Risk Management

BASEL COMMITTEE ON BANKING

SUPERVISION(BCBS)

Where do Indian Banks stand?

Where do Indian Banks stand?

Bank credit to industrial sector:
above 20% on an average between
2012-2016, -0.2% as of August
2016
Total Gross NPA : ` 6 lakh crores

What is Risk Management?

Identification

Analysis

Acceptance/Mitigation of uncertainty in investment

decisions

Types of Risks

Risk

NonFinancial
Risk

Financial
Risk

Credit Risk

Borrower
Risk

Intrinsic
Risk

Market Risk

Portfolio
Risk

Interest
Rate Risk

Liquidity
Risk

Strategic
Risk

Currency
Forex Risk

Hedging
Risk

Funding
Risk

Political
Risk

Legal Risks

Operational
Risks

Basel Committee on Banking Supervision

Established in 1975 by G-10 central bank governors
Headquarters: Basel, Switzerland
Member countries: Argentina,Australia,Belgium, Brazil,
Canada,China, France, Germany, Hong Kong SAR,
India,Indonesia, Italy,Japan, Korea,Luxembourg,Mexico,
the Netherlands,Russia, Saudi Arabia, Singapore, South
Africa,Spain,Sweden,Switzerland,Turkey, the United
Kingdom and theUnited States.

BASEL I: Background

Bretton Woods system of foreign exchange broke down in 1974

1974: Herstatt Bank was liquidated by German regulators after the bank failed to
pay counterparty banks in US $ in exchange of Duetschemark (erstwhile German
currency)

1974: Franklin National Bank of New York had to shut down its operations due to
heavy foreign exchange losses

1988: BCBS released International convergence of capital measurement and

capital standards also called BASEL I norms

BASEL I: Credit Risk & Risk-weighting

of Assets

Tier 1 capital: minimum 4% of risk-weighted assets

Paid-up capital
Disclosed reserves (retained earnings, legal reserves)

Tier 2 capital: maximum 100% of Tier 1 capital

Undisclosed reserves
Asset revaluation reserves
General provisions
Hybrid instruments (must be unsecured, fully paid up)
Subordinated debt

BASEL I: Credit Risk & Risk-weighting

of Assets

Risk Weight of Assets

Risk-Weights

Assets

0%

Cash

0%

Claims on Central Govt

20%

Claims on OECD & multilateral development banks

20%

Claims on banks outside OECD with residual maturity < 1 year

20%

Claims on public sector entities of OECD countries

50%

Mortgage loans

100%

All other claims

BASEL I: Implementation in India

1985: Health code system designed by RBI used to evaluate individual advances under 8
categories: satisfactory, irregular, sick (viable), sick (sticky), advances recalled, suit filed accounts,
decreed debts, bad and doubtful debts

1992: Narasimhan Committee Report recommended risk-weighting of assets for Indian banks from
April 1992

Foreign banks operating in India were required to reach CRAR level of 8% by March 1995

Indian banks operating abroad were required to reach CRAR level of 8% by March 1997

All other banks were required to reach CRAR levels of 4% by March 1993 and 8% by March 1996

All banks reached minimum regulatory levels by 2006

Why BASEL I failed?

Lack of risk sensitivity

Limited Collateral Recognition

Incomplete coverage of Risk sources

Emphasis on book values rather than on market values

Depending on inputs from central bankers worldwide BCBS released

International Convergence of Capital Measurement and Capital Standards: A
Revised Framework also called BASEL II.

BASEL II: Objectives

Enhance quality & stability of international banking system

Create a level playing field for internationally active banks

Promote usage of more stringent practises in the field of risk

management

BASEL II
Increasing sensitivity to capital requirements
for different risk levels
Introduction of regulatory capital needs for
operational risk
Providing enough flexibility to local
regulators to suit local needs
Increased power to national regulatory
authorities to evaluate a banks capital
adequacy by considering its specific risk
profile
Improving recognition of risk-reduction
techniques
Implementing detailed mandatory
disclosures of risk exposures and risk
policies

BASEL II: Implementation in India

2005: RBI issued primary guidelines on BASEL II and target of

implementation was set for March 2007, but was later postponed

Minimum Regulatory standards: 9% CRAR, 6% Tier 1 CRAR

(international standard was 8% and 4.5% respectively)

Drawbacks of BASEL II

Provided incentives to banks to underestimate risks

The models effectiveness depended on a strong regulator which was

not the case in some countries like USA

BASEL II was unable to cover market risks, especially for investment

banks

The 2007 sub-prime crisis made the bankers feel the need for enhanced
risk management regulations.

BASEL II.5
BASEL II.5 was introduced in 2008 to strengthen the capital base, by increasing
capital requirements

IRC was introduced to estimate and capture default and credit migration risk

Additional charge for correlational risk was introduced

SVaR was introduced to include capital requirements under stressed conditions

Introduced standardized charges for securitization and re-securitization. These

instruments were primarily responsible for loans being incorrectly classified.

BASEL III: Background

Lehmann Bros. fiasco showed that even big banks did not always
understand the risks too well

The banking sector was poorly governed and their incentive structures
encouraged too much risk taking

Mispricing of credit, liquidity risk and excess credit growth

To address such risks BCBS introduced BASEL III Accord in September 2010

BASEL III: Pillar 1(Capital)

Quality & level of Capital: Common Equity to be at least 4.5% of

risk-weighted assets

Capital loss absorption at the point of non-viability

Capital conservation buffer: Comprising common equity of 2.5% of

risk-weighted assets. Constraint on a banks discretionary distributions
will be imposed when banks fall into the buffer range

Countercyclical buffer: Imposed within a range of 0-2.5% comprising

common equity, when authorities judge credit growth is resulting in an
unacceptable build up of systematic risk

BASEL III: Pillar 1(Risk Coverage)

Securitization: Requires banks to conduct more rigorous credit analyses of

externally rated securitisation exposures

Trading book: Introduction of a stressed value-at-risk framework to help

mitigate procyclicality

Counterparty credit risk: : more stringent requirements for measuring

exposure; capital incentives for banks to use central counterparties for
derivatives; and higher capital for inter-financial sector exposures

Bank exposures to central counterparties (CCPs): The Committee has

proposed that trade exposures to a qualifying CCP will receive a 2% risk weight
and default fund exposures to a qualifying CCP will be capitalised according to a
risk-based method that consistently and simply estimates risk arising from such
default fund.

BASEL III: Pillar 1(Containing

Leverage)

Leverage ratio: A non-risk-based leverage ratio that includes offbalance sheet exposures will serve as a backstop to the risk-based
capital requirement. Also helps contain system wide build up of
leverage.

BASEL III: Pillar 2(Risk Management

& Supervision)

Address firm-wide governance and risk management

Capturing the risk of off-balance sheet exposures and securitisation activities

Managing risk concentrations

Providing incentives for banks to better manage risk and returns over the long
term

Sound compensation practices

Valuation practices

Stress testing

Accounting standards for financial instruments corporate governance and

supervisory colleges

BASEL III: Pillar 3 (Market Discipline)

Relate to securitisation exposures and sponsorship of off-balance sheet

vehicles

Enhanced disclosures on the detail of the components of regulatory

capital and their reconciliation to the reported accounts

BASEL III: Implementation in India

Enhanced Capital requirements: Minimum Tier 1 capital CRAR of 9%

Introduction to Capital Conservation Buffer: Additional reserve

buffer of 2.5%

Introduction of Counter Cyclical Buffer: 0-2.5% of common equity

Leverage Ratio: Minimum leverage ratio of 4.5%

Liquidity Risk Management:

BASEL III: Drawbacks

High regulatory capital will increase barriers to entry. Given that 38% of
the worlds adult population is still unbanked, there is a high risk that
these people wont have a bank account anytime soon.

Risk-weighting methods remain unchanged.

A lot of risk weighting depends on credit rating agencies, who can go

terribly wrong as we know from 2007 sub-prime crisis

It aims to harmonize banking regulations across the world, which might

mean some countries moving towards lenient regulations

Its been suggested by some economists that Basel III Accord is likely to
hurt acountrys growth by keeping the scarce capital tied up.

Thank You!!