BFM-CH - 10 - Module B

Risk Regulations in Banking Industry
CAIIB
Bank Financial Management
Module B
Risk Management
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in
In Banking Industry risk regulations have several goals, like:

1. Improving the safety of the banking industry.
2. Levelling the competitive playing field of banks.
3. Promoting sound business and supervisory practices.
4. Controlling and monitoring 'Systemic Risk'
5. Protecting interest of depositors.


Systemic Risk: It is risk of failure of the whole banking system.
Individual bank's failure is one of the major sources of the
systemic Risk.
Basel Committee on Banking Supervision (BCBS) - established
for risk-based regulation in a changed world envirnment.
The Risk of settlement that arises for time difference came to be
known as ' Herstatt Risk'
Basel Commitee established Basel-1 in year 1988 and in year
1996 many changes take place and Basel-2 enforce.
Reason for change Basel-1 to Basel-2:

1. Credit Risk assessment under Basel-I was not risk-sensitive
enough.
2. Financial decisions are not based on economic opportunities.
3. It did not recognize the role of credit risk mitigants.
4. It did not take into account operational risk of banks.
5. Better NPA Management
6. Almost all banks and RRBs in good financial health- meet
CRAR nomr
7. Explosion of new- customer centric products and More
employment.
The Basel-2 accord is based on 3 pillars:

1. Minimum Capital requirement
2. Supervisory Review process
3. Market Discipline


Basel II First Pillar: Minimum Capital requirement :
It is based on credit, market and operational risk to
(a) Reduce risk of failure by cushioning against losses.
(b) Provide continuing access to financial markets to meet
liquidity needs, and
(c) Provide incentives for prudent risk management
Minimum Capital requirement is calculated by:
1. Capital for Credit risk
2. Capital for Market risk
3. Capital for Operational risk

Standardised:
- The standardised approach establishes fixed risk weights
corresponding to each supervisory category and make use of
external credit.
- Specific provisions has already been set aside by the bank agianst
that loan. Like retail and SMEsectors a uniform risk weight of 75%.
- Most Japanese banks will start Basel II as standardised banks
- Most US banks will stay under Basel I
Foundation IRB (Internal Rating Based)
- Measure credit risk using sophisticated formulas using internally
determined inputs of probability of default (PD) and inputs fixed by
regulators of loss Given default (LGD), exposure at default (EAD)
and maturity (M).
- More risk sensitive loan require more capital.
- Most European banks will likely qualify for Foundation IRB status at
start of Basel II
Advanced IRB (Internal Rating Based)

- Measure credit risk using sophisticated formulas and internally
determined inputs of PD, LGD, EAD and M
- Transition to Advanced IRB status only with robust internal risk
Management systems and data
- Top 10 US banks expected to implement Advanced IRB at start of Basel II


Basel II Second Pillar - Supervisory review process
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
Four key principles of supervisory review
Principle 1: Banks should have process for assessing overall capital
adequacy in relation to risk profile and strategy for maintaining capital
levels.
Five main features of rigorous process:
1. Board and senior management oversight
2. Sound capital assessment
3. Comprehensive risk analysis (credit risk, operational risk, market risk,
interest rate risk in banking book, liquidity risk, other risk)
4. Monitoring and reporting
5. Internal control review

Principle 2:
Supervisors should review and evaluate banks internal capital
adequacy assessments and strategies, as well as ability to monitor and
ensure compliance with ratios.
Supervisors should take appropriate action if not satisfied.
Principle 3:
Supervisors should expect banks to operate above minimum ratios and
should have ability to require banks to hold capital in excess of
minimum
Principle 4:
Supervisors should seek to intervene at early stage and require rapid
remedial action
10

Basel II Third Pillar Market Discipline
Impose market discipline on banks by requiring disclosure of key
information relevant to banks risks and capital Qualitative Disclosures
for Securitisation
1. Banks objectives for, and roles played by it in, securitisation
process
2. Banks accounting objectives for securitisation
3. Whether treated as sales or financings
4. Whether bank recognises gain on sale
5. Key assumptions used by bank for valuing retained interests
6. Banks treatment of synthetic securitisations
7. Names of rating agencies used by bank and types of exposures
rated by each agency
11
Example Page no : 213 for determining adjusted Exposure:

Example page no : 224 fo computation of Total CRAR and Tier I
CRAR

12

Q Given that Tier I capital is Rs. 500 crores and Tier II capital Rs. 800
crores and further given that RWA for credit risk Rs. 5000 crores,
capital charge for market risk and operational risk Rs. 200 crores
and Rs. 100 respectively,
Answer the following questions.
1. What are the risk weighted assets for operational risk?*
1) Rs. 1250 cr 2) Rs. 1500 cr 3) Rs. 1111 cr 4) Rs. 2000 cr
2. What are the risk weighted assets for market risk?*
1) Rs. 1000 cr 2) Rs. 1500 cr 3) Rs. 2000 cr 4) Rs. 2222 cr
3. What are the total risk weighted assets?*
1) Rs.7250 cr. 2) Rs. 8333 cr. 3) Rs. 9000 cr. 4) Rs. 7800 cr.
4. What is the Tier I capital adequacy ratio?*
1) 0.0555 2) 0.0581 3) 0.0600 4) 0.0668
5. What is the total capital adequacy ratio?*
1) 0.1486 2) 0.1111 3) 0.1200 4) 0.1282
13
6. CRAR is _________*
1) Tier I capital / Total RWAs 2) Tier II capital / Total RWAs
3) Regulatory Capital / Total RWAs 4) Tier I and II capital/ Total
RWAs
Answers :
1. -
2. -
5. -
6. -
3. -

4. -
14
Case Study: Calculation of capital

International bank has:
Paid up capital - Rs. 100 cr.
Free reserves - Rs. 300 cr.
Provisions and contingencies reserves - Rs. 200 cr
Revaluation reserve - Rs. 300 cr.
Perpetual non-cumulative preference shares - Rs. 400 cr
Subordinated debt- Rs. 300 cr
Risk weighted assets for credit and operational risk - Rs.10000 cr
Risk weighted assets for market risk - Rs. 4000 cr.
15

Tier-I = Capital + Free Reserves + Perpetual non-cumulative
preference shares
Tier-II = Provisions and contingencies reserves maximum 1.25% of risk
weighted assets + Revaluation reserve at discount 55% +
Subordinated
debts.
Total Capital Fund = Tier-I + Tier-II
Capital Adequacy Ratio = Total Capital Fund / Total RWA
Minimum Capital = RWA * 9%
Tier-I capital is equal or more than Tier-II Capital
16

Based on information give answer the following questions:
1. What is the amount of Tier-I capital?
a. 900 cr
b. 800 cr
c. 750 cr
d. 610 cr
2. What is the amount of Tier-II capital?
a. 900 cr
b. 800 cr
c. 750 cr
d. 610 cr
3. Calculate the amount of Capital fund

a. 895 cr
b. 1255 cr
c. 1410 cr
d. 1675 cr
4. What is the capital adequacy ratio of the bank?

a. 9%
b. 9.65 %
c. 10.05 %
d. 10.07 %
17

5. What is amount of minimum capital to support credit and operational
risk?
a. 900 cr
b. 950 cr
c. 1000 cr
d. 1250 cr
6. What is the amount of minimum Tier-I and Tier-II to support the credit
and operational Risk?
a. 900 cr,900 cr b. 600 cr,900 cr c. 450 cr,450cr
d. 300 cr,450cr
7. What is the amount of Tier-I capital fund, to support market risk?
a. 450 cr
b. 350 cr
c. 250 cr
d. 185 cr
8. What is the amount of Tier-II capital fund, to support market risk?
a. 450 cr
b. 350 cr
c. 250 cr
d. 160 cr

18
Answers:
1-b
5-a
2-d
6-c
3-c
7-b
4-d
8-d
Q. General provisions will be admitted upto a maximum of ____ of

RWAs*
1) 0.01 2) 0.025 3) 0.0125
4) 0.015

19
Thank You

20

BFM-CH - 10 - Module B

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Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

In Banking Industry risk regulations have several goals, like:

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Reason for change Basel-1 to Basel-2:

Risk Regulations in Banking Industry

The Basel-2 accord is based on 3 pillars:

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Advanced IRB (Internal Rating Based)

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Example Page no : 213 for determining adjusted Exposure:

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Case Study: Calculation of capital

Risk Regulations in Banking Industry

Risk Regulations in Banking Industry

3. Calculate the amount of Capital fund

4. What is the capital adequacy ratio of the bank?

Risk Regulations in Banking Industry

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Q. General provisions will be admitted upto a maximum of ____ of

Prepared By: Jagat Nagar (M : 9909792440)

Risk Regulations in Banking Industry

Prepared By: Jagat Nagar (M : 9909792440)

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