While preparing fo r Basel II implementation...

1. While preparing for BaselII implementation... 20 października 2004 roku Maciej Majewski Partner Deloitte & Touche Sp. z o.o.

2. What Credit Risk Officer should be aware of? On 26 June 2004 the Basel Committee, after many consultations and analyses, presented the final version of the New Capital Accord. It is aimed at maintaining the current level of the capital (Pillar I) in the system, with simultaneous consideration of: • The better approach to the evaluation of the credit risk (e.g. use of internal ratings-based methods); • The operational risk (NCA introduces capital requirements with respect to this risk); • Importance of the control exercised by the regulator (Pillar II) and provision of appropriate information on the risk managementmethods to external recipients (Pillar III). The Committee has no formal power with respect to supervisions responsible for setting up local regulations but most of them (Group of Ten countries, EU countries, etc.) have already decided to implement Basel II. For implementation in the European Union, this will require a new Capital Adequacy Directive, CAD3 (starting December 2006), to overwrite the existing rules and to extend the scope of the new Basel regime to all credit institutions and investment firms.

3. Credit risk Operational risk 3 years data required for Advanced Measurement Approaches Are you aware of a limited time left in order to meetBasel II implementation requirements? The timetable for implementing the IRB approaches for credit and operational risk capital is tight given the amount of work that still needs to be undertaken: At the end of 2005 Bank will have to start calculating capital requirement using IRB approach and current Accord Transition1 Data set with 5 years of history (PD) and IRB retail (PD/LGD/EAD) Data set with 7 years of history (PD,LGD, EAD) – IRB advanced non-retail Earliest date for Foundation IRB Use credit scoring (rating) system for 3 years before the transition process 2 years of data required for IRB before entering transition period 2012 2004 2005 2006 2007 2008 2009 2010 2011 Transition Key: 1. Transition: During the transition period the data requirements for the IRB and AMA approaches will be relaxed. This is conditional on banks making steady progress during this period. PD – Probability of Default LGD – Loss Given Default EAD – Exposure at Default Systems in place and operating for Basic, Standard and AMA approaches 5 years of data required for AMA

4. Gap Analysis Compliance ü • Does your segmentation and methodologies allow for proper risk identification? • Does your organizational structure reflect proper Credit Risk Management functions? • Have you introduced a default definition? • Do you perform PD/LGD/EAD/ estimations? • Are you able to satisfy the supervisor that your credit risk assessment model / procedure has a good predictive power and that regulatory capital requirements will not be distorted as a result of its use? • Do you have detailed review procedures to ensure your systems and controls are adequate to serve as the basis for the IRB approach? • Are you also aware that for the duration of non compliance, supervisors may requireto hold additional capital under Pillar 2? Have you checked your compliance with Basel II requirements in the area of Credit Risk?

5. Have you checked your compliance with Basel II requirements in the area of Operational Risk? Gap Analysis Compliance ü • Have you identified and defined operational risk in your organisation? • Have you developed operational risk management strategy and set up organizational structure that reflects proper Operational Risk Management functions? • Does your segmentation allow for proper identification of operational risk categories and can you map Bank’s business and gross income to business lines defined by Basel II? • Do you apply adequate risk quantification methods and management tools? • Do you have in place operational risk measurement system and capital calculator? • Have you ensured proper operational risk mitigation tool? • Have you implied operational risk limits and thresholds?

6. Are you able to evidence your compliance with the minimum standards in the following area? Segmentation by asset classes Operating procedures Independent credit risk control unit Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Management oversight of the rating process Group approach/ business lines Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis EAD, M calculation Default definition Basic indicator,standardised method, AMA Quantification techniques: KRI, scorecard, self-assessment Responsibilities of parties that rate borrowers and facilities Operational risk definition, segmentation, categories Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis PD estimations Internal rating system IT solutions supporting credit process Capital calculation engine Minimum number of borrower rating grades Collateral Management Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Haircuts RAROC, RORAC Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis Gap Analysis

7. Do you realize the complexity in closing of any identified gap? Does your Independent credit risk control unit cover the following responsibilities? • Testing and monitoring of credit assessment models in order to improve their performance; therefore, emphasis is to be placed on default cases which should be examined thoroughly before and after the event of default (in non-retail customers). The testing and monitoring will help detect the models’ weaknesses; • Preparation and analysis of summary reports from the Bank’s rating system which should include historical default data sorted by rating at the time of default and one year prior to default, grade migration analyses and the monitoring of trends in key rating criteria; • Implementing procedures which would verify whether the rating definitions are consistently applied across departments and geographic areas; • Reviewing and documenting any changes to the rating process, including the rationale for the changes; • Reviewing/documenting the rating criteria or individual rating parameters in order to evaluate whether they remain predictive of risk; and • Supervising any models used in the rating process. Independent credit risk control unit

8. Are you aware of costs scale and structure related to Basel II requirements implementation? A significant portion of outlays is assigned for investments relatedto credit risk. Operational risk investments account for only 15%. Operational risk 15% Other costs40% IT costs60% Credit risk 85%

9. Do you realise what are your benefits from Basel II implementation? Your capital level is adequate to the level of bared risk You are well evaluated by external rating agencies Shareholder Value You are recognizedby your customers and investors You manage your Bank in accordance with Best Practice Your local and international regulators have appreciation for your effort

10. Services for Banks related to the Basel II requirements: Costs and benefits analysis of implementing various Basel II approaches. Assessment of readiness for implementation of Pillar I requirements – for all approaches to credit risk operational risk and market risk. Assessment of Pillar II and Pillar III compliance. Assessment of data availability in information systems for selected approaches to credit, operational and market risks. Development and implementation of strategy to close gaps in the area of credit, operational and market risk management. Development and implementation of Basel II solutions: e.g. proper scoring/rating methodologies, calculation packs for PD, LGD and EAD, operation risk management tools - loss database, KRI (key risk indicators), process maps, risk maps, self-assessment processes. IT systems for Basel II selection and implementation support. Other services for Banks related to the Basel II: Credit risk management organizational structure design. Credit and collection processes reengineering. Design of operational risk management organizational structure, including description of roles and responsibilities. Development of operational risk management strategy. Design and implementation of unexpected losses (economic capital) and expected losses calculations covering all risk types, i.e. credit, operational and market risk. Design and implementation of the strategy/financial planning process based on RAROC and EVA concepts (including FTP and ABC methodologies). Selection and implementation of IT infrastructure supporting calculation and reporting of risk-based profitability. We can help you!

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