Final Basel II (2)

1

Laws amp Practices of Banking amp Bank Accounts

(Course Code -3101)

Article on

ldquoEffects Of Implementation Of Basel II In Bangladeshrdquo

Department of Accounting amp Information Systems

University of Dhaka

2

Article on

ldquoEffects Of Implementation Of Basel II In Bangladeshrdquo

Submitted TO

IshterMahalShithee

Lecturer

Dept of AampIS

University OfDhaka

Submitted By(Group-3)

1 Md RezaulKarim (16113) 2 Ibne Al JayedHossain (16133)

3 Fayez Ahmed (16134) 4 Iffad Mahmud (16098)

5 ZeniaAkter (16102) 6SikandarHossain (16152)

7 BabuMarma (16171) 8 Saddam Hossain (16129)

9 NeloyDevNath (16127)

Date of Submission 07-07-2012

3

Acknowledgement

It is our refreshment stand to thankIshterMahalShithee the adhering Lecturerof the Department of Accounting amp Information Systemsand University of Dhaka for rendering us her expertise knowledge and giving the opportunity of practical exposure through this article

Practical knowledge is deep-seated for the application of conjectural intelligence Bearing this in mind the course teacher introduced a program for the students of the courseldquoLaws amp Practices of Banking amp Bank Accounts (Course Code-3101)rdquoto prepare an article The goal of this article is to expose the students to learn about Basel II We would like to thank the honorable teacher to provide us the opportunity to apply classroom learning in practice There are always some differences between theories and practical This article bridges the gaps between them

Basel II is a new issue in the banking sector All the banks are required to follow Basel II as it is to follow according to central bankrsquos guideline By making article on this topic we have learned not only about Basel II but also many practical aspects For this we would like to give special thanks to our madam IshterMahalShithee

Table of Contents

4

Particulars Page No

Abstract 5

Introduction 5-6

Objectives 6

Methodology 6

Literature Review 7-8

Interpretation amp Analysis 9-18

Findings 19

Recommendation 17-18

TITLE VIImdashSTUDIES AND REPORTS 18-20

TITLE VIIImdashCORPORATE AND CRIMINAL FRAUD ACCOUNTABILITY

21

TITLE IXmdashWHITE-COLLAR CRIME PENALTY ENHANCEMENTS 22

TITLE XmdashCORPORATE TAX RETURNS 22

TITLE XImdashCORPORATE FRAUD ACCOUNTABILITY 23

Literature Review 25

Conclusions 25

References 26

Abstract

5

This paper has made a study on the effects of implementation of Basel II in the banking sector especially in Bangladesh Basel II is an emerging issue that must be followed by the banks mandatorilyFor the purpose of preparing article we have selected 10 leading banks in Bangladesh We have practically visited the 10 banks amp talked with the executive officer of those banks In our study we have found that Basel II has been being implemented by the banks All the banks are strictly following Basel II requirement

Under Basel II all the banks are required to maintained its capital based on its risk (such as operational risk market risk financial risk etc) and as a result not only the depositors interest are protected but also banks credibility has been increased

Introduction

Basel II is a recommendatory framework for banking supervision which was issued by Basel committee in June 2004The Basel II accord is a document that outlines the minimum capital requirements to which all large internationally active banks in the G10 countries must adhere It is published under the auspices of the Bank for International Settlements (BIS) specifically the Basel Committee on Banking Supervision and is intended to be adopted in all of the G10 jurisdictions It is also expected that many of the principles of the accord may also be adopted for internationally active banks in other jurisdictions outside of the G10

The accord has three key pillars

6

From Basel I to Basel II Previously Basel I was to maintain by the bank But Basel I was not so much effective As a result Basel II has been initiated by the Basel committee Basel II replaces Basel I The objectives of the new Basel capital accordis tohelliphellip

1048707 Enhance the sensitivity of capital requirements to the degreeof risk involved in banksrsquo positions and activities

1048707 Encourage banks to improve their risk measurement andmanagement systems

1048707 Increase the role of banking supervisors and the role ofmarket discipline

1048707 Constitute a more comprehensive approach to addressingrisks the banks are exposed to

1048707 Promote safety and soundness in the financial system as wellas competitive equality

Same objectives but more advanced tools

Objectives

In performing our research we have set the following objectiveshelliphellip

1 Whether the banks in Bangladesh are in compliance with Basel II

2 What is the effect of implementation of Basel II

3 What is the present condition of implementation of Basel II

Methodology

We have conducted our research based on both primary amp secondary dataWe have selected 10 leading banks in Bangladesh namely Eastern Bank Ltd Al-ArafahIslami Bank Ltd Prime Bank Ltd South east Bank Ltd Dhaka Bank Ltd NCC Bank Ltd Social Islami Bank Ltd Dutch Bangla Bank Ltd Mutual Trust Bank Ltd amp Standard Bank Ltd We have practically visited those banks amp collected information by questionnaire

7

Literature Review

Many researches have been done by different researcher amp analyst on the implementation of Basel IIamp its effects

A research done by Richard J Herring on ldquoThe Rocky Road to Implementation of Basel II in the United Statesrdquo reveals that the implementation of Basel II would reduce compliance costs dramatically for both banks and regulators and limit the extent to which Basel II might reduce the average level of capital in the system It would also reduce the risk of exacerbating business cycles and increase the transparency of capital charges and capital adequacy measures

An article published by The Institute of International Finance Inc on ldquoThe Implementation of Basel IIrdquo states that notwithstanding the continuingchallenges the investments that both banks and supervisors aremaking in preparation for Basel II have already resulted in growth in theSophistication and responsiveness of risk-management capabilities The Institute continues to appreciate the openness of the BCBS its working groups and subgroups and their eagerness to work with the industry on refinements and relative details as well as fundamental issuesA report published by FINANSINSPEKTIONEN states thatthe minimum capital requirement for internationally active ban (Group 1 banks) decreases moderately and there is a clear incentive for banks to adopt more risk-sensitive and sophisticated measurement methods to calculate the capital coverage requirement

A Whitepaper Prepared By MichegraveleMcCormac Managing Director Adastra Corporation states that the New Basel Capital Accord also known as Basel II has sparked on-going discussion in the global financial institution sector on risk management with volumes published on the formulae and risk modeling approaches that will be utilized to determine portfolio risk segments operational risk levels and the associated required capital allocation

Another study by FREDERIK C MUSCH on ldquoBASEL II IMPLEMENTATION IN THE MIDST OF TURBULENCErdquo states that the positive aspects introduced by Basel II capital regulation ndash namelyenhanced risk sensitivity and flexibility the increased importanceattached to risk mitigation techniques and an emphasis onsupervisory review and market discipline ndash are a step forward towards amodern and global banking regulatory framework Having beenimplemented under severe financial market conditions however Basel IIrsquosinherent

8

weaknesses were brought to the forefront compellinginternational regulators to revisit several of its aspects that might not havebeen adequately addressed under more benign market circumstances

Another research by John C DUGANamp Jennifer XI on ldquoUS IMPLEMENTATION OF BASEL IIrdquo states that much has been written about the Basel III agreement on capital and liquidity requirements for internationally active banks Far less attention has been paid to the status of international efforts to implement Basel II In particular there have been many questions about the slow pace of Basel II implementation in the United States compared to countries in Europe and Asia

There are many criticism of Basel II KPMG calls it a `Risk Management Revolution disguised as RegulationrsquoHariMisra on his special report on ldquoBasel II Framework and India Compliance Vs Opportunityrdquo states that risk-based financial regulation is inherently pro-cyclic pro-cyclicality means that banks governed by Basel II (capital tied to risks) will loosen credit in `good timesrsquo (when risk perceptions are low) and restrict it when times are bad (when risks rise again) If most banks act in this fashion having adopted the accord they would accentuate the crisis in bad times jeopardizing stability He also shows that Basel II requires heavy implementation cost amp it creates complexity in banking operation

Interpretation amp Analysis

Under Basel II all banks are required to maintain three pillars In pillar I (Minimum capital requirement) all banks are required to maintain capital that must at least 10 of risk weighted asset

Under pillar II (Supervisory Review Process) all banks must have a supervisory review process that is solely responsible for identifying risk of a particular bank amp making report to the Bangladesh Bank

Under pillar III (Market discipline) all banks are required to make proper disclosure on its maintaining minimum capital requirement amp supervisory review process

Now we will go for detail analysis regarding Basel II of different bankshelliphelliphellip

9

Eastern Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It has a separate Basel II unit

The Bank complied with all the required conditions except condition 14 (e) for maintainingregulatory capital as stipulated in the revised RBCA guidelines by Bangladesh Bank as perfollowing details

1048707The amount of Tier 2 capital will be limited to 100 of the amount of Tier 1 capital Status of Compliance Complied

1048707 50 of revaluation reserves for fixed assets and securities eligible for Tier 2capital Status of Compliance Complied

1048707 10 of revaluation reserves for equity instruments eligible for Tier 2 capitalStatus of Compliance There was no unrealized gain from quoted equities as on the reporting date

1048707Subordinated debt shall be limited to a maximum of 30 of the amount of Tier 1 capital Status of Compliance As on the reporting date there was no subordinated debt in the capital structure of EBL

1048707 Limitation of Tier 3 A minimum of about 285 of market risk needs to be supported by Tier 1 capital Supporting of Market Risk from Tier 3 capital shall be limited up to maximum of 250 of a bankrsquos Tier 1 capital that is available after meeting credit risk capital requirementStatus of compliance Capital required for meeting credit risks was BDT1101302 million against maintained tier i capital of BDT 1024407 million Capital required for meeting 285 of market risks was BDT 27331 million (BDT 95899 X 285) as on the reporting date So this condition is not met

10

Al-ArafahIslami Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Qualitative Disclosures(as of 31stDecember 2010)Figures in crore takab) The total amount of Tier-I capital 95828

Paid-up capital 46773Non- repayable share premium account -Statutory Reserve 16818General Reserve -Retained earnings 12748Minority interest in subsidiaries 19489Non-cumulative irredeemable preference shares -Dividend equalization account ndash

c) The total amount of Tier-2 and Tier-3 capital 9300d) Other deductions from capital -e) Total eligible capital 105128

C) Capital AdequacyByfollowing Standardized Approach for assessingand mitigating Credit Risk Standardized Rule Based Approach for quantifying Market Risk and Basic Indicator Approach for Operational measurement

For the consolidated group CAR1449

For stand aloneCAR 1256

11

Prime Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Quantitative disclosures (as of 31stDecember 2010)

Taka in MillionParticulars Solo Consolidated

The amount of Tier-1 capital (A)

I Fully Paid up capital 577637 577637

II Non repayable share premium account 224123 224123

III Statutory reserve 439163 439163

IV General reserve - -

V Retained earnings 269126 338390

VI Minority interest in subsidiaries - -

VII Non-cumulative irredeemable preference shares - -

VIII Dividend equalization account - -

Sub-Total (A) 1510049 1579313

The total amount of Tier 2 and Tier 3 capital (B) 567161 569171

Total eligible capital (A+B) 2077210 2148484

12

consolidated capital adequacy ratio1169

South east Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Quantitative disclosures(as of 31stDecember 2010)

The total amount of Tier-I capital 1515920Paid-up capital 831700Non- repayable share premium account -Statutory Reserve 451930General Reserve 24770Retained earnings 206760Minority interest in subsidiaries 770Non-cumulative irredeemable preference shares -Dividend equalization account -The total amount of Tier-2 and Tier-3 capital 384090Other deductions from capital -Total eligible capital1900010C) Capital Adequacy RatioFor the consolidated group1146For stand alone1150

13

Dhaka Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Quantitative DisclosureFor the year ended December 31 2009

Tk (Crore)Amount of Tier-1 capital1048707 Fully Paid-up CapitalCapital Deposited with BB 212771048707 Statutory Reserve 197021048707 General Reserve 0341048707 Retained Earnings 5323Total Tier-1 Capital 46336 Total amount of Tier-2 capital (net of deductions from Tier-2 capital) 10000Total eligible capital 56336

CAPITAL ADEQUACY (Qualitative Disclosure)Dhaka Bankrsquos policy is to maintain 1-2 higher than the minimum required capital

14

NCC Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Capital adequacy position and Basel II

Basel II accord to be implemented from 2010 (parallel 2009) places heavy reliance on the internal risk assessment and management technique for the purpose of quantifying and allocating capital for credit market and operational risks To cope with this new change NCC has already formed a committee for implementation of Basel II Capital Accord NCCrsquos total risk weighted assets (RWAs) and core capital stood BDT 41848 and BDT 3648 respectively as at 31 December 2008 The bank attained adequate capital level of 1061 (regulatory requirement is 10) as at 31 December 2008 This ratio was same in 2007 although the RWAs relatively less than RWAs of 2008

15

Social Islamic Bank Ltd

The Bank complied with all the required conditions for maintaining regulatory capital as stipulated in the RBCA guidelines by Bangladesh Bank for the year ended 31 December 2011 as per following detailsbull The amount of Tier II capital will be limited to 100 of the amount of Tier I capitalIt reported Tier I capital for an amount of BDT 82737 crore whereas Tier II capital was BDT‐ ‐12608 crore as on 31 December 2011 which is only 1524 of Tier I capital Status for‐ compliance Compliedbull Fifty percent (50) of Assets Revaluation Reserves shall be eligible for Tier II or Supplementary Capital Revaluation reserve for fixed assets was BDT 11385 crore as on 31 December 2011 whereas only 50 or BDT 5692 crore was accounted for as Tier II capital‐ Status for compliance Compliedbull A minimum of about 285 of market risk needs to be supported by Tier I capital Supporting of Market Risk from Tier III capital shall be limited up to a maximum of 250 of a bankrsquos Tier I capital available after meeting credit risk capital requirementsCapital required for meeting credit risks was BDT 65828 crore so the core (Tier I) capital aftermeeting credit risk was BDT 16909 crore Capital required for meeting 285 of market risks was BDT 6875 crore as on the reporting dates Status for compliance Compliedbull Up to 10 of revaluation reserves for equity instruments shall be eligible for Tier II Capital‐Page 2 of 16 No revaluation reserve for equity instrument maintained Status for compliance Compliedbull Subordinated Debt shall be limited to a maximum of 30 of the amount of Tier I capitalSIBL did not have any Subordinated Debt as on the reporting dates Status for complianceComplied

16

Dutch Bangla Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Quantitative Disclosures (for the year ended 31 December 2011)

The amount of Tier 1 capitalPaid up capital 20000Non-repayable share premium account 111Statutory reserve 36577General reserve -Retained earnings 20479Minority interest in subsidiaries -Non-cumulative irredeemable preference shares -Dividend equalization account 2574Total of Tier 1 capital 79740Total amount of Tier 2 and Tier 3 capital 30118Other deductions from capital [Deferred tax asset

17

against the specific loan loss provision] 4510Total eligible capital 105349

Capital Adequacy Ratio

For the consolidated group 112For stand-alone 112

Mutual trust Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Capital Adequacy

Mutual Trust Bankrsquos policy is to maintain 1-2 buffer capital ie higher than the minimum required capital The Bank strictly follows the guidelines of Bangladesh Bank regarding capital adequacy Bank has Capital Adequacy ratio of 1196as against the minimum regulatory requirement of 10 Tier-1 capital adequacy ratio is 810 against the minimum regulatory requirement of 5 The Bank policy is to manage and maintain its capital with the objective of maintaining strong capital ratio and high rating Due to sustainable growth in all aspects including advance 470055 Crore deposit 590508 Crore total eligible capital of the Bank surplus by 11327 Crore

18

Standard Bank Ltd

As per Bangladesh Bank guideline Eastern Bank Ltd has been working in compliance with Basel II It also has a separate Basel II unit

Tier-2 (Supplementary Capital)

Total amp Tier-1 Capital Ratio For the consolidated group

Total CAR 1092 Tier-1 CAR 985

Forstand alone Total CAR 1144 Tier-1 CAR 1033

19

Findings

In our study we have found the followings

1 All the banks are strictly following Basel II as per Bangladesh Bank guideline2 All the banks have maintained their capital adequacy ratio at least 10 of total risk

weighted asset that we have found in the Basel II disclosure made by the banks 3 All the banks have separate Basel II unit amp have supervisory review process that is solely

responsible for identifying the risks based on which the banks must maintain its capital 4 The supervisory review process is active for all the banks amp they make reports to he

Bangladesh Bank about the risk of the banks5 All the banks are in regulatory framework As a result the depositorrsquos interests are

protected as all the banks are maintaining their capital based on risk (credit risk financial risk amp operational risk)

6 Banks credibility has also been increased as one bank can compare their capital adequacy ratio (CAR) with other banks

7 Banks liquidity problem has been reduced

Recommendation

Although Basel II is an important tool for bank but it has some limitation Basel II has high implementation cost Its pillar II amp pillar III has yet to implement Moreover Basel II only recognize credit risk financial risk amp operational risk but it does not provide any method amp tools for calculating other risks such as liquidity risk strategic risk interest risk etc As a result Basel III has been undertaken by the Basel committee amp will be implemented from 2013

Conclusion

In fine we can say that besides some limitation Basel II is an important tool for both the bank amp its stakeholders If it is implemented properly it will create a new dimension in the banking sector As banking sector plays a vital role in the context of Bangladesh the proper implementation of Basel II in our country will contribute a large in our economy

20

Referrence

1048707 A text book on general banking L R Chowdhury (2009)

1048707 Banking Law amp Practices Sayed Ashraf Ali amp R A Hawladar (2009)

1048707Basel II disclosure Eastern Bank Ltd 2011

1048707Basel II disclosure Al-ArafahIslami Bank Ltd 2011

1048707Basel II disclosure Prime Bank Ltd 2010

1048707Basel II disclosure South east Bank Ltd 2011

1048707Basel II disclosure Dhaka Bank Ltd 2009

1048707Basel II disclosure NCC Bank Ltd 2010

1048707Basel II disclosure Social Islami Bank Ltd 2011

1048707Basel II disclosure Mutual Trust Bank Ltd 2011

1048707 Basel II disclosure Dutch Bangla Bank Ltd 2011

1048707Basel II disclosure Standard Bank Ltd 2011

1048707 Article by Richard J Herring on ldquoThe Rocky Road to Implementation of Basel II in the United Statesrdquo (2007)

1048707 Article by The Institute of International Finance Inc on ldquoThe Implementation of Basel IIrdquo ( November 2005)

1048707 Article by FREDERIK C MUSCH on ldquoBASEL II IMPLEMENTATION IN THE MIDST OF TURBULENCErdquo (June 2008)

1048707 Article by John C DUGAN amp Jennifer XI on ldquoUS IMPLEMENTATION OF BASEL IIrdquo( October 2008)

1048707 Basel Committee on Banking Supervision International Convergence of Capital Measurement and Capital Standards July 1988 (Basel I) available at httpwwwbisorgpublbcbs04apdf

1048707 Basel Committee on Banking Supervision International Convergence of Capital Measurement and Capital Standards A Revised Framework June 2004 rev June 2006 (Basel II) available at httpwwwbisorgpublbcbs128pdf

1048707 Basel Committee on Banking Supervision Basel III A Global Regulatory Framework forMore Resilient Banks and Banking Systems December 2010 rev June 2011 (Basel III) available at httpwwwbisorgpublbcbs189pdf

21