Risk Weighted Asset calculation under BASEL

Biswaranjan Mohanty

25 April 2013

Minimum Capital Charges: Minimum capital requirements based on market, credit and operational risk to (a) reduce risk of failure by cushioning against losses and (b) provide continuing access to financial markets to meet liquidity needs, and (c) provide incentives for prudent risk management

First Pillar

Second Pillar

Third Pillar

Basel II – Three Pillars

Supervisory Review: Qualitative supervision by regulators of internal bank risk control and capital assessment process including supervisory power to require banks to hold more capital than required under the First Pillar

Market Discipline: New public disclosure requirements to compel improved bank risk management

Fundamental calculation

Tier I + Tier II Capital Adequacy Ratio = ------------------------ Risk weighted asset

Risk weighted asset = Exposure X Risk weight of the counterpaerty

E* = max {0, [E x (1 + He) – C x (1 – Hc – Hfx)]}

where:E* = the exposure value after risk mitigationE = current value of the exposureHe = haircut appropriate to the exposureC = the current value of the collateral receivedHc = haircut appropriate to the collateralHfx = haircut appropriate for currency mismatch between the collateral and exposure

Basel II – Sovereign Capital Charges

Rating AAA to AA-

A+ to A-

BBB+ to BBB-

BB+ to B-

Below B- Unrated

Risk Weight 0% 20% 50% 100% 150% 100%

Claims on non-central government public sector entities based on corporate exposure risk weights

Claims on multilateral development banks have 0% risk weight if conditions are met, including: (i) majority of MDB’s ratings are AAA, (ii) significant portion of shareholders are AA- or better rated sovereigns, (iii) funding is in form of paid-in equity with little or no leverage, and (iv) conservative lending criteria

At national discretion, lower risk weight for banks’ exposures to their sovereign (or central bank) in domestic currency; if adopted, other regulators may permit same risk weight

Sovereigns

Risk weights for sovereign exposures:

Basel II – Bank Capital Charges

Option 2: At national discretion, banks risk weighted on basis of own external ratings (plus more favourable risk weight if claim maturity < 3 months)

Banks 2 options, selected by national regulator to apply for all banks in jurisdiction: Option 1: Banks risk weighted one category below risk weights of banks’ sovereigns:

Rating of the bank

AAA to AA-

A+ to A-

BBB+ to BBB-

BB+ to B-

Below B- Unrated

Risk Weight 20% 50% 50% 100% 150% 50%

Short-term 20 % 20 % 20 % 50 % 150 % 20 %

Rating of sovereign

AAA to AA-

A+ to A-

BBB+ to BBB-

BB+ to B-

Below B- Unrated

Risk Weight 20% 50% 100% 100% 150% 100%

Local currency reduction: National regulators may reduce by one notch risk weight of local currency bank debt having maturity of less than 3 months, subject to floor of 20%

Exposures to securities firms treated as bank claims if regulatory arrangements comparable, otherwise the will have corporate treatment

Basel II – Corporate Capital Charges

Option 2: At national discretion, all corporates risk weighted at 100% without regard to external ratings. (No cherry picking)

Includes claims on insurance companies

Corporate

2 options, selected by national regulator to apply for all banks in jurisdiction:

Option 1: Corporates risk weighted as set out in following chart (supervisory authority to increase 100% risk weight for unrated corporates where warranted by higher default rates):

Rating AAA to AA-

A+ to A-

BBB+ to BB-

Below BB- Unrated

Risk Weight 20% 50% 100% 150% 100%

Basel II – Retail Capital ChargesRetail

Generally 75% risk weight if:

Exposure to individual or small business Exposure takes form of revolving credit, line of credit, personal loan, lease Portfolio diversified (granular); Basel II accord suggests no aggregate exposure to

any one counterparty should exceed 0.2% of overall regulator retail portfolio Maximum aggregate counterparty exposure €1 million or less

Basel II – Real Estate Capital Charges

Real Estate

Residential Real Estate 35% risk weight for exposures fully secured by mortgages on residential property

occupied by the borrower or rented

Commercial Real Estate Generally 100% risk weight, given experience in numerous countries with troubled

credits over the past few decades

Basel II – Off Balance Sheet ItemsOff Balance Sheet Items

Off-balance sheet items converted into credit exposure equivalents using credit conversion factor (CCF)Commitments

Original maturity of up to one year: 20% CCF Original maturity in excess of one year: 50% CCF Unconditionally cancelable: 0% CCF

Securities lending Repo and reverse repo transactions: 100% CCF

Where there is an undertaking to provide a commitment on an off-balance sheetitem, banks are to apply the lower of the two applicable CCFs.

Basel II – Other assets All other assets at 100 % weightage Investments in equity or regulatory capital instruments issued by banks or securities firms

will be risk weighted at 100%, unless deducted from the capital base. Under IRB approach 300 % for equity holdings those are publicly traded and 400 % for other equity holdings.

At national discretion, gold bullion held in own vaults risk-weighted at 0%. In addition, cash items in the process of collection can be risk-weighted at 20%.

High risk categories

The following claims will be risk weighted at 150% or higher: Claims on sovereigns, PSEs, banks, and securities firms rated below B-. Claims on corporates rated below BB-. Securitisation tranches that are rated between BB+ and BB- will be risk weighted at 350%. 150 % risk weight for venture capital and private equity investments.

Basel II-Past due treatmentPast Due Unsecured portion of exposure past due for more than 90 days, net of specific provisions,

risk weighted as follows:- 150% when specific provisions less than 20% of outstanding amount of

exposure- 100% when specific provisions 20% or more of outstanding amount of

exposure- 100% when the specific provisions 50% or more of outstanding amount of

exposure, with supervisory discretion to reduce risk weight to 50% in such case

Essentials: Non-performing loan under Basel II is any loan that is past due for more than 90 days, but

subject to national variation For purposes of defining secured portion of non-performing loan, eligible collateral and

guarantees will be recognised as under CRM rules for performing loans Capital charges depend on level of specific provisions held against loan

Eligible collaterals and standard supervisory haircut

Haircuts Assuming daily remargining and 10 day holding period Currency mismatch – 8 % Zero haircut on repo transactions for core market participants under certain conditions

Maturity mismatch P=P*(t-0.25)/(T-0.25)P---adjusted collateralP*---actual collateral valuet-- min (T, residual maturity of the credit protection arrangement) expressed

in yearsT-- min (5, residual maturity of the exposure) expressed in years

Thank you

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