Free Essay

Basel I and Ii

In:

Submitted By paglababa
Words 3956
Pages 16
ICRA Indonesia Comment
June 2013

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II
Contact:
Pradnya Desai Manager– Rating Analyst +62 21 576 1516 desai.pradnya@icraindonesia.com Drafted in 1988 and 2004 respectively, Basel I and II have, through quantitative and technical benchmarks, helped develop a level playing field in the banking

The “Basel Committee on Banking Supervision” (BCBS) is comprised of the central banks and regulatory authorities of mainly the G20 countries (including Indonesia) and other leading nations. The committee issues broad guidelines and standards to ensure best practices in the banking supervision and risk management. (Source: www.bis.org)

supervision, regulation and capital adequacy standards across the signatory nations. As of today, more than 100 countries have implemented Basel I and around 112 countries are implementing Basel II (Source: Wikipedia, Basel committee on banking supervision survey, 2010). Basel II generated more interest on account of the multitude of financial crises that the world economy faced during the 1990s and early 2000s. Further, its implementation gained momentum among the emerging economies after the 2008 crisis. While many countries have already commenced Basel III (drafted in 2010) implementation, Indonesia is yet to finalise the norms on the subject. Basel III while relevant at a future date will not be implemented in the near future and hence this article has confined itself to Basel II. This article limits itself to exploring the benefits of adapting Basel II guidelines over Basel I with respect to only the ‘minimum capital requirement’, which is one among the three pillars of Basel II. In particular, its scope within ‘minimum capital requirement norms’, is limited to credit risk for corporate/commercial exposure. However, it needs to be noted that the scope of Basel accord and in particular Basel II is substantially wider and covers several types of risks including marketing and operational risk. While it would be much exhaustive to provide full details, the salient features of Basel I and II with respect to credit risk have been presented in the following table.

ICRA Indonesia

Page 1

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Table 1: Comparison of the credit provisioning norms of Basel I and Basel II Criteria Basel I Basel II Risks addressed Credit risk Credit risk, market risk and operational risk Minimum capital 8% of risk weighted assets 8% of risk weighted assets (A)+ operational requirements risk provisioning + market risk provisioning Risk weights Differential only for near cash Varying risk weight across all asset and OECD related exposures, categories. 100% for non-OECD and (Varied risk weights for claims on corporate as follows: private exposure (Claims on corporate AAA to AA- categories = 20% of (A) A+ to A- categories = 50% of (A) uniformly at 100%) BBB+ to BB- =100% of (A) Below BB- = 150% of (A) Unrated = 100% of (A) ) Methodology to asses One size fits all Standardised Approach – An external credit risk rating (SA) Foundation Internal Rating Based Approach (F-IRB) Advanced Internal Rating Based Approach (A-IRB) Defined approaches even to address operational and market risks
(Source: various online, www.bis.org)

As noted above, calculating capital adequacy requirements under Basel II follows a more comprehensive approach. Initially, the Basel provisioning was meant to be implemented by banks that had international presence. However, in order to be perceived as a more evolved platform for international investment and to eliminate impact on the domestic competition within individual country due to the differential provisioning requirements, every signatory country began to pledge implementation across its entire banking sector. Basel II implementation in Indonesia – the roadmap and actual performance Indonesia pledged its commitment towards implementation of Basel II as early as 2006. Bank Indonesia (BI) had in fact charted out a roadmap for implementation of Basel II and committed to implementation of Basel II by 2010. (Source: A presentation made by SWD Murniastuti, then Deputy Director, Directorate of Banking Research and Regulation, Bank Indonesia in year 2006). As per the envisaged plan, all the commercial banks were proposed to meet the capital requirements of the framework by adopting the least sophisticated approaches initially. ‘Least sophisticated’ in the context of calculating risk weighted assets (RWA) would entail enlisting help of external credit rating agencies in risk assessment (SA), while more sophisticated would be developing own, time tested internal ratings based (IRB) risk assessment models, F-IRB being less sophisticated than A-IRB. Any bank capable of making necessary system changes and meeting all the other requirements adequately was proposed to allow the adaptation of more sophisticated approaches upon the regulatory approval. By 2010, it was expected that the framework would have been applied in full scope. While Indonesia took a lead in charting out an implementation timeline as compared to many other emerging economies, the implementation has been quite slower. Indonesian banks have consistently maintained a healthy financial risk profile marked by strong profitability for some time now. Added to this is

ICRA Indonesia

Page 2

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

their experience of handling the recent financial crisis. Both these aspects have probably elevated the level of Indonesian banks’ confidence, which could account for delay in adoption of Basel II. So far, Indonesian banks are well capitalised, if we consider Basel II norms in terms of size and quality of equity base. In absence of categorical information on the public domain, it may be concluded that Indonesia’s banks are still to calculate risk weighted assets in a differential manner according to Basel II. In February 2011, BI issued the final rule about adopting SA for capital adequacy calculations, to be brought into effect from January 2012. However, there is no publicly available update on risk weight calculations by the Banks. It is possible that due to the present healthy capitalisation, majority of large banks refrained from imposing an external credit rating on their clients. In view of benign interest rate scenario and multiplicity of funding channels, the other banks too refrained from imposition of credit rating on the corporate clients to remain with the competition. Why banks need to adapt a defined and time tested risk weighted approach A clearly defined risk weighted approach is essential for objective decision making as the data or risk assessment in varied periods and for varied industries can be compared. Past records can be utilised to arrive at trends and default analyses during the business cycles. While each bank already has its own risk assessment methods, streamlining the same with Basel II standards will eventually have to be done by all the banks in line with BI’s commitment to the cause. This is not only in the interest of Basel II conformance, but will also assist risk assessment in depth and improve overall credit risk management. At the end of the year 2012, the collective capital adequacy ratio (CAR) of Indonesian banks averaged at a healthy figure of around 17.4%. So far, given the healthy balance sheets marked by high profitability, the capital adequacy requirement as per Basel II has been taken care of without specific efforts. Even so, since the bank loans have not been rated externally within Indonesia, the actual credit distribution across the risk categories is yet to be seen. Looking from a different perspective, maintaining capital adequacy at present strong levels may not always be achievable on the back of the continuous high credit growth that Indonesia has been witnessing in recent years. With Basel III on the anvil, non-adherence to Basel II will further widen the regulatory gap, leading to different pace of adoptions of Basel between Indonesia and the majority of Basel signatories, many of which are Indonesia’s trade partners. An uneven playing field may not last long however. Through Basel III the reserve requirements will further increase and the growth in credit may not be always matched by growth in the capitalisation. All the above factors notwithstanding, the guideline of attaching risk weights to each asset class is precursor to the overall minimum capital requirement. Thus, in order to be Basel II compliant, even a bank perceived to have the lowest risk profile still needs to perform the capital attribution per risk type and demonstrate that the capital levels are still adequate according to the regulatory needs. Thus, assignment of risk weights either by way of SA or IRB becomes important. As on March 1, 2013, published credit ratings within Indonesia do not include any bank loan ratings. Following is broadly the rating statistics:
Table 2: Outstanding credit ratings in Indonesia as on March 31, 2013 (Source: Websites of various rating agencies)

Total rated entities 163

Of which Banks 40

Corporate 63

NBFCs, Insurance and others 60

Total Amount rated (IDR bn) 264,032.2

Instrument types Bonds, MTNs, Sukuk (Islamic bonds), ABS

ICRA Indonesia

Page 3

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Considering the fact that BI has already released guidelines for adaptation of Basel II, one is led to conclude that present risk provisioning within Indonesian banking space is 100%, irrespective of risk weight. Thus, based on 100% risk weight to corporate exposures, the CAR situation of Indonesian commercial banks as per the position available up to year ended December 2012 was as follows: Figure 1: The trend in credit growth and the provisioning of the Indonesian Banks

(Source: Bank Indonesia)

The above graph can also lead one to conclude that the capitalisation is not commensurate with the credit growth. While there is a recovery in CAR in 2008 onwards, and it remains healthy as the credit grows, the channels of raising capital may not be as easily available. Further, since the existing risk weight being applied is 100%, the growth in capital provisioning should have matched the growth rate in risk weighted assets, i.e. the provisioning growth should be linear with RWA growth, however the same is not the case. Immediate and tangible benefits of moving towards Basel II framework on capital adequacy ICRA Indonesia believes that banks can achieve optimum risk management by using credit ratings to assign their risk weights and at the same time can release further capital. To explore the benefits of the attaching risk weights while calculating capital adequacy, ICRA Indonesia has attempted to examine figures released by Bank Indonesia in December 2012. Please also refer to the graphs above. As on December 31, 2012, out of total outstanding credit of Rp 2,707.8 trillion, 70.5% viz Rp 1,909.0 trillion was the collective working capital and investment credit. We will assume for simplicity that these were total corporate advances. To explain the impact of differential risk weights, we need to have credit profiles of the corporate available in the public domain. As discussed earlier, since the credit ratings are not being done for risk weights, this data is not available. We have therefore considered credit rating distribution of emerging markets by one of the leading international credit rating agencies for this analysis.

ICRA Indonesia

Page 4

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Figure 2: Credit Rating Distribution in the Emerging Markets

As per this distribution, we can conclude that, roughly, the rating distribution of emerging markets is following: Table 3: Emerging market rating distribution
Rating Share (%) AAA 1 AA 2.5 A 12.5 BBB 29 Sub-investment Grades 55

Thus, almost 45% of the ratings are investment grade. This statistic is as per number of issuer credit ratings. We shall be extending this statistic to assume that the amount of exposure too follows the same distribution. It has been empirically noted that the higher rating categories in reality have large exposures per entity. Usually these entities are substantially larger in size as compared to the lower category ratings and hence larger in funding requirements. Thus the assumption that the amount of exposure too would follow rating distribution is conservative in our opinion. We have however, in the absence of data, extrapolated this rating distribution for our analysis and estimated that out of total lending of Rp 1.909 trillion, the investment grade exposure amounted to Rp 859.0 trillion. In the following diagram it can be seen that adapting differential ratings in case of investment grade ratings will result in lower requirement for capital provisioning.

ICRA Indonesia

Page 5

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Figure 3: Gap between Credit risk provisioning amount as per Basel I and Basel II

The following table captures relevant calculations. Table 4: The differential if Basel II risk provisioning is followed Rating (Amounts in Rp. trillion) AAA to AA A Capital Provisioning (A) 8% 8% Risk weight 20% 50% Calculation =(A)*20% =(A)*50% Estimated investment grade corporate 66.8 238.6 credit (As per December 2012 figures) Basel I provisioning (X) 5.3 19.1 Basel II provisioning (Y) 1.0 9.6 Excess (X-Y) 4.3 9.5

BBB 8% 100% =(A)*100% 553.6 44.3 44.3 0

Total 8% 859.0 68.7 55.4 13.8

Thus, if all the banks had implement risk weighted approach, the overall capital released would have been around Rp 13.8 trillion as of December 2012 which could have been used to meet further demand for borrowings. The important thing to note here is that in this distribution, we have assumed more than 50 % of exposure in sub-investment grade. As the economy progresses, this distribution will change with increase in investment grade corporate and thus will require lesser and lesser provisioning percentage wise. Illustrative impact on major banks and expected loan in the medium term The early birds with respect to implementation of this approach would be large banks, which would have systems and resources to allocate for immediate implementation. Thus, continuing with example above, we have considered 5 largest banks in the Indonesia as per 2012 statistics. We have assumed corporate credit of around 70.5% in line with earlier data.

ICRA Indonesia

Page 6

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Table 5: Impact of differential provisioning - A simulation for the top 5 banks
Figures as of Dec. 2012 (Rp trillion except CAR) Mandiri BRI BCA BNI CIMBNiaga Total

CAR (%) Total Loans Corporate credit (~70.5%) (C) Investment grade credit out of (C ) above Basel I provisioning (X) Basel II provisioning (Y) Capital released (X-Y)

15.5 339.9 239.6 107.8 8.6 6.9 1.7

16.9 347.9 245.3 110.4 8.8 7.1 1.8

14.7 256.7 180.9 81.4 6.5 5.2 1.3

17.6 192.6 135.8 61.1 4.9 3.9 1.0

15.1 133.6 94.2 42.4 3.4 2.7 0.7

15.9 1,270.7 895.8 403.1 32.3 25.8 6.5

These banks controlled around 47% of total advances in 2012. Since overall corporate credit in the economy accounted for around 70.5% of the total credit, needless to say, these banks also controlled substantial part of the corporate credit that went into the economy. Assuming linear credit distribution, if we assume 70.5% of the advances of top 5 banks were to corporate, then amount of around Rp 6.5 trillion could have been released into the economy in year 2012 with Basel II compliance by the top 5 banks. There remains a disincentive for lower category ratings to be considered given the higher provisioning requirements for sub investment grade exposure as compared to unrated exposure and we have assumed that in such a case the companies may not accept ratings, as typically seen in the bond markets and that the banks will continue to treat them as unrated since presently there is no disincentive for an unrated bank loan in Indonesia. Important thing to consider here is the fact that eventually, as a result of Indonesia’s commitment to implement Basel II, all the corporate exposures will have to be risk weighted as per the level of risk. Meaning, even the sub-investment grade exposure will eventually have to be rated and the risk weight provided for. The only variable that remains is time. Since Indonesia will soon commence its adoption of Basel III norms with more stringent requirements, the sooner Basel II is adopted, the smoother the transition will be for the banks with respect to capital provisioning. Moreover, as the investment grade entities accept these ratings, more capital could be released in the market – which will have a trickledown effect. The market awareness too shall increase with respect to risk management among the corporate and historical data for default studies could be streamlined across the banking sector. ICRA Indonesia expects the credit growth between 20-22% in 2013, while over the medium term, it is expected to remain above 20%. Given such a high growth, the capitalisation may not happen to match the demand every time. A scenario where capitalisation of banks is not commensurate with credit growth offers a challenge to all the banks, especially the smaller banks whose cost of capital is relatively higher. These banks will also be at a comparative disadvantage while raising capital in equity markets. This challenge can be tackled with adherence to Basel II capital adequacy guideline, as demonstrated in this article. As an exercise, we can explore the tentative amount of capital that could be released as a result of such implementation. Continuing with the example from above, let us consider following projection depicting capital provisioning calculations under Basel I and II. We have assumed a credit growth of 20% on year-on-year basis:

ICRA Indonesia

Page 7

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Table 6: Impact of differential provisioning on the banking sector over the medium term (Amounts in Rp trillion) Total credit in the economy Corporate exposure (70.5%) Investment grade credit Basel I provisioning (X) Basel II provisioning (Y) Capital released (X-Y)
Source: ICRA Indonesia’s estimates

2012 2,707.8 1,909.0 859.1 68.7 54.9 13.8

2013 3,249.4 2,290.8 1,030.9 82.5 65.9 16.6

2014 3,899.2 2,748.9 1,237.0 98.9 79.1 19.9

2015 4,679.1 3,298.7 1,484.4 118.8 94.9 23.9

2016 5,614.9 3,958.5 1,781.3 142.5 113.8 28.7

2017 6,737.9 4,750.2 2,137.6 171.0 136.6 34.4

Above exercise based on the 20% credit growth shows us substantial amount of release of capital estimated to be around Rp 34.4 trillion over the medium term. It would be easier for all the players to follow the standardised approach of allocating risk weights, i.e. using the credit ratings assigned by the external rating agencies. The rating agencies have dedicated personnel to track and analyse credit movements within a particular corporate, sector or economy. Their models are time tested and updated to accommodate the current environment. The constant monitoring of rated universe by the rating agency also encourages adherence to credit discipline, while the assessment of strengths and weaknesses by rating agencies which are independent entities ensures that conflict of interest is minimised. The alternative to SA, IRB too can be implemented. However, for IRB, high end IT infrastructure to collate real time information within the risk management software would be required. This entails high investment in IT with no precedent of successful implementation within the country. Also next immediate need would be for training. As a result, adoption of SA has been more popular. As per the Financial Stability Institute and BCBS survey in 2010, 96 out of the total 112 respondent countries have explicitly adopted SA. Impact on the corporate sector Basel II guidelines also serve to improve corporate environment. An assessment by an independent entity offers to corporate unbiased views on the current and potential performances based on the existing risk management and financial discipline. Furthermore, an investment grade rating can actually be of corporate advantages. Since investment grade ratings fall in relative safer categories as compared to the sub-investment grade ratings, they can be used to negotiate lower interest rate with the banks along with better commercial terms. Conclusion We explored the comparative impact of implementation of Basel II vis a vis Basel I and concluded that adoption of Basel II norms with respect to calculation of risk weighted assets in terms of credit risk is more desirable. In present scenario, with the help of examples, we concluded that a substantial amount of capital estimated at Rp 6.5 trillion could have been released into the economy of the country in 2012 if the top 5 banks had followed Basel II method for calculating risk weighted assets for credit risk. The total amount released, had all the banks followed same approach is Rp 13.8 trillion. Furthermore, assuming the annual credit growth of 20%, the Basel II implementation could result in the release of large capital amounting to Rp 34.4 trillion over 2017, which could be utilised to disburse more loans across the economy, leading to a trickledown effect.

ICRA Indonesia

Page 8

ICRA Indonesia Comment

Minimum Capital Provisioning for Credit Risk – a Comparative Study of Basel I and Basel II

Since implementation of Basel II as well as Basel III shall happen in Indonesia eventually, the exercise of attaching risk weights needs to commence sooner or later. Moreover, with substantial capital provisioning as required under Basel III, coupled with the fact that the capitalisation may not always be in tune with credit growth, ICRA Indonesia believes that the timely implementation of Basel II becomes more necessary to ensure smooth transitioning to Basel III. This will not only enable a release of more capital into a growing economy, but also will result in availability of data to study default and transitioning across entities of varied sizes, across all the sectors and contribute to improvement in the risk management practices. There are many reasons why non-implementation of Basel II norms is a disadvantage, especially in growing competition. ICRA Indonesia believes that the international competitive forces coupled with the regulatory commitment, eventually will lead the banks to implement Basel II. The option that remains here is the decision on what approach to follow – the standardised approach or the internal rating based approach. While IRB needs substantial investments in IT and human resources, the SA has offered easier approach by utilising the use of external ratings by independent rating agencies.

© Copyright, 2013, ICRA Indonesia. All Rights Reserved. All information contained herein has been obtained by ICRA Indonesia from sources believed by it to be accurate and reliable. Although reasonable care has been taken to ensure that the information herein is true, such information is provided ‘as is’ without any warranty of any kind, and ICRA Indonesia in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness or completeness of any such information. All information contained herein must be construed solely as statements of opinion and ICRA Indonesia shall not be liable for any losses incurred by users from any use of this publication or its contents.

ICRA Indonesia

Page 9

Similar Documents

Free Essay

Basel (I Ii Iii)

...THE BASEL CAPITAL ACCORDS BY JOE LARSON APRIL 2011 I. Introduction Banks are a vital part of a nation’s economy. In their traditional role as financial intermediaries, banks serve to meet the demand of those who need funding. As such, banks make it possible for people to buy homes and for businesses to expand. Banks therefore facilitate spending and investment, which fuel growth in the economy. However, despite their important role in the economy, banks are nevertheless susceptible to failure. Banks, like any other business, can go bankrupt. However, unlike most other businesses, the failure of banks, especially very large ones, can have far-reaching implications. As we saw during the Great Depression and, most recently, during the global financial crisis and the ensuing recession, the health of the bank system (or lack thereof) can trigger economic calamities affecting millions of people. Consequently, it is imperative that banks operate in a safe and sound manner to avoid failure. One way to ensure this is for governments to provide diligent regulation of banks. Yet, with the advent of globalization, banking activities are no longer confined to the borders of any individual country. With cross-border banking activities rapidly increasing, the need for international cooperation in bank regulation has likewise increased. Ready to meet this need is the Basel Committee on Bank Supervision (BCBS). In its role as the international advisory authority on bank regulation, the BCBS...

Words: 9857 - Pages: 40

Free Essay

Internship Report of Corporate Credit in Bank

...CHAPTER I INTRODUCTION 1.1 Background Basel Capital accord is a capital adequacy framework developed by the Basel committee. In 1988, the Basel Committee decided to introduce a capital measurement system commonly referred to as the Basel Capital Accord. This system provided for the implementation of a credit risk measurement framework with a minimum capital requirement of 8% on banks Risk Weighted Assets (RWA). The 1988 framework is also known as "Basel – I". Since 1988, this framework has been progressively introduced not only in member countries but also virtually in all other countries. The "international convergence on capital measurement and capital standard -2004" is popularly known as Basel-II. It is a capital adequacy related standard framed by Basel committee. After the successful implementation of 1988 accord in more than 100 countries, the Basel Committee on Banking Supervision reached an agreement on a number of important issues for promoting best and uniform banking practices as well as setting standards and guidelines for supervisory function. Following extensive interaction with banks, industry groups and supervisory authorities that are not members of the Committee, the revised framework was issued on 26 June 2004, which is being regularly revised and updated. The Basel-II aims to replace Basel I and to make the capital framework more risk sensitive. Basel II has recommended major revision on...

Words: 2395 - Pages: 10

Free Essay

Case

...Basel I DEFINITION OF 'BASEL I' A set of international banking regulations put forth by the Basel Committee on Bank Supervision, which set out the minimum capital requirements of financial institutions with the goal of minimizing credit risk. Banks that operate internationally are required to maintain a minimum amount (8%) of capital based on a percent of risk-weighted assets. Basel II is the second of the Basel Accords, (now extended and partially superseded[clarification needed] by Basel III), which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision. BREAKING DOWN 'Basel I' The first accord was the Basel I. It was issued in 1988 and focused mainly on credit risk by creating a bank asset classification system. This classification system grouped a bank's assets into five risk categories: 0% - cash, central bank and government debt and any OECD government debt 0%, 10%, 20% or 50% - public sector debt 20% - development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank debt (under one year maturity) and non-OECD public sector debt, cash in collection 50% - residential mortgages 100% - private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and equipment, capital instruments issued at other banks The bank must maintain capital (Tier 1 and Tier 2) equal to at least 8% of its risk-weighted assets. For example, if a bank has risk-weighted assets of $100 million, it is required to maintain...

Words: 3940 - Pages: 16

Premium Essay

Risk Management in Banking

...CHAPTER I: INTRODUCTION 1. THEME OF THE STUDY Risk management underscores the fact that the survival of an organization depends heavily on its capabilities to anticipate and prepare for the change rather than just waiting for the change and react to it. The objective of risk management is not to prohibit or prevent risk taking activity, but to ensure that the risks are consciously taken with full knowledge, purpose and clear understanding so that it can be measured and mitigated. It also prevents an institution from suffering unacceptable loss causing an institution to suffer or materially damage its competitive position. Functions of risk management should actually be bank specific dictated by the size and quality of balance sheet, complexity of functions, technical/ professional manpower and the status of MIS in place in that bank. 1.2 INTRODUCTION Risk: the meaning of ‘Risk’ as per Webster’s comprehensive dictionary is “a chance of encountering harm or loss, hazard, danger” or “to expose to a chance of injury or loss”. Thus, something that has potential to cause harm or loss to one or more planned objectives is called Risk. The word risk is derived from an Italian word “Risicare” which means “To Dare”. It is an expression of danger of an adverse deviation in the actual result from any expected result. Banks for International Settlement (BIS) has defined it as- “Risk is the threat that an event or action will adversely affect an organization’s ability...

Words: 9309 - Pages: 38

Premium Essay

Risk Management in Banking Sector

...CHAPTER I: INTRODUCTION 1. THEME OF THE STUDY Risk management underscores the fact that the survival of an organization depends heavily on its capabilities to anticipate and prepare for the change rather than just waiting for the change and react to it. The objective of risk management is not to prohibit or prevent risk taking activity, but to ensure that the risks are consciously taken with full knowledge, purpose and clear understanding so that it can be measured and mitigated. It also prevents an institution from suffering unacceptable loss causing an institution to suffer or materially damage its competitive position. Functions of risk management should actually be bank specific dictated by the size and quality of balance sheet, complexity of functions, technical/ professional manpower and the status of MIS in place in that bank. 1.2 INTRODUCTION Risk: the meaning of ‘Risk’ as per Webster’s comprehensive dictionary is “a chance of encountering harm or loss, hazard, danger” or “to expose to a chance of injury or loss”. Thus, something that has potential to cause harm or loss to one or more planned objectives is called Risk. The word risk is derived from an Italian word “Risicare” which means “To Dare”. It is an expression of danger of an adverse deviation in the actual result from any expected result. Banks for International Settlement (BIS) has defined it as- “Risk is the threat that an event or action will adversely affect an organization’s ability...

Words: 9309 - Pages: 38

Free Essay

Basel 2

...Accountants of India - Batch 129 Basel II Implications on Indian Banks Group Members Rahul Sharma (ERO0097549) Abhishek Tulsyan (CRO0137558) Sikha Kedia (ERO0105399) Gourav Modi (ERO0016925) Praveen Didwania (ERO0110131) Index of Contents Topics Page No. I. Introduction A. B. C. D. E. F. G. Background Functions of Basel Committee The Evolution to Basel II – First Basel Accord Capital Requirements and Capital Calculation under Basel I Criticisms of Basel I New Approach to Risk Based Capital Structure of Basel II First Pillar : Minimum Capital Requirement Types of Risks under Pillar I The Second Pillar : Supervisory Review Process The Third Pillar : Market Discipline 3 3 3 3 3 4 4 II. The Three Pillar Approach A. B. C. D. 5 5 6 6 7 7 7 III. Capital Arbitrage and Core Effect of Basel II A. Capital Arbitrage B. Bank Loan Rating under Basel II Capital Adequacy Framework C. Effect of Basel II on Bank Loan Rating IV. Basel II in India A. Implementation C. Impact on Indian Banks D. Impact on Various Elements of Investment Portfolio of Banks E. Impact on Bad Debts and NPA’s of Indian Banks D. Government Policy on Foreign Investment E. Threat of Foreign Takeover 8 8 9 10 10 10 V. Conclusion A. SWOT Analysis of Basel II in Indian Banking Context B. Challenges going ahead under Basel II 11 11 13 13 VI. VII. References The Technical Paper Presentation Team 2 I. Introduction: A. Background Basel II is a new capital adequacy framework...

Words: 4743 - Pages: 19

Free Essay

Basel Norms

...Basel I The Basel Accords are some of the most influential—and misunderstood—agreements in modern international finance. Drafted in 1988 and 2004, Basel I and II have ushered in a new era of international banking cooperation. Through quantitative and technical benchmarks, both accords have helped harmonize banking supervision, regulation, and capital adequacy standards across the eleven countries of the Basel Group and many other emerging market economies. On the other hand, the very strength of both accords—their quantitative and technical focus—limits the understanding of these agreements within policy circles, causing them to be misinterpreted and misused in many of the world’s political economies. Moreover, even when the Basel accords have been applied accurately and fully, neither agreement has secured long-term stability within a country’s banking sector. Therefore, a full understanding of the rules, intentions, and shortcomings of Basel I and II is essential to assessing their impact on the international financial system. This paper aims to do just that—give a detailed, non-technical assessment of both Basel I and Basel II, and for both developed and emerging markets, show the status, intentions, criticisms, and implications of each accord. Basel I Soon after the creation of the Basel Committee, its eleven member states (known as the G-10) began to discuss a formal standard to ensure the proper capitalization...

Words: 4711 - Pages: 19

Free Essay

Basel

...Basel II to Basel III: Changes and Requirements Hesham Hamdy Chief Risk Officer, Arab International Bank Nairobi, 7-8 March 2012 Basel; what is it? • A New Standard for the Measurement of Risks in Banks, and for the Allocation of Capital to cover those risks, published by the Basel Committee of G10 Central Banks. • What Does Basel Committee Do? - Acts as Think-Tank for banking regulators - Issues guidance on best practice for banks - Standards accepted worldwide - Generally incorporated in national banking regulations Basel I • Basel I was the round of deliberations by central banks from around the world, and in 1988, the Basel Committee (BCBS) in Basel, Switzerland, published a set of minimum capital requirements for banks. This was known as the 1988 Basel Accord, and was enforced by law in the Group of Ten (G-10) countries in 1992 . • Basel I primarily focused on credit risk. Assets of banks were classified and grouped in five categories according to credit risk, carrying risk weights of zero (for example home country sovereign debt), ten, twenty, fifty, and up to one hundred percent (this category has, as an example, most corporate debt). Basel I (continued) • Banks with international presence were required to hold capital equal to 8 % of the risk-weighted assets. • Basel I was then widely viewed as outmoded because the world has changed as financial corporations, financial innovation and risk management have developed. Therefore, a more comprehensive set of...

Words: 3834 - Pages: 16

Premium Essay

Is Basel Iii a Better Support to Islamic Banks Than Basel Ii?

...Is Basel III a better support to Islamic banks than Basel II? International Interdisciplinary Conference On Changes, Challenges and Consequences In Commerce, Engineering, Technology and Social Science. Institute of Business Management and Research, Chakan & Choice Institute of Management Studies and Research, pune, 15th March, 2014. Dr. Atmaram palnitkar Research Guide& Principal of Dayanand College OF Commerce, Latur. palnitkarav@rediffmail.com&9423347478 Abdul-Jabbar Qasem Ali Al-badaani Research Scholar of Com and Magt Sci, SRTM University, Nanded. Amaf3600@gmail.com&7709670130 ------------------------------------------------- ------------------------------------------------- ABSTRACT Banking activities involve many risks calculated and otherwise. Banks have to take appropriate measures and require management of their capital and credit and implementation procedures in keeping with the best international practices, to mitigate potential losses and avoid projected pitfalls. In view of the recent financial crisis, due to wrong management or improper implementation as well as the collapse of large economies has had a cascading effect all round the world in the form of collapses of famous institutions and banks, and thus arose a decision to have a better financial control in the form of Basel I to be later followed by Basel II and Basel III. Thus a new culture in financial controls and risk management has arisen to safeguard the banking...

Words: 3374 - Pages: 14

Free Essay

Basel Ii

...Members |   | Argentina | Central Bank of Argentina | Australia | Reserve Bank of Australia Australian Prudential Regulation Authority | Belgium | National Bank of Belgium | Brazil | Central Bank of Brazil | Canada | Bank of Canada Office of the Superintendent of Financial Institutions | China | People's Bank of China China Banking Regulatory Commission | European Union | European Central Bank European Central Bank Single Supervisory Mechanism | France | Bank of France Prudential Supervision and Resolution Authority | Germany | Deutsche Bundesbank Federal Financial Supervisory Authority (BaFin) | Hong Kong SAR | Hong Kong Monetary Authority | India | Reserve Bank of India | Indonesia | Bank Indonesia Indonesia Financial Services Authority | Italy | Bank of Italy | Japan | Bank of Japan Financial Services Agency | Korea | Bank of Korea Financial Supervisory Service | Luxembourg | Surveillance Commission for the Financial Sector | Mexico | Bank of Mexico Comisión Nacional Bancaria y de Valores | Netherlands | Netherlands Bank | Russia | Central Bank of the Russian Federation | Saudi Arabia | Saudi Arabian Monetary Agency | Singapore | Monetary Authority of Singapore | South Africa | South African Reserve Bank | Spain | Bank of Spain | Sweden | Sveriges Riksbank Finansinspektionen | Switzerland | Swiss National Bank Swiss Financial Market Supervisory Authority FINMA | Turkey | Central Bank of the Republic of Turkey ...

Words: 1869 - Pages: 8

Premium Essay

Basel

...BASEL NORMS – BOON OR BANE? BY Pallabi ROY (PGDMB13/035) PRITAM SATHPATY (PGDMB13/077) SAGAR CHoUDHARY (PGDMB13/081) SHERIN MATHEWS (PGDMB13/049) SOHINI BANERJEE (PGDMB13/052) TUSHAR SHARMA (PGDMB13/086) table of contents TOPIC PAGE NO. 1. INTRODUCTION 1 2. Importance of Regulation of Bank Capital 2 3. BCBS : A Historical Background 3 4. BASEL I ACCORD 4 I. SALIENT FEATURES 5 II. ADVANTAGES OF BASEL I 9 III. SHORTCOMINGS OF BASEL I 11 5. baSEL II 13 I. from basel i to basel ii - the journey continues 13 II. OBJECTIVES 15 III. THE ACCORD IN OPERATION 15 IV. IMPACT OF BASEL II ON INDIA 26 a. IMPACT ON THE INDIAN BANKING SYSTEM 26 b. POSITIVE IMPACT 27 c. NEGATIVE IMPACT 29 V. Basel II and the global financial crisis 30 6. BASEL III 32 I. INTRODUCTION 32 II. OBJECTIVES 32 III. CHANGES MADE IN THE BASEL ACCORD 33 IV. COMPARISON OF CAPITAL REQUIREMENTS UNDER 39 BASEL II AND BASEL III V. macroeconomic impact of basel iii 40 A. Impact on Individual Banks 40 B. IMPACT ON THE FINANCIAL SYSTEM 40 C. impact of basel iii on the indian 42 banking system VI. RBI GUIDELINES 44 VII. CONCERNS WITH BASEL III 45 7. CONCLUSION ` 50 Introduction Banks are...

Words: 12833 - Pages: 52

Free Essay

Finance

...N0. 470 WORKING PAPER NO: 470 BASEL BANKING NORMS – A PRIMER Akshay Uday Shenoy PGP Student Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 560076 akshay.shenoy@iimb.ernet.in Yatin Balkrishna Mohane PGP Student Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 560076 yatin.mohane@iimb.ernet.in Charan Singh RBI Chair Professor Economics & Social Science Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 5600 76 Ph: 080-26993818 charansingh@iimb.ernet.in Year of Publication-October 2014 Basel Banking Norms – A Primer1 Abstract This paper aims to first build a deeper understanding of the emergence of Basel banking norms (Basel I), and the transition to each of the subsequent regulations (Basel II and Basel III). The primary purpose of developing this understanding is to further analyze the extent of effectiveness of the Basel norms. To explore how such regulations impact an economy, we have specifically looked at five economies of the world (including India), which are geographically apart, in this context. The idea here is to study how, for instance, banking institutions have shaped up to these norms – and whether the effects were favorable or adverse. We then conclude by conceptually looking at the future direction of regulations such as the Basel norms in the banking industry. Keywords: Banking, Financial Services, Regulation, Basel Norms, Capital Adequacy, Liquidity ...

Words: 13616 - Pages: 55

Free Essay

Basel Ii Implemenatation

...Research Title Basel II Capital Accord and implementation implications in Albania Prepared: Elda Lila Mentor : Professor William Handorf, Ph.D., July 2007 Abstract: Basel II Capital Accord and implementation implications in Albania 2 Abstract: Basel II Capital Accord and implementation implications in Albania 2 I. What is New Basel Capital Accord and its Evolution 4 II. Adoption of Basel II 5 BCBS Countries 5 In Other Countries 6 Banking Supervision Improvement Priorities 6 III. History of Banking Supervision in Albania (Banking System in Albania and Supervisory Process. 7 IV. Three Pillars of Basel II and the implications related to the implementation in Albania: 10 1.Pillar 1 – Capital Defined 11 1.1 Pillar 1 – Credit Risk 11 1.2 Pillar 1 – Market Risk 15 1.3 Pillar 1 – Operational Risk 16 2. Pillar 2 – The Supervisory Review Process 16 3. Pillar 3 – Market Disclosure 18 V. Reference List 21 Abstract: Basel II Capital Accord and implementation implications in Albania I. The first part is concentrated in what is new Basel Capital Accord and its Evolution. Supervisors have long sought to ensure that banks maintain adequate capital to cover all risks. In 1988, the Basel Committee on Banking Supervision agreed the 'International Convergence of Capital Measurement and Capital Standards', more commonly known as the Basel Capital Accord which in most countries is fully implemented...

Words: 4572 - Pages: 19

Free Essay

Basel Ii

...The Basel II was proposed in 1999 as a more comprehensive capital adequacy accord, formally known as A Revised Framework on International Convergence of Capital Measurement and Capital Standards, and informally as “Basel II”. Each Pillar of Basil I was expanded to cover new approaches. A. Pillar I Known as Minimum Capital Requirements, Basel II creates a more sensitive measurement of a bank’s risk-weighted assets. It broadens the scope of regulation to include assets of the holding company of an internationally active bank to avoid the risk that a bank will “hide” risk-taking by transferring its assets to other subsidiaries. Basel II proposes three mutually exclusive methods. The first method, known as the Basic Indicator Approach, recommends that banks hold capital equal to fifteen percent of the average gross income earned by a bank in the past three years. Regulators are allowed to adjust the 15% number according to their risk assessment of each bank. The second method, known as the Standardized Approach, divides a bank by its business lines to determine the amount of cash it must have on hand to protect itself against operational risk. Each line is weighted by its relative size within the company to create the percentage of assets the bank must hold. The third method, the Advanced Measurement Approach is much more demanding for regulators and banks alike: it allows banks to develop their own reserve calculations for operational risks. Regulators, of course, must approve...

Words: 522 - Pages: 3

Free Essay

Business

...Risk Based Capital (Basel II) for Banks in Bangladesh: A straightforward Journey Abu Hena Mohd. Razee Hassan K. M Abdul Wadood Abstract Banks operating in Bangladesh are much enthusiastic for maintaining risk based capital in line with Basel II. Self audit report 2008 on compliance with Basel Core Principles (BCPs) shows, Operational independence of Bangladesh Bank, supervisory tools, existing prudential regulations for core risk management as introduced in banking industry by BB has developed an environment is favorable for implementing Basel II. Bangladesh Bank (BB) has commenced the implementation of Basel II from January 2009 and has provided banks guideline for computing Minimum Capital requirement (MCR) on the basis of Risk Weighted Assets (RWA). The techniques of calculation of RWA will follow Standardized Approach for Credit Risk, Standardized (Rule Based) Approach for Market Risk and Basic Indicator Approach for Operational Risk. In Standardized Approach risk weight of exposures will be differentiated based on external credit assessments and the risk weights will be inversely related to the credit rating of the counter party. Calculation of RWA under Standardized Approach is supported by External Credit Assessment Institute (ECAI). The recognition process of BB will ensure ECAIs eligibility criteria as required by the Basel II document. In addition to computing MCR banks have to calculate adequate capital with the procedure as stated in the section second pillar or...

Words: 4270 - Pages: 18