7may Capital Adequacy

8/3/2019 7may Capital Adequacy

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MODULE D

CAPITAL ADEQUACY AND PROFITPLANNING.

A PRESENTATION BY

K.ESWAR MBA (XLRI) CAIIBASST. GENERAL MANAGER.


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What is the Basel Committee?

Established at the end of 1974 by Central Bank Governors ofG10 to address cross-border banking issues

Reports to G10 Governors/Heads of SupervisionMembers are senior bank supervisors from G10, Luxembourgand Spain

Work undertaken through several working groups


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From Basel I to Basel II

Basel I :1988 Capital Accord established minimum capital

requirements for banks

Risk Weights were straight jacket nature or One size fitsapproach

Eg Sovereigns were given 0% Risk weight, Banks 20% andcorporate 100%.

Lacked in its objectives to strengthen the soundness and stability

of Banks.

CapitalRisk weighted assets

8 %Minimum ratio:


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BASEL II

In 1998, Committee started revising the 1988 Accord:International Convergence of capital measurement and capitalstandards:

More risk sensitive

More consistent with current best practice in banks riskmanagement

Numerator (definition of capital) remains unchanged.

Basel II provides Banks incentives to Banks invest andincrease sophistication of their internal risk managementcapabilities to gain reduction in capital.

Greater Disclosure by Banks.

Follow certain standards of market discipline.


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What are the basic aims of Basel II?

To deliver aprudent amount of capitalin relation to risk

To provide the right incentives forsound risk management

To maintain a reasonable level playing field

Basel II isnot intended to be neutral between differentbanks/different exposures

However, there is a desire not to change theoverallamountof capital in the system


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Three pillars of the Basel II framework

Credit risk

Operational risk

Market risk

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

Enhanced disclosure

Core disclosures andsupplementary disclosures.

Minimum Capital

Requirements

Supervisory

Review ProcessMarket Discipline


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The three pillars

All three pillars together are intended toachieve 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.

S C C


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Market

Credit

Operational

BANKS TYPICALLY FACETHREE KINDS OF RISK

Risk of loss due to unexpected re-pricing of assets owned by thebank, caused by either

Exchange rate fluctuation

Interest rate fluctuations

Market price of investmentfluctuations

Risk of loss due tounexpected borrowerdefault

Risk of loss due to asudden reduction inoperational margins,caused by eitherinternal or externalfactors

Daily pricechange (%)

Unexpectedprice volatility

Time

Time

Defaultrate (%)

UnexpecteddefaultAvg. default

Time

Monthly changeof revenue to cost(%)

Unexpectedlow costutilization

Example

Stocks

Loans with credit rating 3

Business unit A

Type of Risk


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Pillar I Credit Risk

StandardizedApproach

Foundation InternalRatings

Based Approach

AdvancedInternal

Ratings BasedApproach

Risk weights are based onassessment by external creditassessment institutions

Banks use internal estimations ofprobability of default (PD) to calculate riskweights for exposure classes. Other riskcomponents are standardized.

Banks use internal estimations ofPD, loss given default (LGD) andexposure at default (EAD) tocalculate risk weights for exposureclasses

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

Reduce Capital requirements


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Pillar I Operational Risk

Basic IndicatorApproach

Standardizedapproach

AdvancedMeasurement

Approach.

.



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Pillar I Market Risk

StandardizedDurationMethod.

Internal ModelsMethod

(VaR basedapproaches)



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Advantages of capital

Provides safety and soundness

Depositor protection

Limits leveraging

Cushion against unexpectedlosses

Brings in discipline in risk taking


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Framework


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Claims on corporates

Creditassessmentby domesticratingagencies

AAA AA A BBBandbelow

Unrated

Risk weight 20% 50% 100% 150% 100%


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Mapping process draft guidelines

Short term ratings Riskweights

CARE 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 UNRATED

UNRATED

100%


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Mapping Long term ratings.

AAA 20%

AA 30%

A 50%

BBB 100%

BB AND BELOW: 150%

UNRATED 100%

+- SIGN CORROSPONDING MAINRATING WILL BE USED.


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Retail Portfolio - Criteria

Orientation criterion - exposure to individualperson or persons or to a small business.

Product criterion - revolving credit, line of credit,personal term loan and lease small businessfacilities and commitments.

Granularity criterion- regulatory retail portfolio issufficiently diversified to a degree that reduces therisk in the portfolio no aggregate exposure toone counterpart can exceed 0.2% of the overall

regulatory retail portfolio Low value of individual exposures- the maximum

aggregate retail exposure to one counterpartcannot exceed an absolute threshold of euro 1million.( Rs. 5 Crores for our Bank)

Turnover Rs.50 Crores.(AVERAGE FOR LAST 3


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Exclusion in Regulatory Retail.

Mortgage loans to the extent they qualify fortreatment as claims secured by residentialproperty: Margin 25% : RW upto Rs.30 lakhs

:50% and Rs.30 lakh and above 75% Margin lessthan 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 superannuationfunds or mortgage.

Other staff loans : 75% RW


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Past Dues ( NPAs)

Past due loans

The unsecured portion of any loan that is pastdue for more than 90 days, net of specificprovisions, to be given higher risk weight

150% if specific provision or= 20%

if provision = or > 50% with supervisory

discretion for 50% weight 100% if provision > or = 15% if fully secured


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Credit Risk Mitigation

Simple & comprehensive approaches

Legal certainty, robust recoveryprocedures

Effects of CRM not to be doublecounted

Should not result in increasing other

risks Haircuts to be used in the

comprehensive approach


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Eligible financialcollateral

Cash EQUIVALENT, CDs, Counter party deposit withlending 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


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Internal Ratings Based

Approach Internal ratings based (IRB) approach Foundation

Advanced

Goal: Should contain incentives for migration

from standardized to IRB approach

.


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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 theirown PD, LGD, EAD.


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General Market Capital charge

Captures risk of loss arising from generalchanges in market interest rates / other marketvariables

Two Approaches

Standardized Duration approach.

Internal risk management models

RBI adopted Standardized approach.

Specific charge is similar to credit risk.


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Market Risk Internal Models

BIS requirement:1. VaR to be calculated daily2.

Confidence level of 99%3. Holding period 10 days4. Historical data for at least one year to be

taken and updated at least once in aquarter .


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Operational Risk

Explicit charge on capital

Basic Indicator approach 15% ofgross income

Gross income = net interest incomeplus net non interest income.

Gross of any provisions. Gross of operating expenses.

Exclude realized profits/losses from

sales investments from Banking book.


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GROSS INCOME

GROSS INCOME = NET PFORIT+PROVISIONS+OPERATINGEXPENSES-PROFIT ON SALE OF

INVSTEMENT-INCOME FROMINSURANCE-EXTRA ORDINARY ITEMOF INCOME+ LOSS ON SALE OF

INVESTMENT


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Operational Risk

Standardised Approach- Capital charge is calculated as asimple 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 18Agency Services 15

Asset Management 12

Retail Brokerage 12


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General Standards to qualify for

sophisticated approaches Active involvement of Board and senior

management in oversight of ORMframework.

Sound RM system implemented withintegrity.

Sufficient resources and skill level for use of

the approach. Subject to initial monitoring by supervisor.


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Supervisory review.

Supervisors need to concentrate onriskNot addressed under pillar I VizConcentration risk.

Factors not addressed in pillar 1 suchstrategic risk or interest rate risk inBanking book.

Factors external to Bank viz Businesscycles.


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Supervisory Review

Principle I : Board and seniormanagement overview on assessing theircapital 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 minimumregulatory capital ratios.

Principal IV: Supervisors to intervene at

early stage.


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MARKET DISCIPLINE

a. Third Pillar to supplement first two pillars namelyminimum capital requirement and supervisory review.

b. The aim of this pillar is o encourage market discipline bydeveloping a set of disclosure requirements which allowsmarket participants to assess :

Scope of application

Capital

Risk Exposures

Risk assessment processes

Ultimately Capital Adequacy


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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 non-

disclosure but indirectly by way of lower riskweight under pillar-1 provided certain

disclosures are made etc.


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e. Interaction with accounting disclosures :

Disclosure framework not to conflict with requirementsunder accounting standards.

f. Scope and frequency of disclosures

All banks should provide Pillar-III disclosures bothqualitative and quantitative as on March end each yearalong with annual financial statements.

Banks with capital funds of more than Rs.500 crores andtheir significant subsidiaries must disclosure on quarterlybasis.

- Tier1 Capital

- Total Capital- Total required capital

- Total Capital adequacy ratios


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QUESTIONS ON NPA NORMS AND PROVISIONS

Under Income recognition guidelines 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 toincome 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.

All of above.

None of above.


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If any advance including bill purchased and discounted becomes NPA as at the end of anyquarter/half year/year, interest accrued and credited to income account in the previousperiods if not realized:

Need not be reversed.

To be reversed.

None of above.

Both of the above.

Interest realized in NPA may be taken to income provided the credits towards the interest arerealized not from fresh or addl facilities.

True

False.

Recovery in NPA account should be first appropriated towards

Interest

Principal

In equal proportion.

None of above.

Recovery in Suit filed/decreed/compromised cases,recovery should first be appropriatedtowards

a. Interest,

b. Principal

c. Principal or as per terms of decree or settlement.

d. None of above.


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Availability of security/net worth 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.

Account 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 forshort 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.

In case when bank charges interest monthly, the date of classification of NPA in case of nonservice of interest will bea. 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.


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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.

An asset to be classified as Doubtful asset if it remained :

Remained as sub standard asset for 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 somesalvage value or recovery value.

Over due for 5 years.

Over due for 10 years.

None of above.


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A CC account of borrower is out of order for 90 days. IN his Term Loan installment and interestregularly 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 andinterest is serviced regular.: Debenture of company:

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 proprietorshipaccount 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.

Depend on security.


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TL account of ABC Co. is NPA . It is partnership concern. One of partners A is having a CC

account which is in 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 itis not out order

Will be NPA

Will not be NPA

Depends on account status.

Depends on NW.

In account XYZ Ltd borrower committed fraud. But interest and installment recoveredregularly:

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 i.e realizable value of security is less than 50% and it wassanctioned just 3 months back:

Classify account as SA

Classify account as SSA

Classify account as DA

Classify account as LA


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Realizable value of security less than 10%

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 allowedagainst 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 oldstock statement.

None of above.

Both are true.

A CC account not reviewed by branch on 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 .


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X Co. is consortium account. No credits came to account for last 90 days. But party remittedthe money to consortium leader SBI in time.

Account will be NPA treating as non served in the books 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.:

Will be treated as NPA.

Will be treated as NPA only if guaranteed is invoked and guarantee is not honored.

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


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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.

Advance granted against security of gold :

a. Need not be classified as NPA if value of security covers the interest even if interest notservice.

b. Income recognition guidelines are normally applicable.

c. Both are true.

d. None of true.

Advance granted against security of government security :

a. Need not be classified as NPA if value of security covers the interest even if interest notserviced.

b. Income recognition guidelines are normally applicable.

c. Both are true.

d. None of true

Provision on standard assets:

.25%

.25% for SME and agricultural advances and .40% for others.

.40 for all

None of above.


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Provision on commercial real estate will attract a provision of

a. 1%

b.0.25%

c.0.40%

d.None.

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%

The above provision on SSA is made on outstanding in any SSA accounts is net of unrealizedinterest and held in CD nominal account and realized securities held in CD nominal accountshould be made without making any allowance for ECGC/CGTMSE guarantee cover andsecurities available:

True.

False.

Not sure.

None.


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Provisions on DA secured upto one year of remaining in DA category:

20%

30%

50%

100%

Provision on DA secured upto 3 years of remaining in DA category:

30%

20%

50%

100%

Provisions on DA secured. Remaining in DA for more than 3 years.

100%

50%

150%

10%


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Provision on DA unsecured irrespective of age.

100%

10%

50%

70%

In case loss assets 100% of the outstanding after adjusting realized value of security held,claim received , unrealized interest held in nominal account, interest suspense account andmargin held account:

True.

False.

Not sure.

None.


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Profit Planning. Profitability for Banks depends on six

factors:

Interest Income

Fee Based Income.

Trading Income.

Interest expenses.

Staff expense. Other operating expense.


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Profit Planning. Basel committee norms have brought

in standardization in the norms forcapital adequacy and providedbenchmarks.

Hence Banks have to optimum mix ofassets and liabilities , keep balanceof capital requirement and optimize

profits.


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Out of four scenariosWhich scenario require highest capitalWhich scenario gives highest returns

I II III IVInv in G.ec yield 6% 1000 400 300 300AAA corp 8%

interest0 600 300 300

A corp. interest

10%0 0 400 200

Lending to BBB+

Corp. Interest 12%0 0 0 200

Total 1000 1000 1000 1000


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Thank You!

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7may Capital Adequacy

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