Risk Regulations in Banking Industry

CAIIB Bank Financial Management

Module B

Risk Management
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Risk Regulations in Banking Industry

In Banking Industry risk regulations have several goals, like:

1. Improving the safety of the banking industry. 2. Levelling the competitive playing field of banks. 3. Promoting sound business and supervisory practices. 4. Controlling and monitoring 'Systemic Risk' 5. Protecting interest of depositors.

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Risk Regulations in Banking Industry

Systemic Risk: It is risk of failure of the whole banking system. Individual bank's failure is one of the major sources of the systemic Risk. Basel Committee on Banking Supervision (BCBS) - established for risk-based regulation in a changed world envirnment.
The Risk of settlement that arises for time difference came to be known as ' Herstatt Risk' Basel Commitee established Basel-1 in year 1988 and in year 1996 many changes take place and Basel-2 enforce.
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Risk Regulations in Banking Industry

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 Management 6. Almost all banks and RRBs in good financial health- meet CRAR nomr 7. Explosion of new- customer centric products and More employment.
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Risk Regulations in Banking Industry

The Basel-2 accord is based on 3 pillars:

1. Minimum Capital requirement 2. Supervisory Review process 3. Market Discipline

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Risk Regulations in Banking Industry

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 risk 3. Capital for Operational risk
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Risk Regulations in Banking Industry

Standardised: - The standardised approach establishes fixed risk weights corresponding to each supervisory category and make use of external credit. - Specific provisions has already been set aside by the bank agianst that 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 by regulators 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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Risk Regulations in Banking Industry

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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Risk Regulations in Banking Industry

Basel II Second Pillar - Supervisory review process Qualitative supervision by regulators of internal bank risk control and Capital assessment process, including supervisory power to require banks 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 capital adequacy in relation to risk profile and strategy for maintaining capital levels. Five main features of rigorous process: 1. Board and senior management oversight 2. Sound capital assessment 3. Comprehensive risk analysis (credit risk, operational risk, market risk, interest rate risk in banking book, liquidity risk, other risk) 4. Monitoring and reporting 5. Internal control review
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Risk Regulations in Banking Industry

Principle 2: Supervisors should review and evaluate banks internal capital adequacy assessments and strategies, as well as ability to monitor and ensure compliance with ratios. Supervisors should take appropriate action if not satisfied. Principle 3: Supervisors should expect banks to operate above minimum ratios and should have ability to require banks to hold capital in excess of minimum Principle 4: Supervisors should seek to intervene at early stage and require rapid remedial action
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Risk Regulations in Banking Industry

Basel II Third Pillar Market Discipline Impose market discipline on banks by requiring disclosure of key information relevant to banks risks and capital Qualitative Disclosures for Securitisation

1. Banks objectives for, and roles played by it in, securitisation process 2. Banks accounting objectives for securitisation 3. Whether treated as sales or financings 4. Whether bank recognises gain on sale 5. Key assumptions used by bank for valuing retained interests 6. Banks treatment of synthetic securitisations 7. Names of rating agencies used by bank and types of exposures rated by each agency
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Risk Regulations in Banking Industry

Example Page no : 213 for determining adjusted Exposure: Example page no : 224 fo computation of Total CRAR and Tier I CRAR

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Risk Regulations in Banking Industry

Q Given that Tier I capital is Rs. 500 crores and Tier II capital Rs. 800 crores and further given that RWA for credit risk Rs. 5000 crores, capital charge for market risk and operational risk Rs. 200 crores and Rs. 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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Risk Regulations in Banking Industry

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/ Total RWAs Answers : 3 1. 5. 3 3 2. 6. 4 3 3. 2 4. -

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Risk Regulations in Banking Industry

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 cr Revaluation reserve - Rs. 300 cr. Perpetual non-cumulative preference shares - Rs. 400 cr Subordinated debt- Rs. 300 cr Risk weighted assets for credit and operational risk - Rs.10000 cr Risk weighted assets for market risk - Rs. 4000 cr.
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Risk Regulations in Banking Industry

Tier-I = Capital + Free Reserves + Perpetual non-cumulative preference shares Tier-II = Provisions and contingencies reserves or 1.25% of risk weighted 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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Risk Regulations in Banking Industry

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 3. Calculate the amount of Capital fund a. 895 cr b. 1255 cr c. 1410 cr d. 610 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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Risk Regulations in Banking Industry

5. What is amount of minimum capital to support credit andoperational risk? 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 the credit 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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Risk Regulations in Banking Industry

Answers:

1-b 5-a

2-d 6-c

3-c 7-b

4-d 8-d

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

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

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Risk Regulations in Banking Industry

Thank You

Prepared By: Jagat Nagar (M : 9909792440) - jagatnagar@yahoo.co.in

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