Presented by: Viraf Badha 101 Saurabh Bahuwala 102 Subodh Bhave 103 Sonia Bose 105 Hashveen Chadha

106 Preeti Deshpande 107 Priya Deshpande 108

What's Risk ?
1995 – Barings 1996 – Sumitomo Bank 2005- Global Trust Bank 2006- Western Union Bank

Need for Basel
 Increase in volume of financial flow  Wide spread banking net work  Difference in supervisory control  Quality of assets  Spate of failure of banks  Integration of market

BASEL :Basic Objective
Uniform regulation of banking sector across the globe. In nutshell it address both the liability & the asset side of b/s

Basel ..  Recommendations towards common approaches & standards  International standard  1988 – Basel I  1999.  1930: BIS (Bank International for International Settlements) established. .  Up to 1980:focus on managing cross border capital flows  Basel committee established in 1974  Consists of 25 technical working groups  No super national supervisory authority  Specifies broad supervisory standards and guidelines.Basel II (Draft guidelines).brief history & work.  Focus on development of Breton wood system up to 1970..

 to develop business volumes linked to capital. Prudential Accounting Norms  Capital adequacy  Income recognition  Asset classification  Provision .Basel I: objectives  To ensure capital adequacy to meet financial crisis.  Parameters to measure and manage risk via Prudential accounting norms.

 TIER II CAPITAL: This can absorb losses in the event of a winding up. Cushion for unexpected losses.Capital Adequacy  TIER I CAPITAL: This one can absorb losses without a bank being required to cease operation.  One quarter default for recognizing income  Either installment or interest or both  Borrower wise and not Facility wise  Out of order – applicable to cash /overdraft a/c .  Measured on Risk Weighted Assets (RWA) Income Recognition  Interest income not to be recognized until it is realized. Accrual system to actual. and also provides lesser degree of protection to depositors. This is Core Capital.

& principal. residential housing beyond Re 20 lakhs and commercial real estate loans .  Standard asset – 0. Normal risk.Asset classification  Standard asset – servicing of int. capital market exposures.  Substandard Asset -10% on the outstanding amount. 1% for personal loans. Provisioning norms  Loss Assts – 100% of out standing amount  Doubtful Assets – 100% on unsecured portion & 20-50 %for the secured portion.40%.  Sub-Standard – NPA for a period up to 12 months. Asset coverage / net worth of borrower not enough to cover the loan  Doubtful asset –age of NPA is more than 12 months.  Loss Assets – no chance of recovery but not written off.

 To bridge the cap between Regulatory & Economic capital  BASEL I did not address risk mitigation techniques such as collateral.Why BASEL II ?  One size fit approach to be replaced by a menu of options for banks to choose  More risk sensitive to encompass all risks especially operational risk. particularly for the emerging markets” . guarantees etc  More emphasis on banks’ internal control and management  More disclosure through market discipline China Banking Regulatory Commission- “To a large extent we are convinced that Basel II is more about risk management than capital regulation.

 The new framework proposes a significant refinement of regulatory and supervisory practice and encourages increased attention to risk management practices. .Objectives of Basel II  To encourage better and more systematic risk management practices. especially in the area of credit risk and to provide improved measure of capital adequacy. to adopt better risk management techniques and to evaluate their performance relative to market expectations and relative to competitors.  Introduction of Basel II has given incentives to many of the best practices banks.

New Basel Capital Accord The New Basel Capital Accord Supervisory Review Process • Minimum capital requirements Regulatory and Economic capital Market Discipline Minimum Capital Requirements • Supervisory review process Transaction based to risk based supervision • Market discipline Risk exposure. migration assets from standard to NPA etc .

PILLAR I: Explained  Credit Risk:  Standardized approach  Internal Rating Based Approach (Foundation IRB/Advanced IRB)  Operation Risk:  Basic Indicator Approach  Standardized approach  Advanced Measurement Approach  Market Risk:  VaR models for Trading Book (AFS + HFT) and EaR models for Banking Book (HTM) .

= 8% • Greater recognition of collaterals. • More refined treatment of securitization. • Charge for Operational Risk introduced Economic Capital .Pillar 1 Eligible capital ON-BALANCE-SHEET CREDIT RISK + Off-balance-sheet credit risk + Market risk + OPERATIONAL RISK Key Changes: • Wider spectrum of credit risk weights.

Credit Risk Credit Risk Standardized Approach Internal Rating Based approach Securitization Framework Foundation IRB Advanced IRB .

land and building. equities etc. Securities issued by Central/ State Governments. plant and machinery will be recognized for assigning lesser risk weight of 100%. Debt securities. KVPs. other collaterals viz. NSCs. . only where the bank is having clear title and the valuation is not more than 3 years old and value of machinery not higher than the depreciated value. LIC policies. Gold. IVPs. when provisions reach 15%..  In case of NPAs.Collaterals  The following collateral instruments are eligible for recognition in comprehensive approach: Cash.

.Risk weights on claims Option 1 = Risk weights based on risk weight of the country Option 2a = Risk weight based on assessment of individual bank Option 2b = Risk weight based on assessment of individual banks with claims of original maturity of less than 6 months.

in St.Govt Exposures guaranteed by State Govt Exposures on RBI/DICGC/CGTSI Exposures on ECGC Staff loans secured by superannuation benefits Claims on Multilateral Development Banks Claims on Banks (based on CRAR of Bank) Claims on Corporate based on ext.& Inv.rating) Unrated claims in excess of Rs.Other Risk Weights             Exposures to Central Govt.10 cr Claims on Commercial Real Estate Consumer credit/personal loans/credit cards Claims on restructured/rescheduled a/cs 0% 20% 0% 50% 20% 20% 20%-625% 20%-150% 150% 150% 125% 125%* *(till satisfactory performance of one year from the date when the first payment of interest/installment falls due) .

 The rating should be in force and confirmed from the monthly bulletin of the concerned rating agency. these exposures should be reckoned as long term exposures and accordingly long term ratings accorded by agencies will be relevant. (CRISIL) • FITCH Ratings and • ICRA Limited • SMERA is not recognized • .External Credit Assessments  Disclose the names of the credit rating agencies that Banks use for the risk weighting of their assets.  Credit assessment must be publicly available.  Even though CC accounts are sanctioned for period one year or less. The rating agency should have reviewed the rating at least once during the previous 15 months. • Recognized agencies Credit Analysis and Research Ltd..  All loans above Rs 10cr will be rated by outside credit rating agencies under standardized approach.

people and systems or from external events” Technology Risk Regulatory Financial Compliance Risk Control Risk Social.What is operational risk ? “The risk of direct or indirect loss resulting from inadequate or failed internal processes. Ethical and Environmental Risk Product and Sales Risk Service Delivery (Operations) Risk Legal Risk People Risk .

capital charge is calculated by multiplying the beta factor assigned to that business line.  Under each business line.Standardized Approach & Advanced Measurement Approach  Standardized Approach:  Bank’s activities would be divided into 8 business lines as under:  Corporate finance.  Advanced Measurement Approach:  Regulatory capital will equal the risk capital measured by Bank’s internal risk measurement. Commercial Banking. Gross income is calculated for each business line and not for Bank as a whole. Asset Management and Retail brokerage. Retail banking. Trading. Agency services. Payment & settlement. .  Measured by bank’s internal risk measurement system using quantitative and qualitative approach.  Capital charge against each business to be provided on the basis of annual average income for 3 years.

 RBS focuses on testing of risk in each transaction. evaluation of  In short. . allocation of audit resources etc. adherence to legal & regulatory requirements etc.Risk Based Supervision  Present audit focuses on transaction testing – accuracy & reliability of records. periodicity of audit. effectiveness risk management & controls. it is a migration form transaction to risk based audit. inherent risks in various activities of institution. prioritization of audit areas. financial reports.

Sr. account’ payment Ageing report Advances or debit balances outstanding for more than 3 months 3 Applicable taxes Lack of awareness not/ short about tax laws and deducted before rules payment Incorrect/ delays in/ non-updation of tax deduction masters in system Up-to-date information Low-High Frequency of on tax laws in consultation with tax department Periodic review and updation of tax rates in tax master in system reviewing and updating tax masters Number of instances of non/short tax deducted . No. Advance Register. Key Risks 1 Ops risk – Bill passing activity Sources Controls FrequencySeverity High –High Bills passed without adequate supporting Negligence Accepting photocopies Standard checklist of Key Risk Indicator Number of instances instead of originals Non-availability of a valid supporting for specific transaction type Exceptional payment made pending receipt of supporting acceptable supporting Reject vouchers with inadequate supporting of bills passed without adequate supporting 2 Advances accounted in Check for possible Advances not Lowadjusted against different account advances before Medium payment payment Advances not tracked Periodic scrutiny of GL separately and accounted as ‘on a/c’s.

Teeming and lading fraud Inaction due to communication gaps between Departments KYC fraud by employee Loss of branch assets Non compliance of statutory provisions Physical assault on bank staff Salary paid in excess Theft of instrument by staff Account used for suspected fraudulent purpose Bogus call received for cash extortion .Level 3) Cheque deposit credited to wrong account Customer fraud .Cash embezzelement KYC fraud by RL customer Software error Activity (Loss Event .Level 3) Excess cash .Misuse by outsider Account used for fraudulent transactions Connectivity failure Fraudulent instrument presented in inward clearing Fraudulent instrument presented in payments Vandalism by outsiders DRA fraud .vendor Loss of receipt books by DRA Cash shortage .Teller error Debit card fraud .Examples – Unusual Events .Retail Asset (CV) Delivery failure .LCC Operations DRA fraud .Loss types Activity (Loss Event .Teller error Delivery failure .

portfolio.Pillar II: Supervisory Review  Banks should have Internal Capital Adequacy Process (ICAAP). .  ICAAP should faithfully capture the risks attached in the bank’s  Supervisor may take early supervisory action by asking bank to maintain additional capital.  Supervisor would take appropriate action if they are not satisfied with the Bank’s minimum capital.  Supervisor should verify maintenance of minimum capital requirements by banks.

 Risk exposures. risk assessment process.  Financial position and performance.Pillar III: Market Discipline  To enable the market to understand the strengths and weaknesses of the Bank.  Providing disclosures that are based on a common framework is an effective means of informing the market about a bank’s exposure to those risks and provides a comprehensive disclosure framework that enhances comparability.  Basic business. Disclosure Regime  Board approved policy for disclosures. management and corporate governance information. .  Accounting policies. risk exposure.  To encourage market discipline by developing a set of disclosure requirements which allow market participants to assess key pieces of information on capital.  Risk management strategies and practices.

 Control orientation to strategic advantage.  Better internal capital management  Improvement in credit portfolio quality and better recognition of risk mitigation. .Benefits Of Disclosure Regime  Incentive for improved risk analysis and pricing of risks.

Current directives of RBI  Draft guidelines .  Standardized approach – March 2009  Parallel run  RBI may enforce to have a uniform credit rating approach to measure capital requirement since credit rating is a yard stick for capital provisioning . Smaller banks may suffer.  Social obligation of public sector banks.  Technological up gradation involves huge capital requirement but return may not match. .  Low penetration of credit rating and it has got to improve.Feb 05.  Revised draft guidelines .March 2006.

 From a technology perspective some progress had been made in credit and market risk management but not in Operation Risk.  A large number of Banks had not fully understood the complexities of Operation Risk  27% of banks expected their capital requirements to increase by 1-2% while .Indian perspective  FICCI’s 2005 survey (India) 20% expected the increase to be larger than 3%  IBA’s 2006 survey (India)  A long term roadmap for Basel II implementation was missing in India. in respect of operational risk.  40% of the banks considered cost of compliance to be a significant concern in implementing Basel II  KPMG India 2006 survey (27 public and private sector banks)  Compliance with regulation was driving Basel II implementation in half the banks surveyed. 65% banks had gone into implementation without a preceding project planning exercise.  Only a few (16%) had commenced planning for the more advanced approaches.

Indian perspective As of 2005 .

 Too much disclosure may cause information over load and may create problem to the respective bank vis-à-vis competitors.issues  Banks by manipulating credit risk measurement. Non deliberate under estimation also may lead to lower CAR.  Non availability of data over longer time horizon to measure risk based on historical data.  Competition among banks for high quality loans/customers may exert pressure on interest spread .Implementation . . It will lead to regulators identifying themselves the banks they supervise.  Burden of approving internal risk models. may reduce CAR. It will come difficult not to bail out of a large problem since supervisors have validated and approved of internal rating system of bank facing financial crisis.

• Broad brush approach – irrespective of quality of counter party or credit • Encouraging regulatory arbitrage by cherry picking • Lack of incentives for credit risk mitigation techniques • Not covering Operational risk  Capital Requirement  Profitability  Risk Management Architecture  Rating requirement  Choice of Alternative Approaches  Absence of Historical Database  Incentive to Remain Unrated         Supervisory Framework Corporate Governance Issues National Discretion Disclosure Regime Disadvantage for Smaller Banks Discriminatory against Developing Countries External and Internal Auditors .Challenges….

O’Neill on SWM share holder wealth max. CFO. Bank of America .The highest potential for increasing shareholder value is improving the way allocate capital to businesses. Michael E. (including) taking away capital from businesses that are not achieving return expectations..