Risk Management and Basel ii & iii – an overview (JAIIB PPB Unit-08)

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Risk Management System

•Banks are required to identify, measure, monitor and control the overall level of risks undertaken by them.

Risk Management Structure:  Risk Management  Deptt. /Committee. 

Loan Review Mechanism (LRM):  evaluation of quality of loans and   improvements in credit administration. •

Credit Risk: Credit default & counterparty risk •

Market Risk: Market risk arising from adverse changes in market variable such as interest rate, foreign exchange rate, equity price and commodity price •

–Liquidity Risk, Interest Rate Risk, Foreign Exchange Risk, Commodity Price Risk, Equity Price Risk –

Operational Risk: Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.

Capital Adequacy for Banks

•Importance of capital for any organisation •

•Imp. Of stake •

•Capital helps absorb losses •

•Banks with low capital can`t increase business •

•DICGC cover only up to 1 lac •

Basel   I Accord

•CAR- Bank of International Settlement- 1988

•Central Bank Governors-G – 10 Countries formed B.C.B.S. •

•8% of risk weighted assets ( RBI – 9%) •

• Only credit risk covered •

•In 1996, Market Risk also covered •

Basel II

Basel II- Revised Framework considers capital requirement for not only credit & Market risks but also operational risks •

Basel II has 3 pillars

•1) Min. Capital requirement

•2) Supervisory Review

•3) market Discipline

Tier I , II & III Capital

Tier I Capital •Paid up equity capital+ disclosed reserves •Perpetual non cumulative pref. Shares-PNCPS

Tier II Capital •Undisclosed reserves •revaluation reserves-55% •General provisions-  ( max. Up to 1.25% of RWA ) •Hybrid ( debt / equity ) capital •Subordinated term Debt- over 5 years •This can be up to 50 % of Tier I •Tier II capital can be  up to 100% of Tier I capital

Tier III Capital •Short term subordinated Debt covering Market Risk( not to exceed 250 % of Tier I capital required to support Market Risks) •Investment in subsidiaries & securitised assets will be reduced from Tier I & Tier II capital  50% each

Supervisory Review- Pillar II

• •Need to consider systemic & other Bank specific risks as well

4 Principles •1) Banks to have Internal system of assessing risks for computing capital •

•2) Supervisors to review system to strengthen them •

•3) To have > min. Capital required •

•4) Ensure Min. Capital required is not breached

Market Discipline- Pillar III

•Relates to disclosures: (as per Board approved Policy) •

•Disclosures be made through annual report/ website •

•To enable market participants to take an informed view •

•Capital structure •Capital adequacy •Credit/market/ operational risks

•Credit risk mitigates

•Securitisation disclosures •

BASEL III

Objectives of the Basel III:

1.Improve  bank’s ability to absorb shocks  from financial and economic stress ●

2.   Improve risk management and governance ●

3.   Strengthen banks’ transparency and disclosures. ●

•Takes care of Economic or Financial stress of Banks – Features •

•1) Better quality capital- equity  raised from 2% to 4.5% of RWA •

•Capital conservation buffer- 2.5% of RWA for economic & financial risks •

•Counter Cyclical Buffer- Increase capital in good times- 0 to 2.5% of RWA

•Tier I capital raised from 4% to 6% • •

•Total CAR to be 8% + 2.5% or 10.5% •

•Leverage ratio – capital/ total assets to be 3% •

Implementation of Basel III in India- RBI Guidelines

•1) To be implemented effective 31.3.19

•2)  Initially CAR will be lower & higher later

3) Counter Cyclical Buffer guidelines to be issued later

4) As against 8% , RBI prescribed 9% CAR

•5) Min. Equity for Tier I to be 5.5% instead of 4.5% & overall to be 7% instead of 6%

6) Capital conservation Buffer to be 2.5% of RWA

•7) Leverage Ratio to be 4.5% instead of 3% •

*****Be continue for Unit-09****

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