Basel II Introduction to the New Regulation for capital adequacy

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Basel IIIntroduction to the New Regulation for
capital adequacy

• October 2006

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Summary

• What is Basel? Basel I vs. Basel II
• Basel II in Raiffeisen International and
  Raiffeisen Romania
• The costs of Basel II implementation
• Specifics for leasing companies

3
Summary

• What is Basel? Basel I vs. Basel II
• Basel II in Raiffeisen International and
  Raiffeisen Romania
• The costs of Basel II implementation
• Specifics for leasing companies

4
What is Basel? Basel I vs. Basel II
From Basel I to Basel II

• In 1988, the Basel Committee on Banking
  Supervision (BCBS), under the auspices of the
  Bank of International Settlements (BIS), in
  Basel, Switzerland, published a set of minimal
  capital requirements for banks. This is known as
  the Basel I or 1988 Basel Accord.
• Basel I applies to banks with international
  presence which are required to hold capital equal
  to 8 of the risk-weighted assets.
• The New Capital Accord or Basel II is addressed
  to
• Focus on internationally active banks but
  principles apply to all banks
• Within EU all credit institutions and securities
  firms.
• Basel II introduce a different method of
  calculating the capital adequacy ratio
  (solvability ratio) in parallel with new (more
  strict) requirements regarding supervision and
  transparency of banks.

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What is Basel? Basel I vs. Basel II
Why Basel II ?

• Rationale for a New Accord
• More risk sensitivity. Basel I is credit
  insensitive with fixed risk percentages applied
  to certain, pre-defined risk categories 0, 20,
  50, 100, it does not differentiate
  creditworthiness of borrowers - one size fits
  all!
• More emphasis on internal models and supervisory
  review. Basel I did not permit internal models.
• Objectives of the New Accord
• The level of capital is directly correlated with
  the risk profile and the risk appetite of a bank
• Continue to enhance competitive equality
• Greater emphasis on banks own assessment of risk
  and a comprehensive coverage of various risks
• The framework of 3 complementary pillars will
  help making the banking system Safer, Sounder,
  and More Efficient.

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What is Basel? Basel I vs. Basel II

• Romania adopted the EU Directive instead of Basel
  II Accord
• The key differences between Basel Capital Accord
  and EU Directive are as presented below

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What is Basel? Basel I vs. Basel II
The impact of Basel II is reflected in the
following issues
Extensivecoverage
In Europe, all banks and investment companies
need to comply with the new rules for capital
and risk management, for all component business
areas
Scope forcompetitive gains
Companies with extensive and well diversified
risk portfolios have the opportunity to
improve market position
Reportingtransparency
The new disclosure rules on capital and risk
management will have a direct impact on
credit rating and share price
Business mix
The new rules on capital and risk management will
have a direct impact on business investment/divest
ment decisions and market perception of these
decisions
Supervision
Regulators are likely to expect the leading and
most complex institutions to aspire to the
most advanced approaches
Riskmanagement
There will be far greater regulatory and market
focus on effective risk management
Implementationeffort
Although banks are at varying levels of
sophistication regarding risk management,
data architecture and system infrastructure,
Basel II will involve a major change programme
at considerable cost
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What is Basel? Basel I vs. Basel II
Evolution of Regulatory Capital
Capital Ratio Total Capital
Credit Risk (RWA of Banking Book)
1988 Basel Capital Accord
Basel I
Capital Ratio Total Capital
Credit Risk Market
Risk (MR RWA for
trading book)
1996 Market Risk Amendment
Definition unchanged
Basel II
Capital Ratio Total Capital
Credit Risk Market
Risk
Operational Risk
2004 New Basel Capital Accord
8 minimum unchaned
No change
New capital charge
RWA calculations revised
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What is Basel? Basel I vs. Basel II
Pillar 1 - Minimum Capital Requirement

• For each of the 3 categories of risks - credit
  risk, market risk and operational risk,
• there are several measurement options
  (approaches).
• Credit Risk
• Standardised Approach
• Internal Rating Based Foundation Approach
  available only for non-retail clients
• Advanced Measurement Approach
• Market Risk
• Standardised Approach
• Internal Approach
• Operational Risk
• Basic Indicator Approach
• Standardised Approach
• Advanced Measurement Approach (AMA)

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What is Basel? Basel I vs. Basel II
Pillar 1 Credit Risk
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What is Basel? Basel I vs. Basel II
Pillar 1 - 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
• includes legal risk
• excludes strategic and reputation risk

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What is Basel? Basel I vs. Basel II
Market Risk / Trading Book

• Basel I was concentrated purely on Interest Rate
  Risk and was based upon either maturity or
  duration bands.
• Later on it was amended to include FX and Equity
  Risks.
• Value-at-Risk (VaR) is the most popular internal
  model.

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What is Basel? Basel I vs. Basel II
Pillar 2 Supervisory Review

• The key principle of the supervisory review
• Banks should have a process for assessing their
  overall capital adequacy in relation to their
  risk profile and a strategy for maintaining their
  capital levels
• The key premise Supervisors are empowered to
  require and penalize banks to hold capital above
  the minimum. Supervisors will conduct regular
  review to ensure adequate capital if review
  fails, supervisor should increase capital charge.
• Responsibility for adequate capital rests with
  the banks management

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What is Basel? Basel I vs. Basel II
Pillar 3 Market Discipline

• Extensive disclosure requirements By disclosing
  detailed information about all risk types, a bank
  enables other participants in the market to
  assess its risk position and the adequacy of its
  capital.
• Mandatory disclosures
• Way in which the accord is applied within the
  group
• Amount and quality of the groups capital
• Qualitative and quantitative information on the
  methods used and measurement of all three forms
  of risk in the banking book, including strategies
  for managing future risk
• An analysis of the capital adequacy of the
  group, including contingency plans for times of
  stress.
• Supplementary disclosures, at request of regulator

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Summary

• What is Basel? Basel I vs. Basel II
• Basel II in Raiffeisen International and
  Raiffeisen Romania
• The costs of Basel II implementation
• Specifics for leasing companies

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Basel II in Raiffeisen International and
Raiffeisen Romania
RZB Group approaches for Pillar 1

• RZB Group aims to implement starting 01.01.2008
• Internal Rating Based Foundation Approach for
  Credit Risk and
• Standardized Approach for Market and Operational
  Risks
• Raiffeisen Bank Romania and Raiffeisen Leasing
  Romania will
• implement starting 01.01.2008
• Standardised Approach for Credit, Market and
  Operational Risks

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Summary

• What is Basel? Basel I vs. Basel II
• Basel II in Raiffeisen International and
  Raiffeisen Romania
• The costs of Basel II implementation
• Specifics for leasing companies

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The costs of Basel II implementation

• Basel II is a business issue and an IT issue and
  is a major change programme at considerable cost
• Basel II implementation doesnt mean only
  implementation of IT system and software programs
  but also implementation of best practices in risk
  management
• Basel II requires substantial work and effort as
  well as significant investments, as major changes
  can occur at the level of the organization
• Basel II is an opportunity to reduce costs and
  improve efficiency to gain competitive advantage.
  Reducing risks means it is reduced the amount of
  money to be put aside for covering the risks.
• The cost and availability of capital for all
  banks in future are closely related to the
  efficient and effective implementation of IFRS
  and Basel II. This is the most important issue
  for any bank for the next three to five years,
  with massive impacts on margins, business
  strategy, and internal project execution.

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The costs of Basel II implementation

• In July 2006 NBR requested a quantitative impact
  study (QIS), based on 31 December 2005 figures,
  in order to evaluate the impact of new capital
  accord - Basel II implementation the study was
  focused on for credit operational risk only
• 28 banks, representing 90 of the entire banking
  system, participated to this study
• For credit risk all the 28 banks used the
  standardized approach and the result on the
  capital adequacy ratio (CAD) is a 1.5 percentage
  points reduction, from 20.99 based on current
  regulations to19.47
• For operational risk different approaches were
  used 18 banks used base approach and 10 banks,
  including Raiffeisen bank, used standardized
  approach operational risk will put a
  supplementary pressure on CAD ratio, reducing it
  with another 1.6 percentage points
• In conclusion, for both credit and operational
  risks, the reduction in CAD ratio for the 28
  banks, will be 3.1 percentage points
• Even with this negative impact, the CAD ratio at
  Romanian banking system is still well above the
  new minimum level of 8 proposed by NBR,
  following the implementation of Basel II
  requirement starting 1st of January 2007.