WELCOME TO THE VIRTUAL CLASS

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.

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BASEL II ACCORD

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

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MINIMUM CAPITAL REQUIREMENT.

• CREDIT RISK
• 1. STANDARDISED APPROACH.
• 2. INTERNAL RATING BASED APPROACH.-
  FOUNDATION.
• 3. INTERNAL RATING BASED APPROACH- ADVANCED.

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MINIMUM CAPITAL REQUIREMENT.

• MARKET RISK
• 1. STANDARDISED APPROACH.
• (A) MATURITY, (B) DURATION.
• 2. INTERNAL MODELS METHOD.

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MINIMUM CAPITAL REQUIREMENT.

• OPERATIONAL RISK
• 1. BASIC INDICATOR APPROACH.
• 2. STANDARDISED APPROACH.
• 3. ADVANCED MEASUREMENT APPROACH.

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SUPERVISORY REVIEW PROCESS

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

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MARKET DISCIPLINE

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

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REGULATORY CAPITAL

• 1. TIER I
• 2. TIER II
• 3. TIIER III

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TIER I- CORE CAPITAL

• CAPITAL
• FREE RESERVES
• UNALLOCATED SURPLUSES LESS SPECIFIED DEDUCTIONS.

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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)

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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
  BANKS TIER I CAPITAL REQUIRED TO SUPPORT MARKET
  RISK OF THE BANK

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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.

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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.

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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

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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

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RISK WEIGHTS OF SOVEREIGN AND THEIR CENTRAL BANKS.
Credit rating of sovereigns RW of sovereigns RW for banks in that country
AAA to AA- 0 20
A to A- 20 50
BBB to BBB- 50 100
BB to B- 100 100
Below B- 150 150
Unrated 100 100
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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.

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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.

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RISK WEIGHTS

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

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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.

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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.

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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.

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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.

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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)

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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.

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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.

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CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS.
CLAIMS ON GOVT. GOVT.SECU. OTHER APPROVED SEC.GTD.BY GOVT. MATURITY ALL ALL SPECIFIC CAPITAL CHARGE OF EXPOSURE 0 0
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CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS
CLAIMS ON GOVT. Other apprvd. Sec. not gtd. By government. Other non appr. Sec. gtd. By government./claims on Banks MATURITY all all CAPITAL CHARGE OF EXPOSURE 1.8 1.8
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CAPITAL CHARGE FOR INTEREST RELATED INSTRUMENTS
CLAIMS ON GOVT. Claims on banks for residual term /other Tier II bonds. Tier II bonds/ claims on others Mortgage All others MATURITY Upto 6 m 6 m to 24 m gt24 m All All All CAPITAL CHARGE. 0.3 1.125 1.8 9 4.5 9
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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.

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CAPITAL CHARGE FOR EQUITIES IN THE TRADING BOOK

• FOR SPECIFIC RISK 9. SPECIFIC RISK IS COMPUTED
  ON THE BANKS GROSS EQUITY POSITION.
• GENERAL MARKET RISK CHARGE9 ON THE GROSS EQUITY
  POSITION.
• FE OPEN POSITION GOLD OPEN POSITION 9
• THE OPEN POSITION WOULD BE THE LIMIT OR ACTUAL
  WHICHEVER IS HIGHER.

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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.

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CAPITAL CHARGE FOR O.R.

• 1. BASIC INDICATOR APPROACH.
• 2. STANDARDISED APPROACH.
• 3. ADVANCE MEASUREMENT APPROACH.

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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.

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STANDARDISED APPROACH

• BANKS 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

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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.

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ADVANCE MESUREMENT APPRAOCH.

• Banks 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 Banks internal OR
  measurement system using qualitative and
  quantitative criteria for the AMA.

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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.

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QUALITATIVE STANDARDS

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

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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.

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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.

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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.

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VARIOUS OTHER ASPECTS

• PERSONNEL SELECTION.
• WORK CULTURE.
• ORGANISATIONAL STRUCTURE.
• SYSTEM REVIEW/REVISION.

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EXTERNAL CREDIT ASSESSMENT INSTITUTE CRITERIA

• OBJECTIVITY
• INDEPENDENCE
• INTERNAL ACCESS
• TRANSPARENCY.
• DISCLOSURES.
• RESOURCES.
• CREDIBILITY.

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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.

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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.

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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 BANKS
  INTERNAL CAPITAL ADEQUACY ASSESSMENT/STRATEGIES .

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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.

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MARKET DISCIPLINE

• IT IS IN SUPPORT TO PILLAR 1 AND 2.
• DISCLOSURES FOR ALLOWING PUBLIC TO
  ASSESSKEYINFORMATION AND THERBY MAKE INFORMED
  DECISIONS.

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PROFIT PLANNING

• FACTORS AFFECTING PROFITABILITY
• 1. TRUSTEE FOR DEPOSITORS AND NEED TO GIVE
  ATTRACTIVE RETURNS TO DEPOSITIORS.
• 2. RESPONSIBILITY TOWARDS SHAREHOLDERS NEEDS
  MAXIMIATION OF PROFIT.

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PROFIT PLANNING INVOLVES

• BALANCE SHEET MANAGEMENT COVERING
• 1. CREDIT.
• 2. INVESTMENT AND NON FUND BASED INCOME.
• 3. INCOME COMES FROM INTEREST ON ADVANCES, FEE
  BASED INCOME AND TREASURY OPERATIONS.

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TOTAL INVESTMENT
I II III IV
A) Investment in Govt. Securities with yield 6 and risk weightage of 0 1000 400 300 300
b) Lending to AAA rated customers with yield 8 p.a. risk weightagof 20 0 600 300 300
c) Lending to AA rated customers with yield of 10 p.a. risk weightage of 50 0 0 400 200
d) Lending to A rated customers with yield of 12 p.a. and risk weightage of 100 0 0 0 200
Total investment 1000 1000 1000 1000
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YIELD ON INVESTMENT
Yield I II III IV
a) 6 60 24 18 18
b)8 0 48 24 24
c)10 0 0 40 20
d)12 0 0 0 24
Total Yield 60 72 82 86
Rate 6.00 7.20 8.20 8.60
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Risk Weighted Assets I II III IV
a) 0 0 0 0
b) 0 120 60 60
c) 0 0 200 100
d) 0 0 0 200
RWA 0 120 260 360
Capital Required (at 8 CRAR) 0 9.6 20.8 28.8
57

• LENDING TO LOWER RATED CUSTOMERS RISK GETS
  ENHANCED NEEDING MORE CAPITAL BUT ALSO GIVES
  IMPROVED YIELD ON THE ASSETS.
• THE EFFECT OF NPA.
• (I) NO INCOME (II) PROVISIONING AND (III)
  ADDITIONAL CAPITAL

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FEE BASED INCOME

• REDUCING INCOME FROM TRADITIONAL SERVICES.
• NEW TECHNOLOGICAL SERVICE LIKE DEPOSITORY
  SERVICES, INTERNET BANKING, E COMMERCE.
• THIRD PARTY PRODUCTS.
• CROSS SELLING OF PRODUCTS.

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TREASURY INCOME

• TRADING IN SECURITIES, FOREIGN EXCHANGE,
  EQUITIES, BULLION, COMMODITIES, DERIVATIVES.

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EXPENDITURE SIDE

• INTEREST EXPENSES.
• OPERATING EXPENSES.

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.ThankYou and All the Best