BANKING AND INSURANCE

Presented by: Shubhangi Jawale Meghna Patil Ambrish Shah Sourabh Suryawanshi Amit Jain P - 12 P - 25 P - 32 C - 35 C - 44

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Basel committee Basel I Basel II Pillars of Basel II Issues and Challenges Advantages Impact Differential Conclusion

BASEL
‡ Basel Committee on Banking supervision (BCBS) ‡ Established in 1975 in Basel, Switzerland. ‡ Published a set of minimal capital requirements for banks.

. ‡ It was enforced by law in the Group of Ten(G-10) countries in 1992.BASEL I ‡ Basel I also known as the 1988 Basel Accord. ‡ Basel I is now widely viewed as outmoded.

CLASSIFICATION OF BANK'S ASSETS IN RISK CATEGORIES ‡ 0% . central bank and government debt and any OECD government debt ‡ 0%.cash. OECD securities firm debt. plant and equipment. non-OECD bank debt and non-OECD public sector debt ‡ 50% . 20% or 50% .private sector debt. non-OECD bank debt real estate. capital instruments issued at other banks .public sector debt ‡ 20% . 10%. ‡ 100% . OECD bank debt.development bank debt.residential mortgages.

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BASEL II ‡ Basel II is the second of the Basel Accords. ‡ Which recommendations on banking laws and regulations. ‡ Basel II is a voluntary agreement between the banking authorities of the major developed countries. ‡ Published in June 2004. .

‡ Basel I does not reflect credit quality gradations in asset quality. ‡ Basel I had too little risk-sensitivity and it did not give bankers. . supervisors. ‡ Banking has become too complex to be addressed by Basel I simplistic approach. or the marketplace.NEED OF BASEL II ‡ Much better capital framework was required than Basel I. meaningful measures of risk.

PILLARS OF BASEL II ‡ Minimum Capital Requirements ‡ Supervisory Review ‡ Market Discipline .

credit and operational risk .The First Pillar Minimum Capital Requirements ‡ Part 2 of Basel II describes the calculation of the total minimum capital requirements for credit. ‡ Minimum Capital Charges: Minimum capital requirements based on market. market and operational risk. .

‡ The principle behind these requirements is that rating and risk estimation systems and processes provide a meaningful assessment of borrower and transaction characteristics ‡ A meaningful differentiation of risk. and reasonably accurate and consistent quantitative estimates of risk.CREDIT RISK ‡ Pillar 1 of Basel II sets out the quantitative and qualitative requirements and formulae to calculate capital for credit risk. .

validation.Risk management and measurement ‡ In order of increasing sophistication and risk sensitivity these options are: the Standardized Approach the Internal Ratings Based (IRB) Foundation Approach (FIRB) the IRB Advanced Approach (AIRB). . and operational requirements. ‡ Under an IRB approach. banks rely partly on their own measures of a borrower s credit risk to determine their capital requirements. subject to strict data.

The Standardized Approach is supported by external credit assessments. . corporate. banks. multilateral development banks. retail loans. non-central government public sector entities. residential real estate and commercial real estate. ‡ The main supervisory categories in the Standardized Approach are claims on sovereigns.STANDARDIZED APPROACH ‡ Where exposures are assigned to risk weight categories based on their characteristics.

the loan's risk is generally weighted with 100% . If there is no external rating.CORPORATE. as assigned by external rating agencies. BANK AND SOVEREIGN EXPOSURES ‡ The individual borrower's quality is reflected by its external rating.

and corporates rated below BB-. sovereigns and banks rated below B. or that is rented.Basel II also identifies certain higher risk assets which are weighted at 150%. that is or will be occupied by the borrower. ‡ Lending fully secured by mortgages on residential property. .RETAIL EXPOSURES ‡ Retail exposures are generally weighted at 75% under the standardized approach. can be risk weighted at 35%. These include. ‡ Higher risk categories.

The risk weight functions produce capital requirements for the Unexpected Loss portion. .The Internal Ratings-Based Approach ‡ The two main principles behind the Internal Ratings Based (IRB) Approaches (Foundation and Advanced) are the usage of banks own information about the credit quality of their assets and the promotion of best practices in risk measurement and risk management. ‡ The IRB Approach is based on measures of Unexpected Loss and Expected Loss.

‡ The expected losses are calculated separately and are compared to the total allowable provisions .Unexpected losses and expected losses ‡ The IRB risk weight functions produce capital requirements that should cover the unexpected losses of the bank.any shortfalls or excesses of provisions over expected losses could be adjusted to or recognized as capital under Basel II. .

Operational risk Definition The Basel II definition of operational risk is the risk of loss resulting from inadequate or failed internal processes. people and systems or from external events . .

The measurement methodologies The Basic Indicator Approach Standardized Approach Advanced Measurement Approach (AMA). .

The Basic Indicator Approach ‡ This approach uses gross income as a proxy for operational risk. ‡ The Accord specifies the calculation of the charge as follows: Banks using the Basic Indicator Approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage of positive annual gross income. with the capital charge equal to 15% of the average of gross income for the last three years. .

The Standardized Approach ‡ In the Standardized Approach. but in this case it is broken out by eight standard business lines. The business lines. each with a different beta factor to calculate capital. and retail brokerage. gross income is again a proxy measure for operational risk. agency services. asset management. retail banking. payment & settlement. . commercial banking. trading & sales. are as follows: corporate finance.

and Business environment and internal control factors .Advanced Measurement Approaches (AMA) ‡ Under the AMA approach the capital requirement will equal the risk measure generated by the bank s internal operational risk measurement system. which based on: Internal loss data External loss data Scenario analysis.

.g. equity. capital and money markets. where the bank may act on its own account or on behalf of its clients in the commodity. interest and foreign exchange rates. bond and commodity prices. ‡ Market risk arises where there are adverse movements in market prices e. foreign exchange.Market risk ‡ Market risk is the risk of financial loss relating to a bank s trading activities. equity.

‡ Banks use several measures to manage their exposure to CCR including ‡ Potential future exposure (PFE) ‡ Expected exposure (EE) .Measures of Counterparty Credit Risk (CCR) ‡ Credit exposure. which is defined as the cost of replacing the transaction if the counterparty defaults assuming there is no recovery of value.

risk management guidance. and supervisory transparency and accountability.Pillar 2 : Supervisory Review Process ³ The aim of Pillar 2 of the Basel II document is to discuss and describe the key principles of supervisory review.´ .

Pillar 2 : Supervisory Review Process .

management and employees ‡ Good risk management ‡ Documentation and evidence for doing what is required ‡ Monitoring and review .Pillar 2 : Supervisory Review ‡ The legal and corporate structure ‡ Authority and responsibility of the board.

Pillar 2 : Supervisory Review ‡ Strong internal control systems ‡ Effective risk and compliance function ‡ Effective internal audit function ‡ Supervisory transparency and accountability .

Basel II Third Pillar Market Discipline .

and other relevant factors.Objective The aim is to achieve market discipline through disclosures that will allow market participants to assess information about capital adequacy. . risk exposures.

Materiality 6. Frequency . Disclosure requirements 2. Achieving appropriate disclosure 4.The Third Pillar ± Market Discipline A. Guiding principles 3. Interaction with accounting disclosures 5. General considerations 1.

ISSUES AND CHALLENGES ‡ Capital Requirement ‡ Profitability ‡ Risk Management Architecture ‡ Rating Requirement ‡ Choice of Alternative Approaches .

ISSUES AND CHALLENGES ‡ Supervisory Framework ‡ Corporate Governance Issues ‡ National Discretion ‡ Disadvantage for Smaller Banks ‡ Discriminatory against Developing Countries ‡ External and Internal Auditors .

Advantages ‡ Improves Risk Management ‡ Benefits to consumers and businesses also ‡ Curtailment of credit to Infrastructure projects ‡ Opportunity for IT companies ‡ Greater transparency of the financial position and risk profile of banks. .

IMPACT ‡ Reduce the availability of funds ‡ Higher Interest Costs & Competitive advantage of corporate borrowers ‡ Impact on Infrastructure development ‡ Shorter Term to maturity of lending ‡ Impact on Companies ‡ Changes in Capital Risk Weighted Assets Ratio (CRAR) .

Difference .

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