Basel Accord-History

•Who is the author of the Basel Accord?

The BCBS
• What is BCBS?
Basel Committee on Banking Supervision
•What is this committee?
One of the standing committees whose secretariat is
located at Bank for International Settlements ( BIS)
Basel Switzerland;
Other standing committees are:
Committee on Global Financial System;
Committee on Payment & Settlement Systems
 Bank for International
•
Settlements ( BIS)
Company limited by shares
• Registered office situated at Basle, Switzerland
• Why Basle?
– Choice of Switzerland for the seat of BIS was a compromise by those countries that
established the BIS: Belgium, France, Germany, Japan, the United Kingdom and the
United States
– Independent neutral country
• Objectives :
– Promote cooperation of central banks
– Provide additional facilities for international financial operations
– Act as trustee or agent in regard to international financial settlements entrusted to it
under agreements
• Authorized activities of BIS:
– Bank authorized to accept deposits in gold and currencies form central banks; to buy
& sell gold & currencies; marketable securities, make advances or place deposits
with central banks; Bank can deal with commercial banks
– Bank not authorized to lend to governments or deal with individuals
 Basel Committee on Banking
Supervision: BCBS
• The collapse in 1974 of Bankhaus Herstatt in
Germany and of the Franklin National Bank in the
US; prompted the G10 central bank Governors to
set up the Basel Committee on Banking
Supervision.
• BCBS formed in the end of 1974 by the central
bank governors of the Group of G10 countries
• The Committee's members come from Belgium,
Canada, France, Germany, Italy, Japan,
Luxembourg, the Netherlands, Spain, Sweden,
Switzerland, United Kingdom and United States
 Road to Basel Accord: Basel I

• Document titled: International Convergence of

Capital Measurement and Capital Standards,
popularly known today as Basel-I finalised
and released in July 1988; Implementation by
end-1992
• Initially Basel I includes only Credit Risk
• Later on Market Risk introduced in 1999.
 Basel-II Accord

• In the year 2004, BCBS released a document

- “ International convergence on capital
Measurement and Capital standards: A revised
framework”
- Popularly known as Basel-II Accord
- It includes three risks:
1. Credit Risk
2. Market Risk &
3. Operational Risk.
 Basel-II Accord
 Intended to ensure that banks have adequate capital to bear the
risks
 Banks to develop and use better risk management techniques in
monitoring and managing their risks`
 Reserve Bank of India has formed steering committees
involving various bankers to finalize on approaches to be used
by Banks operating in India.
 Draft Guidelines on Basel II framework issued by RBI in
February 2005.
 Final Guidelines Issued in April 2007
 Implementation
 by March 2008 - For Foreign Banks and Indian Banks having operations
outside India
 By March 2009 – For all other Indian Banks excluding Local Banks
 The Three Pillars

Supervisory Disclosure
Minimum Capital Review &
Requirement Process Market Discipline
 Pillar- 1 Minimum Capital
Requirement
• Specifies standards for minimum capital
requirement of a Bank and distinct
approaches for computation of capital
requirement for
– Credit Risk
– Market Risk
– Operational Risk
 Pillar- 2 Supervisory Review
Process
• Banks should have Internal Capital Adequacy
Assessment Process (ICAAP)
• Supervisory review and evaluation of banks’ internal
capital adequacy assessments & strategies
• Supervisor (RBI) to keep checks on adequacy of
capitalization levels of banks
• Supervisors to expect banks to operate above the
minimum regulatory capital ratios
 Pillar 3- Market Discipline
• Disclosure requirements for banks
• To complement the minimum capital requirements
( Pillar I) and the supervisory review process (Pillar II)
• Recognises the fact that , apart form regulators, banks
are also monitored by markets
• Market Discipline involves enhanced transparency in
disclosure by banks especially the risk processes and
risk positions prevalent in the banks.
• This is intended for general public.
 Credit Risk

Credit Risk Defined as :

• The possibility of losses associated with
diminution in the credit quality of borrowers or
counterparties
• In Bank’s portfolio Losses stem from outright
default due to inability or unwillingness of a
customer or counter party to meet commitments
in relation to lending, trading, settlement, and
other financial transactions.
 Credit Risk
• Direct lending – funds may not be repaid
• Guarantees or LCs – funds may not come upon crystallization
of the liability
• Treasury products – the payment or series of payments due
from the counterparty under the respective contracts may not
come
• Securities trading – settlement may not be effected
• Cross-border exposure – availability and free transfer of
currency may be restricted or ceased.
• Credit risk may be carried in the banking book or the trading
book or in the off-balance sheet items
 Capital Charge for Credit Risk

Approaches:

• Standardised Approach (SA)

• Internal Rating Based Approach (IRB)

 Capital Charge for Credit Risk
Standardised Approach (SA)
• All commercial banks in India to adopt Standardised
Approach (SA) for credit risk.
• Under SA, rating assigned by eligible external credit rating
agencies will largely support the measure of credit risk
• RBI approved external agencies:
– CARE
– CRSIL
– Fitch India Ltd
– ICRA ltd
• Exposures to be risk weighted net of specific provisions
 Capital Requirement
• As per NCAF, Banks in India are required to
maintain 9% Capital of their Risk Weighted Assets
(RWA).
• This 9% is popularly known as CRAR
– Capital to Risk Weighted Assets Ratio
• Capital and RWA are two important elements
• CRAR
– {Capital / RWA (CR+MR+OR)}*100
 Elements of Capital
 Tier 1 Capital
 Paid-up equity capital, statutory reserves, and other disclosed
free reserves, if any
 Capital reserves representing surplus arising out of sale
proceeds of assets
 Innovative perpetual debt instruments eligible for inclusion in
Tier I capital, which comply with the regulatory requirements
as specified
 Perpetual Non-Cumulative Preference Shares (PNCPS), which
comply with the regulatory requirements as specified
 Any other type of instrument generally notified by the Reserve
Bank from time to time for inclusion in Tier I capital
 Elements of Capital
 Tier 2 Capital
 Revaluation reserves
 General Provisions and Loss Reserves
 Hybrid debt capital instruments
 Subordinated debt
 Innovative Perpetual Debt Instruments (IPDI) and
Perpetual Non-Cumulative Preference Shares (PNCPS)
 Any other type of instrument generally notified by the
Reserve Bank from time to time for inclusion
 Elements of Capital
 Limits of Tier 2 Capital
• Upper Tier II instruments along with other components of
Tier II capital shall not exceed 100 per cent of Tier I capital
• The above limit will be based on the amount of Tier I after
deduction of
– goodwill,
– DTA
– other intangible assets
• Subordinated debt instruments eligible for inclusion in
Lower Tier II capital will be limited to 50 percent of Tier I
capital after all deductions
 Various Types of Claims

Claims on Sovereigns
Claims on Banks
Claims on PSEs
Claims on Corporate
Claims on Regulatory Retail
Claims on NBFCs (ND-SI)
Claims on Personal Loans (Retail Type)
Claims on Commercial Real Estate
Claims on - Domestic Sovereigns
Claims Risk
Weight
(%)
Central Government( FB & NFB) 0%
Central Government guaranteed claims 0%
State Government( FB & NFB) 0%
State Government guaranteed claims 20%
RBI, DICGC, CGTMSE 0%
ECGC 20%
Above risk weights apply only for standard performing loans;
otherwise risk weights as applicable to NPAs will apply
Claims on Public Sector Entities
(PSEs)
• Domestic PSEs: Risk weighted in the same manner as corporate
• Foreign PSEs: Risk weighted as per rating assigned by
international rating agencies:

S&P/FITCH AAA to AA A BBB <BB Unrated

Moody’s Aaa to Aa A Baa to Ba <Ba Unrated

Risk Weight 20 50 100 150 100

(%)
 Claims on Corporate
• Claims on corporate will include all exposures (FB & NFB)
other than those qualifying for inclusion under sovereign; bank;
regulatory retail; residential mortgage; non-performing assets &
specified category all of which are separately addressed
• To be risk weighted as per the rating agencies registered with
SEBI and chosen by RBI
• Risk weights for long term & short term claims on corporates
specified under the guidelines: 20%; 30%; 50%;100%; 150%.
Unrated claims upto threshold level: 100%.
Long term claims on corporate – Risk weight
Domestic rating AAA AA A BBB BB & Unrated
Agencies below
Risk Weight 20% 30% 50% 100% 150% 100%
(%)
 Claims on Corporate
Short-term claims on corporate – Risk weight
Short -Term Rating Risk
Weights
CRISIL ICRA CARE FITCH
P1+ A1+ PR1+ F1+ 20%
P1 A1 PR1 F1 30%
P2 A2 PR2 F2 50%
P3 A3 PR3 F3 100%
P4 & P5 A4 / A5 PR4,PR5 B,C,D 150%
 Claims on Corporate
• UNRATED CLAIMS
– RBI may increase the standard risk weights for unrated
where warranted by overall default experience
– Under Pillar 2, RBI would consider whether unrated
corporate claims of individual banks warrant a standard RW
higher than 100%
– No claim on unrated corporate to given a risk weight
preferential to that assigned to the sovereign of
incorporation
– Unrated standard restructured loans to corporate to be
assigned a higher RW of 125% until satisfactory
performance under the revised payment schedule for one
year from the due date of payment of first interest /principal
under the revised schedule.
 Claims on Banks
Banks incorporated in India & foreign bank branches in India and
Excludes investment in equity shares and other instruments
eligible for capital status

Complying with scheduled banks non-scheduled

CAR banks
Risk Weight 20% 100%

CAR (%) Scheduled Non-scheduled

As on date of last full audit* Banks RW banks RW
6 to < 9 50% 150%
3 to < 6 100% 250%
0 to < 3 150% 350%
Negative 625% 625%
* Fresh subsequent capital raised can be reckoned
Claims: Regulatory Retail Portfolios

To qualify as retail claims for regulatory capital

purposes, exposures (FB & NFB) to meet all
four criteria:
• Orientation criteria
• Product criterion
• Granularity criterion
• Low value of individual exposures
 Orientation criteria
Exposure is to an individual person or persons or
to small business
– Person as above would mean any legal person
(individual, HUF, partnership, firm, trust, private limited
companies, public limited companies, cooperative societies,
etc.)
– Small business is one where the total average annual
turnover is < Rs. 50 crore
• Existing entities: average of the last 3 years
• New entities: Projected turnover
• Entities yet to complete three years: Both Actual & Projected
 Product criteria

Exposure(FB &NFB) takes the form of

– Revolving credits
– Lines of credits
– Overdrafts
– Term Loans ( installment loans, student loans)
– Small business facilities & commitments
 Granularity criteria

Exposure is sufficiently diversified :

– Aggregate exposure to one counterpart not to exceed
0.2% of the overall regulatory retail portfolio
• Aggregate exposure: Gross Amount ( excluding CRM)
• One counterpart: one or several entities which can be
considered as a single beneficiary; banks can use group
exposure concept
– NPAs under retail loans to be excluded from the
overall RR portfolio when assessing granularity
criterion
 Low Value Individual exposure
criteria
• Maximum aggregated exposure to one
counterpart not to exceed Rs. 5 crore
– Exposure means sanctioned limit or actual
outstanding, whichever is higher , for all FB &
NFB, including Off-Balance Sheet exposures
– For Term Loans- exposure shall mean actual
outstanding
Claims Related to RRP will be assigned risk
weight of 75% except the following Claims
• Exposures by way of investment in securities ( such as
bonds and equities, whether listed or not)
• Mortgage loans to the extent they qualify as claims
secured by residential property or claims secured by
commercial real estate
• Loans & advances to bank’s own staff fully covered by
superannuation benefits and/or mortgage of flat/house
• Consumer credit, including personal loans and credit
card receivables
• Capital market exposures
• Venture capital funds
 Regulatory Retail Portfolios

• RBI to play a crucial role under Pillar 2 in

respect of risks in the RR portfolio of
individual banks
• If warranted, may mandate a RW higher than
75% for individual banks
 Claims secured by residential
property
• Loans to individuals for acquiring residential property fully
secured by mortgages on residential property that is/will be
occupied by borrower, or rented
• Shall be Risk Weighted as below:
– Amount of loan upto Rs. 30 lakh : 50%
– Amount of loan above Rs.30 lakh : 75%
Subject to:
• Loan to Value (LTV) ratio is not more than 75%
• Board approved valuation policy
• LTV: Total o/s in account: (Principal + Accrued interest + other charges )/
Realisable value of property mortgaged
• If the LTV is > 75%then RW is 100 %
• Restructured loan will attract 25% more RW.
• All other claims secured by residential property would attract :
RW applicable to counterparty or to the purpose for which
bank has extended finance, whichever is higher.
Claims secured by commercial
real estate
• Exposures ( FB & NFB) secured by mortgages on
commercial real estate (office buildings, retail space;
multi-purpose commercial premises; multi-family
residential buildings; multi-tenanted commercial
premises; industrial or warehouse space; hotels; land
acquisition; development and construction, etc).
• Also includes exposures to entities for setting up
Special Economics Zone or for acquiring units in
SEZs which includes real estate
• Such exposures to attract RW of 100%
 Specified categories
• Venture Capital funds : RW 150%.
• Consumer credit-personal loans & credit card
receivables :
– RW of 125%
– More , if warranted by external rating of the counterparty
• Capital market exposures & claims on non-deposit
taking systemically important NBFCs:
– RW of 100%
– More , if warranted by external rating of
the counterparty
 Other Assets

• Loans & Advances to banks own staff fully

covered by superannuation benefits &
mortgage of flat/house: RW 20%
• Other loans & advances to bank staff: eligible
for inclusion under RR : RW 75%
• All other assets: RW 100%
 Non-Performing Assets
• Unsecured NPA ( other than a qualifying Residential
Mortgage addressed separately) will carry RW as below:
• 150% RW: Specific Provisions <20% of outstanding
amount of NPA
• 100%* RW: Specific Provisions are at least 20% of
outstanding amount of NPA
• 50% RW : Specific Provisions are at least 50% of
outstanding amount of NPA
– For computing level of Specific Provisions in NPA: All
funded exposures of a single counterparty without netting
off eligible collateral to be reckoned in the denominator
– For computing secured portion of NPA, eligible collateral
will be the same as reckoned for CRM
 Non-Performing Assets
where a NPA is fully secured by the following forms of collateral
that are not recognised for credit risk mitigation purposes, either
independently or along with other eligible collateral,
– Land & Building ( valuation not more than 3 years old)
– Plant & Machinery ( value not higher then depreciated value reflected in
the audited balance sheet of the borrower, not more than eighteen months)
– Clear title available; well documented
NPA will carry RW as below:
- 150% RW: Specific Provisions <15% of outstanding amount of NPA
- 100%* RW: Specific Provisions are at least 15% of outstanding amount of
NPA
- 50% RW : Specific Provisions are at least 50% of outstanding amount of
NPA
 Non-Performing Assets

If NPA is secured by residential property,

then NPA will carry RW as below:
– 100% RW: Specific Provisions <20% of
outstanding amount of NPA
– 75%* RW: Specific Provisions are at least
20% of outstanding amount of NPA
– 50% RW : Specific Provisions are at least
50% of outstanding amount of NPA
 Off-Balance Sheet Items
• Total RW Off –Balance Sheet Credit Exposure
– RW amount of market related + RW amount of non-market
related Off-balance sheet items
– Risk Weighted amount of credit exposure of off-balance
sheet item is calculated as below
– Calculate Credit Equivalent Amount: (CEA)
• Notional amount * specified CCF OR by applying the Current
Exposure Method
– Multiply CEA by RW applicable to counterparty/purpose
of finance/type of asset, whichever is higher
• If item is secured by eligible collateral or guarantee,
credit risk mitigation can be applied.
 Credit Risk Mitigation
• Credit risk mitigation refers to the process or
techniques by which Credit Risk exposures are
mitigated in whole or in part
• Credit Risk can be mitigated by acceptance of
collateral security &/or guarantee.
• The collateral security can be Land & building / plant
& machinery or other financial security.
• Under Basel II only eligible financial collaterals/
guarantees are recognized for availing benefit of lower
capital charge.
 Credit Risk Mitigation

• The following Credit risk Mitigation

techniques are permitted by the RBI under
BASEL II framework to avail benefit of lower
capital charge.
• On – Balance Sheet netting.
• Collateralised Transaction.
• Guarantees.
 Credit Risk Mitigation
On-balance sheet netting
• Confined to loans/advances and deposits, where :
• Netting arrangements are legally enforceable: specific lien; proof
of documentation
• Capital requirements can be calculated on basis of net credit
exposures subject to:
» Well-founded legal basis for netting/offsetting regardless of
bankruptcy/insolvency of counterparty
» Able to determine at any time loans/advances & deposits with
the same counterparty subject to netting
» Relevant exposures monitored and controlled on net basis
• Same formula as earlier; loans & advances would be “exposure”
and deposits would be “ collateral”; haircuts will be 0 except for
currency mismatch.
 Credit Risk Mitigation

What is a collateralised transaction?

• Bank has a credit exposure that is hedged by
collateral posted by the counterparty ( to
whom bank has a credit exposure-on or off-
balance sheet) or a third person on his behalf.
• Bank has a specific lien on the collateral
• Requirements of legal certainty are met
 Credit Risk Mitigation

Framework
• Simple Approach: risk weight of the collateral
substituted for the risk weight of the
counterparty for the collateralised portion-
similar to 1988 Accord
• Comprehensive Approach: allows fuller offset
of collateral against exposures by reducing the
exposure amount by the value ascribed to the
collateral.
 Credit Risk Mitigation
Some minimum conditions
• Only eligible financial collaterals can be used.
• Allowed only on account-by-account basis , even
within regulatory retail portfolio
• Credit quality of counterparty and value of collateral
not to have a material positive correlation
• Clear and robust procedures for timely liquidation of
collateral
• If held by custodian, bank to ensure segregation of
assets
 Credit Risk Mitigation
Eligible financial collateral
• Cash, certificate of deposits or instruments issued by lending bank on
deposit with the bank
• Gold: (Bullion & jewellery): value of collateralised jewellery to be arrived at
after notionally converting to 99.99 purity.
• Central & State Government Securities
• KVP & NSC: no lock-in-period and can be encashed within the holding
period
• Life Insurance Policy with a declared surrender value
• Debt securities rated ( subject to certain conditions) -next slide
• Debt securities not rated, where issued by a bank ( subject to certain
conditions)-next slide
• Listed equities-including convertible bonds ( listed on a recognised stock
exchange and included in the BSE-SENSEX & BSE 200 of BSE; S& P
CNX NIFTY and Junior NIFTY of NSE and the main index of any other
recognised stock exchange, in the jurisdiction of bank’s operation)
• Mutual Fund investments regulated by securities regulator (price for the
units is publicly quoted daily i.e., where the daily NAV is available in public
domain; and the mutual fund is limited to investing in the eligible
instruments,.i.e. investments listed in eligible financial collateral)
 Credit Risk Mitigation
Eligible financial collateral
• Debt securities rated by a chosen credit rating agency
and sufficiently liquid attracting 100% or lesser risk
weight:
– at least BBB (-) or
– at least PR3/P3/F3/A3 for short-term debt instruments
• Debt securities not rated by a chosen Credit Rating
Agency and sufficiently liquid where these are:
– issued by a bank; and listed on a recognised exchange; and
classified as senior debt; and all rated issues of the same seniority
by the issuing bank that are rated at least BBB(-) or PR3/P3/F3/A3
by a chosenCredit Rating Agency; and the bank holding the
securities as collateral has no information to suggest that the issue
justifies a rating below BBB(-) or PR3/P3/F3/A3 and; there is
sufficient confidence about the market liquidity of the security
 Credit Risk Mitigation

Haircut

• Application of haircuts to exposure and collateral:

haircut for exposure will be a premium and for the
collateral will be a discount

• Additional downward adjustment for the collateral if

exposure and collateral held in different currencies
 Credit Risk Mitigation

Comprehensive approach: Haircuts

• Standard Supervisory Haircuts
Parameters set out in the Accord
• Own-estimate Haircuts: Bank’s own
internal estimates of market price
volatility
Banks in India to use only the former for
both exposure and collateral
 Credit Risk Mitigation
Comprehensive approach
Standard Supervisory Haircuts:
Assumptions:
– Daily mark-to-market
– Daily re-margining
– 10 business day
holding period ( time normally
required for realising the collateral value)
Unrated bank exposures or bank lends
non-eligible instruments, eg.NI grade corp
sec, haircut on exposure to be same as for
equity traded on recognised SE not part

of main index,i.e 25%

 Credit Risk Mitigation
• Comprehensive approach: Standard Supervisory Haircuts:
• Prescribed haircuts would apply to security w.r.t rating of the
issuer and to exposure w.r.t rating of the counterparty
• Exposure/Eligible unrated securities issued by Central or State
Governments: same as AAA debt
• Sovereign to include RBI, DICGC, CGTMSE
• Haircut will be determined by:
• Maturity of exposure
• External rating assigned to exposure
• Counterparty category
• NSC, KVP, SV of LIP, Banks own deposits as collateral: 0
haircut
• HC for currency risk: 8% ( daily m-t-m & 10 –business day
holding period)
 Credit Risk Mitigation
• If collateral is a basket of assets, haircut on basket:

where ai= weight of the asset ( measured by units of currency)

& Hi= haircut applicable to that asset
 Credit Risk Mitigation
Collaterals: Maturity Mismatch
• When residual maturity (RM) of collateral < RM of underlying exposure
• Conservative definition of maturity of both exposure & collateral:
• Exposure maturity: longest possible remaining time before obligation
is scheduled to be fulfilled, including grace period
• Collateral maturity: shortest possible taking into account embedded
options which may reduce its term
• Maturity relevant is residual maturity
• When is CRM not recognised, when mismatch exists?
• If there is a maturity mismatch & CRM has an original maturity <1
year, CRM not recognised; i.e. maturity of collateral for exposures
with original maturities of <1 year to be matched to be recognised
• Collateral with maturity mismatches will not be recognised if collateral
has a RM </= 3 months
• Other cases of maturity mismatches, partial recognition given to CRM
 Credit Risk Mitigation
Collaterals: Maturity Mismatch
Adjustment to be applied for maturity mismatch with
recognised CRM ( collateral , on-balance sheet netting
& guarantees)
 Credit Risk Mitigation
Comprehensive approach
• Calculation of capital for a collateralised transaction:
E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]}
where:
E*= the exposure value after risk mitigation
E = current value of the exposure
He= haircut appropriate to the exposure
C= the current value of the collateral received
Hc= haircut appropriate to the collateral
Hfx= haircut appropriate for currency mismatch between the
collateral and exposure
The exposure amount after risk mitigation will be multiplied
by the risk weight of the counterparty to obtain the risk-
weighted asset amount for the collateralised transaction.
 Credit Risk Mitigation
Guarantees
• Direct, explicit, irrevocable & unconditional can be treated as
credit protection
• Whose guarantees are recognised?
• Entities with lower risk weight than counterparty
• Sovereigns, sovereign entities( BIS, IMF, European central banks, MDBs, ECGC
& CGTMSE), banks & PDs with lower risk weight
• Other entities rated AA (-) or better. Includes guarantee of parent, subsidiary &
affiliate companies having a lower risk weight
• Guarantor rating should be an entity rating: factoring all liabilities &
commitments of the entity
• Substitution approach-same as 1988 Accord; protected portion of
the counterparty exposure : RW of guarantor; uncovered portion:
risk weight of underlying counterparty:
• Exposures covered by state government guarantees to attract a risk weight of 20%
• If credit protection is denominated in a different currency, amount of exposure
deemed to be protected to be reduced by application of a haircut Hfx: 8%
 Credit Risk Mitigation
Guarantees: Operational requirements
• Must represent a direct claim on protection provider
• Explicitly referenced to specific exposures or pool of exposures:
extent of cover clearly defined
• Irrevocable: no clause for unilateral cancellation of cover or for
increase in effective cost of cover on deterioration of credit quality of
guaranteed exposure
• Unconditional: no clause that could prevent the guarantor from
obligation to pay in a timely manner in the event of counterparty's
default
• When exposure is classified as non-performing: guarantee shall cease
to be a credit risk mitigant
• Explicitly documented
• Guarantee to cover all types of payments governing the transaction:
notional amount, margin payments, etc. If guarantee covers principal
only, interests and uncovered payments to be treated as unsecured
amount