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Servicing its depositors Discharging the responsibility of infrastructural investment Acquiring assets Establishing branch network Entering into fund based activities Maintaining net worth requirements
Equity Ratio - ratio of equity capital over loans and investments Ratio of Paid up Capital to Reserves Capital-Deposit Ratio
used previously in USA & UK high C-D ratio implies low risk for depositors Extent varies on the quality of assets into which the deposits are converted
Canada. United Kingdom and United States. Italy. Luxembourg. Germany. The Basel Committee.An international clearing bank for Central banks) in 1974 due to the need for uniform capital standards. established by the central-bank Governors of the G-10 countries. the Netherlands. Spain. . Switzerland.` ` ` BCBS was formed under the auspices of BIS (Bank for International Settlements. Sweden. The Committee's members come from Belgium. France. Japan.
1988 ± Basel Accord I 1999 ± Consultative paper (Proposal to replace 1988 accord with Basel II) 2004 ± The Final Accord 2006 .Implementation in G10+3 countries Implementation across EU Implementation in Emerging Markets .
Principal purposes: ` ` To ensure an adequate level of capital in the international banking system To create a more level playing field so that banks could no longer build business volume without adequate capital backing The Basel Accord I became a World standard with well over 100 countries applying the framework to their banking system .
20%. 100%) according to their debtor category.CAR The definition of capital is broadly into two tiers ±Tier 1 and Tier 2 Weights are assigned to each asset depending on its riskiness. .` ` ` ` Requires the banks to hold capital equal to at least 8% of its Risk Weighted Assets . 50%. Assets are classified into four buckets (0%.
To assess the CAR. three aspects are relevant: ` ` ` Composition of Capital Composition of Risk Weighted Assets Assigning Risk Weights .
supplementary capital .` Tier 1 Capital .core capital .not permanent in nature and not readily available .most permanent and readily available support against unexpected losses ` Tier 2 Capital .
intangible assets and losses will be deducted from Tier 1 capital .Consists of : ` ` ` ` Paid up capital Statutory reserves Disclosed free reserves Capital reserves representing surplus arising out of sale proceeds of asset Equity investments in subsidiaries.
Consists of : ` Interest free funds from head office kept in a separate account in the Indian books specifically for the purpose of meeting the Capital Adequacy norms ` Statutory reserves kept in Indian books ` Remittable surplus retained in Indian books which is not repatriable so long as the bank functions in India .
Consists of : ` Undisclosed reserves and Cumulative perpetual preference shares ` ` ` ` Revaluation reserves General provisions and loss reserves Hybrid debt capital instruments Subordinated debt .
should be fully paid up .absorb expected losses .not encumbered by any known liability ` Cumulative perpetual preference shares .` Undisclosed Reserves .present accumulations of post tax profits .should not contain clauses which permit redemption by the holder .
the subsequent deterioration in asset value. typically premises and marketable securities Their reliability depends on the accuracy of estimates of market value of the assets.` - Revaluation Reserves Arise from revaluation of assets that are undervalued in the books. or in forced sale. Need to be discounted to a minimum of 55% when including in tier 2 capital - - . the actual liquidation value etc.
25 percent of weighted risk assets. - ` - Hybrid Debt Capital Instruments Combine characteristics of both Debt and Equity Where these Instruments have close similarities to equity. They are admitted up to a maximum of 1. in particular when they are able to support losses on an on-going basis without triggering liquidation .` - General Provisions and loss revenues Are not attributable to the actual diminution in value or identifiable potential loss in any specific asset and are available to meet unexpected losses.
Limited to 50 percent of Tier 1 Capital. free of restrictive clauses and should not be redeemable at the initiative of the holder. unsecured. subordinated to the claims of other creditors. - .` - Subordinated Debt Fully paid up. Should have a minimum remaining maturity of 1 year. Should have a minimum initial maturity of 5 years. Subjected to progressive discounts as they approach maturity.
Remaining Term to Maturity More than 4 but less than 5 More than 3 but less than 4 More than 2 but less than 3 More than 1 but less than 2 Does not exceed 1 year Discount Rate 20 percent 40 percent 60 percent 80 percent 100 percent .
The total of Tier 2 elements can be a maximum of 100 percent of the total of Tier 1 elements. . Investment by banks in the subordinated debt of the other banks shall be subject to the ceiling of 5 percent of their investment in shares or corporate bodies. the same as used for computing CAR. A bank¶s total investment in the Tier 2 Bonds issued by other banks and financial institutions shall be permitted to a maximum of 10 percent of its total capital.` ` ` ` The sum of Tier 1 and Tier 2 capitals will represent the capital funds for the computation of CAR.
The aggregate is taken into account for reckoning the minimum capital ratio.` ` ` ` ` ` Risk adjusted assets would mean weighted aggregate of funded and non funded items. Conversion factors are assigned to Off-Balance Sheet items.5 percent for market risk in addition to credit risk. . Investment in all securities should be assigned a risk weight of 2. The value of each asset is multiplied by the relevant weights to produce risk-adjusted values of assets and off-balance sheet items. Degrees of credit risk expressed as a percentage weighting are assigned to Balance sheet items.
Cash .g. E.Loans guaranteed by Government of India/ State Government .Investment in Government securities .Investment in other approved securities guaranteed by Central/State Government .Investment in securities where payment of interest and repayment of principal is guaranteed by Central/State Government.Claims on Central government and Central Banks denominated in national currency .` 0% . Indira/ Kisan Vikas Patra .
Loans and advances granted to staff of banks which are fully covered by superannuation benefits and mortgage of flat or house. .Investment in securities which are guaranteed by banks or PFIs .Claims on commercial banks and Public Financial Institutions . .Investment in approved securities where payment of interest and repayment of principal is not guaranteed by the Central/State Govt.` 20% .Investments in bonds issued by other banks or PFIs .
Investment in mortgage backed securities of residential assets of housing finance companies which are recognised by National Housing Bank .` 50% .Housing loans to individuals against the mortgage of residential property .Advances covered by ECGC/DICGC .
Furniture.` 100% .Loans granted to public sector undertakings of State governments .Loans granted to public sector undertakings of government of India .Investments in subordinated debt instruments and bonds issued by other banks or public financial institutions for the Tier 2 capital .Claims on private sector .Deposits with SIDBI/NABARD in lieu of the shortfall in lending to priority sector . fixtures and premises .
forward deposits and partly paid up shares and securities .Forward assert purchases. where the credit risk remains with the bank ` .The credit risk exposure of such items is calculated by multiplying the face amount of each of such item by the credit conversion factor ` This is then multiplied by the risk weight attributed Examples: .Sale and repurchase agreement and asset sales with recourse.Certain transaction-related contingent items .Short term self-liquidating trade-related contingencies .
Funded risk assets Amount (Rs.87 0 0.00 Others 918.03 Certificate of deposits 4. Crore) Crore) (1) (3) Particulars RW (%) Cash and Bank Balance with RBI 188.85 Total 1201.5 0 0 Investments GOI Securities 601.85 100 81.05 Other approved securities 352.09 Fixed assets 147.65 22.5 15.80 others 27.94 Other assets 81.5 1.5 28.22 .16 2.1.13 2.5 8.09 100 918. (1) *(2) (rs.46 Advances guaranteed by GOI 359.77 102.94 100 147.36 0 0 Money at call and short notice 212.
33 78.82*. Off-Balance sheet items Amount (Rs.02 + 713.07 crores .52 209. 1411.45 * .52 100 100 131.Particulars Guarantees given on behalf of constituents Forward exchange contracts (2141. Crore) RW (%) Crore) (1) (3) 131.85 Total risk Weighted asset = Rs.33 78.05) Total 2. (1) *(2) (rs.
02 crores Tier 2 Particulars Amount (Rs. Crore s) 36.62 1 .696 17.88 36.26 + 20.62 34. Crore ) 36.95 = Rs 158.956 Total capital = 89.29 1 .02 + 69.6 + 94.64 undisclosed reserves Revaluation reserves eneral provisions and loss reserves total 69.` Capital Tier 1 = Equity + statutory reserves + capital reserves ± Equity investments in subsidiaries = 11.98 crores .4 1 or 1.13 = Rs.Discount rate 1 0.29 ± 37. 89.2 o ic ever R is lo er Amount conside re d (Rs.
98 1411.Capital Adequacy ratio = Capital Risk Weighted Assets = 158.3 % Which is more than the stipulated requirement .07 = 11.
but Insufficiently sensitive to risk . A loan to Reliance is deemed as risky as a loan to Haldirams Very limited account of risk mitigation .E. . No incentive structure to improve risk measurement and risk management practice .g.1988 Capital Accord served the industry well.does not sufficiently recognise credit risk mitigation techniques.Very broad categories of risk weights. such as collateral and guarantees.
A flat 8 percent charge for claims on the private sector has given banks an incentive to move high quality assets off their balance sheet.To lend to poorer quality credits .` Perverse incentives leading to regulatory arbitrage . thus reducing the average quality of their loan portfolios.To securitise better quality assets . the Basel Committee decided to propose a more risk-sensitive framework in June 1999. . ` The regulatory capital requirement has been in conflict with increasingly sophisticated internal measures of economic capital. Therefore.
capital incentives for good risk management Increased risk sensitivity Broad brush structure .The Exi i g r The New r Focus on a single risk measure More emphasis on banks¶ internal methodologies. menu of approaches. supervisory review & market discipline One size fits all Flexibility.
New Basel Capital ccord Pi ³Q r1 i ive´ Pi ³Q r2 i ive´ Pi r 3 ³M rke F r e ´ Market Discipline Minimum Capital Requirements Supervisory Review Process Calculati f capital require e ts Cre it risk Operati al risk vance ppr aches Trading b k arket risk Pr cess f r assessing verall capital adequacy Banks are expected to operate above the ini um regulatory capital ratios Early intervention by supervisors Disclosure requirements Capital structure isk exposures Capital adequacy .
Unchanged u 8% Credit Risk + Market Risk + Operational Risk Total Capital Significantly Refined Relatively Unchanged New (Could be set higher under pillar 2) .
% of revenue (b) Standard indicator approach .% of revenue/assets. by line of business (c) Advanced Measurement Approach ± internal models etc .` ` Market risk ± As per Basel Accord I Credit risk (a) Standardised approach ± more granular version of Basel I (b) Foundation Internal Rating Based Approach (IRB) ± uses banks¶ own credit ratings (c) Advanced IRB ± other inputs also determined by bank ` Operational risk (a) Basic indicator approach .
.Unrated BB100% 150% 100% Risk-weight 50% ` IRB approaches (Foundation and Advanced) Risk weights a function of internal credit ratings Theoretically unlimited number of grades (minimum 7 for performing loans) Does not allow banks themselves to determine all the elements needed to calculate their own capital requirements.` Standardised approach Risk weights (largely) a function of external ratings Credit assessment AAA to AA20% A+ to ABBB+ to Below BB. Determined through a combination of the quantitative inputs provided by banks and the formulae specified by the Committee.
banks or corporates depends on four quantitative inputs: ` Probability of Default (PD). which measures the likelihood that the borrower will default over a given time-horizon ` Loss Given Default (LGD). which measures the proportion of the exposure that will be lost if a default occurs ` Exposure at Default (EAD) which. measures the amount of the facility that is likely to be drawn if a default occurs ` Maturity (M).The IRB calculation of risk-weighted assets for exposure to sovereigns. which measures the remaining economic maturity of the exposure . for loan commitments.
LGD Supervisory rules set by EGD M . by Banks¶ own estimate Provided by banks. based on own estimates. Provided by banks. based on own estimates. on own estimates. based Provided by banks. Provided by banks. the committee Supervisory rules set by the committee Supervisory rules set by the committee or at National Discretion. based on own estimates. based on own estimates.Foundation IRB PD Advanced IRB Provided by banks.
or external events.´ ` ` ` In the near term operational risk is not likely to attain the precision with which market and credit risk can be quantified. . Approaches to operational risk are continuing to evolve rapidly. people and systems. operational risk is defined as the risk of ³losses resulting from inadequate or failed internal processes. This has posed obvious challenges to the incorporation of the New Accord.In the Basel II framework.
Setting targets for capital commensurate with bank¶s particular risk profile ` The process subject to supervisory review and intervention .` ` Inclusion of a supervisory element Requires Bank Management .developing an internal capital assessment process .
` Enhanced disclosure by banks .Detailed requirements on internal methodologies for credit risk.Areas covered are calculation of capital adequacy and risk assessment methods . credit risk mitigation techniques and asset securitization These norms are set up basically to ensure that market participants can understand the risk profiles and adequacy of capital .
2000. to meet the international standards. At the end of March 2002. there were 25 PSBs with a CRAR exceeding the stipulated 9% The implementation of Basel New Accord has been estimated to be completed by end-2006 .this has been raised to 9% with effect from March 31.` ` ` ` The initial Capital to Risk-weighted Ratio (CRAR) was initially set at 8 % However.
efficient disclosure reporting Communicating the approach Finding the right IT partner for the compliance .Areas to be considered by an organisation while preparing for Basel II ` ` ` ` ` ` Reviewing existing frameworks Deciding the approach for risk measurement and management Building flexible and scalable system Developing reliable.
` Poses great challenges of compliance for banks and financial institutions. But.. crunching numbers and performing complex calculations. Increasingly. ` Requires strategising risk management for the entire enterprise.Basel II ` Offers a variety of options in addition to the standard approach to measuring risk. . banks and securities firms world over are getting their act together. building huge data warehouses. ` Paves the way for financial institutions to proactively control risk in their own interest and keep capital requirement low.
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