|


|

  
1988 Basel Capital Accord
Capital Funds
CAR =---------------------------
Risk Weighted Assets
Capital funds = Tier I Capital + Tier II Capital
Minimum requirements of Capital Funds:

Existing Banks 9%
New Private Sector Banks 10%
Banks undertaking insurance Business 10%
Local Area Banks 15%
 i 
  i 

 

Tier I
1. Paid up Capital
2. Statutory Reserves
3. Other Disclosed Free Reserves
4. Capital Reserves
5. Investment Fluctuation Reserve
6. Perpetual Debt Instruments
7. Perpetual Non-
Non-cumulative
Preference Shares
Tier II
1.Undisclosed Reserves and
cumulative perpetual preference
shares
2.Revaluation Reserves at a discount
of 55% while determining the value of
Tier II Capital
3.General Provisions and loss
reserves up to a max of 1.25% of
Risk Weighted Assets
4.Hybrid Debt Capital
5. Subordinated Debt
 
 
 




þ Cash & Balance with RBI 0%
þ Balances with Other Banks 20%
þ Government / Approved Securities 2.5%
þ Secured loans To Staff 20%
þ Housing Loan to Individuals 75%
þ Loan to PSUs 100%
þ Other Loans 100%
þ Exposure to Capital Markets 125%
þ Commercial Real Estates 150%
 |


 

þ Frame Work
Basel II

Pillar I Pillar II Pillar III

Minimum Supervisory Review Market Discipline
Capital Requirement

Credit Market Operational

Risk Risk Risk

  
 

Pillar--I
Pillar
Total Capital
Capital Adequacy = --------------------------------------------->9%
--------------------------------------------->9%
Credit Risk + Market Risk + Operational Risk
Tier I Capital ( Core Capital) = Equity Capital + Disclosed Reserves*
( Disclosed Reserve = Share Premiums +Retained Profit + General Reserve)

Tier II Capital( Supplementary Capital) = Undisclosed Reserves+ Asset

Revaluation Reserves + General Provisions/Loan Loss Reserve + Hybrid
Debt Capital Instrument + Subordinated Debt+ Redeemable Cumulative
Preference Shares
Tier III Capital ( for market risk only) = Short term subordinated debt with a
maturity of at least 2 years
 i 
 


Tier I Capital = Paid Up Capital + Statutory

Reserves +Surplus arising out of sale proceeds of
assets ( capital reserve ) + Investment
Fluctuation Reserve + Innovative Perpetual Debt
Instruments + Perpetual Non-
Non-Cumulative
Preference Shares
Minus
(Equity Investment in Subsidiaries +Intangible
Assets + Losses in current period and those
brought forward from previous periods. )
 ï
 


þ Supervisors need to assure that
þ * Banks have in place a process for assessing their
overall capital in relation to risks
þ * Banks indeed operate above the minimum regulatory
capital ratios
þ * Coercive action is taken as soon as possible when
problems develop



  
þ Disclosure

Disclosure

Capital Levels Capital

Risk Exposure Adequacy

! 






Type Of Risk Basel II - Prescribed Approaches

Credit Risk Standardized Approach( 1988 Accord)

Foundation IRB Approach
Advanced IRB Approach
Market Risk Standardized Approach
Internal Models Approach

Operational Risk Basic Indicator Approach

Standardized Approach
Internal Measurement Approach
 


þ Basel II Framework
Credit Risk

Standardized
Approach IRB Approach

Foundation IRB Advanced IRB

Approach Approach
 


þ Standardized Approach ( External Rating for
Corporates )
þ AAA/ AA-
AA- (20%), A+/A-
A+/A- (50%), BBB+/ BB-
BB-
(100%) Below BB-BB- (150%) , Unrated (100%)
þ Foundation IRB Approach: Bank estimates PD
(Probability of Default) and Central Bank gives
LGD and EAD
þ Advanced IRB Approach : Banks give all PD, LGD
and EAD




þ Basel II Framework

Market Risk

Standardized Internal Models

Approach Approach




þ Standardized method has an add-
add-on approach.
Market Risk =Interest Rate Risk + Exchange Risk
+ Equity Risk + Commodity Risk. This method
provides a rough but conservative measure of the
capital charge for market risk.
þ Internal Model Approach is bank¶s own
assessment which has to earn the confidence of
the central bank besides a strong verification
based on back-
back-testing.
 _
 

þ Basel II Framework

Operational Risk

Basic Indicator Standardized Advanced Internal

Approach Approach Measurement
Approach
 _
 

þ Basic Indicator Approach: This uses a single indicator as a
proxy for the firm¶s exposure to operational risk. It could be
a percentage of bank¶s gross income. This is, however, a
crude assessment.
þ Standardized Approach: It distinguishes business lines and
business volumes. For each business line the operational
risk charge (ORC) would be the product of a broad indicator
of business activity times a standardized loss factor. For
asset management, for example, the indicator could be
total funds under management, for trading and sales, it
could be gross income etc. Total ORC could be sum of all
these.
þ In Internal Measurement , Probability of Loss event, loss
given that event combined with exposure indicator would
help in arriving at expected loss.
|


 
 |



þ ÎBasel IIIÎ is a comprehensive set of reform
measures, developed by the Basel Committee on
Banking Supervision, to strengthen the
regulation, supervision and risk management of
the banking sector. These measures aim to:

þ improve the banking sector's ability to absorb

shocks arising from financial and economic
stress, whatever the source

þ improve risk management and governance

þ strengthen banks' transparency and disclosures

 
"


1. ü








 



Greater emphasis placed on the common equity component of Tier
1 capital, ‡ Simplification of Tier 2, Elimination of Tier 3 and
Detailed regulatory capital disclosure requirements.





  
 


 


 
 

 .
(Enhanced risk coverage will address issues that arise in
connection with the use of derivatives, repos, and securities
financing arrangements)



 


  


(This ratio will supplement the Basel II risk capital framework)

 
   

 


! 
 ü 
#


  

 
 !
 
$


þ  
 "# 

$%
! 




þ "#

 

&'% 

! 




þ " 


("#

 "



) 

*'% 
! 


.
 


%% 



þ In addition to raising the quality and level of the
capital base, there is a need to ensure that all
material risks are captured in the capital
framework. Failure to capture major on- and off-
balance sheet risks, as well as derivative related
exposures, was a key factor that amplified the
crisis
  


|!!
þ Capital conservation buffer is designed to ensure
that banks build up capital buffers outside
periods of stress which can be drawn down as
losses are incurred. Banks should hold buffers
above the regulatory minimum. When buffers
have been drawn down, one way banks should
look to rebuild them is through reducing
discretionary distributions of earnings.
þ A capital conservation buffer of 2.5%, comprised
of Common Equity Tier 1, is recommended above
the regulatory minimum capital requirement.
 


%%  |!!
þ Losses incurred in the banking sector can be
extremely large when a downturn is preceded by
a period of excess credit growth. These losses
can destabilize the banking sector and spark a
vicious circle, whereby problems in the financial
system can contribute to a downturn in the real
economy that then feeds back on to the banking
sector. These interactions highlight the particular
importance of the banking sector building up
additional capital defenses in periods where the
risks of system-wide stress are growing
markedly.
 


%%  |!!
þ Banks will be subject to a countercyclical buffer that varies
between zero and 2.5% to total risk weighted assets. The
buffer that will apply to each bank will reflect the
geographic composition of its portfolio of credit exposures.
Banks must meet this buffer with Common Equity Tier 1 or
other fully loss absorbing capital.
   $
!
|


 
! 
Common Tire I Capital Total Capital
Equity
Tier I
Minimum 4.5% 6.0% 8.0%

Conservation 2.5%
Buffer

Minimum + 7.0% 8.5% 10.5%

Conservation
Buffer
Counter 0-2.5%
Cyclical Buffer
Range
 !

þ www.bis.org
þ www.europa.eu.int
þ www.federalreserve.gov
þ www.sec.gov
þ www.rbi.org.in