Process Document

for
SRP-SREP Dialogue on ICAAP
(Implementation of 2nd Pillar of Basel II)




February 2011





Bangladesh Bank




[Type the company name]
[Pick the date]


























Basel II Implementation Cell
Banking Regulation & Policy Department
Head Office


3



SRP-SREP Dialogue:
Process of linking capital to the level of risk management

The key principle of the supervisory review process (SRP) is that banks have a process for assessing
overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital at an
adequate level. Banks should have an exclusive body (called SRP team) where risk management unit is an
integral part, and a process document (called Internal Capital Adequacy Assessment Process-ICAAP) for
assessing their overall risk profile, and a strategy for maintaining adequate capital. Adequate capital means
enough capital to compensate all the risks in their business, and to develop and practice better risk
management techniques in monitoring and managing their risks. ICAAP includes regulations of a banks
own supervisory review of capital positions aiming to reveal whether it has prudent risk management and
sufficient capital to cover its risk profile. Supervisory Review Evaluation Process (SREP) of BB includes
dialogue between BB and the banks SRP team followed by findings/evaluation of the banks ICAAP.
During SRP-SREP dialogue BB will review and determine additional capital to MCR of banks. For this
SREP team may collect relevant information stated below from banks and different departments of BB:

Particulars of risks against which
capital required
Process of determining capital mentioned in annexure and source
of information for checking & counter checking may be as follows
Required
Capital
Credit risk From Department of Off-site Supervision (DOS) xxx
Market risk From Department of Off-site Supervision (DOS) xxx
Operational risk From Department of Off-site Supervision (DOS) xxx
A) Capital Requirement against Credit, Market & Operational risks xxxxx
Residual risk Annexure-1, to be collected from banks, BRPD and DBI xxx
Evaluation of Core Risk
management
Annexure-2, to be collected from banks, DBI 1,2&3, FEIVD, AMLD
and DOS
xxx
Credit concentration risk Annexure-3, to be collected from banks, DBI 1,2&3. xxx
Interest rate risk in the banking book Annexure-5, to be collected from banks and DOS xxx
Liquidity risk Annexure-6, to be collected from banks and DOS xxx
Reputation risk Annexure-7, to be collected from banks, BRPD & DOS xxx
Settlement risk Annexure-8, to be collected from banks, FEPD and FEIVD
Strategic risk Annexure-9, to be collected from bank and related Depts. of BB xxx
Environmental & Climate change
risk
Annexure-10, to be collected from bank and related Depts. of BB xxx
Other material risk Annexure-11, to be collected from bank and related Depts. of BB xxx
B) Requirement of additional capital under SRP xxxxx
Total Capital Requirement (A+B) for the year -------- xxxxx


4


Annexure-1
Residual Risks
As banks mitigate risks by way of collaterals, the collaterals can pose additional risks (legal, documentation,
valuation risk etc.), which may deteriorate the impact of risk mitigation. For example:
a) The liquidation procedure of the collateral is difficult and time consuming,
b) The valuation of the collateral is inappropriate (e.g. overvaluation).
c) Physical non existence of collateralized property, etc
Capital charge may be calculated in the following way:
Outstanding
amount of total
Loans &
Advances/
Investment
-- bp of Column (a) to
be determined as
capital charge by the
bank due to error in
documents including
physical non-
existence of
collateral
-- bp of Column
(a) to be
determined as
capital charge by
the bank due to
error in valuation
-- bp of Column (a) to
be determined as capital
charge by the bank due
to delay in process of
legal action and
execution of court
verdict (time value of
money +legal
processing cost).
Total capital
charge to be
estimated by
the bank
(b+c+d)
(a) (b) (c) (d) (e)
xxxx xxxx xxxx xxxx xxxx

How to collect information and counter check:
Information of column (a) will be collected from Banking Regulation and Policy Department
(BRPD) bp of column (b), (c) and (d) would be determined by the banks on the basis of their reality.
BB will counter check the information with observation of Department of Banking Inspection
(DBI)1,2&3 in this regard.
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.








5

Annexure-2
Evaluation of Core Risk Management
Core risk management guidelines are provided with the banks with a view to enhance knowledge, skill and to
introduce uniform risk management system in the banks. Non-compliance of core risk management comes
out of under-estimation of assessment procedure, valuation, level of implementation etc. and leads to the
banks financial losses. It may be caused by the negligence, knowledge limits, insufficient data or changes
which make approaches imperfect. To check these issues management of core risks and its rating could be
evaluated and disregard of core risks management may be linked with the additional capital requirement. The
bank should assess the potential deficiencies of the applied methods and take them into consideration during
the SRP. If BB finds the capital requirement of the bank calculated with the applied methods insufficient to
cover its risks at the time of its review, it may require the banks to take specific action or raise additional
capital determined through the SRP-SREP dialogue.
To check the issue, management of core risks and its rating could be evaluated and inadequate management
of core risks may be linked with the additional capital requirement in the following way:
Rating of core risk
management
Evaluation Minimum Capital
Requirement (MCR)
Additional Capital
required
(--- bp of MCR)
1 Strong
xxxx
Nil
2 Satisfactory Nil
3 Fair 10 bp =xxx
4 Marginal 30 bp =xxx
5 Unsatisfactory 50 bp =xxx

Core Risk Rating of Core
Risk Management
(a)
Corresponding bp

(b)

Risk wise Capital
requirement
(--- bp of MCR)

CRM x xx xxx
ALM x xx xxx
ICC x xx xxx
AML x xx xxx
FEX x xx xxx
ICT x xx xxx
Additional Capital Requirement (Total): xxxx

6


How to collect information and counter check:
Core Risk Ratings may be collected from the core risk management rating that would be determined
by the banks themselves and these will be counter checked by the ratings conducted by DBI 1,2&3,
Foreign Exchange Inspection & Vigilance Department (FEIVD), Anti Money Laundering
Department (AMLD) and compiled by Department of Off-site Supervision (DOS).
Finally through SRP-SREP dialogue additional capital will be determined on the basis of
observation/reality for this risk management.
7

Annexure-3
Credit Concentration Risk
Credit concentration risk may arise from exposure to a single entity / group and/or exposures in the same
economic or geographic sector and/or credit concentration in dependent industries. Downturn in
concentrated activities and/or areas may cause huge losses to a bank relative to its capital and can threaten
the banks health or ability to maintain its core operations. Concentration may be used in a broader sense
and include the following reasons:
Concentration by economic purpose (Sector),
Concentration by size of Loan Accounts/ in the name of a single borrower
Concentration by a legally connected group of borrowers
Concentration by region (Geographical)
Concentration by Portfolio Type (Granularity)

Credit concentration by business segment can be quantified based on Herfindahl-Hirschman Index (HHI)
as follows:


s
i
=Share (%) of credit by ith business segment of total assets

i)HHI 0.01 indicates homogeneous concentration index
ii) HHI>0.01 to <0.1 indicates satisfactory concentrated index
iii)HHI =0.1 to 0.18 indicates moderate concentration
iv) HHI >0.18 indicates high concentration

Additional capital can be calculated on the basis of the following way/Qualitative J udgment:
HHI Minimum Capital Requirement
(MCR)
Additional Capital
(--- bp of MCR)
HHI 0.01

xxxx
Nil
0.01<HHI<0.1 30 bp =xxx
HHI=0.1 to 0.18 40 bp =xxx
HHI >0.18 50 bp =xxx

1. Assets by Economic Purposes (% of total Loans and advances) ------------------ HHI =xxx
Agriculture,
Fishing &
Forestry
Industry Trade
Financing
Transport &
Communication
Housing
& Real
Estate
financing
Construction,
Health &
Storage
Consumer
Credit
Others
Textile RMG Leather Others
----% ---% --% ----% ---% ---% ---% ---- % ----% ----% ---%

=
n
i
i
s HHI
2
8


2. Assets by size of accounts in the name of a single borrower (% of total Loans and advances) ----HHI=xxx
(Tk. In Crore)
50 and
above
40 - 50 30 - 40 30 - 20 20 -10 10 - 5 1 - 5 1 and
below
----% ----% ----% ----% ----% ----% ---- % ---- %
(Note : Lower limit excluded)

3. Assets by size of accounts in the name of a legally connected group of borrowers
(% of total Loans and advances) ------ HHI=xxx

50 and
above
40 - 50 30- 40 30 - 20 20 - 10 10 - 5 1 - 5 1 and
below
----% ----% ----% ----% ----% ----% ---- % ---- %
(Note : Lower limit excluded)

4. Assets by region (% of total Loans and advances) ------------------ HHI =xxx
(Tk. In Crore)
Dhaka Chittagong Khulna Sylhet Rajshahi Rangpur Barisal
----% ----% ----% ----% ----% ----% ----%

5. Assets by Portfolio /Type of Exposure (% of total Loans and advances) -----------------HHI =xxx
(Tk. In Crore)
Govt. PSE Bank &
NBFI
Corporate SME Capital
Market
Consumer Res. Real
Estate
Com. Real
Estate
----% ----% ----% ----% ----% ----% ----% ----% ----%

Concentration of Assets HHI bp MCR Additional Capital required
(--- bp of MCR)
Assets by Economic Purposes xxx xx
xxxx
xxx
Assets by size of accounts in the name
of a single borrower
xxx xx xxx
Assets by size of accounts in the name
of a legally connected group of
borrowers
xxx xx xxx
Assets by region xxx xx xxx
Assets by Portfolio /Type of Exposure xxx xx xxx
Additional Capital Requirement (Total): xxxx


9



How to collect information and counter check:

1. Information of table 1, 2, 3, 4 & 5 (% of total Loans and advances) would be collected from banks and be
counter checked by the information collected by DBI 1,2&3.

2. Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.









10

Annexure-4
Interest Rate Risk in the Banking Book (IRRBB):
Interest rate risk is the current or potential risk to earnings and capital arising from adverse movements in
interest. This is in respect of the banking book only from pillar 2 (SRP) contexts. Interest rate risk is very
important from the perspectives short term earnings and economic value consideration. Significantly
reduced earnings can pose a threat to capital adequacy. So, volatility of earnings is an important focal
point for interest rate analysis. However, measurement of the impact on economic value (the present value
of the banks expected net cash flows) provides a more comprehensive view of the potential long term
effects on an institution's overall exposures. Supervisory focus will primarily be on:

measuring interest rate risk in relation to economic value, and
considering interest rate risk in relation to earnings as a supplementary measure.

There are numerous ways that financial institutions currently identify and measure IRRBB. Their methods
reflect the specific form of the risk in question and the nature, scale and complexity of their activities.
IRRBB includes:
I. re-pricing risk - related to the mismatch in the maturity and re-pricing of assets and liabilities
and off balance sheet short and long term positions,
II. yield curve risk - arising from changes in the slope and the shape of the yield curve,
III. basis risk - arising from hedging exposure to one interest rate with exposure to a rate which re-
prices under slightly different conditions, and
IV. option risk - arising from options, including embedded options, e.g. consumers redeeming fixed rate
products when market rates change.

Supervisors recognize that there are various levels of centralization of ALM within institutions. Some may
have a centralized management and assessment functions for IRRBB while others do not.
Institutions usually consider two different, but complementary, perspectives in their process of assessing
IRRBB.
A. Earnings perspective: The earnings perspective focuses on the sensitivity of earnings in the short term
to interest rate movements. Institutions usually adopt this perspective due to two main reasons: (i) this is
the variable through which an interest rate change has an immediate impact on reported earnings; and (ii)
the assessment of interest rate risk is difficult because it is mainly based on assumptions about the
behavior of long term instruments, such as stable demand deposits or other noninterest bearing balance
sheet items and those with embedded options.

B. Economic value perspective: The economic value perspective focuses on the sensitivity of the
economic values of the banking book items to interest rate changes. To use this approach as the shorter
term earnings perspective will not completely capture the impact of interest rate movement on the market
value of long term positions.
11


Monitoring and management of IRRBB
A variety of techniques and models are used by institutions to analyze interest rate risk, both in terms of
economic value and in terms of earnings. These models vary from very simple calculations to statistical
simulation models of a wide range of scenarios. The most commonly used techniques for analyzing the
interest rate risk in the banking book are gap analysis, earnings at risk (EaR), duration of equity (and/or price
value of one basis point and economic value of equity (EVE).
Institutions may use a wide range of tools to measure and monitor IRRBB. But, the banks management must
determine most appropriate monitoring system and management technique depending on the nature, scale
and complexity of their business.
Gap analysis is one of the most traditional management techniques and has been developed by banks to
analyze the mismatch or re-pricing risk in the banking booking in particular. An advantage of gap analysis is
that it is a simple method, which is fairly easy to communicate to management.
Gap analysis measures:
a) the arithmetic difference between the interest-sensitive assets and liabilities of the banking
book in absolute terms.
b) gap analysis shows the cash flows, including on a cumulative basis, of a portfolio, sub
portfolio or product by maturity segment based upon the contractual maturities of financial
instruments or assumptions regarding them.
c) gap report shows the exposure that is released during a particular time period and the
exposure that is outstanding during a particular time period.
Using gap analysis, the earnings sensitivity of the banking book to interest rate movements can be derived.
When the value of interest-sensitive liabilities exceeds that of interest-sensitive assets, including off-balance-
sheet positions, there is a negative or liability-sensitive gap. This means that if market interest rates rise, net
interest income is adversely affected.
Conversely, a positive or asset sensitive gap means that if market interest rates fall, net interest income is
adversely affected.
The vulnerability of an institution towards the adverse movements of the interest rate can be measured by
using duration GAP analysis. The banks shall follow the following steps in carrying out the interest rate risk
on net worth:
Estimate the market value of all on-balance sheet rate sensitive assets and liabilities of the
bank/NBFI to arrive at market value of equity
Calculate the durations of each class of asset and the liability of the on-balance sheet Portfolio
Arrive at the aggregate weighted average duration of assets and liabilities
12

Calculate the duration GAP by subtracting aggregate duration of liabilities from that of
assets.
Estimate the changes in the economic value of equity due to change in interest rates on
on-balance sheet positions along the three interest rate changes.
Calculate surplus/ (deficit) on off-balance sheet items under the interest rate change.
Estimate the impact of the net change (both for on-balance sheet and off-balance sheet) in the
market value of equity on the capital adequacy ratio (CAR).
Market value of the asset or liability shall be assessed by calculating its present value discounted
at the prevailing interest rate.
The outstanding balances of the assets and Liabilities should be taken along with their
respective maturity or re-pricing period, whichever is earlier
Duration is the measure of a portfolios price sensitivity to changes in interest rates. Longer the duration
causes larger the changes in the price for a given change in the interest rates. Larger the coupon lower would
be the duration and smaller would be the change in the price for a given change in the interest rates.

Market Value (MV
t
)
or
Present Value (PV
t
)

n
=
t=1

CF
t


(1+YTM)
t

Where -
CF
t
=Coupon/Cash flow at time t
t =remaining periods of time to maturity ,
YTM =the yield to maturity of the security, and
n =the number of cash flows.



Yield To Maturity (YTM)

Where-
CF =Coupon/Cash flow
F =Face Value
P =Purchase Price
t =Years to maturity



MV=
10
+
10
+
10+100
=105.15 1+.08 (1+.08)
2
(1+.08)
3

13

Suppose a bond of Tk. 100 with the maturity of 3 years, 10% coupon. At the effective YTM at 8% market
value (MV) of the bond will be calculated as follows:
Duration


D =

n

t=1

tCF
t




100 =

n

t=1

tCF
t



100

(1+YTM)
t
(1+YTM)
t

n

t=1
CF
t
MV or PV
(1+YTM)
t

Where -
CF
t
=cash flow at time t,
t =the number of periods of time until the cash flow payment,
YTM =the yield to maturity of the security generating the cash flow, and
n =the number of cash flows.
Suppose a bond of Tk. 100 with the maturity of 3 years, 10% coupon. At the effective YTM at 8% duration
[(D), Macaulay Duration] of the bond will be calculated as follows:

D=
110
+
210
+
3(10+100)

100=2.74 years
1+.08 (1+.08)
2
(1+.08)
3

10
+
10
+
10+100
1+.08 (1+.08)
2
(1+.08)
3


Weighted Average Duration
The duration GAP is measured by comparing the weighted average duration of assets with the weighted
average duration of liabilities (leverage-adjusted).

Weighted Average Duration of Assets(DA)


DA


n
=
a=1


WaDa
Where -
Wa = value of the asset a divided by the Total assets
Da = duration of the asset a
n =total number of assets

Weighted Average Duration of Liability(DL)

DL

n
=
l=1

WlDl

14

Where -
Wl = value of the liabilities l divided by the Total liabilities
Dl= duration of the liabilities l
n =total number of liabilities l
Duration Gap




Example:
Suppose ABC bank has the following Asset & Liability positions on end of Dec-2010:

The weighted average duration of assets shall be calculated as follows:
DA=1.94(1000/10000)+3.62(500/10000)+5.62(2000/10000)+2.73(6000/10000) = 3.13
DL =1.90 (5000/9000) +2.78 (3000/9000)+.25 (500/9000)= 2.26




DGAP


= DA -


MVL


DL

MVA
(Taka in Cr.)
Assets : Book
Value
%Coupon Remaining
Period
(Years)
Yield to
Maturity

Market
Value
Duration
(year)
Cash 80 - - - 80 -
3 year GTB (HFT) 1000 6% 2 6% 1000 1.94
5year GTB (HFT) 500 7% 4 7% 500 3.62
10 year GTBs (HTM) 2000 8% 7 8% 2000 5.62
Investment in shares 100 - - - 100 -
3 year Commercial
Loan
6000 10% 3 10% 6000 2.73
Non Earning Assets 320 - - - 320 -
Total Assets (TA): 10000 8.55% 8.55% 10000 3.13
Liabilities :
Current Deposits 500 - - - 500 -
3years Term Deposit 5000 5% 2 5% 5000 1.90
5years Term Deposit 3000 8% 3 8% 3000 2.78
Borrowings 500 4% .25 4% 500 .25
Total Liabilities (TL): 9000 5.67% - 5.67% 9000 2.02
Equity Capital 1000 - - - 1000 -
Total Liabilities and
Equities :
10000 - - - 10000 -
15







Example:
Suppose ABC bank has the following Asset & Liability positions on end of Dec-2010:
(Assumed 1 percent increase in all rates)


The average duration of assets >liabilities, hence asset values change by more than liability values. Here the
duration of assets (3.13) exceeds the duration of liabilities (2.02), which signifies that assets are more price
sensitive than that of liabilities and certain rise in interest rate would cause greater decrease in the value of
assets leading to decrease in the market value of equity (In the above example shows decrease in equity value
from Tk. 1000Cr. to 880Cr.). Longer the DGAP causes larger the changes in the market value of equity.


Where -
i =The change in the interest rate
y =The effective yield to maturity of Total Assets


DGAP


= DA -


MVL


DL

MVA

DGAP

= 3.13 -

9000

2.26

= 1.096

10000
(Taka in Cr.)
Assets : Book Value Coupon Remaining
Period
(Years)
Yield to
Maturity
( int. rate 1%)
Market
Value
Cash 80 - - - 80
5 year GTB (HFT) 1000 6% 2 7% 976
10 year GTB (HFT) 500 7% 4 8% 483
15 year GTBs (HTM) 2000 8% 7 9% 1899
Investment in shares 100 - - - 100
3 year Commercial Loan 6000 10% 3 11% 5853
Non Earning Assets 320 - - - 320
Total Assets (TA): 10000 - 9.49 9711
Liabilities :
Current Deposits 500 - - - 500
3years Term Deposit 5000 5% 2 6% 4908
5years Term Deposit 3000 8% 3 9% 2924
Borrowings 500 4% .25 5% 499
Total Liabilities (TL): 9000 - - 6.6 8831
Equity Capital 1000 - - - 880
Total Liabilities and Equities : 10000 - - - 9711
16

Therefore, 1% point rise in interest rate would cause a fall in its market value of equity by:

MVE - 1.096 (0.01/ (1+0.0855) 10000
= -100.97 cr.

To summarize, our calculations of Duration Gap for coupon bonds have revealed four facts:

1. The longer the term to maturity of a bond, everything else being equal, the greater its duration.
2. When interest rates rise, everything else being equal, the duration of an Asset/ bond falls.
3. The higher the coupon rate on the Asset/bond, everything else being equal, the shorter the duration.

The greater the duration of, the greater the percentage change in the market value of the security for a given
change in interest rates. Therefore, the greater the duration of Assets, the greater its interest-rate risks.

Stress testing can also be performed, in order to measure financial institutions vulnerability under stressed
market conditions like sudden changes in the level and slope of the term structure of interest rates, changes in
the relationships among key market rates, etc.
To facilitate supervisors monitoring of interest rate risk exposures across institutions, banks would have to
provide the results of their internal measurement systems, expressed in terms of economic value relative to
capital, using a standardized interest rate shock.
If supervisors determine that banks are not holding capital commensurate with the level of interest rate risk,
they must require the bank to reduce its risk, to hold a specific additional amount of capital or some
combination of the two. Supervisors should be particularly attentive to the sufficiency of capital of outlier
banks where economic value declines by more than 20% of the sum of Tier 1 and Tier 2 capital as a result
of a standardized interest rate shock (200 basis points) or its equivalent, as described in the supporting
document Principles for the Management and Supervision of Interest Rate Risk.

Banks may be advised to conduct Duration Gap Analysis and provide the detail to BB:
When conducting the analysis, positions on the banks balance sheet would be slotted into the maturity
approach according to the following principles:
(a) All assets and liabilities belonging to the banking book and all OBS items belonging to the banking book
which are sensitive to changes in interest rates (including all interest rate derivatives) are slotted into a
maturity ladder comprising a number of time bands large enough to capture the nature of interest rate
risk in a national banking market.
(b) Separate maturity ladders are to be used for each currency accounting for more than 5% of either
banking book assets or liabilities.
(c) On-balance-sheet items are treated at book value.
17

(c) Fixed-rate instruments are allocated according to the residual term to maturity and floating-rate
instruments according to the residual term to the next re-pricing date.
(d) Exposures (defined in Guidelines on Risk Based Capital Adequacy, December 2010, Page-8-9, Section-
2.2.10, 2.2.11, 2.2.12, 2.2.13) which create practical processing problems because of their large number of
accounts and relatively small individual amount.
(e) Time and Demand Deposits are slotted according to their corresponding maturity.
(f) Derivatives are converted into positions in the relevant underlying. The amounts considered are the
principal amount of the underlying or of the notional underlying.
(h) Futures and forward contracts, including forward rate agreements (FRA), are treated as a combination of
a long and a short position. The maturity of a future or a FRA will be the period until delivery or exercise of
the contract, plus - where applicable - the life of the underlying instrument.
(For example, a long position in a J une three month interest rate future (taken in April) is to be reported as a
long position with a maturity of five months and a short position with a maturity of two months.)
(i) Swaps are treated as two notional positions with relevant maturities. For example, an interest rate swap
under which a bank is receiving floating-rate interest and paying fixed-rate interest will be treated as a long
floating-rate position of maturity equivalent to the period until the next interest fixing and a short fixed-rate
position of maturity equivalent to the residual life of the swap. The separate legs of cross currency swaps are
to be treated in the relevant maturity ladders for the currencies concerned.
(j) Options are considered according to the delta equivalent amount of the underlying or of the notional
underlying.
18

Annexure-5
Liquidity Risk
Liquidity risk occurs when a bank is unable to fulfill its commitments in time when payment falls due. Banks
should come up with estimates on their liquidity risk. The purpose of liquidity measurements is to ensure that
the institution remains solvent in its day-to-day operations at all times and in meeting up long term
obligations. In order to maintain immediate liquidity, analyses are to be carried out concerning future
liquidity as well. Regulations and procedures are to be implemented which serve the ongoing and forward-
looking measurement and management of the institutions financing position. Alternative scenarios are to be
developed and decisions on net financing positions should be reviewed on a regular basis. Contingency plans
should be available for handling a potential liquidity crisis.

For assessing capital requirements against liquidity risk, the following ratio can be applied :
1. Liquidity Coverage Ratio (LCR)

1. Liquidity Coverage Ratio (LCR)
This standard aims to ensure that a bank maintains an adequate level of unencumbered, high-quality liquid
assets that can be converted into cash to meet its liquidity needs for a 30 calendar day time horizon under a
significantly severe liquidity stress scenario specified by supervisors.
LCR=
For the year-------- (As on last day of the month)
Month J an Feb Mar Apr May J un J uly Aug Sep Oct Nov Dec Average
LCR xx xx xx xx xx xx xx xx xx xx xx xx xx

High Quality Liquid Assets:
Cash in
hand
Balance
with BB
& SB as
agent of
BB
(includin
g f.cy)
Deposit
with
other
Bank
(Current
A/C)
Treasur
y bill
(HFT)
Unencu
mbered
Foreign
cy.
Deposit
with BB
Cash
in
transit
Mudaraba
interbank
deposit
Money
at call
and
Short
Notice
(Net)
Short
notice
deposit
Prize
Bond
Total
xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx


Total net cash outflows over the 30 calendar days =outflows Min {inflows; 75% of outflows}=xxx

19

Average Index MCR Capital charge
(bp of MCR amount)
LCR <100%
xxxx
50 bp =xxx
LCR =100%-150% Nil
LCR=151%-200% 20 bp =xxx
LCR >200% 30 bp =xxx

How to collect information and counter check:
Particular of all liquid assets, cash outflows and cash inflows are to be collected from banks and DOS and
may be counter checked with observation & analysis of DBI 1,2&3.
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.
20

Annexure-6
Reputation Risk
Reputation risk is the current or prospective indirect risk to earnings and capital, decline in the customer
base, costly litigation arising from adverse perception of the image of the banks on the part of customers,
counterparties, shareholders, investors or regulators.
Reputation risk may originate from the lack of compliance with industry service standards, failure to deliver
on commitments, lack of customer-friendly service and fair market practices, low or inferior service quality,
unreasonably high costs, a service style that does not harmonize with market benchmarks or customer
expectations, inappropriate business conduct or unfavorable authority opinion and actions.
Signs of significant reputation risk include the extensive and repeated voicing of a negative opinion on the
institutions performance and overall quality by external persons or organizations, especially if such negative
opinion receives broad publicity along with poor performance by the institution which may lay the grounds
for such opinions.
In general a reputational risk may potentially damage the standing or estimate of an organization in the eyes
of third-parties. The harm to a firms reputation is intangible and may surface gradually. However, there is
strong evidence that equity markets immediately react to the reputational consequences of some events.
There are several paths by which reputational risk can induce losses for a firm:
Loss of current or future customers - Typically this involves a reduction in expected future revenues,
but it could also involve an increase in costs if, for example, increased advertising expenditures are
necessary to restrain reputational damage.
Loss of employees or managers within the organization, an increase in hiring costs
Reduction in current or future business partners
Increased costs of financial funding via credit or equity markets
Increased costs due to government Policy, Supervisory regulations, fines, or other penalties

For checking reputation risk:
a) CAMELS or credit rating done by eligible ECAI recognized by BB rating may be checked. The worse
rating will be considered for determining additional capital requirement for reputation risk
b) Evidence of internal fraud in individual banks may be checked
c) Evidence of regulatory non-compliance, violation of/failure to meet commitments, penalty, negative
public opinion on the institutions performance, Law suits by external parties, adverse media exposure may
be checked.
d) Capital requirement may be linked on the basis of check list and credit rating done by eligible ECAI
recognized by BB.


21

1. CAMELS/ Credit Ratings
CAMELS/ Credit Ratings 1 2 3 4 5&6
MCR xxx
Capital charge
(bp of MCR amount)
Nil Nil 20bp =xx 50bp =xx 150bp=xx

2. Evidence of internal fraud
No. of Evidence of
internal fraud in last
05 (five) year
Nil 1-3 4-6 7-9 10-12 More than
12
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

3. Evidence of regulatory non-compliance
No. of Evidence of
regulatory non-
compliance or other
failure in last one
year (J an-Dec)
Nil 1-5 6-10 11-15 16-20 More than
20
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

**Evidence of regulatory non-compliance means major regulatory non-compliance/violation of/failure to meet commitments/negative public opinion
on the institutions performance/Law suits by external parties/adverse media exposure noticed by offsite and onsite departments


4. Penalty imposed by BB
No. of Evidence of
penalty in last one
year (J an-Dec)
Nil 1-3 4-6 7-9 10-12 More than
12
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

5. Evidence of Bills accepted (foreign & domestic) but payment not disbursed/payment delayed
**

No. of Evidence of
penalty in last one
year (J an-Dec)
Nil 1-5 6-10 11-15 16-20 More than
20
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx
** Delayed means payment not disbursed within the agreed stipulated time according to the documents or existing rules.
22


6. All types of Payables (except bills accepted) not settled in due time (foreign & local currency)
No. of Evidence of
penalty in last one
year (J an-Dec)
Nil 1-10 11-20 21-30 31-40 More than
40
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

7. Deposit Claims not paid/paid in delay
**

** Deposit claims paid in delay refers to the payment of deposit claims within more than 3 working days after the claim

8. Quality of Customer Service


** Quality of customer service would be assessed on the basis of qualitative judgment.

Factors Capital charge
(bp of MCR amount)
CAMELS/ Credit Ratings
(worse Rating will be considered)
xxx
Evidence of internal fraud xxx
Evidence of regulatory non-compliance xxx
Penalty imposed by BB xxx
Evidence of Bills (imported) accepted but payment not
disbursed/payment delayed
xxx
All types of Payables not settled in due time (foreign & local currency) xxx
Deposit Claims not paid/paid in delay xxx
Quality of Customer Service xxx
Total xxx

No. of Evidence of
penalty in last one
year (J an-Dec)
Nil 1-10 11-20 21-30 31-40 More than
40
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx
Service Rating
(J an-Dec)
Excellent Very Good Good Satisfactory Below-
Satisfactory

MCR xxx
Capital charge
(bp of MCR
amount)
Nil 5bp =xx 10bp =xx 20bp =xx 100bp=xx

23


How to collect information and counter check:

Information may be collected from FEPD, FEIVD, DBI 1,2&3, DOS, BRPD & banks
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.
24

Annexure-7
Settlement Risk
Settlement risk arises when an executed transaction is not settled as the standard settlement system.
Settlement risk addresses to the credit risk and liquidity risk elements. Treasury transactions, trading book
items (deals) and capital market dealings concluded as part of investment services convey a settlement risk
that is a specific mix of credit and liquidity risk. The banks pose to the risk when it fulfills its contractual
obligations (payment or delivery), but the counterparty fails or defaults to do the same. The assessment will
be on actual basis and add on method.

For checking this risk:
a) Issues of foreign trade settlement may be checked.
b) All types of receivables that have not been realized or have been realized lately.

1. Evidence of Bills accepted (foreign & domestic) by counterparty banks (local/foreign) but payment
not realized/payment delayed
**

No. of Evidence in
last one year (Jan-
Dec)
Nil 1-5 6-10 11-15 16-20 More than
20
MCR Xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx
** Delayed means payment not realized within the agreed stipulated time according to the documents or existing rules.

2. All types of Receivables (except bills accepted) not settled in due time (foreign & local currency)
No. of Evidence in
last one year (Jan-
Dec)
Nil 1-10 11-20 21-30 31-40 More than
40
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

Factors Capital charge
(bp of MCR amount)
Evidence of Bills (export) accepted by counterparty banks
(local/foreign) but payment not realized/payment delayed
xxx
All types of Receivables not settled in time (foreign & local currency) xxx
Total xxx


How to collect information and counter check:

Information may be collected from FEPD, FEIVD, DBI, DOS, BRPD & banks
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.
25

Annexure-8
Strategic Risk
Strategic risk means the current or prospective risk to earnings and capital arising from non-adaptability with
the changes in the business environment, adverse business decisions, the overlooking of changes in the
business environment etc.
Typical sources of strategic risk are:
o Intervention of Board of Directors into the activities of the management of banks.
o Credit-Deposit Ratio (CDR)/ Investment-Deposit Ratio (IDR) of banks falls too low or goes too
high,
o Too high operating expenses as percentage of operating income,
o Too high classified loans/investments as percentage of total outstanding loans/investments,
o Too low recovery rate of total classified loans/investments,
o Too high weighted average Cost of Fund- Components of Cost of fund will include Cost of Capital,
Cost of debt, Cost of Deposit and Cost of other funds
o Too high rate of Loan/investment written-off,
o High Dependency on Call-money market.
The above mentioned sources of strategic risk may be a strong indication of strategic risk if the institution
persistently proceeds against the clearly articulated requirements and trends of the economic environment in
matters which exercise a substantial influence on its services and business performance, or if the institution
fails to revise its strategy despite clearly identifiable and substantial changes in the environment. Capital
requirement will be linked on the basis on check list and add on basis.

1. Evidence of Intervention of BoD in Management and Administration of Bank

No. of Evidence of
internal fraud in
last year (Jan-Dec)
Nil 1-3 4-6 7-9 10-12 More than
12
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx
26


2. Evaluation of CDR / IDR (Daily average of last one year (Jan-Dec))

CDR IDR (for Islami banks) MCR Capital charge (bp of MCR amount)
CDR <75% IDR <80%
xxxx
30 bp =xxx
75% CDR<81% 80% IDR<85% 10 bp =xxx
81% CDR85% 86% IDR90% Nil
85%<CDR90% 90%<IDR95% 20 bp =xxx
CDR >90% IDR >95% 40 bp =xxx

3. Total Operating Expenses as % of Total Operating Income
Percentage
Last year (Jan-Dec)
0-35% 36%-40% 41%-45% 46%-50% 51%-60% More than
60%
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

4. Classified Loans/Investments as % of Total Outstanding Loans/Investments
Percentage
Last year (Jan-Dec)
0% - 3% 4%-6% 7%-9% 10%-12% More than 12%
MCR xxx
Capital charge
(bp of MCR amount)
10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

5. Classified Loan Recovery as % of Total Classified Loans/Investments
Percentage
Last year (Jan-Dec)
More than
25%
25%-20% 19%-15% 14%-10% 9%-5% Less than
5%
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx

6. Loan/Investment Written-off as % of Total Classified Loans/Investments

7. Interest Waiver as % of Total Classified Loans/Investments
Percentage
Last year (Jan-Dec)
0%-3% 4%-6% 7%-9% 10%-12% 13%-15% More than
15%
MCR xxx
Capital charge
(bp of MCR amount)
10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx 200bp=xx
Percentage
Last year (Jan-Dec)
0%-2% 3%-5% 6%-8% 9%-10% 11%-13% More than
13%
MCR xxx
Capital charge
(bp of MCR amount)
10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx 200bp=xx
27

8. Weighted Average Cost of Fund (%)

9. Borrowing from Call Money Market as % of Total Deposit (Last year (Jan-Dec))
** Daily Average of Borrowing fromCall Money Market Total Deposit on the date of --
10. Rescheduling of Loans & Advances/Investments (Exposure amount more than Tk. 1.00 Crore)

10.1. No. of cases for rescheduling of 1 time

10.2 . No. of cases for rescheduling of 2 times

10.3. No. of cases for rescheduling of 3 times or more

Cases of rescheduling MCR Weighted Average bp
**
(bp of MCR amount)

1 time 2 time 3 times or more xxx xxx
No. bp No. bp No bp

Total xxx

*** Weighted Average bp={(No. of cases for 1 time bp)+(No. of cases for 2 times bp)+(No. of cases for 3 times bp)}Total no. of cases
Percentage 0%-5% 6%-7% 7%-9% 9%-10% 10%-11% More than
11%
MCR xxx
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx
Percentage of total
deposit fund
0-2% 3-4% 5-6% 7%-8% 9%-10% More than
10%
MCR xxx
Capital charge
(bp of MCR amount)
10bp =xx 20bp =xx 50bp =xx 100bp=xx 150bp=xx 200bp=xx
No. of cases in
last year (Jan-Dec)
Nil 1-10 11-20 21-30 31-40 More than
40
Capital charge
(bp of MCR amount)
Nil 5bp =xx 10bp =xx 15bp =xx 20p=xx 25bp=xx
No. of cases in
last year (Jan-Dec)
Nil 1-5 6-10 11-15 16-20 More than
20
Capital charge
(bp of MCR amount)
Nil 10bp =xx 20bp =xx 30bp =xx 40p=xx 50bp=xx
No. of cases in
last year (Jan-Dec)
Nil 1-3 4-6 7-10 11-15 More than
15
Capital charge
(bp of MCR amount)
Nil 20bp =xx 50bp =xx 100bp =xx 150p=xx 200bp=xx
28


Factors Capital charge
(bp of MCR amount)
Evidence of Intervention of BoD in Management and Administration of
Bank
xxx
Evaluation of CDR/IDR xxx
Total Operating Expenses as % of Total Operating Income xxx
Classified Loan as % of Total Outstanding Loan/Investment xxx
Classified Loan Recovery as % of Total Classified Loan/Investment xxx
Loan/Investment Written-off as % of Total Classified Loans/Investments xxx
Interest Waiver as % of Total Classified Loans/Investments xxx
Weighted Average Cost of Fund (%) xxx
Average Daily Borrowing from Call Money Market as % of Total Deposit xxx
Rescheduling of Loans & Advances/Investments (Exposure amount more
than Tk. 1.00 Crore)
xxx
Total xxx

Apart from the factors the following aspects would be checked for assessing strategic risk of a bank:
Capital growth plan of next 07 (seven) years,
Growth rate of loans and advances of last 05 (five) years,
Growth rate of all types of Deposits of last 05 (five) years,
Growth rate of Operating Profit of last 05 (five) years,
Growth rate of Net Profit of last 05 (five) years,

How to collect information and counter check:
Information may be collected from FEPD, FEIVD, DBI-1,2&3, DOS & BRPD
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.
Strategic Risk
29

Annexure-9
Environmental & Climate Change Risk (Effective from July, 2011)
Environmental and climate change risk refers to the uncertainty or probability of losses that originates from
any adverse environmental or climate change events (natural or man made) and/or the non-compliance of the
prevailing national environmental regulations. This is a facilitating element of credit risk arising from
environmental issues. These can be due to environmental impacts caused by and / or due to the prevailing
environmental conditions. These increase risks as they bring an element of uncertainty or possibility of loss
in the context of a financing transaction. Environmental and climate change risk can hamper the business
stability of the borrowers in respect of both- i) profitability and ii) reputation. Consequentially, the extent of
risk for the banks will be higher. Sources of Environmental and climate change risk can be:
Natural Disasters (Flood, Cyclone, Earthquake, Climate change impacts etc.)
Man made Disasters (Fire, Deforestation, Illegal land/river acquisition)
Land location
Regulatory non-compliance
Labor / social risks
Community / public opposition
Changing Export Market conditions
Environmental and climate change risk can be of following types:
Direct Risk
Indirect Risk
Security / collateral risk
Business / industry risk
Management risk
Legal Risk
To check the issue, Sector Environmental Due Diligence (EDD) Check list can be evaluated and for each
sector specified in the Environmental Risk Management guidelines, Environmental Risk Rating (EnvRR)
may be linked with the additional capital requirement in the following way:
For each sector average bp can be calculated in the following manner:






Sector EnvRR Minimum Capital
Requirement (MCR)
Additional Capital required
(--- bp of MCR)
Low (L)
xxxx
Nil
Moderate(M) 5 bp
High(H) 10 bp
Unrated(UR) 20bp
30

Consolidated Capital Requirement Calculation
Sector No. of client Average bp
**
(b)
MCR
(c)
Additional Capital
(d)=(b) x (c) EnvRR L M H UR
Poultry x xx xx
Dairy x xx xx
Cement x xx xx
Fertilizers x xx xx
Pesticides x xx xx
Pharmaceuticals x xx xx
Engineering and
basic metal
x xx xx
Housing x xx xx
Pulp & paper x xx xx
Sugar & distilleries x xx xx
Tannery x xx xx
Additional Capital Requirement (Total) xxx
*** Average bp =(Lbp*N0.0f client + Mbp*N0.0f client+ Hbp*N0.0f client+ URbp*N0.0f client) Total no. of client


How to collect information and counter check:
Information may be collected from DOS, DBI 1,2&3.
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.



31

Annexure-10
Other Material Risks
SRP requires that the banks internal capital allocation process should cover all risks which have not been
identified earlier but are material for the institution. Such risks may include e.g. strategic risk or reputation
risk, but the institution needs to consider all risks not specified in case it can be captured in the institutions
operation and can be regarded as material. Risks may appear which are specific to the institution and derive
from its non-standard activities or clientele but fall outside the scope of usual risk definitions. The institution
is free to use its own terminology and definitions for other material risks, although it should be able to
explain these to BB in detail, along with the related risk measurement and management procedures. BB is not
providing a detailed list and definitions of other risks. It is the banks responsibility to map out other relevant
risks for which it has to elaborate an adequate risk identification mechanism. The institution needs to
examine the materiality of the identified risk and the result of the assessment. Furthermore, it has to be able
to explain these satisfactorily to the BB.
Materiality: In the context of an institutions activities, all risks which affect the achievement of business
objectives should be considered material. Other risks are usually difficult or impossible to quantify, thus their
measurement and management typically call for qualitative methods. Therefore, institutions are advised to
elaborate detailed methodologies for their evaluation and management which enable the revealing of risks
and help to keep them under control. There might be a strong link between these risks and other risks, either
because the former may amplify the latter (e.g. strategic risk can increase credit risk) or because they stem
from the escalation of basic risks (e.g. IT problems carrying a high operational risk may also result in the fast
increase of reputation risk if they impact customer systems). Thus the assessment of the materiality of other
risks is a highly subjective exercise. BB would take a stand on this matter in the course of the SREP process,
during the dialogue with the institution and on the basis of submitted documentation.
For checking this risk:
a) The materiality of risk is a qualitative judgment. Banks are responsible to develop detailed methodologies
for evaluating and managing other material risk.
b) May be checked from media report and different departments of BB

How to collect information and counter check:
Banks may asked to report adverse material events to BB
Information may be shared with Vigilance, DBI 1,2&3 , DOS & BRPD, AMLD
Finally through SRP-SREP dialogue additional capital will be determined for this specific risk.
32

Annexure-11

Stress Testing
Impact on capital will be detected through stress testing and it would be included in risk profile of a bank.
The comparison between the regulatory capital (minimum as well as adequate) requirement and the results of
stress testing of the banks would be made. Stress test is used to measure the vulnerability or exposure to the
impacts of exceptional, rare but potentially occurring events like - interest rate changes, exchange rate
fluctuations, changes in credit rating, events which influence liquidity, etc. The following methods can be
employed for measuring the impact of the above factors in an SRP context:
a) Simple sensitivity tests determine the short-term sensitivity to a single risk factor,
b) Scenario analyses involve risk parameters (with low but positive probability) which change
along a pre-defined scenario and examine the impact of these parameters.
As a starting point the scope of the stress test may be limited to simple sensitivity analysis. Following
different risk factors can be identified and used for the stress testing :
a) interest rate,
b) forced sale value of collateral,
c) non-performing loans (NPLs),
d) share prices,
e) foreign exchange rateand
f) liquidity
Stress test shall be carried out assuming three different hypothetical scenarios:
a) Minor level shocks: These represent small shocks to the risk factors. The level for different risk
factors can, however, vary.
b) Moderate level shocks: It envisages medium level of shocks and the level is defined in each risk
factor separately.
c) Major level shocks: It involves big shocks to all the risk factors and is also defined separately for
each risk factor.

How to collect information and counter check:

Stress testing results of the banks would be collected from DOS.
Finally in SRP-SREP dialogue stress testing results would be evaluated with the total capital
requirement. In case of exceptional adverse results, BB would instruct additional capital
requirement.
Basel-II Implementation Cell, Banking Regulation and Policy Department, Bangladesh Bank
www.bb.org.bd