By S.K.Mishra Asstt. General Manager Central Bank Of India Mumbai OVERVIEW OF BASEL- II.

By

S.K.Mishra

Asstt. General Manager

Central Bank Of India

Mumbai

OVERVIEW OF BASEL- II

What is riskWhat is risk

Risks are uncertainties resulting in Risks are uncertainties resulting in adverse outcome in relation to planned adverse outcome in relation to planned objective or expectationsobjective or expectations

. Impact of such uncertainties could be . Impact of such uncertainties could be favourable as well as unfavourable favourable as well as unfavourable resulting in higher or lower variability in resulting in higher or lower variability in net cash flow effecting the profits. net cash flow effecting the profits.

Banking is a Business built on risk Banking is a Business built on risk

Bank acts as financial intermediary Bank acts as financial intermediary between fund providers & fund users.between fund providers & fund users.

While dealing with Depositors’ money & While dealing with Depositors’ money & creating financial assets out of that, bank creating financial assets out of that, bank has to undertake various types of risks. has to undertake various types of risks.

To do business, Bank has to take To do business, Bank has to take calculated risk i.e. calculated risk i.e. Risk-Reward EquilibriumRisk-Reward Equilibrium by by identifyingidentifying, , quantifyingquantifying, , pricingpricing, , monitoringmonitoring & & mitigatingmitigating risks through Risk risks through Risk Management processManagement process

4

It is more than compliance – it is about building value by optimizing, rather than minimizing risks

Risk management is not about avoiding risk. It helps you to be aware of the risks inherent in your business and take advantage of this knowledge to gain competitive advantage and enhance shareholder value

Valuecreates

shareholder wealth

Risk creates

opportunity

Opportunity creates value

Risk Management PhilosophyRisk Management Philosophy

• Why Capital?Why Capital?

Any business entity needs Capital. Capital is the base Any business entity needs Capital. Capital is the base on which business is expanded and profit is earned. on which business is expanded and profit is earned.

The Capital belongs to the owners or shareholders as The Capital belongs to the owners or shareholders as their stakes in the business, who earn profit or their stakes in the business, who earn profit or dividends proportionate to their capital, subject to the dividends proportionate to their capital, subject to the availability of profits for appropriation.availability of profits for appropriation.

Source of capital is limited & it is costly too. But scope Source of capital is limited & it is costly too. But scope of business growth is unlimited. of business growth is unlimited.

Capital has a capacity to absorb unexpected losses.Capital has a capacity to absorb unexpected losses. A banking business is no exceptionA banking business is no exception to this. to this.

Capital and Loss AbsorptionCapital and Loss Absorption Any business carries RISK of losses, expected or Any business carries RISK of losses, expected or

unexpected.unexpected. Expected LossesExpected Losses are cushioned through the ‘ are cushioned through the ‘Risk Based Risk Based

Asset Pricing Process’.Asset Pricing Process’. For exampleFor example, a vegetable seller knows that a small , a vegetable seller knows that a small

portion of the vegetables may rot or may not get sold portion of the vegetables may rot or may not get sold at the end of the day and accordingly adjusts his at the end of the day and accordingly adjusts his price to cover up this likely loss. As all vegetable price to cover up this likely loss. As all vegetable sellers do the same, he still remains competitive in sellers do the same, he still remains competitive in the marketthe market..

Unexpected losses are to be set off against Unexpected losses are to be set off against CapitalCapital. . Larger capital base gives a cushion to withstand Larger capital base gives a cushion to withstand

unexpected losses.unexpected losses. Thus a relationship of risk-weighted assets to capital Thus a relationship of risk-weighted assets to capital

was put in place & known as ‘Capital to Risk-weighted was put in place & known as ‘Capital to Risk-weighted Asset Ratio (Asset Ratio (CRARCRAR)’.)’.

Role of Capital in Management of Role of Capital in Management of RiskRisk

As per Basel accord aggregated risk As per Basel accord aggregated risk determines capital needs.determines capital needs.

Supply of capital is limited & capital has got Supply of capital is limited & capital has got its cost.its cost.

Whereas there is unlimited scope of business Whereas there is unlimited scope of business expansion & creation of assets. But supply of expansion & creation of assets. But supply of capital is limited to support the increasing capital is limited to support the increasing Risk weighted assets due to business growth. Risk weighted assets due to business growth.

Solution is in Basel –II.Solution is in Basel –II. It has stipulated less requirement of capital It has stipulated less requirement of capital

for good quality of assets, having lesser risk for good quality of assets, having lesser risk weight & assets with loss provision. weight & assets with loss provision.

What is BaselWhat is Basel

BASEL IS A PLACE IN SWITZERLAND BASEL IS A PLACE IN SWITZERLAND HOUSING THE HEADQUARTERS OF HOUSING THE HEADQUARTERS OF BANK FOR INTERNATIONAL BANK FOR INTERNATIONAL SETTLEMENTS (BIS)SETTLEMENTS (BIS)

BANK FORINTERNATIONALSETTLEMENTS,BASEL,SWITZERLAND.

What is Bank International for What is Bank International for

International Settlements (International Settlements (BIS)BIS) Established in 1930 to promote co operation among central Established in 1930 to promote co operation among central

banks of member countries. Members consist of central banks of member countries. Members consist of central banks of various countriesbanks of various countries

Recommendations will help countries for convergence Recommendations will help countries for convergence towards common approaches & standards towards common approaches & standards

It is widely accepted as international standard of best It is widely accepted as international standard of best practices in bankingpractices in banking

The committee recommendations do not have any legal The committee recommendations do not have any legal binding but are the accepted international best practicesbinding but are the accepted international best practices’’

The BIS has currently 55 central banks as members including The BIS has currently 55 central banks as members including India India

BASEL - GENESISBASEL - GENESIS Herstatt Bank, Frankfurt in Germany failed on Herstatt Bank, Frankfurt in Germany failed on

26 June 74. Banking license was withdrawn 26 June 74. Banking license was withdrawn after close of banking hours. Correspondent after close of banking hours. Correspondent bank in N.Y. suspended payments in New bank in N.Y. suspended payments in New York. Banks which were to receive $ funds did York. Banks which were to receive $ funds did not get the same.not get the same.

Settlement risk Settlement risk Failure of many such banks lead to make Failure of many such banks lead to make

regulators think of uniform regulation of regulators think of uniform regulation of banking sector across the globe.banking sector across the globe.

Herstatt BankHerstatt Bank

The Time Zone difference is 5.00 The Time Zone difference is 5.00 Hours and US is lagging behindHours and US is lagging behind

date Time in US Time in Germany

26.06.1974 10.00a.m 3.00 p.m..

Settlement Time before 3.30P.M. The bank was liquidated

What is BASEL What is BASEL COMMITTEE -COMMITTEE -

A COMMITTEE ON BANKING REGULATIONS AND SUPERVISORYA COMMITTEE ON BANKING REGULATIONS AND SUPERVISORY PRACTICES KNOWN AS BASEL COMMITTEE ESTABLISHED INPRACTICES KNOWN AS BASEL COMMITTEE ESTABLISHED IN 1974 IS KNOWN AS BASEL COMMITTEE1974 IS KNOWN AS BASEL COMMITTEE

BASEL COMMITTEE IDENTIFIED CAPITAL ADEQUACY AS THE BASEL COMMITTEE IDENTIFIED CAPITAL ADEQUACY AS THE CORE PRINCIPLE FOR EFFECTIVE BANKING SUPERVISIONCORE PRINCIPLE FOR EFFECTIVE BANKING SUPERVISION

THE OBJECTIVE OF CAPITAL ADEQUACY REQUIREMENT IS AN THE OBJECTIVE OF CAPITAL ADEQUACY REQUIREMENT IS AN INSURANCE AGAINST RISK OF DEFAULT OR UNEXPECTED INSURANCE AGAINST RISK OF DEFAULT OR UNEXPECTED LOSSES LOSSES

FIRST ACCORD ON CAPITAL ACCORD WAS ESTABLISHED IN FIRST ACCORD ON CAPITAL ACCORD WAS ESTABLISHED IN 19881988

CAR at 9% OF CAPITAL CAR at 9% OF CAPITAL

Implemented in India In 1992-93

1.Income Recognition2.Asset Classification3.CRAR

•Interest not paid by the borrower not be considered as income•Classification into Sub-standard, Doubtful and Loss Assets•Their provision requirement depending on the age.•CRAR – 9% of the Capital of the Assets of the Balance Sheets

This turned the TNW of almost all Indian Banks into –ve.Govt. had to infuse Rs.100 millions into Banks to meet this Ratio.

Basel I - Dec 1988

NEED FOR Basel IINEED FOR Basel II Basel I adopted a ‘Basel I adopted a ‘One Size fits AllOne Size fits All’ approach ’ approach

and covered only Credit Risk and market Risk. and covered only Credit Risk and market Risk. Risk weights are same for good and bad Risk weights are same for good and bad

quality of credit.quality of credit. NPAs & Standard Assets attract same NPAs & Standard Assets attract same

quantity of capital.quantity of capital. Market Risk was not covered initially and the Market Risk was not covered initially and the

subsequent proposals treated all subsequent proposals treated all investments as similar.investments as similar.

Operational Risk was not addressed at all.Operational Risk was not addressed at all. Basel I did not address the issue of supervisory Basel I did not address the issue of supervisory

control and review process.control and review process. Basel I did not address the issues of Market Basel I did not address the issues of Market

Discipline by way of adequate and quality Discipline by way of adequate and quality disclosures by banks.disclosures by banks.

Introduction of new financial productsIntroduction of new financial products

Objectives of Basel-IIObjectives of Basel-II

For strong , sound and stability of For strong , sound and stability of international banking systemsinternational banking systems

More risk sensitive More risk sensitive New paradigm for allocating New paradigm for allocating

regulatory capitalregulatory capital

1988 Accord - talked about mainly on Credit Risk 1996 BCBS guidelines on Market Risk was introduced2008/2009 Basel II Accord – Introduces Operational Risk.

Basel Committee experts say – Bank’s should have their own capital to cover all the potential losses.

It specifies how much cushion/capital a bank should have against the risk involved with the Credit. (Capital Charge calculation) market risk and Operational risk

Features of BASEL-II

All Commercial banks in India (except Local Area Banks and Regional Rural Banks) shall adopt:

Standardized Approach for Credit Risk

Basic Indicator Approach for Operational Risk

Standardized Duration Approach for Market Risk

On or before the following dates –

31.03.2008 - for those Indian banks having overseas presence and all foreign banks operating in India.

31.03.2009 - all other Banks

BASEL II IMPLEMENTATION IN INDIA

Three pillars of the Basel II framework

– Credit risk

– Operational risk

– Market risk

– Bank’s own capital strategy

– Supervisor’s review

– Enhanced disclosure

Minimum Capital Requirements

Supervisory Review Process

Market Discipline

Pillar I – Minimum Capital Pillar I – Minimum Capital RequirementsRequirements

The new Accord maintains the current definition of total capital and the minimum 8% requirement*

Total capital = Tier 1 + Tier 2Tier 1: Shareholders’ equity + disclosed reservesTier 2: Supplementary capital (e.g. undisclosed reserves, provisions)

Total Capital

Market Risk The risk of losses in trading positions when prices move adversely

Credit Risk The risk of loss arising from default by a creditor or counterparty

Operational Risk The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events

Total capitalCredit risk + Market risk + Operational risk

= Bank’s capital ratio (minimum 9%)

* The revisions affect the denominator of the capital ratio - with more sophisticated measures for credit risk, and introducing an explicit capital charge for operational risk

TIER I TIER I (PURE CAPITAL)(PURE CAPITAL)

TIER II TIER II ( MAX. 100% OF TIER I)( MAX. 100% OF TIER I)

PAID UP EQUITY PAID UP EQUITY CAPITALCAPITAL

REVALUATION RESERVEREVALUATION RESERVE

SHARE PREMIUMSHARE PREMIUM GEN. PROVISIONS & LOSS GEN. PROVISIONS & LOSS RESERVESRESERVES

STATUTROY RESREVESTATUTROY RESREVE HYBRID DEBT CAPITAL HYBRID DEBT CAPITAL INSTRUMENTSINSTRUMENTS

CAPITAL RESERVECAPITAL RESERVE(surplus out of sale (surplus out of sale proceeds of Assets)proceeds of Assets)

SUBORDINATED DEBTSUBORDINATED DEBT

INNOVATIVE PERPETUAL INNOVATIVE PERPETUAL DEBT INSTRUMENTSDEBT INSTRUMENTS

15% 15% OF OF TOTAL TOTAL TIER iTIER i

UNDOSCLOSED UNDOSCLOSED PROVISIONSINVESTMENT PROVISIONSINVESTMENT FLUCTUATION RESERVEFLUCTUATION RESERVE

TIER I CAPITAL: This one can absorb losses without a bank being required to cease operation. This is Core Capital.

TIER II CAPITAL: This can absorb losses in the event of a winding up, and also provides lesser degree of protection to depositors.

Limit to raise Tier II Limit to raise Tier II capital capital

Banks are not allowed to raise Tier IIBanks are not allowed to raise Tier II

Capital more than Tier I. In other Capital more than Tier I. In other words Tier II capital is capped at words Tier II capital is capped at 100%of Tier I capital100%of Tier I capital

Within Tier II capital banks can raise Within Tier II capital banks can raise subordinated debts upto the subordinated debts upto the maximum of 50 % of Tier I capitalmaximum of 50 % of Tier I capital

Capital to Risk Weighted Assets Capital to Risk Weighted Assets RatioRatio

This is the ratio that the Capital Fund bears This is the ratio that the Capital Fund bears with the Total Risk Weighted Assets of the with the Total Risk Weighted Assets of the Bank.Bank.

Capital fund is the sum total of Tier I and Capital fund is the sum total of Tier I and Tier II capital.Tier II capital.

Risk Weighted Assets is calculated by Risk Weighted Assets is calculated by converting the assets on a specified date/ converting the assets on a specified date/ balance sheet date (on which that CRAR balance sheet date (on which that CRAR has to be calculated) at a prescribed risk has to be calculated) at a prescribed risk weight factors for various categories. weight factors for various categories.

BASLE IICLAIMS OF DOMESTIC SOVEREIGNS

1. Both Fund based & Non-Fund based claims on Govt. - 0% RW

2. Central Govt. Guaranteed Claims will also attract - 0% RW

3. Investment in State Govt. Securities - 0% RW

4. State Govt. Guaranteed Claims - 20% RW

5. Claims on RBI, DICGC & CGTSME - 0% RW

6. Claims on ECGC - 20% RW

• The above RW will be applicable as long as they are classified as Standard/Performing Assets.

Risk ManagementRisk ManagementRisk Identification would mean Risk Identification would mean

recognition of all possible risks in the recognition of all possible risks in the particular business in question & particular business in question & examining its impact on cash flow, examining its impact on cash flow, then prioritize them to manage at then prioritize them to manage at Micro or Macro level. and begins withMicro or Macro level. and begins with

1.Risk Identification1.Risk Identification

2.Risk Measurement2.Risk Measurement

3.Risk Monitoring & Control3.Risk Monitoring & Control

4.Risk Mitigation4.Risk Mitigation

MarketMarket

CreditCredit

OperationalOperational

Risk Identification Risk Identification Type of Risk

OUR FOCUS BASEL I

Credit RiskCredit Risk

What is a credit risk and when does it What is a credit risk and when does it arisearise

A credit risk arises on account of A credit risk arises on account of default by a borrower in repayment default by a borrower in repayment of interest and/or Installmentsof interest and/or Installments

Credit Risk - FrameworkCredit Risk - Framework

What are the risk What are the risk Which, when and how much to Which, when and how much to

accept that results in improving accept that results in improving bottom linebottom line

How can we monitor and controlHow can we monitor and controlCan we reduce… how?Can we reduce… how?

Credit Risk – Organisational Credit Risk – Organisational structurestructure

Board of Directors Board of Directors Risk Management CommitteeRisk Management CommitteeCredit Policy CommitteeCredit Policy CommitteeCredit Risk management DepartmentCredit Risk management Department

Credit Risk - TypesCredit Risk - Types

Portfolio Risk Portfolio Risk

- Concentration Risk- Concentration Risk

- Systematic- SystematicTransactionTransaction

- Default - Default

- Down grade- Down grade

Credit Risk - MeasurementCredit Risk - Measurement

Rating ModelRating Model

QuantificationQuantification

Manage Portfolio qualityManage Portfolio quality

Quantitative ceilingQuantitative ceilingEvaluation of rating wise distributionEvaluation of rating wise distribution Industry / sector wise monitoringIndustry / sector wise monitoringTarget for probable defaults / Target for probable defaults /

provisioningprovisioningRapid port folio reviewRapid port folio reviewDiscriminatory time schedule for Discriminatory time schedule for

reviewreview

Credit Risk ManagementCredit Risk ManagementInstrumentsInstruments Appraisal process Appraisal process Risk analysisRisk analysis Credit Audit / Loan reviewCredit Audit / Loan review MonitoringMonitoringGuidelinesGuidelines Approving authority/ Delegation of powerApproving authority/ Delegation of power Credit appraisalCredit appraisal Prudential limitsPrudential limits Rating standards and Bench marksRating standards and Bench marks Risk pricingRisk pricing

Credit Risk MitigationCredit Risk Mitigation

Securitisation Securitisation Credit DerivativesCredit DerivativesCredit default swapsCredit default swapsCredit Linked notesCredit Linked notesTotal return swapsTotal return swaps

RISK MONITORING & CONTROLRISK MONITORING & CONTROL

1.Organizational Structure2.Comprehensive Risk Management

Approach3.Policy Adoption at the Corporate

level4.Guidelines5.Strong MIS6.Well laid-out Procedures7.Periodical reviews and Evaluations8.Audit reports

Categories of Exposure

Exposures in five categories because of different risk characteristics

1.DOMESTIC SOVEREIGNS2.BANKS3.CORPORATES4.RETAIL PORTFOLIOS5.NPA

CLAIMS ON BANKSCLAIMS ON BANKS

Claims on Scheduled Banks, which Claims on Scheduled Banks, which comply with the minimum CRAR comply with the minimum CRAR prescription of RBIprescription of RBI

20%20%

Claims on Non-Scheduled Banks Claims on Non-Scheduled Banks which comply with the minimum which comply with the minimum CRAR prescription of RBICRAR prescription of RBI

100%100%

BASLE IICLAIMS OF DOMESTIC SOVEREIGNS

1. Both Fund based & Non-Fund based claims on Govt. - 0% RW

2. Central Govt. Guaranteed Claims will also attract - 0% RW

3. Investment in State Govt. Securities - 0% RW

4. State Govt. Guaranteed Claims - 20% RW

5. Claims on RBI, DICGC & CGTSME - 0% RW

6. Claims on ECGC - 20% RW

• The above RW will be applicable as long as they are classified as Standard/Performing Assets.

Eligible financial collateralEligible financial collateral Cash EQUIVALENT, CDs, Counter party Cash EQUIVALENT, CDs, Counter party

deposit with lending Bank.deposit with lending Bank. Gold – bullion & jewellery (99.99 purity)Gold – bullion & jewellery (99.99 purity) Central & State Govt. securitiesCentral & State Govt. securities , KVP, NSC, LIC policy, KVP, NSC, LIC policy Debt securities rated by recognized credit Debt securities rated by recognized credit

rating agencyrating agency PSEs – at least BB ratingPSEs – at least BB rating Other entities – at least AOther entities – at least A ST debt instruments – at least ST debt instruments – at least

P2+/A3/PL3/F3P2+/A3/PL3/F3 Mutual Fund units – daily NAV to be available Mutual Fund units – daily NAV to be available

on public domain on public domain

Retail PortfolioRetail PortfolioRetail Category - The maximum aggregated Retail exposure to one counterparty should not exceed the absolute threshold limit of Rs. 5 Crores. (If the turnover is more than 50 Crores it will be classified as CorporateRegulatory retail should not be confused with our Retail lending schemes No Rating is required A flat rate of 75% standard Risk Weight will be applicable.

With following EXCEPTIONS –1.Real Estate Exposure2.Housing Loan3.Consumer Credit, NBFC and IPO Finance4.Staff Loans

SlSl RETAIL CATEGORYRETAIL CATEGORY Amt. ThresholdAmt. Threshold RW (%)RW (%)

11 REAL ESTATEREAL ESTATE 100%100%

22 HOUSING LOAN HOUSING LOAN

Up to Rs.30 LakhUp to Rs.30 LakhWhere LTV is> 75%Where LTV is> 75%

Above Rs.30 LakhAbove Rs.30 LakhWhere LTV is > 75%Where LTV is > 75%

50%50%75%75%

75%75%100%100%

33 CONSUMER CREDITCONSUMER CREDITNBFC NBFC IPO FINANCEIPO FINANCE

125%125%

44 STAFF LOANSSTAFF LOANS Secured by PFSecured by PF

OthersOthers

20%20%

75%75%

LTV - LOAN TO VALUE RATIO SHOULD NOT EXCEED 75% WHERE LTV =Total Outstanding ( principal + Int.+ Other Charges)

----------------------------------------------------------- Realizable Value of the property mortgaged

Corporate Corporate Exposure to a party irrespective of constitution if the Exposure to a party irrespective of constitution if the

following conditions are satisfiedfollowing conditions are satisfied

The total Exposure sanctioned limit or outstanding The total Exposure sanctioned limit or outstanding (whichever is higher ) above 5 Crores (whichever is higher ) above 5 Crores

Average turnover for three years is more than RS 50 Average turnover for three years is more than RS 50 Crores Crores

ALL CORPORATE TO BE RATED BY AN EXTERNAL ALL CORPORATE TO BE RATED BY AN EXTERNAL AGENCY IDENTIFIED BY RBIAGENCY IDENTIFIED BY RBI

RISK WEIGHT WILL BE AS PER THE RATING RISK WEIGHT WILL BE AS PER THE RATING

CAPITAL CHARGE FOR CREDIT RISKStandardized Approach - Rating assigned by the eligible external credit rating agencies will support the measure of credit Risk. Reserve Bank of India has identified 4 such domestic external Credit rating Agencies under the revised Framework. These are :1. CARE2. CRISIL 3. FITCH 4. ICRA

SHORT TERM RATINGSSHORT TERM RATINGS RWRW

CARECARE CRISILCRISIL FITCHFITCH ICRAICRA

PR1+PR1+ P1+P1+ F1+F1+ A1+A1+ 20%20%

PR1PR1 P1P1 F1F1 A1A1 30%30%

PR2PR2 P2P2 F2F2 A2A2 50%50%

PR3PR3 P3P3 F3F3 A3A3 100%100%

PR4 / PR4 / PR5PR5

P4 & P4 & P5P5

B,C, DB,C, D A4 / A4 / A5A5

150%150%

unrateunratedd

unrateunratedd

unrateunratedd

unrateunratedd

100%100%

LONG TERM RATINGSLONG TERM RATINGS RWRW

AAAAAA 20%20%

AAAA 30%30%

AA 50%50%

BBBBBB 100%100%

BB & BelowBB & Below 150%150%

UnratedUnrated 100%100%

Unrated Accounts-Risk Unrated Accounts-Risk weightweight

Unrated exposure of Rs.50 Crores Unrated exposure of Rs.50 Crores and above will attract 150% risk and above will attract 150% risk weight during financial year 2008-weight during financial year 2008-2009.2009.

With effect from1.4.2009 for With effect from1.4.2009 for exposures beyond 10.00 Crores risk exposures beyond 10.00 Crores risk weight will be 150%.weight will be 150%.

Unrated Corporates to attract risk Unrated Corporates to attract risk weight of 100% w.e.f 15weight of 100% w.e.f 15thth Nov,2008 Nov,2008

Corporate Exposure - ExampleCorporate Exposure - Example

Rating Exposure (Rs.)

Risk Wt.

Risk Wt. Asset (Rs.)

Capital Req. @ 9% (Rs.)

AAA 100.00 20% 20.00 1.80

AA 100.00 50% 50.00 4.50

A 100.00 100% 100.00 9.00

Unrated 100.00 125% 125.00 11.25

BBB & below

100.00 150% 150.00 13.50

Risk Weights - ExampleRisk Weights - Example Say a bank has four assets/advances with Say a bank has four assets/advances with

varying degree of Risks as follows:varying degree of Risks as follows:

Asset Category

Amount

(Rs. Crore)Risk Wt.

Risk wt. Asset (Rs.Cr.)

Capital Req. @ 9%

A 150.00 20% 30.00 2.70

B 150.00 50% 75.00 6.75

C 100.00 75% 75.00 6.75

D 50.00 100% 50.00 4.50

Total 450.00 230.00 20.70

Capital Req. for Risk Wt. Asset of Rs 230 Crores @ 9% = Rs 20.70 Crore

In case All Asset of Rs 450 Crores carries a weight of 100 %, Capital requirement would be @ 9% = Rs 40.50 Crores

Risk Weights for NPAsRisk Weights for NPAs

Under Basel I Accord, NPAs were treated like Under Basel I Accord, NPAs were treated like any standard asset for the purpose of risk any standard asset for the purpose of risk weights for capital allocation.weights for capital allocation.

Basel II Accord gives a separate treatment for Basel II Accord gives a separate treatment for NPAs. ‘Higher the provision made, lower will be NPAs. ‘Higher the provision made, lower will be the Risk weight’.the Risk weight’.

NON PERFORMING ASSETS

RWRW

When Specific When Specific Provision areProvision are

Less than 20% of the Less than 20% of the outstanding amount of NPAoutstanding amount of NPA

150%150%

More than 20% but less than More than 20% but less than 50% of the outstanding 50% of the outstanding amount of NPAamount of NPA

100%100%

Equal to or more than 50% of Equal to or more than 50% of the outstanding amount of NPAthe outstanding amount of NPA

50%50%

OFF BALANCE SHEET ITEMSThe risk-weighted amount of an off-balance sheet item that gives rise to credit exposure is generally calculated by means of a two-step process.

1.The notional amount of the transaction is converted into a credit equivalent amount, by multiplying the amount by the specified Credit Conversion Factor.2.The resulting credit equivalent amount is multiplied by the Risk Weight applicable to the counterparty or to the purpose for which bank has extended the finance or the type of asset, which ever is higher.

SlSl InstrumentsInstruments CCFCCF

11 General Guarantees of indebtedness General Guarantees of indebtedness (includes standby LC serving as (includes standby LC serving as Financial guarantee)Financial guarantee)

100%100%

22 Performance Bonds, Bid Bonds, Performance Bonds, Bid Bonds, Indemnities, Standby LCIndemnities, Standby LC

50%50%

33 Short Term trade LC for both issuing Short Term trade LC for both issuing and confirming Banksand confirming Banks

20%20%

Market RiskMarket Risk

Any adverse change in the market Any adverse change in the market rates which affects the investment rates which affects the investment portfolio, is called a market riskportfolio, is called a market risk

It is managed by Treasury It is managed by Treasury Department Central OfficeDepartment Central Office

59

What is Operational RiskWhat is Operational Risk

The risk of loss resulting from The risk of loss resulting from inadequate or failed internal processes, inadequate or failed internal processes, people and systems or from external people and systems or from external events” events”

Operational Risk

Operational Risk refers to the risk of losses resulting from inadequate or failed internal processes, people, and systems or from external events. Management' of operational risk is taken to mean the 'identification, assessment, monitoring and control / mitigation' of this risk.Basel-II requires specific capital allocation accounting for Operational Risk.

Internal fraud- Employees committing frauds, either in collusion with the customers , or on their own . For example,

External fraud- From outside source People oriented- Negligence Process Oriented- Inadequate procedures &

supervision. Technology Oriented- Poor or obsolete

technology, inadequate maintenance. External Cause- Natural calamity, social or

political context, legal liability.

Events having the Potential to Result in Substantial Losses

Capital Allocation for Capital Allocation for Operational RiskOperational Risk

There are 3 approaches for allocation for There are 3 approaches for allocation for capital under Operational Risk : capital under Operational Risk :

- Basic Indicator ApproachBasic Indicator Approach

- Standardised ApproachStandardised Approach

- Advanced Measurement Approaches Advanced Measurement Approaches (AMA)(AMA)

- Basic Indicator ApproachBasic Indicator Approach requires banks to set aside requires banks to set aside capital equal to 15 per cent of the average annual gross capital equal to 15 per cent of the average annual gross income over the previous three years when gross income over the previous three years when gross income was positive.income was positive.

Strategy for Reducing operational Strategy for Reducing operational

RiskRisk Meticulous compliance of system and Meticulous compliance of system and

procedures procedures Compliance of KYC NormsCompliance of KYC Norms

Increase in fee based business of the Bank Increase in fee based business of the Bank particularly insurance income, mutual fund etc.particularly insurance income, mutual fund etc.

Examination of each activity from Risk Angle.Examination of each activity from Risk Angle.

Identifying and designating one Risk officer in Identifying and designating one Risk officer in each department/Regional Office Level each department/Regional Office Level

Expectations Expectations Profitability is the key for improved Profitability is the key for improved

CRAR. Every one can contribute to CRAR. Every one can contribute to Capital through surplus Reserve.Capital through surplus Reserve.

i.i. Reduction in NPA & recovery in Reduction in NPA & recovery in written off accounts.written off accounts.

ii.ii. Canvassing fee based business from Canvassing fee based business from selling Insurance/ MF products etc.selling Insurance/ MF products etc.

iii.iii. Meticulous compliance of systems & Meticulous compliance of systems & procedures thereby reducing credit procedures thereby reducing credit & operational risk.& operational risk.

Conclusion Conclusion

Risk is central concern spanning whole Risk is central concern spanning whole of Balance Sheet.of Balance Sheet.

RM is for improving performance, RM is for improving performance, earnings and Net Worth.earnings and Net Worth.

Enables appropriate price to minimize Enables appropriate price to minimize expected losses and provisions.expected losses and provisions.

Enables appropriate capital for Enables appropriate capital for unexpected losesunexpected loses

A JOURNEY FROM COMPLIANCE TO A JOURNEY FROM COMPLIANCE TO PROFITPROFIT