WELCOME TO THE VIRTUAL CLASS – MODULE D CAPITAL MANAGEMENT AND PROFIT PLANNING.

1. WELCOME TO THE VIRTUAL CLASS – MODULE D CAPITAL MANAGEMENTAND PROFIT PLANNING. SIMON PHILIP VICE PRINCIPAL BANK OF INDIA MANAGEMENT DEV. INSTT. CBD BELAPUR.

2. BASEL I ACCORD • FOR THE FIRST TIME PROVIDED FRAMEWORK FOR CAPITAL ADEQUACY. • DEFINED COMPONENTS OF CAPITAL. • ALLOTTED RISK WEIGHTS TO ASSETS. • PRONOUNCED THE MINIMUM RATIO OF CAPITAL TO SUM TOTAL OF RW ASSETS. • INITIALLY COVERED ONLY CREDIT RISK AND SUBSEQUENTLY MARKET RISK.

3. BASEL II ACCORD. • IMPLEMENTATION: • FOR BANKS HAVING GLOBAL PRESENCE AND FOREIGN BANKS IN INDIA FROM MARCH, 2008. • FOR OTHER BANKS FROM MARCH, 2009.

4. BASEL II ACCORD • REVISED FRAMEWORK COVERING OPERATIONAL RISK. • BASED ON THREE PILLARS. 1. MINIMUM CAPITAL REQUIREMENTS. 2. SUPERVISORY REVIEW PROCESS. 3. MARKET DISCIPLINE.

5. MINIMUM CAPITAL REQUIREMENT. • CREDIT RISK: 1. STANDARDISED APPROACH. 2. INTERNAL RATING BASED APPROACH.- FOUNDATION. 3. INTERNAL RATING BASED APPROACH- ADVANCED.

6. MINIMUM CAPITAL REQUIREMENT. • MARKET RISK: 1. STANDARDISED APPROACH. (A) MATURITY, (B) DURATION. 2. INTERNAL MODELS METHOD.

7. MINIMUM CAPITAL REQUIREMENT. • OPERATIONAL RISK: 1. BASIC INDICATOR APPROACH. 2. STANDARDISED APPROACH. 3. ADVANCED MEASUREMENT APPROACH.

8. SUPERVISORY REVIEW PROCESS • TO ENSURE ROBUST INTERNAL PROCESSES FOR RISK MANAGEMENT FOR ADEQUACY OF CAPITAL. • EVALUATION OF RISK ASSESSMENT. • PRESCRIBE DIFFERENTIAL CAPITAL WHEREVER NECESSARY.

9. MARKET DISCIPLINE • DISCLOSURE NORMS ABOUT RISK MANAGEMENT PRACTICES AND ALLOCATION OF REGULATORY CAPITAL. • TO ENHANCE DISCLOSURES.- CORE AND DISCRETIONARY. • TIMELY DISCLOSURES.

10. REGULATORY CAPITAL • 1. TIER I • 2. TIER II • 3. TIIER III

11. TIER I- CORE CAPITAL • CAPITAL • FREE RESERVES • UNALLOCATED SURPLUSES LESS SPECIFIED DEDUCTIONS.

12. TIER II- SUPPLEMENTARY CAPITAL. • SUBORDINATED DEBT OF MORE THAN 5 YEARS MATURITY. • LOAN LOSS RESERVES. • REVALUATION RESERVES. • INVESTMENT FLUCTUATION RESERVES. • LIMITED LIFE PREFERENTIAL SHARES. • (TIER II CAPITAL IS RESTRICTED TO 100% OF TIER I CAPITAL AND LONG TERM SUB DEBT NOT TO EXCEED 50% OF TIER I CAPITAL)

13. TIER III CAPITAL • SHORT TERM SUBORDINATED DEBT. • FOR THE SOLE PURPOSE OF MEETING A PROPORTION OF THE CAPITAL REQUIREMENT FOR MARKET RISK. • SHORT TERM BOND MUST HAVE AN ORIGIANL MATURITY OF ATLEAST 2 YEARS • TIER 3 CAPITAL WILL BE LIMITED TO 250% OF A BANK’S TIER I CAPITAL REQUIRED TO SUPPORT MARKET RISK OF THE BANK

14. CAPITAL ADEQUACY • ANY CAPITAL REQUIREMENT ARISING IN RESPECT OF CREDIT RISK OR COUNTER PARTY RISK MUST BE MET BY TIER I & II CAPITAL. • MINIMUM OF 28.5% OF MARKET RISK NEEDS TO BE SUPPORTED BY TIER I CAPITAL.

15. CREDIT RISK AND CAR • RATING METHODOLOGY 1. EXTERNAL AGENCY. 2. INTERNAL ASSESSMENT. • FOR CREDIT RATING OF SOVEREIGN THE COUNTRY SCORES OF EXPORT CREDIT AGENCY MAY BE RECOGNISED.

16. CREDIT RATING OF COMMERCIAL BANKS. • ALL BANKS IN A GIVEN COUNTRY WILL BE ASSIGNED A RW- ONE BELOW THE RW ASSSIGNED TO THAT SOVEREIGN. • HOWEVER, FOR CLAIMS ON BANKS IN COUNTRIES WITH SOVEREIGN RATING BB+ TO B- AND BANKS IN RATED COUNTRIES RW WILL BE CAPPED AT 100%

17. CREDIT RATING OF COMMERCIAL BANKS • BASES THE RISK WEIGHTING ON THE EXTERNAL CREDIT ASSESSMENT OF THE BANK ITSELF. UNRATED BANKS WILL HAVE A RW OF 50%

18. RISK WEIGHTS OF SOVEREIGN AND THEIR CENTRAL BANKS.

19. VARIOUS RISK WEIGHTS • RETAIL AND SME EXPOSURE S ATTRACT RISK WEIGHT OF 75%. • LENDING FULLY SECURED BYMORTGAGE ON RESIDENTIAL PROPERTY : RW 35% • LOAN SECUREEDBY COMMERCIAL PROPERTY: RW 100% • PAST DUE LOANS: 150% WHEN SPECIFIC PROVISIONS ARE LESS THAN 20% OF THE LOAN AMT.AND 100% IF HIGHER PROVIS.

20. VARIOUS RISK WEIGHTS • IN CASE OF PAST DUE HOUSING LOANS: 100% IF PROVISIONING IS BELOW 20%. 50% IF HIGHER PROV. • FOR OFF B/S ITEMS, CREDIT CONVERSION FACTOR IS USED. • NETTING OF THE SECURITIES FROM THE OUTSTANDING EXPOSURE IS PERMITTED.

21. RISK WEIGHTS • WHEN THE CLAIM AMOUNT IS GUARANTEED BY ANOTHER PARTY/ AGENCY WITH A BETTER RATING , THE RW WOULD REDUCE ACCORDINGLY.

22. SIMPLIFIED STANDARDISED APPROACH • For sovereign exposures rating, one being used by Export Credit Agency. • Risk weight for the corporates is flat 100%, since ratings are not used. • Reduced risk weights of 75% and 35% for retail and housing portfolio.

23. IRB APPROACH. • CAPITAL CHARGE COMPUTATION IS DEPENDENT ON THE FOLLOWING PARAMETERS: • PD: PROBABILITY OF DEFAULT. • LGD: LOSS GIVEN AT DEFAULT. • ED: EXPOSURE AT DEFAULT. • M: EFFECTIVE MATURITY.

24. IRB APPROACH. • COMPUTES CAPITAL REQUIREMENT OF EACH EXPOSURE DIRECTLY. • CATEGORISATION OF ASSETS AS CORPORATE, SOVEREIGNS, BANKS, RETAIL AND EQUITY ETC. • BANKS PROVIDE THEIR OWN ESTIMATES OF PD,LGD,EAD,M.

25. CAPITAL CHARGE FOR MARKET RISK. • MARKET RISK IS DEFINED AS THE RISK OF LOSSES IN ON BALANCE SHEET AND OFF BALANCE SHEET POSITIONS ARISING FROM MOVEMENTS IN THE MARKET PRICES.

26. MARKET RISK • THE MARKET RISK POSITIONS WHICH REQUIRE CAPITAL CHARGE ARE : • (I) INTEREST RATE RELATED INSTRUMENTS IN TRADING BOOK. • (II) EQUITIES IN TRADING BOOK. • (III) FOREIGN EXCHANGE OPEN POSITIONS (INCLUDING POSITIONS IN PRECIOUS METALS) THROUGHOUT THE BANK (BOTH BANKING AND TRADING BOOKS)

27. MARKET RISK • A TRADING BOOK CONSISITS OF FINANCIAL INSTRUMENTS AND COMMODITIES HELD EITHER WITH TRADING INTENT OR IN ORDER TO HEDGE OTHER ELEMENTS IN TRADING BOOK. • THE POSITIONS NEED TO BE VALUED FREQUENTLY AND ACCURATELY.

28. MARKET RISK • IN INDIAN SCENARIO THE TRADING BOOKS COMPRISES OF: • SECURITIES UNDER HELF FOR TRDG. • SECURITIES UNDER AVAILABLE FOR SALE. • OPEN FOREX POSITIONS • OPEN GOLD POSITIONS • TRADING POSITIONS IN DERIVATIVES • DERIVATIVES FOR HEDGING TRADING POSITIONS.

29. CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS.

30. CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS

31. CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS

32. CAPITAL CHARGE FOR MARKET RISK: TOTAL OF 4 COMPONENTS • NET POSITION IN THE TRADING BOOK • A SMALL PORTION OF THE MATCHED POSITION IN EACH TIME BAND (VERTICAL DISALLOWANCE) • A LARGER PORTION OF THE MATCHED POSITION ACROSS DIFFERENT TIME BANDS (HORIZONTAL DISALLOWANCE) • A NET CHANGE FOR POSITION IN OPTION.

33. CAPITAL CHARGE FOR EQUITIES IN THE TRADING BOOK • FOR SPECIFIC RISK: 9%. SPECIFIC RISK IS COMPUTED ON THE BANK’S GROSS EQUITY POSITION. • GENERAL MARKET RISK CHARGE:9% ON THE GROSS EQUITY POSITION. • FE OPEN POSITION & GOLD OPEN POSITION: 9% • THE OPEN POSITION WOULD BE THE LIMIT OR ACTUAL WHICHEVER IS HIGHER.

34. OPERATIONAL RISK • OPERATIONAL RISK IS DEFINED AS THE RISK OF LOSS RESULTING FROM INADEQUATE OR FAILED INTERNAL PROCESSES, PEOPLE AND SYSTEMS OR FROM EXTERNAL EVENTS. IT INCLUDES LEGAL RISK BUT EXCLUDES STRATEGIES AND REPUTATIONAL RISK.

35. CAPITAL CHARGE FOR O.R. • 1. BASIC INDICATOR APPROACH. • 2. STANDARDISED APPROACH. • 3. ADVANCE MEASUREMENT APPROACH.

36. BASIC INDICATOR APPROACH • EQUAL TO THE AVERAGE OVER THE PREVIOUS 3 YEARS OF A FIXED PERCENTAGE. • DENOTED BY ALPHA OF POSITIVE ANNUAL GROSS INCOME. • THE AMOUNT SHOULD BE GROOS OF ANY PROVISION. • SHOULD BE GROSS OF OPERATING EXPENSES. • SHOULD EXCLUDE REALISED PROFITS/LOSSES FROM SALE OF INVESTMENT. • SHOULD EXCLUDE EXTRA ORDINARY OR IRREGULAR ITEMS AND INCOME DERIVED FROM INSURANCE.

37. STANDARDISED APPROACH • BANK’S ACTIVITIES DIVIDED IN TO 8 BUSINESS LINES. • 1. CORPORATE FINANCE: 18% • 2. TRADING/SALES : 18% • 3. RETAIL BANKING : 12% • 4. COMMERCIAL BKG. : 15% • 5. PAYMENTS/SETTLMTS : 18% • 6. AGENCY BUSINESS : 15% • 7. ASSETS MGMT. : 12% • 8. RETAIL BROKERING : 12%

38. STANDARDISED APPROACH • WITHIN EACH BUSINESS LINE, GROSS INCOME IS A BROAD INDICATOR FOR OPERATIONAL RISK EXPOSURE. • THE CAPITAL CHARGE FOR EACH B/L IS COMPUTED BY MULTIPLYING GROSS INCOME BY A FACTOR CALLED BETA, ASSIGNED TO THAT B/L. • THE TOTAL CHARGE IS THE THREE YEAR AVERAGE OF THE SIMPLE SUMMATION OF THE REGULATORY CAPITAL CHARGES FOR EACH OF THE B/L.

39. ADVANCE MESUREMENT APPRAOCH. • Bank’s internal operational risk measurement system is used which is to be vetted by the Central Bank. • The regulatory capital requirement will equal the risk measure generated by the Bank’s internal OR measurement system using qualitative and quantitative criteria for the AMA.

40. QUALITATIVE STANDARDS • Bank must have independent OR management function. • Integration of ORM system with the day to day RM process. • Regular reporting of OR exposure and loss experience. • Documentation of ORM system.

41. QUALITATIVE STANDARDS • Regular review by internal/external auditors. • Validation of ORM system by supervisory authorities.

42. QUANTITATIVE STANDARDS • Consistency in the system. • Bank should calculate regulatory capital and the sum of Expected Loss (EL) and unexpected Loss (UL) • The measurement system must be sufficiently granular to capture major events of OR.

43. QUANTITATIVE STANDARDS. • System for determining co-relations mustbe sound and the bank must validate the co relation assumptions. • The system must have key elements that meet with Supervisory standards. • A Bank needs to have a credible, transparent, well documented and verifiable approach for weighing fundamental elements in the RM system.

44. QUANTITATIVE STANDARDS • Internally generated measures must be based on a minimum 5 years observation period of internal loss data. • To use relevant external data. • Bank must use scenario analysis of expert opinion in conjunction with external data to evaluate its exposure to high severity events.

45. VARIOUS OTHER ASPECTS • PERSONNEL SELECTION. • WORK CULTURE. • ORGANISATIONAL STRUCTURE. • SYSTEM REVIEW/REVISION.

46. EXTERNAL CREDIT ASSESSMENT INSTITUTE: CRITERIA • OBJECTIVITY • INDEPENDENCE • INTERNAL ACCESS • TRANSPARENCY. • DISCLOSURES. • RESOURCES. • CREDIBILITY.

47. SUPERVISORY REVIEW • TO ENSURE THAT BANKS HAVE ADEQUATE CAPITAL TO SUPPORT ALL RISKS INTHEIR BUSINESS. • TO ENCOURAGE BANKS TO DEVELOP AND USE BETTER RISK MANAGEMENT TECHNIQUES IN MONITORING AND MITIGATING THEIR RISKS.

48. SUPERVISORS NEED TO CONCENTRATE: • RISK CONSIDERED UNDER PILLAR 1 BUT NOT FULLY CAPTURED SUCH AS CREDIT CONCENTRATION RISK. • FACTORS THAT ARE NOT ADDRESSED IN PILLAR 1 PROCESS SUCH AS STRATEGIC RISK OR INTEREST RATE RISK IN THE BANKING BOOK. • FACTORS EXTERNAL TO THE BANK E.G. BUSINESS CYCLE EFFECTS.

49. PRINCIPLES: SUPERVISORY REVIEW • BANKS SHOULD HAVE A PROCESS FOR ASSESSING THEIR CAPITAL ADEQUACY IN RELATION TO THEIR RISK PROFILE AND A STRATEGY FOR MAINTAINING THEIR CAPITAL LEVELS. • SUPERVISORS SHOULD REVIEW AND EVALUATE BANK’S INTERNAL CAPITAL ADEQUACY ASSESSMENT/STRATEGIES .

50. PRINCIPLES: SUPERVISORY REVIEW • SUPERVISORS SHOULD EXPECT BANKS TO OPERATE ABOVE THE MINIMUM REGULATORY CAPITAL RATIOSAND SHOULD HAVE THE ABILITY TO REQUIRE BANKS TO HOLD CAPITAL IN EXCESS OFTHE MINIMUM. • SUPERVISORS SHOULD INTERVENE AT AN EARLY STAGE TO PREVENT CAPITAL FALL.