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BASEL Committee on Banking Supervision

Keep an eye on BCBS website

www.bis.org/BCBS

THE FIRST BASEL ACCORD

The first Basel Accord (Basel-I) was completed

in 1988
1988 BASEL ACCORD (BASEL-I)

1)The purpose was to prevent international banks from

building business volume without adequate capital
backing
2) The focus was on credit risk
3) Set minimum capital standards for banks
4) Became effective at the end of 1992

Basel I

Minimum capital ≥
requirements

Risk-weighted Definition of
Assets Capital
(Denominator) (Numerator)

Credit Risk Market Risk

(1988) (1996)

Standardized Models
Approach Approach
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Basel 1988

Capital Adequacy Ratio =

Capital (Tier1+Tier2)
‫ = ـــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــ‬8 %
Risk Weighted Assets (Credit Risk)

1996 Market Risk + Tier 3

BASEL-I CAPITAL REQUIREMENTS

Capital was set at 8% and was adjusted by a

loan’s credit risk weight
Credit risk was divided into 5 categories: 0%,
10%, 20%, 50%, and 100%
▫ Commercial loans, for example, were assigned to
the 100% risk weight category
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Example

Corporates : 100 million

Risk Weighted Assets = Asset * Risk weight
RWA = 100 * 100%
RWA = 100
Minimum Capital Requirements= 100* 8%
MCR = 8
Observe : All Corporate Credit Portfolio with
RW 100%

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Three Reinforcing Pillars under Basel II

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99.9% Shaded area is equal to

1 - confidence level

Frequency

Potential
loss rate
Expected loss: Unexpected loss: Unexpected loss: NOT covered
covered by provisions covered by capital
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Capital Requirement under Basel II

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Risk Measurement

Credit Risk
Operational Risk
Market Risk

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Standardized Approach
Under this approach,the bank allocates certain risk
weightings for each category of assets and off-balance
sheet items depends on External Credit Rating Agencies
(ECRA) to arrive at a total figure for risk-weighted assets
(RWA)

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Standardized Approach – Risk Weights

3 Claims on banks of an original maturity of less than three months

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Calculate the risk weighted assets and minimum

capital requirements for the following exposures:

Asset Rate Value Provisions

Bank- option1 A 230 7
Mortgages 80 2
Company1 BBB 150 15
Company2 A- 90 4.5
Auto Loan 50 2
Company3 Unrated 70 3.5
Total 670 34
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RWA & Capital Requirements

Capital
Asset Rate Value Provisions Exposure RW RWA
Req.

Bank- option1 A 230 7 223 %50 112 8.9

Mortgages 80 2 78 %35 27 2.2

Company1 BBB 150 15 135 %100 135 10.8
Company2 A- 90 4.5 86 %50 43 3.4
Auto Loan 50 2 48 %75 36 2.9

Company3 Unrated 70 3.5 67 %100 67 5.3

Total 670 34 636 419 33.5

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Internal Risk Rating-based Approach

The IRB approach recognizes that banks are customarily
better informed of their debtors than a rating agency .
By switching to a more advanced approach , many banks
will benefit from reduced capital allocation under the capital
rules as a result of the more accurate linkage between
capital and risk .

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Introduction to Credit Risk

Credit Risk Types and Drivers
Types of credit risk Drivers of the credit risks

Riskiness of a borrower, including Probability of default (PD)

approximation of size

Riskiness of a transaction Loss given default (LGD)

Likely size of exposures Exposure at default (EAD)

Time dimension Maturity

Diversification / concentration Correlation

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Risk Components & Expected Loss

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Example

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Example

Capital Requirements = Exposure * capital

charge”K”
Capital R.= 200* 1.91%= 3.82

RWA= K * 12.5 * EAD

RWA = 1.91% * 12.5 * 200
RWA = 47.75
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Example
PD = .3%
Value = 300
Provision = 3
Credit risk mitigation with collateral = 170
LGD = 40%
K = 0.93%
Calculate Expected Loss, RWA , and Capital
requirements .

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Example
EAD = 300- 3 – 170 = 127
EL = PD* EAD* LGD
EL= 0.3% * 127 * 40%
EL = 0.15
RWA = K * 12.5 * EAD
RWA = 0.93% * 12.5 * 127
RWA = 14.76
Capital requirements = K * EAD = 1.18
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Introduction to Operational Risk

Operational risk is the risk of direct or indirect
loss resulting from inadequate or failed internal
processes, people and systems or from external
events.

Types of operational risk Examples

Process risk can arise at any stage of an end-to-
Internal process
end process in the value chain
Inadequate training and management, human
People error, lack of segregation, reliance on key
individuals, lack of integrity, honesty, etc.
System IT systems and data corruption problems.
Adverse external events and independent
External events
external events.

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Introduction to Market Risk

Market risk is the risk of losses in on and off-
balance sheet positions arising from movements
in market prices.
Capital charge for market risk consists of
charges for interest rate risk , foreign exchange
risk , equity risk , and commodity risk .

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The Importance of Supervisory Review

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The Key Principles of

Supervisory Review
1. Calculation of Overall Capital Adequacy.
2. Review and Evaluation of Strategy and Capital
Adequacy Calculations.
3. Supervisor May Order a Higher Level of Capital
Adequacy.
4. Supervisor May Intervene at an Early Stage to
Prevent Decline in Bank Capital.

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ICAAP Five Factors

1. Board and senior management oversight,
including the responsibility for setting the
bank’s tolerance for risks.
2. Sound capital assessment.
3. Comprehensive assessment of risks
encompassing all material risks not covered in
Pillar 1.
4. Monitoring and reporting.
5. Internal control review.

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Objectives of Pillar 3
Pillar 3, which is intended to complement Pillar 1
and Pillar 2, in principle aims to:
‒ Promote a sound business environment for the
banking system; and
‒ Provide supervisors with added powers to enforce
sound banking operations, among others through
disclosure requirements.

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Thank you

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