BFM-Ch-_10_-_Module_B

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Prepared By: Jagat Nagar (M : 9909792440)- [email protected]

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Risk Regulations in Banking Industry

CAIIB

Bank Financial Management

Module B

Risk Management

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Systemic Risk: It is risk of failure of the whole banking system.Individual bank's failure is one of the major sources of thesystemic Risk.

Basel Committee on Banking Supervision (BCBS)- establishedfor risk-based regulation in a changed world envirnment.

The Risk of settlement that arises for time difference came to beknown as 'Herstatt Risk'

Basel Commitee established Basel-1 in year 1988 and in year1996 many changes take place and Basel-2 enforce.

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Reason for change Basel-1 to Basel-2:1. Credit Risk assessment under Basel-I was not risk-sensitive

enough.2. Financial decisions are not based on economic opportunities.3. It did not recognize the role of credit risk mitigants.4. It did not take into account operational risk of banks.5. Better NPA Management6. Almost all banks and RRBs in good financial health- meet

CRAR nomr

7. Explosion of new- customer centric products and Moreemployment.

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The Basel-2 accord is based on 3 pillars:1. Minimum Capital requirement2. Supervisory Review process3. Market Discipline

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Basel II First Pillar: Minimum Capital requirement :It is based on credit, market and operational risk to

(a) Reduce risk of failure by cushioning against losses.(b) Provide continuing access to financial markets to meet

liquidity needs, and(c) Provide incentives for prudent risk management

Minimum Capital requirement is calculated by:1. Capital for Credit risk

2. Capital for Market risk3. Capital for Operational risk

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Standardised:

- The standardised approach establishes fixed risk weightscorresponding to each supervisory category and make use ofexternal credit.- Specific provisions has already been set aside by the bank agianstthat loan. Like retail and SMEsectors a uniform risk weight of 75%.- Most Japanese banks will start Basel II as standardised banks

- Most US banks will stay under Basel I

Foundation IRB (Internal Rating Based)- Measure credit risk using sophisticated formulas using internally

determined inputs of probability of default(PD) and inputs fixed byregulators of loss Given default(LGD), exposure at default(EAD)and maturity(M).

- More risk sensitive loan require more capital.- Most European banks will likely qualify for Foundation IRB status at

start of Basel II

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Advanced IRB (Internal Rating Based)

- Measure credit risk using sophisticated formulas and internally

determined inputs of PD, LGD, EAD and M- Transition to Advanced IRB status only with robust internal risk

Management systems and data- Top 10 US banks expected to implement Advanced IRB at start of Basel II

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Basel II

Second Pillar - Supervisory review process

Qualitative supervision by regulators of internal bank risk control andCapital assessment process, including supervisory power to requirebanks to hold more capital than required under the First Pillar

Four key principles of supervisory review

Principle 1: Banks should have process for assessing overall capitaladequacy in relation to risk profile and strategy for maintaining capitallevels.Five main features of rigorous process:1. Board and senior management oversight2. Sound capital assessment3. Comprehensive risk analysis (credit risk, operational risk, market risk,interest rate risk in banking book, liquidity risk, other risk)4. Monitoring and reporting5. Internal control review

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Basel II Third Pillar Market Discipline

Impose market discipline on banks by requiring disclosure of keyinformation relevant to banks risks and capital Qualitative Disclosuresfor Securitisation

1. Banks objectives for, and roles played by it in, securitisationprocess2. Banks accounting objectives for securitisation3. Whether treated as sales or financings4. Whether bank recognises gain on sale

5. Key assumptions used by bank for valuing retained interests6. Banks treatment of synthetic securitisations7. Names of rating agencies used by bank and types of exposuresrated by each agency

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Example Page no : 213 for determining adjusted Exposure:

Example page no : 224 fo computation of Total CRAR and Tier ICRAR

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Q Given that Tier I capital is Rs. 500 crores and Tier II capital Rs. 800crores and further given that RWA for credit risk Rs. 5000 crores,capital charge for market risk and operational risk Rs. 200 crores andRs. 100 respectively,

Answer the following questions.

1. What are the risk weighted assets for operational risk?*1) Rs. 1250 cr 2) Rs. 1500 cr 3) Rs. 1111 cr 4) Rs. 2000 cr

2. What are the risk weighted assets for market risk?*1) Rs. 1000 cr 2) Rs. 1500 cr 3) Rs. 2000 cr 4) Rs. 2222 cr

3. What are the total risk weighted assets?*1) Rs.7250 cr. 2) Rs. 8333 cr. 3) Rs. 9000 cr. 4) Rs. 7800 cr.

4. What is the Tier I capital adequacy ratio?*1) 0.0555 2) 0.0581 3) 0.0600 4) 0.0668

5. What is the total capital adequacy ratio?*1) 0.1486 2) 0.1111 3) 0.1200 4) 0.1282

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6. CRAR is _________*

1) Tier I capital / Total RWAs 2) Tier II capital / Total RWAs

3) Regulatory Capital / Total RWAs 4) Tier I and II capital/ TotalRWAs

Answers : 1. - 3 2. - 4 3. - 2 4. - 3

5. - 3 6. - 3

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Case Study:Calculation of capital

International bank has:Paid up capital - Rs. 100 cr.Free reserves - Rs. 300 cr.Provisions and contingencies reserves - Rs. 200 crRevaluation reserve - Rs. 300 cr.Perpetual non-cumulative preference shares - Rs. 400 crSubordinated debt- Rs. 300 cr

Risk weighted assets for credit and operational risk - Rs.10000 crRisk weighted assets for market risk - Rs. 4000 cr.

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Tier-I= Capital + Free Reserves + Perpetual non-cumulativepreference shares

Tier-II= Provisions and contingencies reserves or 1.25% of riskweighted assets (Which ever is less)

Total Capital Fund= Tier-I + Tier-II

Capital Adequacy Ratio= Total Capital Fund / Total RWA

Minimum Capital= RWA * 9%

Tier-I capital is equal or more than Tier-II Capital

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Based on information give answer the following questions:1. What is the amount of Tier-I capital?a. 900 cr b. 800 cr c. 750 cr d. 610 cr

2. What is the amount of Tier-II capital?a. 900 cr b. 800 cr c. 750 cr d. 610 cr

3. Calculate the amount of Capital funda. 895 cr b. 1255 cr c. 1410 cr d. 1675 cr

4. What is the capitaladequacyratio ofthe bank?a. 9% b. 9.65 % c. 10.05 % d. 10.07 %

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5. What is amount of minimum capital to support credit andoperationalrisk?a. 900 cr b. 950 cr c. 1000 cr d. 1250 cr

6. What is the amount of minimum Tier-I and Tier-II to support thecredit and operational Risk?a. 900 cr,900 cr b. 600 cr,900 cr c. 450 cr,450cr d. 300 cr,450cr

7. What is the amount of Tier-I capitalfund, to support market risk?a. 450 cr b. 350 cr c. 250 cr d. 185 cr

8. What is the amount of Tier-II capital fund, to support market risk?a. 450 cr b. 350 cr c. 250 cr d. 160 cr

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Answers: 1-b 2-d 3-c 4-d5-a 6-c 7-b 8-d

Q. General provisions will be admitted upto a maximum of ____ ofRWAs*

1) 0.01 2) 0.025 3) 0.0125 4) 0.015

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Thank You

BFM-Ch-_10_-_Module_B

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