MODULE D

CAPITAL ADEQUACY AND PROFIT

PLANNING.

A PRESENTATION BY

K.ESWAR MBA (XLRI) CAIIB

ASST. GENERAL MANAGER.
31.10.09

The BIS Mission Statement: The

BIS

Aims at promoting monetary and financial stability

Acts as a forum for discussion and cooperation
among central banks and the financial community
Acts as a bank to central banks and international
organisations

What is the Basel Committee?

Established at the end of 1974 by Central Bank Governors of
G10 to address cross-border banking issues
Reports to G10 Governors/Heads of Supervision
Members are senior bank supervisors from G10, Luxembourg
and Spain
Work undertaken through several working groups

Belgium, Canada, France, Germany,

Italy, Japan, Luxemburg, Netherlands, Spain,
Sweden, Switzerland, UK and USA

From Basel I to Basel II

Basel I :1988 Capital Accord established minimum capital

requirements for banks
Capital
Minimum ratio:
8%
Risk weighted assets
Risk Weights were straight jacket nature or One size fits
approach
Eg Sovereigns were given 0% Risk weight, Banks 20% and
corporate 100%.
Lacked in its objectives to strengthen the soundness and stability
of Banks.

BASEL II
In 1998, Committee started revising the 1988 Accord:
International Convergence of capital measurement and capital
standards:
More risk sensitive
More consistent with current best practice in banks risk
management
Numerator (definition of capital) remains unchanged.
Basel II provides Banks incentives to Banks invest and
increase sophistication of their internal risk management
capabilities to gain reduction in capital.
Greater Disclosure by Banks.
Follow certain standards of market discipline.

What are the basic aims of Basel II?

To deliver a prudent amount of capital in relation to risk
To provide the right incentives for sound risk management
To maintain a reasonable level playing field
Basel II is not intended to be neutral between different
banks/different exposures
However, there is a desire not to change the overall amount
of capital in the system

Three pillars of the Basel II framework

Minimum Capital
Requirements
Credit risk
Operational risk
Market risk

Supervisory
Review Process
Evaluate Risk Assessment.
Banks own capital strategy.
Supervisors review.
Ensure soundness and integrity of banks internal
processes to assess the adequacy of capital.
Ensure maintenance of minimum capital
Prescribe differential capital where internal

Market Discipline
Enhanced disclosure
Core disclosures and
supplementary disclosures.

The three pillars

All three pillars together are intended to achieve a level of capital commensurate with a banks overall risk profile.

Tier I capital and Tier II capital.

Core and supplementary capital.
Limits on components of capital.

BANKS TYPICALLY FACE

THREE KINDS OF RISK

Type of Risk

Example

Risk of loss due to unexpected repricing of assets owned by the

bank, caused by either
Exchange rate fluctuation

Interest rate fluctuations

Market price of investment

fluctuations

Stocks

Daily price
change (%)

Market

Time

Risk of loss due to

unexpected borrower
default

Default
rate (%)

Loans with credit rating 3

Unexpected
default
Avg. default

Credit

Time

Operational

Unexpected
price volatility

Risk of loss due to a

sudden reduction in
operational margins,
caused by either
internal or external
factors

Monthly change
of revenue to cost
(%)

Business unit A

Unexpected
low cost
utilization
Time

Pillar I Credit Risk

Pillar 1 Credit Risk stipulates three levels of increasing sophistication. The more
sophisticated approaches allow a bank to use its internal models to calculate its
regulatory capital. Banks who move up the ladder are rewarded by a reduced capital
charge

rea
Inc

Standardized
Approach

se

s
phi
o
S

tic

n
a ti o

Foundation Internal
Ratings
Based Approach

Advanced
Internal
Ratings Based
Approach
Banks use internal estimations of
PD, loss given default (LGD) and
exposure at default (EAD) to
calculate risk weights for exposure
classes

Banks use internal estimations of

probability of default (PD) to calculate risk
weights for exposure classes. Other risk
components are standardized.

Risk weights are based on

assessment by external credit
assessment institutions

Reduce Capital requirements

Pillar I Operational Risk

rea
Inc

Basic Indicator
Approach

se

t
tica
s
i
ph
So

ion

Advanced
Measurement
Approach.

Standardized
approach

Reduce Capital requirements

Pillar I Market Risk

rea
Inc

se

s
phi
o
S

tic

n
a ti o

Internal Models
Method
(VaR based
approaches)

Standardized
Duration
Method.

Reduce Capital requirements

Advantages of capital

Provides safety and soundness

Depositor protection
Limits leveraging
Cushion against unexpected
losses
Brings in discipline in risk taking

Framework

Claims on corporates
Credit
assessment
by domestic
rating
agencies

AAA

AA

BBB
and
below

Unrate
d

Risk weight

20%

50%

100%

150%

100%

Claims on Banks is 20%

but for following.
CRAR of
respective
Bank if less
than 9%

6%
to
<9%

3-<6% 0-<3% Negativ

e

Risk weight

150% 250

400

625%

Mapping process draft guidelines

Short term ratings
CARE

Risk
weights

CRISIL FITCH ICRA

PR1+

P1+

F1+

A1+

20%

PR1

P1

F1

A1

30%

PR2

P2

F2

A2

50%

PR3

P3

F3

A3

100%

PR4/PR5

P4/P5

B/C/D

AR/A5

150%

UNRATED

UNRATED UNRATE UNRATE

D
D

100%

Mapping Long term ratings.

AAA
20%
AA
30%
A
50%
BBB
100%
BB AND BELOW: 150%
UNRATED
100%
+- SIGN CORROSPONDING MAIN
RATING WILL BE USED.

Retail Portfolio - Criteria

Orientation criterion - exposure to individual person or
persons or to a small business.

Product criterion - revolving credit, line of credit,

personal term loan and lease small business facilities
and commitments.
Granularity criterion- regulatory retail portfolio is
sufficiently diversified to a degree that reduces the
risk in the portfolio no aggregate exposure to one
counterpart can exceed 0.2% of the overall regulatory
retail portfolio
Low value of individual exposures- the maximum
aggregate retail exposure to one counterpart cannot
exceed an absolute threshold of euro 1 million.( Rs. 5
Crores for our Bank)
Turnover Rs.50 Crores.(AVERAGE FOR LAST 3
YEARS)

Exclusion in Regulatory Retail.

Mortgage loans to the extent they qualify for

treatment as claims secured by residential property:
Margin 25% : RW upto Rs.30 lakhs :50% and Rs.30
lakh and above 75% Margin less than 25% RW 100%
Consumer credit, credit card exposure etc. RW125%
Capital market exposure and NBFCs RW125%
Commercial Real Estate : RW 150%
Staff loans: 20% if covered by superannuation funds
or mortgage.
Other staff loans : 75% RW

Past Dues ( NPAs)

Past due loans

The unsecured portion of any loan that is past
due for more than 90 days, net of specific
provisions, to be given higher risk weight
150% if specific provision <20% o/s
100% if provision >or= 20%
if provision = or > 50% with supervisory
discretion for 50% weight
100% if provision > or = 15% if fully secured

Credit Risk Mitigation

Simple & comprehensive approaches

Legal certainty, robust recovery
procedures
Effects of CRM not to be double
counted
Should not result in increasing other
risks
Haircuts to be used in the
comprehensive approach

Eligible financial
collateral

Cash EQUIVALENT, CDs, Counter party deposit with

lending Bank.
Gold bullion & jewellery (99.99 purity)
Central & State Govt. securities
IVP, KVP, NSC, LIC policy
Debt securities rated by recognised credit rating
agency

PSEs at least BB
Other entities at least A
ST debt instruments at least P2+/A3/PL3/F3

Equities
Mutual Fund units daily NAV to be available on
public domain

Internal Ratings Based

Internal ratings based (IRB) approach
Approach
Foundation

Advanced
Goal: Should contain incentives for migration
from standardized to IRB approach

IRB approach

Risk components PD, LGD, EAD,

Retail PD, LGD & EAD given by banks

Differentiation between IRB Advanced &

Foundation.
Only PD from Bank in IRB foundation.
In advanced approach Banks provide their
own PD, LGD, EAD.

General Market Capital charge

Captures risk of loss arising from general changes

in market interest rates / other market variables
Two Approaches
Standardized Duration approach.
Internal risk management models

RBI adopted Standardized approach.

Specific charge is similar to credit risk.

Market Risk Internal Models

BIS requirement:
1.
VaR to be calculated daily
2.
Confidence level of 99%
3.
Holding period 10 days
4.
Historical data for at least one year to be
taken and updated at least once in a
quarter .

Operational Risk

Explicit charge on capital

Basic Indicator approach 15% of
gross income
Gross income = net interest income
plus net non interest income.
Gross of any provisions.
Gross of operating expenses.
Exclude realized profits/losses from
sales investments from Banking book.

GROSS INCOME

GROSS INCOME = NET PFORIT+

PROVISIONS+OPERATING
EXPENSES-PROFIT ON SALE OF
INVSTEMENT-INCOME FROM
INSURANCE-EXTRA ORDINARY ITEM
OF INCOME+ LOSS ON SALE OF
INVESTMENT

Operational Risk
Standardised ApproachCapital charge is calculated as a
simple summation of capital charges across 8 business lines
Business lines

% of gross income

Corporate finance

18

Trading & sales

18

Retail Banking

12

Commercial Banking

15

Payment & Settlement

18

Agency Services

15

Asset Management

12

Retail Brokerage

12

General Standards to qualify for

sophisticated approaches

Active involvement of Board and senior

management in oversight of ORM
framework.
Sound RM system implemented with
integrity.
Sufficient resources and skill level for use of
the approach.
Subject to initial monitoring by supervisor.

Supervisory review.

Supervisors need to concentrate on

riskNot addressed under pillar I Viz
Concentration risk.
Factors not addressed in pillar 1 such
strategic risk or interest rate risk in
Banking book.
Factors external to Bank viz Business
cycles.

Supervisory Review

Principle I : Board and senior

management overview on assessing their
capital in relation to risk profile and
strategy.
Principle II: Supervisory review of Banks
internal capital adequacy systems. On
site /off site/discussions etc.
Principal III: Operate above minimum
regulatory capital ratios.
Principal IV: Supervisors to intervene at
early stage.

MARKET DISCIPLINE
a. Third Pillar to supplement first two pillars namely
minimum capital requirement and supervisory review.
b. The aim of this pillar is o encourage market discipline by
developing a set of disclosure requirements which allows
market participants to assess :

Scope of application

Capital

Risk Exposures

Risk assessment processes

Ultimately Capital Adequacy

c. Such disclosures with common framework provides

enhanced comparability.
d. Achieving Appropriate Disclosure

Market Discipline contributes to safe and

sound banking.

Non-disclosure attracts penalty including a

financial penalty.

No direct penalty of additional capital for nondisclosure but indirectly by way of lower risk
weight under pillar-1 provided certain
disclosures are made etc.

e. Interaction with accounting disclosures :

Disclosure framework not to conflict with requirements

under accounting standards.

f. Scope and frequency of disclosures

All banks should provide Pillar-III disclosures both

qualitative and quantitative as on March end each year
along with annual financial statements.

Banks with capital funds of more than Rs.500 crores and

their significant subsidiaries must disclosure on quarterly
basis.
- Tier 1 Capital
- Total Capital
- Total required capital
- Total Capital adequacy ratios

QUESTIONS ON NPA NORMS AND PROVISIONS

Income from non performing assets is recognized on:

Accrual basis.
When debited to account
When actually received.
All of above.
Income from advance against Term Deposit, NSC, IVP, KVP and LIC Pol may be taken to income
provided:
Adequate margin is available.
Cannot be taken to income if not received actually.
In all cases it can be taken to income
All of above.
If Govt guaranteed advance becomes NPA then the interest on such advances
Can be taken to income.
Can be taken only when interest has been realized.
realized.
All of above.
None of above.
If any advance including bill purchased and discounted becomes NPA as at the end of any
quarter/half year/year, interest accrued and credited to income account in the previous periods if
not realized:
Need not be reversed.
To be reversed.
None of above.
Both of the above.

QUESTIONS ON NPA NORMS AND PROVISIONS

Interest realized in NPA may be taken to income provided the credits towards the interest are
realized not from fresh or addl facilities.
facilities.
True
False.
Recovery in NPA account should be first appropriated towards
Interest
Principal
In equal proportion.
None of above.
Availability of security/networth of borrowers or guarantor
Should be taken into consideration for treating account as NPA
Should not be taken into consideration
do
None of above.
Both are true.
A non performing loan shall be a loan or advance:
Interest or instalment overdue for more than 90 days.
Accont remains out of order for 90 days in CC OD
Bill remain over due for more than 90 days for bill purchased or discounted.
All of above are true.
In case of agricultural loan it will be treated as NPA if
a. Installments of principal or interest over due for two crop season if loan is granted for
short duration crops.
b. Installment or interest over for one crop season if loan is for long duration crop.
c. Both are true.
d. Both are wrong.

QUESTIONS ON NPA NORMS AND PROVISIONS

In case when bank charges interest monthly, the date of classification of NPA in case of non
service of interest will be
a. 90 days after date of charging monthly interest.
b. 90 days after the end of quarter in which interest was charged.
c. none of above.
d. both are correct.

In CC account when outstanding balance remains within limit/DP :

Account can become NPA if no credit for 90 days.
If credits are not enough to cover the interest debited during the same period.
Only b is correct.
Both are correct.

Sub standard asset is asset which

Remained as NPA for period less than or equal to 12 months.
Remained overdue for more than 12 months.
None of above.

Doubtful asset is asset which :

Remained as sub standard asset for more than 12 moths.
Remained as over for 3 years.
Remained over due for 4 years.
None of above.

Loss asset is an asset which

Considered un collectable and its continuance as bankable asset is not warranted even if some
salvage value or recovery value.
Over due for 5 years.
Over due for 10 years.
None of above.

QUESTIONS ON NPA NORMS AND PROVISIONS

A CC account of borrower is out of order for 90 days. IN his Term Loan installment and interest
regularly served:
Only CC account is is NPA
Both CC and TL is NPA
None of accounts are NPA
Depends on security and NW of borrower's
A OD account of borrower is NPA. Investment made in debenture of same company and
interest is serviced regulr.:
Need not be classified as NPA
Need to be classified as NPA.
Depends on servicing of interest on debenture.
None of above.
OD account XYZ Ltd a partnership is NPA . One of partner is having a sole proprietorship
account with same bank and availing CC account and this account is in order:
This account will also be NPA
This account will not be NPA
Depends on out of order position.
Depdend on security.
TL account of ABC Ltd is NPA . It is partnership concern. One of partners A is having a CC
account which is in order:
order:
This account will also be NPA
This account will not be NPA.
Depends on account status.
Depends on security and NW
TL account granted to X partner is NPA. CC account of partnership where X is partner even if it
is not out order
Will be NPA
Will not be NPA
Depends on account status.
Depends on NW.

QUESTIONS ON NPA NORMS AND PROVISIONS

In account XYZ Ltd borrower committed fraud. But interest and instalment recovered regularly:
Account should be classified as DA or Loss account.
Account can continue as Standard.
Account will be SSA.
None of above.
Erosion in security value to 50% or more and it was sanctioned just 3 months back :
Classify account as SA
Classify account as SSA
Classify account as DA
Classify account as LA
Erosion in security value leaving value at 10% or less.
Classify account as SA
Classify account as SSA
Classify account as DA
Classify account as LA
In a CC account the stock statement is not submitted for last 3 months and DP is allowed
against old stock statement:
Account will be NPA now.
Account will be NPA if drawings are permitted in such account for 90 days based on such old
stock statement.
None of above.
Both are true.
A CC account no reviewed by branch due date:
It will be NPA on due date.
It will be NPA if not renewed in 180 days from due date.
If will be NPA if not renewed in 90 days from due date.
None .

QUESTIONS ON NPA NORMS AND PROVISIONS

X Co. is consortium account. No credits came to account for last 90 days. But party remitted the
money to consortium leader SBI in time.
Account will be NPA treating as non served in the b ooks of this Bank.
Account will be PA as money received by SBI leader of consortium.
None of above.
Both of above.
FCI given loan by your Bank against Govt Guarantee.
Loan is over due for more than 90 days.:
days.:
Will be treated as NPA.
Will be treated as NPA only if guaranteed is invoked and guarantee is not honoured.
Both are true.
None are true.
Interest on above loan to FCI can be taken to income
No as such exemption is not for recognition of income.
Yes can be taken to income.
None
State Govt guaranteed loans and investment in State Govt guaranteed bonds will
Attract loan provisions and asset classification if over due for 90 days.
Only loan provisioning required.
Only asset classification required.
No need to classify as NPA.
In a account 6 months moratorium is given.
Account will become NPA only if moratorium is over.
It will attract NPA provisions even before moratorium for interest servicing.
None of above.
Provision on standard assets:
assets:
.25%
.25% for SME and agricultural advances and .40% for others.
.40 for all
None of above.

QUESTIONS ON NPA NORMS AND PROVISIONS

Provisions on fully secured SSA

10%
20%
30%
40%
Provision on SSA where abninitio bank has sanctioned with security less than 10%
20%
30%
40%
15%
Provisions on DA secured upto one year
20%
30%
50%
100%
Provision on DA secured upto 3 years
years
30%
20%
50%
100%
Provisions on DA secured. more than 3 years.
100%
50%
150%
10%
Provision on DA unsecured irrespective of age.
age.
100%
10%
50%
70%

Profit Planning.

Profitability for Banks depends on six

factors:
Interest Income
Fee Based Income.
Trading Income.
Interest expenses.
Staff expense.
Other operating expense.

Profit Planning.

Basel committee norms have brought

in standardization in the norms for
capital adequacy and provided
benchmarks.
Hence Banks have to optimum mix of
assets and liabilities , keep balance
of capital requirement and optimize
profits.

Thank You!