Professional Documents
Culture Documents
- A ready Reckoner
Advanced IRB
In addition to PD, the bank adds other inputs such as exposure at default, loss given
default, and maturity. The requirements for this approach are exacting. Supervisor will
be required to validate.
BASEL I
In 1998 the BASEL committee introduced a capital measurement system, which
provided for the implementation of risk measurement framework with a minimum
capital change. This is commonly referred to as BASEL I
BASEL II
Subsequent to the introduction of BASEL I to specific changes in the banking industry,
which emerged, were the extended use of securitisation and derivatives in secondary
market and has a vastly improved risk management system. This had made BASEL I
established for banks operating on a global scale in virtually all financial markets
become outdated. In recognition of this the BASEL committee proposed a new capital
adequacy framework in June, 1999, commonly termed as BASEL II. This recommends a
more risk sensitive, minimum capital requirement for banking organisation. The new
framework was widely debated and discussed by regulatories of different countries and
the BASEL committee released its final document on June 26, 2004.
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Calculation of Capital Requirement
Total bank capital
Risk weighted assets + 12.5 x capital charges for market and operational risk > 8%
Capital Deficiency
A capital deficiency is the amount by which actual capital is less than the regulatory
capital requirement.
Counter Party
The term counter party is used to denote the party to whom the bank has an exposure
on or off balance sheet, Credit exposure or potential credit exposure. The exposure may
for e.g. Take the form of a loan of cash or securities.
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vi. The net credit balance, if any, in the inter office account with Head office/overseas
branches will not be reckoned as capital funds. However, any debit balance in Head
office account will have to be set off against the capital.
Foundation IRB
The bank estimates the probability of default (PD) associated with each borrower, and
the supervisor supplies other inputs, such as loss given default and exposure at default.
FSAP
Financial sector assessment programme is an assessment conducted by IMF to examine
the banking system with the relevant principles of a central bank of the country. India is
one of the early countries which subjected itself voluntarily to FSAP and its banking
system was assessed to be in high compliance with relevant principles.
Operational Risk
Operational risk is defined as the risk of direct or indirect loss resulting from inadequate
or failed internal process, people and systems or from external funds.
Outlier Banks
Banks whose economic value declines by more than 20% of the sum of Tier I and Tier II
Capitals as a result of a standardized interest rate shock of 200 basis points or its
equivalent are considered as Outlier banks and the supervisors need to give special
attention to the capital sufficiency of these banks.
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Pillars of BASEL II
To accomplish the goal of adequate capitalisation of the banks the BASEL II framework
has introduced 3 Pillars that reinforce each other and enhance the quality of processes,
viz, the 1st Pillar is minimum capital requirement, 2nd Pillar is the supervisory review
process and the third Pillar is marketing discipline.
Qualitative Disclosures
Description of approaches followed for specific and general allowances and statistical
methods;
Discussion of the bank credit risk management policy; and For banks that have partly,
but not fully adopted either the foundation IRB or the advanced IRB approach, a
description of the nature of exposures within each portfolio that are subject to the 1.
standardized IRB, 2. foundation IRB, and 3. advanced IRB approaches and of
managements plans and timing for migrating exposures to full implementation of the
applicable approach
Standard Approach
Banks use a risk-weighting schedule for measuring the credit risk of banks assets. The
risk weightings are linked to ratings given to Sovereigns financial institutions by
external credit rating. This is called the Standard Approach.
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the committee with respect to banking risk, including a guidance relating to, many other
aspects like:
the treatment of interest rate in the banking book, credit risk, operational risk,
enhanced cross border indication and corporation and securitisations. The supervisory
review process of the framework is intended not only to ensure that the banks have
quality capital to support all the risks in their business but also to encourage banks to
develop and use better risk management techniques in monitoring and managing the
risk. It recognizes the responsibility of bank management in developing internal capital
assessment process and setting capital targets that rather commensurate with the
banks risk profits and control environment. In the framework, bank management
continues to bear responsibility for ensuring that the bank has adequate capital to
support its risks, beyond the core minimum requirement. The four principles of
supervisory review are listed below:
1. Banks should have members for assessing their overall capital adequacy in relation to
their risk profile and a strategy for monitoring their capital levels.
2. Supervisors should review and evaluate banks internal capital adequacy assessments
and strategies as well as the ability to monitor and ensure their compliance with
regulatory capital ratios. Supervisors should take appropriate supervisory action if they
are not satisfied with the result of the process.
3. Supervisors should expect banks to operate minimum regulatory capital ratios and
should have the ability to require banks to hold capital in excess of the minimum
4. Supervisors should seek to intervene at an early stage to prevent capital from
following below the minimum levels required to support risks characteristics of a
particular bank and should require rapid remedial action if capital is not maintained or
restored.