BANKING AND INSURANCE

Presented by:

Shubhangi Jawale P - 12

Meghna Patil P - 25

Ambrish Shah P - 32

Sourabh Suryawanshi C - 35

Amit Jain C - 44
• Basel committee
• Basel I
• Basel II
• Pillars of Basel II
• Issues and Challenges
• Advantages
• Impact
• Differential
• Conclusion
 BASEL

• Basel Committee on Banking supervision (BCBS)

• Established in 1975 in Basel, Switzerland.

• Published a set of minimal capital requirements

for banks.
 BASEL I

• Basel I also known as the 1988 Basel Accord.

• It was enforced by law in the Group of Ten(G-10)
countries in 1992.
• Basel I is now widely viewed as outmoded.
 CLASSIFICATION OF BANK'S ASSETS IN 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 and non-OECD public sector debt

• 50% - residential mortgages.

• 100% - private sector debt, non-OECD bank debt real estate, plant

and equipment, capital instruments issued at other banks

 BASEL II
• Basel II is the second of the Basel Accords.

• Published in June 2004.

• Which recommendations on banking laws and

regulations.
• Basel II is a voluntary agreement between the
banking authorities of the major developed
countries.
 NEED OF BASEL II
• Much better capital framework was required
than Basel I.
• Banking has become too complex to be
addressed by Basel I simplistic approach.
• Basel I does not reflect credit quality
gradations in asset quality.
• Basel I had too little risk-sensitivity and it did
not give bankers, supervisors, or the
marketplace, meaningful measures of risk.
 PILLARS OF BASEL II

• Minimum Capital Requirements

• Supervisory Review

• Market Discipline
 The First Pillar – Minimum Capital
Requirements

• Part 2 of Basel II describes the calculation of

the total minimum capital requirements for
credit, market and operational risk.

• Minimum Capital Charges: Minimum capital

requirements based on market, credit and
operational risk .
 CREDIT RISK

• Pillar 1 of Basel II sets out the quantitative and

qualitative requirements and formulae to calculate
capital for credit risk.
• The principle behind these requirements is that rating
and risk estimation systems and processes provide a
meaningful assessment of borrower and transaction
characteristics
• A meaningful differentiation of risk; and reasonably
accurate and consistent quantitative estimates of risk.
 Risk management and measurement

• In order of increasing sophistication and risk sensitivity these

options are:
• the Standardized Approach
• the Internal Ratings Based (IRB) Foundation Approach (FIRB)
• the IRB Advanced Approach (AIRB).

• Under an IRB approach, banks rely partly on their own measures

of a borrower’s credit risk to determine their capital
requirements, subject to strict data, validation, and operational
requirements.
 STANDARDIZED APPROACH

• Where exposures are assigned to risk weight

categories based on their characteristics. The
Standardized Approach is supported by external credit
assessments.

• The main supervisory categories in the Standardized

Approach are claims on sovereigns, non-central
government public sector entities, multilateral
development banks, banks, corporate, retail loans,
residential real estate and commercial real estate.
 CORPORATE, BANK AND SOVEREIGN EXPOSURES

• The individual borrower's quality is reflected

by its external rating, as assigned by external
rating agencies. If there is no external rating,
the loan's risk is generally weighted with 100%
 RETAIL EXPOSURES

• Retail exposures are generally weighted at 75% under the

standardized approach.

• Lending fully secured by mortgages on residential property,

that is or will be occupied by the borrower, or that is rented,
can be risk weighted at 35%.

• Higher risk categories- Basel II also identifies certain higher

risk assets which are weighted at 150%. These include,
sovereigns and banks rated below B- and corporates rated
below BB-.
 The Internal Ratings-Based Approach

• The two main principles behind the Internal Ratings

Based (IRB) Approaches (Foundation and Advanced)
are the usage of banks’ own information about the
credit quality of their assets and the promotion of
best practices in risk measurement and risk
management.

• The IRB Approach is based on measures of

Unexpected Loss and Expected Loss. The risk weight
functions produce capital requirements for the
Unexpected Loss portion.
 Unexpected losses and expected losses

• The IRB risk weight functions produce capital

requirements that should cover the unexpected
losses of the bank.

• The expected losses are calculated separately and

are compared to the total allowable provisions
,any shortfalls or excesses of provisions over
expected losses could be adjusted to or
recognized as capital under Basel II.
 Operational risk

Definition

The Basel II definition of operational risk is

“the risk of loss resulting from inadequate or
failed internal processes, people and systems
or from external events”.
The measurement methodologies

• The Basic Indicator Approach

• Standardized Approach

• Advanced Measurement Approach (AMA).

 The Basic Indicator Approach

• This approach uses gross income as a proxy for

operational risk, with the capital charge equal to 15%
of the average of gross income for the last three
years.
• The Accord specifies the calculation of the charge as
follows:
Banks using the Basic Indicator Approach must hold
capital for operational risk equal to the average over
the previous three years of a fixed percentage of
positive annual gross income.
 The Standardized Approach

• In the Standardized Approach, gross income is again a proxy

measure for operational risk, but in this case it is broken out
by eight standard business lines, each with a different beta
factor to calculate capital. The business lines, are as follows:
• corporate finance,
• trading & sales,
• retail banking,
• commercial banking,
• payment & settlement,
• agency services,
• asset management, and
• retail brokerage.
Advanced Measurement Approaches (AMA)

• Under the AMA approach the capital

requirement will equal the risk measure
generated by the bank’s internal operational risk
measurement system, which based on:
• Internal loss data
• External loss data
• Scenario analysis, and
• Business environment and internal control
factors
 Market risk

• Market risk is the risk of financial loss relating

to a bank’s trading activities, where the bank
may act on its own account or on behalf of its
clients in the commodity, foreign exchange,
equity, capital and money markets.
• Market risk arises where there are adverse
movements in market prices e.g. interest and
foreign exchange rates, equity, bond and
commodity prices.
 Measures of Counterparty Credit Risk (CCR)

• Credit exposure, which is defined as the cost

of replacing the transaction if the
counterparty defaults assuming there is no
recovery of value.
• Banks use several measures to manage their
exposure to CCR including
• Potential future exposure (PFE)
• Expected exposure (EE)
Pillar 2 : Supervisory Review Process

“ The aim of Pillar 2 of the Basel II document is to

discuss and describe the key principles of supervisory
review; risk management guidance; and supervisory
transparency and accountability.”
Pillar 2 : Supervisory Review Process
 Pillar 2 : Supervisory Review

• The legal and corporate structure

• Authority and responsibility of the board, management and

employees

• Good risk management

• Documentation and evidence for doing what is required

• Monitoring and review

 Pillar 2 : Supervisory Review

• Strong internal control systems

• Effective risk and compliance function

• Effective internal audit function

• Supervisory transparency and accountability

Basel II – Third Pillar
Market Discipline
 Objective

The aim is to achieve market discipline through

disclosures that will allow market participants to
assess information about capital adequacy, risk
exposures, and other relevant factors.
 The Third Pillar – Market Discipline

A. General considerations
1. Disclosure requirements
2. Guiding principles
3. Achieving appropriate disclosure
4. Interaction with accounting disclosures
5. Materiality
6. Frequency
 ISSUES AND CHALLENGES

• Capital Requirement

• Profitability
• Risk Management Architecture

• Rating Requirement

• Choice of Alternative Approaches

 ISSUES AND CHALLENGES

• Supervisory Framework
• Corporate Governance Issues
• National Discretion
• Disadvantage for Smaller Banks
• Discriminatory against Developing Countries
• External and Internal Auditors
 Advantages

• Improves Risk Management

• Benefits to consumers and businesses also

• Curtailment of credit to Infrastructure projects

• Opportunity for IT companies

• Greater transparency of the financial position and risk profile

of banks.
 IMPACT
• Reduce the availability of funds
• Higher Interest Costs & Competitive advantage of
corporate borrowers
• Impact on Infrastructure development
• Shorter Term to maturity of lending

• Impact on Companies
• Changes in Capital Risk Weighted Assets Ratio (CRAR)
Difference
CONCLUSION