third

row of Figure 3). If these loss-absorbing resources (which up to this point are

all pre-funded) are exhausted, CCPs may call on surviving members to

contribute a further amount, usually up to a pre-determined limit. This is

sometimes termed ‘rights of assessment’ (fourth row in Figure 3).

In the absence of a mechanism to allocate any further losses among its

members, the CCP’s remaining equity then becomes the last resource with

which to absorb losses, though this is often quite a small sum when compared

with initial margin and the default fund. If losses exceed this remaining equity,

the CCP would become insolvent.

24

2.3. CREDIT VALUE ADJUSTMENT (CVA)

CVA is introduced to adjust for the risk that appears for counterparties in derivative

instruments. CVA is defined as the market value of counterparty credit risk. Crisis

such as LTCM (Long Term Capital Management) and collapse of Lehman Brothers

have given birth to CVA charge. In the recent 2008 crisis, counterparty risk losses

resulted from the credit market volatility than from realized defaults. There was

estimation that two thirds of counterparty risk related losses were happened from

CVA volatility and only one third from actual default. During this crisis there was

also implication that banks tend to neglect valuation of counterparty credit risk

because of smaller size of the derivative exposure (or) the high credit rating of the

counterparties (AAA or AA). E.g. If banks were going for any derivative contracts

with smaller companies, the size of contracts was smaller and due to this reason

banks were not focusing on Credit Value Adjustment (CVA). But whatever the

contracts may be there will be exposures. Also if banks were going for contract with

a high credit rating companies like AAA rated companies or AA rated companies,

they had a belief that since they have high credit rating, they will not default (too-

big-to-fail concept). These scenarios resulted in emergence of CVA.

2.3.1. APPROACHES FOR MEASUREMENT OF CVA

There are two approaches to measuring CVA; one is Unilateral and second is

bilateral. Difference between Unilateral and Bilateral CVA has explained

below;

Unilateral Bilateral

Assume that the institution who does

the CVA analysis (Bank) is default

free. E.g. Options

Assume both the counterparty and the

banks have possibility of default.

E.g. Swaps

Gives the current market value of future

losses due to counterparty’s potential

default.

Gives fair value calculation since both

the bank and the counterparty requires

a premium for the counterparty risk.

Table 1: Difference of Unilateral and Bilateral CVA

25

2.3.2. CALCULATION OF CVA CAPITAL REQUIREMENT

There are two approaches and four methods for calculating the CVA capital

requirements;

Standardized Approach Advance Approach

1. Current Exposure Method (CEM)

Advanced Method (AM)

2. Internal Model Method (IMM)

3. Standardized Method (SM)

The problem behind addressing CVA is related to infrastructure, data

management and regulatory reporting. So, Advance method is tough to calculate

on the currently available data and infrastructure.

The Standardized Approach: Institutions using the standardized approach

can stick on this regulatory formula for the calculation of capital requirements

for CVA;

CCP insolvent in the absence of a mechanism to

allocate the residual loss

26

Illustration: On 1 November 201Y, Company X (a large corporate) enters into

a 6 month foreign exchange contract (selling USD= 14 million and buying

Euro= 10 million) with bank Y to hedge its foreign currency risk. Bank Y

enters a back-to-back contract with its parent on the same day that is bank Y

sells USD= 14 million and buys Euro= 10 million forward.

Solution: (Assuming here CVA is not hedged)

Step 1 – Calculating EADi and Mi

Assuming that Bank Y determines the exposure at default for OTC derivatives

by reference to the CCR mark-to-market method,

EADi Amount in EURO

EADcorporate EUR 10mm*1%1= EUR 1,

00,000

EADparent EUR 10mm*1% = EUR 1,

00,000

The discounted exposure at default is calculated by applying a standardized

discounting factor based on the maturity of the transaction.

The effective maturity of both exchange transactions is 6 month.

Step 2 – Calculating wi

Company X = A- Credit rating = 0.8% weight.

Parent = AA- Credit rating = 0.7% weight.

Step 3 – Calculating the capital requirement for CVA and CCR

On 1 November 201Y, the capital requirement for CCR is EUR 5,600 that is;

Company X = EUR 1, 00,000*50 %( External Credit Rating)*8 %( CRAR of

bank Y)

= EUR 4000

And Parent Y = EUR 1, 00,000*20 %( External Credit Rating)*8 %( CRAR of

bank Y)

1 It is noted that 1% is the standardised applied to the notional of a forward foreign currency contract with a maturity of 12 months (or) less.

27

= EUR 1600

The additional capital requirement arising from CVA on 1 November 201Y,

risk is calculated by reference to above formula and amount to EUR 1,366.

Implications of this, CVA risk requires an approx. additional 25% capital

requirement as compared to the CCR.

Standardized Method (SM) – Currently very few financial intuition use this

method.

Current Exposure Method (CEM) – Most common method for calculating

Exposure at default (EAD).

EAD = CE + PFE (Potential future exposure) – C

Where, CE = Current exposure of the transaction,

C = Collateral posted by the counterparty.

The limitations of these two methods are poor support for risk mitigation from

collateral agreements and also these are less risk sensitive.

Internal Model Method (IMM) – It is a way to compute CVA for firms that

have a regulator approved model for CCR.

EAD under IMM –

E (exposure) = max {V [MTM value of the portfolio] – C [amount of

collateral], 0}

With IMM model, we need to focus on Expected Exposure (EE), Expected

Positive Exposure (EPE), Effective Expected Exposure (EEE), and Effective

Expected Positive Exposure (EEPE).

So, EAD = alpha * EEPE

The alpha multiplier is formally defined as the ratio between economic capital

(as computed with the full IMM) and one calculation carried out with

deterministic exposures set to EPE. The existence of the alpha is meant to

account for wrong way risks (WWRs) and other model issues. To the WWR

errors belong;

Correlations of exposures across counterparties

Correlation between exposures and defaults.

Other factors which are meant to be accounted for are;

28

the exposures' volatility

model estimation errors

numerical errors

Advanced Approach - The advanced method is available for banks that

have an approved IMM as well as a specific interest rate risk VaR model.

These banks calculate the CVA capital charge by simulation. The simulation

involves modelling the credit spread and thereby rating of counterparties in

OTC derivative transactions.

We need to calculate two separate version of CVA. The first calculation is

calibrated using market data from the current one year period. The second is

calibrated for a stressed one year period, with increased credit spreads. The

calculations are then added according to produce the CVA capital charge

amount.

29

Since its time extensive and because of poor infrastructure we are not able to

compute CVA based on the Advance Approach.

2.3.3. COMPARISON OF CEM AND IMM METHOD

Since we have seen CEM and IMM method for computation of CVA. Now

we will stress contracts mainly by changing the counterparty’s rating and time

to maturity of the Contracts.

Also, in all scenarios we are the fixed receiver and the contracts have the same

time-to-maturity of 5 years.

All calculations displayed throughout the examples are executed in Matlab

2013b (8.2.0.701).

Below is an overview of the computations we have performed.

For Internal model method: Firstly, CVA is computed using the IMM. This

method has a moderate support in Matlabs most recent version of the Financial

Instruments Toolbox.

Current exposure method: Secondly, CVA is computed using the simpler

CEM.

The reason to why we are not using the advanced method as benchmark for

regulatory CVA is due to the complexity of the model and difficulty in finding

the needed data.

An interest rate swap is an agreement between two parties to exchange interest

rate cash flows on specified intervals and over a certain period of time. Interest

swaps are OTC derivative contracts, which is one of the reasons to why we

will consider them here.

There are a number of different versions of IRS contracts, but the far most

common type, and the one we will consider in this chapter, is the so called

plain vanilla interest rate swap. Under this contract, one of the parties pays a

fixed interest rate, and the other pays a floating rate. The convention is that the

party paying the fixed rate is called the payer, and the party receiving the fixed

rate is called the receiver. The interest rate is paid on a so called notional

30

amount (or notional principal amount or notional value); an imaginary value

which is never exchanged.

Maturity (Months) Rate

3 0.00227

6 0.00341

12 0.00446

24 0.00534

36 0.0071

48 0.0089

60 0.0106

84 0.015

120 0.0199

180 0.0244

240 0.0259

Initial rates used in the calculation of CVA calculation

The following are the setting used in the simulation of CVA under IMM:

Parameter Value

Settlement date 2013-11-05

Principal Amount 1MSEK

Latest floating rate 0:00227

Rate Spread 10 bps

Cash flow frequency once per year

Number of simulation paths 500

Time step 1 month

Compounding continuous

IMM alpha 1.4

31

Rating Drop -

Counterparty 1 2 3 4

Rating AAA BBB B CCC

Weight 0.7 1 3 10

Time-to-

maturity

5 5 5 5

CVA IMM 60260 86090 258270 860910

CVACEM 122400 174800 524500 1748500

Difference 62140 88710 266230 887590

We can implicate from this table that CEM is always calculating a higher

value than the IMM method.

Increasing time-to-maturity, fixed rating –

Counterparty 1 2 3 4 5

Rating AA AA AA AA AA

Weight 0.7 0.7 0.7 0.7 0.7

Time-to-

maturity

1 2 3 4 5

CVA IMM 422 4515 12591 29218 60264

CVACEM 8150 16310 24490 32640 122390

Difference 7728 11795 11899 3422 62126

Counterparty 1 2 3 4 5

Rating BBB BBB BBB BBB BBB

Weight 1 1 1 1 1

Time-to-

maturity

1 2 3 4 5

CVA IMM 603 6450 17988 41739 86091

CVACEM 11650 23300 34980 46630 174850

Difference 11047 16850 16992 4891 88759

32

We can implicate from both cases that if we change time-to-maturity and

rating of the counterparty, in both of scenario CEM is calculating a higher

value than IMM.

We can conclude from derivations of the two methods, IMM and CEM that

the IMM method is much more mathematically sophisticated. The difference

would be in implementation of both methods are, IMM is much more

computer intensive.

2.3.4. ISSUES IN CVA COMPUTATION

There are many issues in computing CVA, which are following;

Options on a portfolio are difficult to price and hedge

Data is difficult to come by and manage

Pricing

Calibration

Sensitiveness

Trading Strategy Analysis

Portfolio Calculation

VaR.

33

3. RESEARCH METHODOLOGY

The objective of this research is to arrive at the optimization of the capital in bank’s

capital by focusing on important changes done by BCBS on their regulatory framework.

Also, there was more focus on data purity and model refining process to use to save capital

in bank’s treasury by way of adopting many prescribed regulatory framework. For this

purpose there has been use of primary data as well as secondary data.

3.1. QUALITATIVE ANALYSIS

This research is done on more of a qualitative than a quantitative ground as it

requires tremendous research on the available policies by BCBS and national

regulators (In case of India, it is RBI). For a start, I conducted study of the available

literatures on capital adequacy framework and how bank can save itself from risk

arising from day-to-day activity in banking operations. These literatures gave an

overall view about the history of financial crisis and what steps have been taken by

regulators to further avoid any crisis. Further, I studied about measurement and

guidance provided by BCBS to banks to save itself from 30-dyas acute stress

scenario (Liquidity Coverage Ratio) and One year stress scenario (Net Stable

Funding Ratio). Further research is performed on individual related concepts which

could have an impact on optimization of capital.

BCBS committee ensures that banks will not neglect any counterparty credit risk

which can arise by down rating of company (or) any issue related with particular

company. The credit valuation adjustment is mandatory for banks after the crisis of

2008-09 in order to keep a check on CCR. A comparatively study has been made on

the models provided by the BASEL committee and which is currently using by most

of the national and international banks.

3.2. QUANTITATIVE ANALYSIS

For better understanding of how capital charge may be reduced, I have taken many

hypothetical examples and also from various resources and tried to showed that how

changing in model can lead to optimization of capital and save bank from any risk

can occur.

34

4. FINDING, ANALYSIS AND IMPLICATIONS

4.1. OPERATIONAL MEASURES

Operational measures is a very important tool for a financial institutions to save

itself from any risk of loss from inadequate or failed internal processes, people and

systems, or from external events.

During the early part of the decade, much of the focus was on techniques for

measuring and managing market risk. As the decade progressed, this shifted to

techniques of measuring and managing credit risk. By the end of the decade, firms

and regulators were increasingly focusing on risks "other than market and credit

risk." These came to be collectively called risk arising from poor operational

measure. This catch-all category of risks was understood to include,

employee errors,

systems failures,

fire, floods or other losses to physical assets,

fraud or other criminal activity,

Data Quality,

Risky Assets,

Flexible credit approval processes.

Employee Errors can be eliminated by proper training whereas system failures can

be eliminated by strong infrastructure. Fire, floods or other losses to physical assets

can be saved by properly controlling and better framework. Fraud (or) other criminal

activity can be eliminated by proper research of employee’s background and

monitoring of employees. But the most important part of operational measures

which banks need to focus are optimization of Risk Weighted Assets (RWA),

enhancement of data quality, stricter credit approval processes, reducing credit

exposure, improving liquidity risk management, closer integration of risk and

finance functions. These operational measures are explained below;

4.1.1. RWA OPTIMIZATION

At the heart of global bank regulatory capital standards, known as The Basel

Accord, is the idea that since assets represent a diversity of risk, each should

be risk weighted differently. Numerous bank regulators and bank

35

reform advocates in the last few years have become increasingly vocal in their

displeasure about this framework. Every time that the Basel Committee for

Banking Supervision (BCBS) comments on Risk Weighted Assets (RWAs),

that would restrict the existing flexibility that exists in how market participants

come up with many of the inputs for the regulatory capital calculation.

Until the Basel Committee finds a compromise between risk measurement

methodologies and those that are flexible, banks are currently extremely

focused on optimizing their RWAs in the hopes of some regulatory capital

relief. In almost fifteen years of working with banks and regulators on Basel I

– III, I have observed a variety of ways that banks optimize their RWAs with

varying degrees of success.

Irrespective of a banks size a good place to start RWAs optimization is the

banking book, since those will carry a full RWAs.

But how can banks optimize it RWAs, because the competition between public

sector and private sector is very high. Banks are aggressively expanding its

networks to cover maximum industry, person, and government agency without

taking consideration of loss (arising from credit loss and market loss).

RWAs are an important part of both the micro- and macro-prudential toolkit,

and can (i) provide a common measure for a bank’s risks; (ii) ensure that

capital allocated to assets is commensurate with the risks; and (iii) potentially

highlight where destabilizing asset class bubbles are arising.

We will take a hypothetical scenario of banks investment and we can see that

how investment done by banks only in few categories will charge high RWAs.

Assume book value = 100 (equal weightage investment) in portfolio of bank.

In the given scenario, we will consider banks investment in defaulted entities

guaranteed by State government. While making such investments, banks

doesn’t check such information about entities like are they defaulted entities

(or) not. Banks relay on information like guaranteed by state government or

central government and without proper verification, make its investment on the

available information. After doing investment, banks realised that they have

considered wrong information and now they need to assign 102.5% risk

weight instead of 0% and such mistakes increased RWAs of individual bank.

36

So, how can banks save itself from the present scenario? Banks need to take

into consideration of some important aspects to optimize its RWAs, which

explained below;

Banks need to check all available information about companies where they

will make investment, and do the proper analysis before making any

investment.

SIDBI/NABARD or investment wherever is mandatory according to RBI

prescribed rule, banks will have to do there without thinking. But instead of

investing more of capital in mandatory areas, it’s better to diversify its

portfolio.

Reduce positions in illiquid assets (BASEL III accord for Liquidity coverage

ratio, banks needs to keep 100% high quality of liquid asset by 2019).

Aggressively, banks can reduce the maturities of portfolios. This action may

have impact a bank’s earning in short run, but in the longer run it will be

advantageous for bank and also it will help in achieving higher Capital

Adequacy Ratio.

Liquid collateral is being used for loans or derivatives.

A category where it is definitely worthwhile for large banks to spend time

exploring is in the area of derivatives. By requiring collateral from

counterparties in OTC derivatives (or) having trades clear through derivatives

clearing organizations, banks can reduce their credit risk, which can provide

capital relief.

Netting derivatives transactions and compression are also ways for banks to

reduce their RWAs. (According to BASEL III accord, banks need to use

Central counterparty for OTC derivatives and banks need to assign 2% RWA).

On the Off-Balance sheet items, BASEL III guidance leaves significant room

for banks to optimize the Credit Conversion Factor (CCF) computation for

multiproduct, multi-counterparty facilities relying on mathematical

calculations.

On the Off-Balance sheet items, banks can try to reduce its investment in non-

funded exposures to commercial real estate, Guarantees issued on behalf of

stock brokers and market makers, non-funded exposures to NBFC-ND-SI etc.

37

which attracts higher Credit conversion factor and in turns it will lead to higher

RWAs.

Diversification of portfolio can also save RWAs.

Assume a bank has made investment in AAA & AA rated (assume 20% risk

weight) bond and simultaneously made investment in BBB rated (assume

100% risk weight) bond. Since the rating is higher, so probability of default is

lower in this scenario. So banks can optimize its RWAs in portfolio by

diversifying as said above with the combination of government issued

instruments (T-bills, bonds, etc.) {Combination of G-Sec + AAA & AA +

BBB}.

Also, banks can diversify its portfolio making investment in AAA & AA rated

and simultaneously can make investment in unrated companies (assume 100%

risk weight but higher risk higher return). Since BBB rated companies

assigned 100% risk weight like unrated companies but probability of default

comparing to unrated is very low in BBB rated. But difference between return

from BBB and unrated companies are far wide. So banks can optimize its

RWAs in portfolio by diversifying as said above with the combination of

government issued instruments (T-bills, bonds, etc.) {Combination of G-Sec

+ AAA & AA + unrated}.

It is advisable for banks to avoid investment in “D” rated companies, since it

assign 150% RWAs and also probability of default is very high and return is

not higher comparable to unrated companies.

Banks can use a uniform and strict methodology to check RWA calculation.

Under BASEL III, Basel committee has prescribed many approaches which

bank can use to minimize its RWAs. Basel committee has introduced many

methods such as, IRB method, Standardized approach etc. to reform the

existing RWAs framework.

Banks can also check Sharpe Ratio, Beta, Regression analysis as a tool to

keep tab on market movement of particularly RWAs before making any

investment.

Beta analysis will give idea that how much systematic risk a particular asset

has relative to an average asset. Assets with larger Betas have greater

systematic risk.

38

Sharpe Ratio measures the slope of Capital market Line (Obtained by

combining the market portfolio and the riskless asset). Closer the Sharpe Ratio

is to the slope of Current Market Line, the better the performance of the fund

in terms of return against risk.

Regression analysis measures the relationship between covariance and

correlation and also it gives an equation, which tells the performance of assets

with respect to the total market return.

Swapping products to a more efficient mix could have significant impacts in

reducing RWA.

Client

Segment

Product Client

need

Product

Examples

Risk

weight

%

Strategy

Retail Domestic

working

capital

financing

Personal

consumpti

on

Overdraft

Consumer

Credit

Salary

guaranteed

loan

100

75

20-40

Switch

to salary

guarante

ed loan

SME/Corpor

ate

Domestic

working

capital

financing

Need for

liquidity

for

domestic

working

capital

financing

Invoice

discounting

Factoring

100

60

Switch

to

factorin

g

Corporate Equipment

Purchase

Financing

for

equipment

purchase

MLT Loan

Equipment

Leasing

90

70

Switch

to

equipme

nt

leasing

SME Liquidity Temporar

y cash

need

Overdraft

Secured

current

account

100

80

Switch

to

current

account

Table 2: Swapping of products

39

4.1.2. STRICTER CREDIT APPROVAL PROCESS

Credit risk is one of the most significant risk that commercial banks faces.

Nearly 40% of the total revenue of a typical bank is generated by credit-related

assets.

The financial crisis of 2008 exposed the inter-linkages between credit risk,

market risk, and liquidity. Beyond the need to be compliant, a stricter credit

approval process and credit risk management can add significant advantage of

a bank business. It helps establish a framework that define corporate

priorities, loan approval process, credit risk rating system, risk-adjusted

pricing system, loan-review mechanism, and comprehensive reporting system.

The output from stricter credit approval process, which help banks in risk-

based pricing, exposure and concentration limit setting, Risk-Adjusted

Return on Capital (RAROC), managing portfolio return profile, setting loss

reserves, and economic capital calculation.

The major problem what banks are facing now for stricter credit approval

policy is lack of quality of data infrastructure, out-dated IT systems, different

definition of customers (most of the banks have 22 definition for “customer”),

large talent gap (specialized skills lacking) etc.

Still several practices are emerging to help overcome of these challenges;

Effective credit approval solution spans across the entire lending value chain

– origination, underwriting, portfolio monitoring, regulatory reporting, and

collections.

Data governance should be centralized across different risk categories

including market risk, regulatory risk, fraud, AML/KYC risks, and

finance/treasury risks.

Have a single definition for customer covering all aspects. It is difficult but not

impossible.

Banks can outsource some of its part of business to third party such as, BPO

service provider, which can help banks for risk analytics, data management,

testing of systems and validation of models to quickly scale up given the

several risk works.

Many time banks provide loan to individual, industry etc. (That is one of the

reason that NPA of banks are higher) but they don’t do proper follow-up. So

40

banks need to avoid this situation and in regular interval (at least quarterly) do

follow-up which covers, frequency of reviews, qualification of review

personnel, scope of reviews, depth of reviews, work-paper and report

distribution etc. Banks need to submit reports which summarize the result of

reviews to the board at least quarterly and findings should be adherence to

internal policies and procedures, and applicable laws and regulations, so that

deficiencies can be remedied in a timely manner.

4.1.3. LIQUIDITY RISK MANAGEMENT

Liquidity is a bank’s capacity to fund increase in assets and meet both

expected and unexpected cash and collateral obligations at reasonable cost and

without incurring unacceptable losses. Liquidity risk is the inability of a bank

to meet such obligations as they become due, without adversely affecting the

bank’s financial condition. Effective liquidity risk management helps ensure a

bank’s ability to meet its obligations as they fall due and reduces the

probability of an adverse situation developing. This assumes significance on

account of the fact that liquidity crisis, even at a single institution, can have

systemic implications.

The liquidity risk is closely linked to other dimensions of the financial

structure of the financial institution, like the interest rate and market risks, its

profitability, and solvency, for example. Having a larger amount of liquid

assets or improving the matching of asset and liability flows reduces the

liquidity risk, but also its profitability.

Liquidity risk can be sub-divided into funding liquidity risk and asset

liquidity risk. Asset liquidity risk designates the exposure to loss consequent

upon being unable to effect a transaction at current market prices due to either

relative position size or a temporary drying up of markets. Having to sell in

such circumstances can result in significant losses. Funding liquidity risk

designates the exposure to loss if an institution is unable to meet its cash

needs. This can create various problems, such as failure to meet margin calls

or capital withdrawal requests, comply with collateral requirements or achieve

rollover of debt.

Table below lists some internal and external factors in banks that may

potentially lead to liquidity risk problems.

41

Internal Banking factors External Banking factors

High off-balance sheet exposures. Very sensitive financial markets

depositors.

The banks rely heavily on the short-

term corporate deposits.

External and internal economic shocks.

A gap in the maturity dates of assets

and liabilities.

Low/slow economic performances.

The bank rapid asset expansions exceed

the available funds on the liability side.

Decreasing depositors trust on the

banking sector.

Concentration of deposits in the short

term tenor.

Non-economic factors.

Less allocation in the liquid

government instruments.

Sudden and massive liquidity

withdrawals from depositors.

Fewer placements of funds in long-

term deposits.

Unplanned termination of government

Deposits.

Table 3: Factors may lead to Liquidity risk problems.

There is also a powerful regulatory imperative: liquidity risk is now included

in the scope of Pillar II ICAAP (Internal Capital Adequacy Assessment

Process), and it requires quantitative measures and reporting, complemented

by improved monitoring and controls. The banks should consider putting in

place certain prudential limits to avoid liquidity crisis:

Cap on inter-bank borrowings, especially call borrowings

Purchased funds such as liquid assets

Core deposits such as Core Assets i.e. Cash Reserve Ratio, Liquidity Reserve

Ratio and Loans

Duration of liabilities and investment portfolio

Maximum Cumulative Outflows. Banks should fix cumulative mismatches

across all time bands

Swapped Funds Ratio, i.e. extent of Indian Rupees raised out of foreign

currency sources.

Intraday liquidity management can become an integral part of an improved

liquidity risk management. (It can achieve by industry best practice for

intraday cash reporting).

Industry best practice for collateral reporting for liquidity management.

42

A central “payment tracker/adviser” platform providing transactional statuses.

Banks need to establish advanced liquidity management and reporting from

market infrastructure such as, the growth in volume and value of transactions

settled through market infrastructure (high value payment system).

Banks can develop their own liquidity analytics to focus on transactional data

rather than on balance information.

Information flows

Figure 4: Liquidity Analytics

Banks can increase their liquidity in multiple ways, each of which ordinarily

has a cost, including:

Shorten asset maturities - This can help in two fundamental ways. First, if

the maturity of some assets is shortened by enough that they mature during the

period of a cash crunch, then there is a direct benefit. Second, shorter

maturity assets generally are more liquid.

Improve the average liquidity of assets - Assets that will mature beyond the

time horizon of an actual or potential cash crunch can still be important

providers of liquidity, if they can be sold in a timely manner without an

excessive loss. There are many ways that banks can improve asset liquidity.

Securities are normally more liquid than loans and other assets, although some

large loans are now designed to be relatively easy to sell on the wholesale

Dashboard Report

Calculation engine

Dashboard Transactional data

warehouse Market Data Customer

Retail

Bank/divisio

ns

Settlement

systems Correspondent

Banks

Branches

43

markets, so this is a matter of degree and not an absolute statement. Shorter

maturity assets are usually more liquid than longer ones. Securities that are

issued in large volume and by large companies generally have greater

liquidity, as do more creditworthy securities.

Lengthen liability maturities - The longer-term a liability, the less likely that

it will mature while a bank is still in cash crunch.

Issue more equity - Common stock is roughly equivalent to a bond with a

perpetual maturity, with the added advantage that no interest or similar

periodic payments have to be made. (Dividends are normally paid only out of

profits and are discretionary.)

Reduce contingent commitments - Cutting back the volume of lines of

credit and other contingent commitments to pay out cash in the future reduces

the potential outflows, thereby improving the balance of sources and uses of

cash.

Obtain liquidity protection - A bank can pay another bank or an insurer, or in

some cases a central bank, to guarantee the availability of cash in the future, if

needed. For example, a bank could pay for a line of credit from another bank.

In some countries, banks have assets pre-positioned with their central bank

that can be used as collateral to borrow cash in a crisis.

The BASEL III liquidity frameworks breaks new ground with given the size

and breadth of the potential effects, policy makers have instituted Liquidity

Coverage Ratio (LCR) and Net Stable Funding ratio (NSFR).

LCR was introduced to increase banks resilience to an acute 30-day stress

scenario. The main motive was to shocks similar to 2007-08 financial crises.

The LCR is complemented by a structural funding ratio, the Net Stable

Funding Ratio, which is structured to ensure that long-term assets are funded

with a minimum amount of stable long term funding. The main motive is to

absorb long term contingencies.

4.1.4. INTEGRATION OF SUBSIDIARIES

Integration of subsidiaries can help parent banks in their bad time. A bank can

work on two models to integrate its subsidiaries:

44

Centralized Model: According to this model, parent bank and subsidiaries are

managed in an integrated manner. Funding, asset allocation, and risk

management are centralized in a manner to maximize their profitability. They

can together raise funds with least risk and they can bear surplus and shortfalls

together, with parent and subsidiaries helping each other.

Decentralized Model: According to this model, parent bank and subsidiaries

operates differently. Funding, assets allocation and other activities will be

performed in a decentralized manner, i.e. the parent and subsidiary will acts as

two different entities, but risk management system and standards would be

integrated. The benefit from running differentially is; there will be some

investors who would be interested in funding the parent company and there

will be some investors who would be interested in funding subsidiaries. So,

they will have greater funding as compared to the centralized model.

If risk management will be integrated together, during crisis it will be

beneficial for both.

4.2. TACTICAL MEASURES

Tactical measures can play a significant role in improving short term performance of

a bank before going for a long term goal. Banks need to redefine their goals before

making any tactical move.

Banks can apply the following approaches for tactical measures;

4.2.1. SHORT AND LONG TERM FUNDING (LCR AND NSFR)

During the early “liquidity phase” of the financial crisis, many banks -

despite adequate capital levels – still experienced difficulties because they

didn’t manage their liquidity in a prudent manner. In response of this, Basel

committee introduced “Liquidity Coverage Ratio (LCR) and Net Stable

Funding Ratio (NSFR)”. The objectivity of the LCR is to promote the short-

term resilience of the liquidity risk profiles of banks. It does this by ensuring

that banks to continuously maintain a stock of unencumbered high quality

liquid assets (HQLA) that can be converted easily and immediately in private

markets into cash to meet their liquidity needs for a 30 day calendar day

liquidity stress scenario. Now, the most important question arises that how can

bank achieve HQLA? According to BASEL III accord, banks need to keep

very safe, very liquid assets, including government bonds and cash held at

45

central banks, are considered to be “Level 1 (cash, central bank reserves, and

certain marketable securities backed by sovereigns and central banks)” assets.

Safe and liquid assets of other types, including specified categories of private

securities, are considered to be in “Level 2 {Level 2A assets (certain

government securities, covered bonds and corporate debt securities), and Level

2B assets (lower-rated plain-vanilla senior corporate bonds and certain

residential mortgage-backed securities}” and are subject to haircuts of up to

50% on their value to represent the potential loss in a fire sale during a time of

crisis. “Level 2” assets may constitute no more than 40% of the total HQLA.

Figure 5: Tactical improvement of LCR

Banks can also monitor potential currency mismatch for the calculation of

LCR. Banks can use its assets as collateral during liquidity/funding stress

scenario and they can serve early warning indicators, if they found any

difficulties for liquidity. Banks can also focus on huge withdrawal of funding

because that can lead to liquidity problem.

LCR=

HQLA/TNCO

Possible decrease

of HQLA

Decrease

existing assets

Decrease total

net outflow

Non-

HQLA

Increase

HQLA

Refinancing of

purchased

HQLA

Increase existing

liabilities Exchange

existing assets

Purchase

additional HQLA

Level 2

Level 1

Sell Repo

Short

Tenor

New

Liabilities

Extend

Tenor

46

The Net stable funding ratio (NSFR) is a more structural measure which

promotes long-run resilience intended to ensure that banks hold sufficient

stable funding (capital and long-term debt instruments, retail deposits and

more than one year maturity wholesale funding) to match their medium and

long-term lending– to be able to survive an extended closure of wholesale

funding markets, banks have to operate with a minimum acceptable amount of

“stable funding” based on the liquidity characteristics of the bank’s assets and

activities over a one-year period. Also, NSFR is the ratio of “available

amount of stable funding (ASF) to required amount of stable funding

(RSF)”. The ASF is the bank’s current liabilities (equity and liabilities) that

are assumed to be available to the bank within one year, whereas the RSF

comprises the bank’s current assets and off balance sheet (OBS) exposures.

The NSFR is intended to deal with a broader problem, to prevent banks from

performing an excessive amount of maturity transformation by making too

many illiquid long-term loans and investments funded with volatile short-term

money. It is considerably more difficult to decide on the right metrics for this

function, since there is no consensus on the right level of maturity

transformation. If the NSFR is viewed as a one-year stress test, its designers

faced the difficult task of evaluating reactions over a one-year period of

liquidity crisis. A 30-day crisis scenario is much easier to construct, because

many of the potential reactions, such as raising equity, changing business

models, or selling units, are difficult to do in that space of time, especially

under adverse conditions. One year gives banks much more room to react and

the authorities a much longer period to work to alter the environment.

4.2.2. SHIFTING TO LESS RISKY SEGMENTS

Reduction of derivative transactions: Bank participation in derivative

markets has risen sharply in recent years. A major concern facing

policymakers and bank regulators today is the possibility that the rising use of

derivatives has increased the riskiness and profitability of individual banks and

of the banking system as a whole instead of new regulation provided according

to BASEL III. There are three main elements to the costs that will be incurred

by OTC derivatives in future: new margin requirement, new capital charge

for exposures and other compliances costs, mainly resulting from

47

additional reporting requirements. In addition to these cost, there may be

scenario of fall in revenue because of greater transparency. The structure

of derivative markets is set to change as a result of the reforms. Cost increase

will lead dealer bank to review the products they offer and possibly withdraw

from certain asset classes which deemed to be costly (or) look to increase

offering for asset classes where client demand is expected to be higher. This

will lead to a shift in the product mix offered by the dealer banks and as a

result usage, across the market. The increase costs for non-cleared products

could move some end users towards less precise hedges by using

cleared/standardized OTC derivatives in place of more expensive derivative,

leaving them with more risk on their own balance sheet.

Estimated additional

Cost (per euro 1

Million notional

Amount traded)

Additional cost for centrally cleared OTC derivative transactions

Initial margin + contribution to the CCP deafult fund

+ Additional cost arising from requiremnets for CCPs + Euro 10

Clearning fees

Capital charge for centrally cleared OTC derivatives transactions Euro 3

Trade, valuation and collateral reporting + compliance costs Euro 0.60

for trade repositiries + compliances costs for CCPs

Total additional costs Euro 13.60

Additional costs for OTC derivatives transactions that will not need to be

centrally cleared

Initial margin for non centrally cleared OTC derivatives transactions Euro 50

Capital charge for non centrally cleared OTC derivatives Euro 120

Trade, valuation and collateral reporting + compliance costs Euro 0.50

for trade repositiries + other compliances costs

Total additional costs Euro 170.50

Table 4: Overview of incremental costs for centrally cleared and no-centrally

cleared OTC derivatives transactions

We estimate that the proposed reforms for centrally cleared OTC derivatives

will lead to incremental transaction cost of Euro13.60 per Euro 1 million

notional. Assume the average notional for a cleared Euro-dominated interest

rate derivative is 110 million would translate into an average additional cost of

Euro 1,496 per transactions. While in the past, trade exposures to CCPs

48

received a 0% risk weight, mark-to-market and collateral exposures to a CCP,

under new rule be subject to 2% or 4% risk weight. These new and higher

risk weights will apply to clearing members but may also to other financial

institutions under certain conditions, e.g. if they enter into a transactions with a

clearing member and the clearing member will complete an offset transactions

with the CCP. Capital charge for exposures to the CCP default fund will add to

the incremental cost of capital requirements. Capital charge for default fund

contributions will need to calculate either using the risk sensitive

‘hypothetical capital requirements’ approach or alternatively applying a

flat risk weight of 1250% to exposures to CCPs default funds.

In total, we estimates additional cost arising from compliance requirement

(daily valuation to trade repositories, collateral reporting, account segregation

and record keeping) to be fairly small- about Euro 0.60 per Euro 1 million

transactions. But this cost may increase if the size of notional amount will

increase and lead to higher capital cost for a dealer bank. OTC derivatives that

will not need to be centrally cleared will be subject to strengthen risk

management requirements, including the need to collateralize positions,

increased capital charge and additional reporting. We estimate that the

proposed reforms for not centrally cleared OTC derivatives will lead to

incremental transaction cost of Euro170.50 per Euro 1 million notional.

Assume, the average notional for a non-cleared Euro-dominated interest rate

derivative is 90 million would translate into an average additional cost of Euro

15,345 per transactions. Non-cleared OTC derivatives will be subject to a

capital charge to protect against variations in the Credit Valuation

Adjustment (CVA). Under the new requirements, financial institutions are

required to hold capital against potential falls in the market value of

counterparty exposures due to increase in Counterparty Credit Risk (CCR).

In effect, financial institutions need to finance more of their assets in order to

meet higher capital requirements. As a result of this reform, dealer bank may

decide to restructure their product offering and pull back from certain asset

classes which are deemed to be too costly (or) increase offering for assets

classes where client demand is expected to be greater. Also, bank can use

internal models for bilateral transactions could help in mitigate costs from

49

margin requirements. However, this comes with the biggest challenge that

bank will face for non-cleared derivatives; the development of the require

model to calculate initial margin. But bank can develop models by two

approaches. Firstly, banks will look to develop their own internal models for

some product sets and submit them for required regulatory approval. Secondly,

we expect the emergence of market based solutions offering a standardized

model approach for some product sets. Common models have also some

operational benefits such as fewer collateralize disputes. These are new

challenges for banks and also it will lead to increase in capital requirement by

banks. Banks can respond to these challenges in an innovative and competitive

way. The larger dealer banks may opt for more defensive strategies in order to

prevent general erosion of client base and protect higher margin product lines.

The large dealer banks can look for alternative products, for example “future

markets” where margin requirements are low.

Reduction of Securitization exposure: In India, Banks do investment in only

security receipt which received 13.5 % specific risk capital charge ( equivalent

to 150% risk weight according to new capital adequacy framework guidelines

by RBI). Since the security receipts are by and large illiquid and not traded in

secondary market, there will be no general market risk capital charge on them.

Still, banks need to avoid huge investment in security receipt to avoid risk

arising from it.

4.2.3. RISK SENSITIVE PRICING

Risk is at the core of banking. At the industry’s most fundamental, banks take

on risk, trade risk, price it, manage it, and ultimately generate a return to

investors who take a share in that risk. Similarly, the central function that

banks play in the economy is to provide credit to support the growth and

development of economies and societies.

It is in this context that RWA calculated by risk-sensitive internal models

provide a means to a much-needed end: an efficient mechanism to measure

and allocate credit. Where bank capital is linked to risk in a coherent and

robust way, it will be allocated in an effective manner, allowing economies to

grow in a long term sustainable and stable manner. If this is not done correctly,

50

capital is misallocated across the national and international economy in ways

which will undermine the effective allocation and pricing of credit. In the

reaction to the crisis and the justified scrutiny of the banking industry and its

practices, it is concerning that the value of risk-sensitivity has been discounted.

The potential distortions of capital lacking risk sensitivity can also affect the

shape of banks’ portfolios, creating the risk of adverse selection. If banks hold

a flat level of capital for assets of all credit quality (or even according to a

partially granular measure that has a low sensitivity to risk), there is a risk that

they will progressively shift their portfolios towards the higher-risk sector,

over-pricing credit for well-rated counterparties and under-pricing it for the

more marginal counterparties. Risk-based capital is intended to ensure that risk

is priced realistically, so that the distortions of under-pricing a given category

of risk are minimized. A true risk-based approach requires a firm to price risk

appropriately internally by imposing an objective capital charge that relates to

the risk. By contrast, a non-risk-based approach, or a “simple” approach such

as Basel I, makes arbitrary risk assessments that necessarily under- or over-

price certain risks. Similarly, a “simple” measure such as a leverage ratio

ignores the differences among risks, creating incentives to take on the

maximum allowable risk for a given quantum of capital.

One of the key metrics of bank performance is their “Return on Capital”.

The Return metric is directly sensitive to the measure of capital used in this

calculation, and in particular to whether that is a risk-adjusted measure of

capital. For instance, a measure of the Return on Regulatory Capital under an

Advanced IRB (Internal Rating Based) approach would use capital that is

based on RWA and the bank’s target capital ratio, meaning it is in turn highly

sensitive to the inputs used in the calculation of RWA: PD (Probability of

Default), LGD (Loss Given default), EAD (Exposure at Default) and

Tenor/Maturity. We will take a hypothetical example to consider check risk

based price sensitiveness of loan in bank portfolio.

In each of these examples, the following assumptions have been made within

the Return on Capital calculations:

Target capital ratio equivalent to 10% of RWA

Cost: Income Ratio (or ‘Efficiency Ratio’) of 50%

Tax rate of 30%

51

The implication what we can make by this example is absolutely central to the

concepts of risk-based pricing and effective risk-return performance

measurement. If the measure of capital is not risk-based, some significant

distortions and false incentives are instead created, with a bias towards weaker,

riskier assets. The capital measure with no risk sensitivity is reflective of Basel

I, the Basel II Standardized Approach for entities without external ratings, and

the leverage ratio. If the measure of capital used is not risk-sensitive, the

returns metric will merely reflect the impact of the spread earned (i.e. the

Gross Revenue), encouraging banks and their staff to concentrate their efforts

on weaker-rated borrowers. The Basel II Standardized Approach brings a

very moderate measure of risk-sensitivity into the equation, but without

reflecting the full risk profile, and still with some anomalies given the blunt

nature of the risk-weights applied. However, a risk-sensitive capital view

(with regulatory capital based on IRB or economic capital) reflects the risk-

return equation much more accurately, and supports more appropriate

incentives.

So, it is advisable to bank use Advanced IRB to make out most of its capital.

52

Indicative equivalent

rating

A+ A- BBB BB BB- B+

Risk

Variable

EAD 10,0

00,0

00

10,000,

000

10,000,0

00

10,00

0,000

10,000,

000

10,000,

000

PD 0.05

%

0.10% 0.25% 1.00% 2.50% 4.00%

LGD 50% 50% 50% 50% 50% 50%

Expected

Loss (EL)

0.02

5%

0.050%

0.125%

0.500

%

1.250%

2.000%

Market spreads 1.00

%

1.50% 2.00% 3.50% 4.50% 5.50%

No Risk

Sensitive

Risk -

weight

100.

0%

100.0% 100.0% 100.0

%

100.0% 100.0%

RWA 10,0

00,0

00

10,000,

000

10,000,0

00

10,00

0,000

10,000,

000

10,000,

000

Return on

capital

3.41

%

5.08%

6.56%

10.50

%

11.38%

12.25%

Standard

ized – If

externall

y rated

Risk –

weight

50.0

%

50.0% 100.0% 100.0

%

150.0% 150.0%

RWA 5,00

0,00

0

5,000,0

00

10,000,0

00

10,00

0,000

15,000,

000

15,000,

000

Return on

capital

6.83

%

10.15%

6.56%

10.50

%

7.59%

8.17%

Advance

d IRB

approac

h

Risk –

weight at

commence

ment

40.4

489

%

57.5527

3%

88.98512

%

148.8

57%

184.25

281%

203.89

692%

RWA at

commence

ment

4044

890

575527

3

8898512 14885

700

184252

81

203896

92

Average

risk –

weight

over full

loan life

24.4

81%

36.7564

2%

60.94566

%

112.8

1093

%

148.59

541%

169.43

514%

Ave. RWA

(loan life)

2448

100

367564

2

6094566 11281

093

148595

41

169435

14

Return on

capital

13.9

4%

13.81% 10.77% 9.31% 7.66% 7.23%

Table 5: Corporate Loan pricing

53

4.2.4. SHIFTING TO HIGHER VALUE CLIENT

The regulatory and market changes have led to increased competition among

suppliers of financial service products. Now consumers demand increasingly

higher levels of service quality. For banks, staying competitive in the new

market environment means not only offering products at reasonable prices but

also tailoring these products to meet individual customer’s needs.

Banks can tailor its product according to customer’s need. Assume that AAA

rated company is need of “10 million” working capital to purchase new

machine and it approached bank “X” and bank “Y”. The rating (both internal

and external) of this company is very good and can be profitable for banks

which will lend to this company. Bank “X” is providing loan at the interest of

“K%” and bank “Y” is providing loan at the interest of “K – 0.75%”, which

will suit the company due to less interest rate comparable to bank “Y”

(Assuming bank Y is the biggest bank). Company will borrow from bank “Y”

since company is paying less interest. This is a common example. There are

many products (or) services which bank can tailor according to customer credit

worthiness and customize to get competitive advantage in market.

4.2.5. DIVERSIFICATION OF FUNDING MIX

The regulatory changes are one of the important factors for banks to adjust

their funding mix in recent time. Diversification of funding profile is

depending on terms of investor types, regions, products and instruments is an

important element. Basically, banks can obtain funding using a variety of

instruments: besides issuing bonds on the capital market, banks rely, for

example, on customer deposit, central bank financing, and the interbank

market and equity capital. Long-term debt securities issued on the capital

market include unsecured and secured bank bonds. In general there is no

typical bank funding profile: the decision on which funding instruments to

choose depends on many factors such as the business model, the current

market situation and the individual company situation. Banks are, however,

always actively seeking the optimum funding mix. But bank can increase

source for funding in the area of capital market & equity, retail client and

54

transaction banks because these are the most liquid source of funding.

Introduction of Basel III also affected funding mix of banks and banks need to

reduce the mismatches between the maturity structure of assets and liabilities

in banks “deposit and lending activities”.

4.3. STRATEGIC MEASURES

Achieving its short term goal, banks can plan action for its long term commitment

and can re-define its business plan to differentiate itself from their competitor.

Banks can apply following approaches for strategic measures;

4.3.1. BUSINESS MODEL

A business model embodies nothing less than the organizational and financial

‘architecture’ of a business. It is not a spread sheet or computer model,

although a business model might well become embedded in a business plan

and in income statements and cash flow projections. But, clearly, the notion

refers in the first instance to a conceptual, rather than a financial, model of a

business. It makes implicit assumptions about customers, the behavior of

revenues and costs.

Figure 6: Elements of business model

Select technologies and features to be

included in the product/services

Determine benfits to the customer from consuming/using product/services.

Identify market segements to be

targeted

Confirm available revenue stream

Review the process on a frequently basis

and capture the value

55

Banks can re-address its business model and can provide technologies and

features which can include in the product/services and can enhance banks

performance as well as it will reduce operational cost of banks. There are

many features which bank can provide to customer but we will discuss on a

few factors which can revolutionize banking sector. India's rural economy has

been growing with disposable incomes rising, especially in rural areas where

spending power accounts for 57% of the $780 billion spent annually compared

to 43% in urban areas. However, 60% of India's rural population, compared

with 40% overall, does not have a bank account. In spite of a robust banking

infrastructure and a government aim to include the rural economy into the

mainstream, only 5% of 600,000 villages have a commercial bank branch and

just 2% of people living in rural India have a credit card.

The simplest and most cost-effective way to each out to this huge untapped

market is through ATMs. At present there are only 150,000 ATMs deployed

in the country and are expected to reach 400,000 by 2017. But the cost of

setting up bank branches or ATMs is still too high and there are still a lot of

red tape and conservative attitudes in the banking business itself. Rural India’s

problems are scarcity of power, accessibility is poor, crisp notes are rare and

the languages and dialects vary. So, for this situation banks can reach out to

these unreached rural areas by using solar powered ATMs. Solar powered

ATMs which use only up to 100 watt. It can also function in temperatures up

to 122 degrees Fahrenheit (50 degrees Celsius) with no air-conditioning. It

stacks notes vertically instead of horizontally so cash "fall" out of the machine

rather than dispensed. Its lean design and few moving parts make it less

susceptible to breakdown.

Second, banks can use aggressively tablet banking service. The tablet will be

fully loaded device which has application form, banks videos explaining their

product and services. Under this service, banks sale staff will visit the

customer at their home and using the tablet get complete formalities for

account opening formalities like details of KYC and photographs of applicant.

Banks can also use tablet service for “home loans” and this will provide

convenience and time saving and also it will reduce cost for documents and

customer will account number through SMS/e-mail alerts.

56

Third, banks can also provide e-Locker, a virtual online locker for its wealth

customers. The locker is available through its internet banking platform for

customers who want to store electronically scanned copies of important

documents like legal agreements, policy documents, degree certificates and

bank statements in various formats.

4.3.2. COST REDUCTION

The most successful banks are not necessarily those making the deepest cost

cuts. Instead, they focus on optimizing their cost base by not just cutting costs,

but by cutting the right costs. They focus on short-term cost cutting efforts

alongside longer-term strategic cost savings. So how can banks reduce their

cost? There are two approaches that banks can adopt which explained below;

Rationalization of branch structure: Banks can rationalize its branches by

checking the staff to customer ratios and can shift staffs to those branches

where customer crowd is more comparable to where it is not. Having the right,

strategic staffing model in place will help maximize your staff and reduce

operating costs. Even bank can sale that business unit if it is not generating

target revenue. So, how can bank achieve this? There are few steps which bank

can follow. As a first step, banks need to carry out a detailed customer

demographics analysis to understand their target customer profile, their

banking behavior and profitability per customer. As a second step, banks

should use the information in the demographics analysis to determine the

optimal ratio between the different types of branches needed to achieve a

differentiated branch network. Finally, banks should rationalize the number of

branches based on business parameters such as branch performance, customer

profitability and strategic. Based on this following information, banks can

work accordingly their requirement.

Rationalization of products: There are thousand types of products/services

which banks are providing to customer. Banks can work Pareto Principle

(80:20 rules), which typically provide implication to bank that 80% of profit

(or) sales coming from the best 20% of the products. This happens because

almost all banks keep adding products to the portfolio without removing worse

performing products and this lead to overloading product operations. Based on

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the result after using this principle, banks can remove those products which are

not generating expected revenues (or) customers are not interested.

4.3.3. ROOM FOR CLIENT MANAGEMENT

While Banks are getting more and more pressure from customer’s increasing

demand, highly competitive market and strict regulations – in the current

environment, understanding customer behavior, attitudes and requirements is

more vital than ever for banks’ strategic thinking, operational planning and

day-to-day customer treatment. So, how can bank overcome from these issues?

Banks can use following steps which may help banks to give more

engagements towards client management.

Banks need to think beyond ‘one-size-fits-all’ strategy to cater to customer’s

increasing demand. Customers also will leave an institution for another based

on getting the services they want and the best price available for it, so

relationship pricing and product bundling become ever more important.

Banks should look at products and pricing based upon a total customer view

and respond to the value that customers bring to the bank across the spectrum

of rates, fees, features and services.

Though there are many challenges in integrating cross-lab data like

extracting data from multiple disparate systems, existence of duplicate records

in business applications/ databases and data sharing impediments due to opt-

out policy/other regulatory requirements, it is crucial to have a 360 degree

view of customer which will help to get a holistic picture of a customer’s

demographics, engagement, need and preferences. This knowledge enables

organizations to precisely target products and services to current customers,

acquire more profitable customers, reduce marketing costs, improve customer

satisfaction and maximize lifetime value.

Sophisticated customer segmentation is the key to cater to individualized

needs and should be based on standard banking metrics – tenure with the bank,

number of accounts, balances of accounts and loans, frequency of interaction

with the bank, channel preferences along with psychographic (values,

attitudes, lifestyles), behavioural (usage rate, price sensitivity, brand loyalty,

58

and benefits sought) and demographic variables (occupation, income, and

family-status).

Banks can use real-time events and deep customer insight to offer cross-

channel marketing campaigns where “moments-of-truth” (wedding, home

purchase/sale, new job, stock transactions, etc.) are acted on as a way to

deepen customer relationships - to determine the next best action, be it an

offer, channel, message, piece of content etc. The more customized

product/service offering, the higher are the barriers to switching banks.

In today’s hyper-competitive market, banks need to move beyond a “one-size-

fits-all” reward model particularly for the most profitable clients. They need to

design a system which let profitable customers enjoy premium benefits and

redeem rewards points.

In the digital age, customers demand more self-service options and any-time,

anywhere service. So expanding customer self-service, case management,

dispute management and event-based decision-making can be perceived

as better customer care, while lowering operational costs and increasing

effectiveness. However, banks should continue to make compelling offers as

incentives for customers to use lower cost channels.

Banks should try to engage consumers through digital channels and advance

its leadership in the digital space as well as expand its social media

engagement on Facebook, Twitter, Pinterest and LinkedIn. Though there

can be several roadblocks and complications – like online account opening is

expensive on per-account bass - however, prices for new delivery channels

always commoditize as usage grows. It is a myth that importance of branches

will diminish as the digital channel usage will increase on the contrary, if

branches are tightly integrated with other channels, that promote and support

them and that quickly finish transactions started there will be more successful

than ever.

The Big data is the new disruptive technology for changing the game. Big

data capabilities provides banks the ability to understand their clients at a more

granular level and more quickly deliver targeted personalized offers. Being

able to anticipate customer needs and resolve them before they become

problems allows banks to deliver timely, concise and actionable insight to

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contact center agents. This can lead to increased sales, improved customer

satisfaction and a reduction in operating costs. Fighting fraud, financial crimes

and security breaches, in all forms, is among the most costly challenges facing

the finance industry. Big data technologies provide a scalable, integrated,

secure and cost effective platform to more quickly prevent, detect and mitigate

internal and external frauds. Big Data Benefits include: Reduced costs of fraud

screening and monitoring fewer false positives, reduced cost of fraud

investigations, reduced payment fraud losses, real time fraud detection and

mitigation, optimized offers and cross-sell.

Banks should seek to attract and retain customers with a compelling multi-

channel experience across all touch points (branches, online, mortgage and

investment advisors, etc.). Technology continues to rapidly change the way

consumers behave and interact. Virtual channels are becoming more relevant,

with the increasing penetration of high-speed Internet connectivity and Web-

enabled mobile devices allowing consumers to spend more time online. Bank

customers will not only continue to use a mix of channels, but will use non-

branch channels for increasingly complex banking transactions While retail

branches remain a core banking channel, research shows that customer traffic

is in some cases flat or declining, as customers come to rely more heavily on

digital/phone channels.

Hip, modern, and fun. That’s exactly the vibe many of the nation’s banks are

trying to achieve as they reimagining their branches and try to lure more

customers into brick-and-mortar offices. Withdrawals and deposits aren’t

attracting customers to brick-and-mortar offices anymore, so banks are turning

to perks like coffee bars and yoga to keep an important gateway open.

4.3.4. ACTIVE APPROACH TO BALANCE SHEET MANAGEMENT

Banks need to actively focus on balance sheet management to optimize its’

capital. Banks can take following steps to have an active approach to balance

sheet management;

Interest rate risk management: In the banking book, interest rate risk

management is the area that has probably the most attention within banks.

There will be re-pricing risk, basis risk, yield curve risk etc.

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Re-pricing risk is the differences in maturity (Fixed rate) and re-pricing

periods (Float rate) for assets versus liabilities and off balance sheet items.

Yield curve risk arises from differing dispersion of assets, liabilities and off

balance sheet items could leave exposures to twist of yield curve (with no

change in average rates). Basis risk arises from positions with same maturity

but priced off different market indicators rates.

Banks need to use re-pricing gaps to earning (based on a mixture of

contractual pricing) and economic value (duration gap and simulation). Bank

can also use Value at risk techniques to measure interest rate risk.

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Liquidity risk management: Certainly the painful experiences and losses

throughout the financial crisis have forced the banks to make strategy to

safeguard itself from liquidity problems. Basel committee has already given

detailed guidance for implementation of LCR and NSFR to avoid short and

long stress period scenario.

Figure 7: Liquidity Risk Complexity

LCR and NSFR will ensure that banks will not face liquidity problems. LCR is

in transition period and banks need to implement it completely by 2018.

Banks can also use cash flow forecasts using stressed (or) expected flow

measures for liquidity risk. In measuring liquidity risk, banks can focus on

factors included in liquidity risk such as contractual maturities, effective

maturities, types of products, types of customers,

Idiosyncratic Liquidity Risk Market Liquidity Risk

Limitation of

funding and/or

increase of funding

cost due to a down

rating

Earlier than

expected call of

deposits as well as

drawing of

committed credit

lines

Deferred cash

inflows

Sell/buy of

assets/liabilities

with high discount

or premiums to

close the liquidity

gap

Risk of taking

losses due

insufficient market

liquidity

Call

Risk

Scheduling

Risk

Credit

Spread

Risk

Product

Risk

Market

Liquidity

Funding Risk

Net cash outflows Liquidity Reserve

Illiquidity/Insolvency

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geographies/countries/regions etc. Also, banks need to strengthen its

collateral management. Banks have to have a clear idea regarding collateral in

order to able to deal effectively with liquidity events that may require using

such assets. It is an area where banks need to improve and apply greater rigour

in knowing precisely which assets can be quickly liquidated and at what price.

Bank can use pre-defined stress testing scenario. In performing stress test

banks can take factors such as repayment, drawdown, non-maturing

product profiles, replicate portfolios, credit events, withdrawal of funding,

contingent liabilities, haircuts etc.

Capital management: The main activities performed by the capital

management unit are capital planning, capital stress testing, capital allocation

and setting the cost of capital. Banks and its management need to cautious

while doing capital management and always use diversification method to get

a better return (risk and return analysis). Management can use Beta analysis,

Sharpe ratio, Regression analysis etc. before taking into consideration for

allocation of capital. Banks can also check rating, creditworthiness etc. before

making any such investment.

Fund transfer pricing: The importance of FTP has been highlighted as it

underpins the interest margin and profitability results and, thus, has a

significant impact on business unit performance measurement and business

behaviour. It has been recognised that aspects like pricing for liquidity,

optionality, customer behaviour and trading portfolios require more attention

to ensure that underlying risks are properly reflected within pricing and

performance measurement practices. The factor which can affect FTP rates are

bank deposit rates, bank loan rates, Government bond yield, Interbank money

market/swap rates, funding liquidity, asset liquidity, option pricing, political

adjustment etc. Banks need to keep an eye on these factors and now-a-days

political adjustment keep an important role for affecting FTP rates. So, banks

need to focus on this factor carefully.

Systems: Banks still tend to operate with a patchwork of legacy systems set up

to manage different aspects of the balance sheet (liquidity risk, interest rate

risk, etc.), but significant changes are needed. With different systems, any kind

of integrated balance sheet management simulation and stress testing is

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virtually impossible. But still banks will need to upgrade to a more integrated

approach, allowing planning and stress scenarios to be carried out across all

aspects of the balance sheet.

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5. CONCLUSIONS

Pre-crisis banks were calculating its capital charge according to Basel II accord. Basel II

which doesn’t indicate worse result can arise from the CCP and CVA hidden charge.

The biggest reason of the crisis was counterparty risk related loss happened from CVA

volatility. Only one third of the loss was actually happened because of the counterparty

default. During that era, banks were tending to neglect counterparty credit risk (CCR)

because of small size of derivative contracts (or) higher rating of the companies (such as

AAA or AA rated).

After the crisis BCBS has come up with a new accord, which is known as BASEL III

accord. Basel III has not only changed the game but also it makes sure that bank will not

repeat those mistakes which have already done by them. It came with a door open for

banks to decide their own strategy for calculation of capital charge with taking into

consideration of factors such as probability of default (PD), Loss Given Default (LGD),

Maturity (M), Exposure at Default (EAD) etc.

Models PD LGD Maturity EAD

Standardized Regulator

determined-

risk weights

Regulator

determined-

risk weights

Regulator

Determined

Regulator

Determined

Foundation-

IRB

Internal Model Regulator

Determined

Regulator

Determined

Regulator

Determined

Advanced-IRB Internal Model Internal Model Formula

Provided

Internal Model

Table 6: Calculating risk weights and EAD under each of the three approaches

It is advisable for banks after the Basel III accords, which have provided more space for

calculation of CCR and CVA charge (For Advanced models banks have to take permission

from regulatory authority). Banks can use any other method which can help them to save

their capital. In section 2, it has shown how bank can save capital for CVA charge

calculation by following IMM method. Also, it implied that CVA is approximately 25%

of CCR as shown in section 2. So, it is better if bank can approach IMM method and try to

reduce this 25% capital to an extent of 20% in initial period and then it can reduce

further after getting more expertise in calculating CVA charge by this method.

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There are also following approaches which bank can adopt to reduce CVA charge which is

given below;

Geography – Location of business of counterparty. Consider Kerala, we know Kerala is

famous for strike and suppose bank counterparty has business in such places. Business of

your counterparty can affect because of this reason and it can also show in their MtM and

it can lead to high CVA. So banks and financial institutions have to carefully observe all

news related to counterparty and on day-to-day basis.

Industry – Suppose textile industry is not performing well and you are going for contracts

with a counterparty which belongs from same industry. So it can lead to high CVA charge

because your counterparty would default (Since probability is high so CVA will high),

since that industry is not performing well.

Macroeconomic factors - Banks and financial institutions have to analyses carefully

about macroeconomic factors before going for a contract with counterparty. Need to check

that particular news related to macroeconomic factor will affect counterparty. If yes, then

it will increase CVA.

Basel III also increased burden for banks in the form of introduction of Capital

Conservation Buffer (CCB), Countercyclical Capital Buffer (CCB) and Global

Systematically Important Banks (G-SIBs). Since it will implement in phase out manner,

banks need to start practicing for these cushion of capitals from now onwards only , unless

it will lead an extra burden on banks treasury and can attract penalty.

BCBS also came with a new approach (LCR & NSFR) to make sure that banks will not

face liquidity problems because of stress scenario which can be for acute 30-days stress

period or over a year time horizon. Since LCR and NSFR are very tactically introduction

by BCBS in regulatory framework, banks need to cautious.

New regulatory framework (Basel III) also introduced additional capital charge for

“Reciprocal Cross Holding” and “Investment in own shares”. Since it will attract

additional capital charges, banks need to reduce its investment in these assets to save

capital.

Also, Basel III made sure that it’s time for banks to improve its data quality. Data quality

is a global issue and not just restricted to any geographical or economic jurisdiction. Data

impurity can lead to time and cost. The basic issue as regards the computerization of the

Indian banking system was that we migrated from the branch banking software to a core

banking solution in which every activity/transaction processing is centralized. At the time

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of migration, since a variety of platforms were used for capturing different business

activities, the data was naturally non-standard and when this data was imported ipso facto,

as part of core banking solution, with a bit of data sprucing, the non-standard data needed

some ‘treatment’ before it could be used across all activities. The problem became more

complex as the banks were migrating to a non-data center environment; without any

business process re-engineering. Since banking business must at all times ensure

accuracy of credit risk exposure calculations. This becomes all the more challenging for

international banks that have global footprints. Several jurisdictions have made it a

requirement to certify the data quality. Banks under certain jurisdictions need to self-

certify the accuracy, completeness, and appropriateness of Basel-critical data.

In the context of Indian banking system, these poor qualities of data lead to higher cost in

banking operations. Additionally the RWA is often influenced by the IT infrastructure,

data availability and data quality. For instance the correct mapping of transactions to

the asset classes or the quality of PD and LGD estimations often depend on the

availability and quality of data.

The requirements of Basel III and the interdependencies among the various matters under

regulation lead also to increased complexity of data requirements, especially in the area of

counterparty credit risk and the new liquidity ratios. Data availability, data

completeness, data quality and data consistency can be critical for a successful

implementation of Basel III. That is the reason banks need to re-engineer its process for

data purity.

The accounting standards may have a material impact on RWA and they may also

explain some of the RWA differences between banks.

There may be chances of Changing of the business model might also affect the

organizational structure, as some units might be reduced or merged with others while new

units are established. Banks can rationalize its branches which are not generating target

revenue and instead of that can open a new section (or) office for CVA and CCR desk

to completely focus for the valuation and pricing for derivatives.

Having a strong regulatory framework, banks have an enough time to work on this

framework. An optimal treasury function can work on these frameworks consistently and

reduce financial risks and financial costs of a bank.

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6. GLOSSARY

BCBS: Basel Committee on Banking Supervision

NPA: Non-performing assets; an asset is tagged as non- performing when it ceases to

generate income for the lender

BASEL guidelines: Recommendations on banking laws and regulations issued by

the BCBS.

RWA: Risk-weighted asset (also referred to as RWA) is a bank's assets or off-

balance-sheet exposures, weighted according to risk. This sort of asset calculation is

used in determining the capital requirement or Capital Adequacy Ratio (CAR) for a

financial institution.

NOVATION: the substitution of a new contract in place of an old one.

EE: Expected Exposures is calculated at each time step as he mean of the potential

positive exposures profiles.

EPE: Expected Positive Exposures is calculated as an average of EE throughout the

one year horizon.

EFFECTIVE EE: is calculated at each time step as the maximum of all absorbed EE

at each future time step.

EFFECTIVE EPE: is calculated as an average of effective EE throughout the one-

year horizon.

CREDIT CONVERSION FACTOR: Following the new capital adequacy rules for

financial institutions: percentages designed to convert the off-balance sheet items to

credit equivalent assets which are then placed in the respective risk-based categories,

therefore they are converted to on-balance sheet equivalents. Hence, the face value of

item requires to be first multiplied by the relevant conversion factor to arrive at risk-

adjusted value of off-balance sheet item.

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7. BIBLIOGRAPHY/WEBLIOGRAPHY

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Accenture. (2013). Counterparty Credit Risk and Basel III A Framework for Successful

Implementation.

Bangalore, I. (1994). Capital Asset pricing model.

BIS. (2013). Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools.

BIS. (2014). Basel III leverage ratio framework and disclosure requirements.

BIS. (2014). Basel III: The Net Stable Funding Ratio.

capgemini. (2013). Basel III: Comaprison of standardized approach and advanced approach.

Capital, S. (2013). Managing Counterparty Credit risk through CVA.

financale, I. (2012). Basel III challenges.

Franzen, D. (2014). Credit Valuation Adjustment In theory and practice.

hill, M. (2013). Return, Risk and the Security Market Line.

https://en.wikipedia.org. (n.d.).

Jones, C. P. (2010). Capital Market Theory.

KPMG. (2011). Basel III: Issues and Implications.

Morgan, J. P. (2014). Leveraging the Leverage Ratio.

NYC. (2012). A Practical Guide to Fair Value and Regulatory CVA.

OCC. (2014). QUALIFYING CENTRAL COUNTERPARTY STATUS.

Shapiro, P. A. (2012). The Capital Asset Pricing Model (CAPM).

Sigman, K. (2005). Capital Asset Pricing Model (CAPM).

Swift. (2011). Managing liquidity risk.

Transformation, T. C. (2013). Credit Valuation Adjustment:The Devil is in the Detail.

USA, S. a. (2010). Pricing Counterparty Risk at the Trade Level and CVA allocations.

Y, E. &. (2014). CVA for derivative contracts.