Discussion on

Regulating Capital in Banks : Where are We?

From Basel I to Basel III

Dirgha Rawal
Bank Supervision Department
Nepal Rastra Bank

2/5/2020
Outline
 Background
 Evolution of Capital Regulation
 Basel III : Way Ahead
 Recent Developments in BSD : Where are
we?
 Conclusion

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Background
• The Basel I – 1988
• capital charge for credit risk only; a simple “broad-brush” approach/ one size fits all
• Amendment to Basel I – 1996
• to incorporate capital charge for market risk
• Market risk capital framework

• The Basel II – 2004

– Enhanced risk coverage
 Credit
 Market and
 Operational risks
– A menu of approaches – standardized to model based with increasing complexity
– Three pillar approach
– Minimum Capital Requirements
– Supervisory Review Process
– Disclosure

Nepal : Implementation of New Capital Adequacy Framework 2007(Updated 2008)

Evolution of Capital Regulations

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 Global Scenario
 Rapid market development and technological Innovation

 New product developments; MBS, ABS, CDO, CDS and other complex
types of financial instruments.

 Increasing Off balance sheet exposures, Subprime Mortgage Products,

Securitization of Assets and increasing banks trading portfolio.

 The capital charge framework for market risk did not keep pace with new
market developments and practices

 Capital charge for market risk in trading book calibrated much lower
compared to banking book positions on the assumption that markets are
liquid and positions can be wound up or hedged quickly

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Global Financial Crisis
 The global financial crisis mostly happened in the areas of trading
book /off balance sheet derivatives / market risk and inadequate
liquidity risk management

 Banks suffered heavy losses in their trading book

 Banks did not have adequate capital to cover the losses

 Heavy reliance on short term wholesale funding

 Unsustainable maturity mismatch

 Insufficient liquid assets to raise finance during stressed period

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Basel II: Weaknesses identified by the crisis

 Basel II attempted to keep the overall level of capital the

same as that under Basel I

 Basel II did not sufficiently capture the risk in complex

structured products

 Basel II capital requirements are procyclical; thereby

amplifying business cycle fluctuations

 Basel II did not consider the impact of stress in the

broader economy

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Enhancement to Basel II
 Post- crisis, global initiatives to strengthen the
financial regulatory system

 July 2009 Enhancement to Basel II – mostly in

trading book

• Pillar 1 – Standardized approach

– Higher risk weights for securitization and other re-
securitization exposures – almost doubled

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Enhancement to Basel II
 Pillar 2 guidance
◦ firm wide governance and risk management;
◦ capturing risk of off balance sheet exposures
and securitization activities;
◦ managing risk concentrations;
◦ managing reputation risk and liquidity risk;
◦ improving valuation practices; and
◦ implementing sound stress testing practices

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Enhancement to Basel II
 Pillar 3
◦ appropriate additional disclosures completing
enhancements in Pillars 1 and 2
 Securitization exposures in trading book
 Sponsorship of off balance sheet vehicles
 Re-securitization exposures; and
 Pipeline and warehousing risks with regard to
securitization exposures

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 Basel III : Way forward
 December 17, 2009 Basel Committee issued two
consultative documents:

◦ Strengthening the resilience of the banking sector

◦ International framework for liquidity risk measurement,
standards and monitoring

 The proposals were finalized and published on

December 16, 2010:
◦ Basel III: A global regulatory framework for more resilient banks and
banking systems
◦ Basel III: International framework for liquidity risk measurement,
standards and monitoring

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 Basel III….
 Objectives
◦ Improving banking sector’s ability to absorb shocks
◦ Reducing risk spillover to the real economy

 Fundamental reforms proposed in the areas of

◦ Micro prudential regulation – at individual bank level
 A new definition of capital (the numerator)
 Enhanced risk coverage (the denominator)
 Calibration and impact
 Other measures
◦ Macro prudential regulation – at system wide basis
 Leverage ratio
 Capital conservation and countercyclical capital buffers
 Systemically important financial institutions

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Basel II and Basel III
Capital Requirements (% of RWA) Basel II Basel III*

 Minimum common equity capital ratio 2.0% 4.5%

 Capital conservation buffer - 2.5%

Common equity + capital conservation 2.0% 7.0%

 Minimum Tier 1 capital ratio 4.0% 6.0%
 Minimum total capital ratio 8.0% 8.0%

Total capital + capital conservation 8.0% 10.5%

 Leverage ratio (non-risk-based) - 3.0%
 Countercyclical capital buffer (nat. discretion)- 0 -2.5%
 SIFI capital buffer - Under Discussion

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Source: “The Basel III-An Enhanced Capital Framework”, Training Hands out FSI-EMEAP Regional Seminar
Stress Testing, Jason George
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Basel III : Main Features
 Raising quality (Tier 1 – 6%, of which TCE - 4.5%), level (8+2.5%
CCB), consistency (deductions mostly from TCE) and
transparency of capital base

 Improving/enhancing risk coverage on account of counterparty

credit risk

 Supplementing risk based capital requirement with leverage ratio

 Addressing systemic risk and interconnectedness

( Capital and liquidity surcharge on SIFIs, Activity restriction/exposure on SIFIs,
Intensive supervision SIFIs)

 Reducing pro-cyclicality and introducing countercyclical capital

buffers (0-2.5%)

 Minimum liquidity standards

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Leverage ratio
• Ratio – 3%
• Objectives – to supplement capital ratio in capturing risk
• Numerator – Tier 1 capital
• Denominator – on and off balance sheet exposure

• As a Pillar 2 measure to start with but will be integrated with Pillar 1

• Leverage ratio will be monitored from January 1, 2011 to see the result of
the above definition and parallel run from January 1, 2013 to 2017 and
final adjustment in 2017 – Disclosure from January 2015

• As Pillar 1 ratio from January 1, 2018

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Liquidity risk measurement

 Key characteristic of the financial crisis was

inaccurate and ineffective management of
liquidity risk

 Two standards/ratios proposed

◦ Liquidity Coverage Ratio (LCR) for short term (30
days) liquidity risk management under stress scenario
◦ Net Stable Funding Ratio (NSFR) for longer term
structural liquidity mismatches

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Liquidity Coverage Ratio (LCR)
– Ensuring enough liquid assets to survive an acute stress
scenario lasting for 30 days

– Defined as stock of high quality liquid assets / Net

cash outflow over 30 days > 100%

– Stock of high quality liquid assets – cash + central bank

reserves + high quality sovereign paper (also in foreign
currency supporting bank’s operation) + state govt., &
PSE assets and high rated corporate/covered bonds at a
discount of 15%

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Net Stable Funding Ratio (NSFR)

◦ To promote medium to long term structural

funding of assets and activities

◦ Defined as Available amount of stable

funding / Required amount of stable
funding > 100%

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Other monitoring tools for liquidity
risk management

◦ Contractual maturity mismatch

◦ Concentration of funding
◦ Available unencumbered assets
◦ Liquidity Coverage Ratio by significant currency
◦ Market-related monitoring tools

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 Nepalese Banking : Self Assessment
 Capital Ratios are already more than Basel requirements (10% and 6%).
Capital Conservation Buffers may be necessary.

 Trading Portfolio of the banks is smaller yet. Low exposure in

securitized assets and off balance sheet exposures.

 Banks mostly follow a retail business model and do not depend on

wholesale funds

 We have already introduced Liquidity Monitoring Framework which is

similar to Liquidity Coverage Ratio of Basel III(not implemented yet in
global context)

 Initiations of Forward looking Approaches : Stress Testing

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Nepalese Banking : Self Assessment
 Nepalese banks are generally not as highly leveraged as
other global counterparts. The leverage ratio of Nepalese
banks would be comfortable.

 Banks having a huge trading book and off balance sheet

derivative exposures may be impacted due to increased
risk coverage (capital) on account of counterparty
credit risk- Low exposure of Nepalese banks in such
areas.

 Special provision for SIFIs is the issue remained yet to be

discussed.
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Thank You

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