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Capital Adequacy – The Basel-II Overview Module D: Balance Sheet Management © M S Ahluwalia

Capital Adequacy The Basel-II Overview

Module D: Balance Sheet Management

Bank Financial Management: Capital Adequacy The Basel-II Overview

CAIIB SUPER NOTES

Contents

Coverage:

1. Introduction

2. Basel

II

Framework

Revised

3. Scope of Application

4. Pillar 1: Minimum Capital Requirements

3. Scope of Application 4. Pillar 1: Minimum Capital Requirements © M S Ahluwalia CAIIB –

Introduction

BCBS released the “International Convergence of Capital Measurement and Capital Standards: A Revised Framework” on June 26, 2004

Updated in Nov 2005 to include trading activities and the

treatment of double default effects

Apply to ‘internationally active’ banks

In Europe it is applicable to all banks

In European Union it is also applicable to financial institutions

2.

BASEL II REVISED FRAMEWORK

The Revised Framework

Adoption of stronger risk management practices by Banks

Greater use of assessment of Risk provided by Bank’s internal systems as inputs to capital calculations

Demands capital allocation for operational risk

National regulators are free to set higher standards

Provides incentives for banks to invest and increase the sophistication of their internal risk management capabilities in order to gain reductions in capital

Aligns regulatory capital with Bank’s risk profiles

Recognizes the role of home country supervisors in implementation

The Three Pillars

Consists of three mutually reinforcing pillars:

Minimum Capital Requirements

Supervisory Review of Capital Adequacy

Market Discipline

The Three Pillars

Pillar I: Minimum Pillar I: Minimum Capital Requirement Capital Requirement Capital for Credit Risk Capital
Pillar I: Minimum
Pillar I: Minimum
Capital Requirement
Capital Requirement
Capital for Credit Risk
Capital for Credit Risk
•Standardised Approach
•Standardised Approach
•Internal Rating Based Approaches
•Internal Rating Based Approaches
•Foundation Approach
•Foundation Approach
•Advanced Approach
•Advanced Approach
Capital for Market Risk
Capital for Market Risk
•Standardised Method
•Standardised Method
•Maturity Method
•Maturity Method
•Duration Method
•Duration Method
Capital for Operational
Capital for Operational
Risk
Risk
•Basic Indicator Approach
•Basic Indicator Approach
•Standardised Approach
•Standardised Approach
•Advanced Measurement Approach
•Advanced Measurement Approach
© M S Ahluwalia
Pillar II: Supervisory Pillar II: Supervisory Review Review EvaluateEvaluate RiskRisk AssessmentAssessment Ensure
Pillar II: Supervisory
Pillar II: Supervisory
Review
Review
EvaluateEvaluate RiskRisk AssessmentAssessment
Ensure soundness and integrity
Ensure soundness and integrity
of Bank’s internal processes to
of Bank’s internal processes to
assess the adequacy of capital
assess the adequacy of capital
Ensure maintenance of
Ensure maintenance of
minimum capital with PCA for
minimum capital with PCA for
shortfall
shortfall
Prescribe differential capital,
Prescribe differential capital,
where necessary i.e., where the
where necessary i.e., where the
internal processes are slack
internal processes are slack
CAIIB – Super-Notes
Pillar III: Market Pillar III: Market Discipline Discipline EnhancedEnhanced DisclosuresDisclosures Core disclosures
Pillar III: Market
Pillar III: Market
Discipline
Discipline
EnhancedEnhanced DisclosuresDisclosures
Core disclosures and
Core disclosures and
Supplementary Disclosures
Supplementary Disclosures
Disclosure Frequency: Half
Disclosure Frequency: Half
Yearly
Yearly
Sirf Business

Scope of Application

All Commercial Banks (except Local Area Banks and Regional Rural Banks)

At solo level (global position) as well as consolidated level

Group

companies

engaged

in

insurance

business

and

businesses

not

pertaining

to

financial

services

may

be

excluded

Applicable Approaches

RBI has stipulated that all commercial banks in India shall adopt:

Standardised Approach (SA) for Credit Risk

Basic Indicator Approach (BIA) for Operational Risk

Standardised Duration Approach (SDA) for Market Risk

4.

MINIMUM CAPITAL REQUIREMENTS

Minimum Capital Requirements

Capital Adequacy Ratio = Regulatory Capital/Total Risk weighted assets

Total capital Ratio 8%

Scope of risk weighted assets expanded to include Market Risk and

Operational Risk

Total RWA include capital requirement for Market Risk and Operational Risk multiplied by 12.5(1/8*100)

Total RWA = RWA for Credit Risk + 12.5 * (Capital Requirement for Market Risk and Operational Risk)

Capital The Three Tiers

Capital – The Three Tiers   • Paid up Capital Tier I or Core • Free
 

Paid up Capital

Tier I or Core

Free Reserves

Capital

Unallocated surpluses

Less specified deductions

Tier II or Supplemental Capital

Subordinated debt of more than 5 years maturity

Loan loss reserves

Revaluation reserves

Investment fluctuation reserves

Limited life preference shares

 

Short Term subordinated debt (maturity < 2 yrs)

Tier III Capital

• Limited to 250% of bank’s Tier I capital required to support market risk

Presently not allowed by RBI

Do you have any questions or queries or some feedback to give? Just mark an

Do you have any questions or queries or some feedback to give?

Just mark an email to super.msahluwalia@yahoo.com

M S Ahluwalia, amongst other things, is a visual artist, blogger, blog designer and of

M S Ahluwalia, amongst other things, is a visual artist, blogger,

blog designer and of course an MBA

Delhi, India.

and Banker from New

To know more about him you may visit his blog-site: Estudiante De La Vida

from New To know more about him you may visit his blog-site: Estudiante De La Vida
from New To know more about him you may visit his blog-site: Estudiante De La Vida