albel pres basel ii quick review
DESCRIPTION
Before jumping to basel III, this is a quick review of Basel II foundations.TRANSCRIPT
Basel II – Quick Review
Ali BELCAID – Managing Consultant
It is intended toward people who are looking for a quick review of the major components of Basel II.
Basel II history
1975 Report to the Governors on the Supervision of Banks’ Foreign Establishments
1988 Internal Convergence of Capital Measurement and Capital Standards
The Basle I Capital Accord 1996 Amendment to the Capital Accord to Incorporate Market Risks
2004 Internal Convergence of Capital Measurement and Capital Standards : A Revised Framework
The Basle II Capital Accord
Main Objectives
More risk sensitive: better reflection of risk
More comprehensive: assesment of additional risks
Taking into account increasing financial innovation
Recognising improvment in risk measurement and control
Putting more emphasis on market discipline
Maintaining the overall level of regulatory capital
Basel II - StructureBasel II Capital Accord
Pillar 1Minimum capital
requirements
Pillar 3Market discipline
Credit risk
Securitization Standardized Approach
Pillar 2Supervisory review
process
Operational risk
BasicIndicator Approach
Advanced Measurement Approaches
Standardized Approach
IRB Advanced
IRB Foundation
Market risk
Standardized Approach
Internal Model
Approach
Pillar 1 – Capital Ratio
Regulatory capital(Definition unchanged)
Credit Risk Exposure
(Measure revised)
Risk-weighted assets(Measure revised)
Minimum required capital ratio
(8% minimum unchanged)
=
Basle II Pillar 1 - Capital Requirement
+Market Risk
Exposure(Measure unchanged)
Operational Risk Exposure
(Measure added)
+
Pillar 1 - Credit Risk
Different approaches are now recognised to compute the credit risk exposure and the associated capital requirement.
Standardised approach
New weighting categories
Recognition of external credit assesment (external ratings)
Internal Rating Based approach (IRB)
Foundation IRB
Advanced IRB
Standardized Approach : Rating
S&P Moody’s InterpretationProbability of default (1Y)
Investment GradeAAA Aaa Superior quality – very strong 0,00%AA+ Aa1
Good quality 0,01%AA Aa2AA- Aa3A+ A1
Good Capacity to service the debt 0,05%A A2A- A3
BBB+ Baa1Appropriate payment capacity 0,37%BBB+ Baa2
BBB- Baa3Speculative Grade
BB+ Ba1Probable but uncertain service of the debt
1,36%BB Ba2BB- Ba3B+ B1
Risky debt, speculatif 6,08%B B2B- B3
CCC – C Caa1 - C Vulnerable, probable default 30,85%D - Default 100%
Standardized Approach : Risk Weight
Risk Weighting categories
Based on S&P classification
AAA to AA-
A+ to A-
BBB+ to BBB-
BB+ to BB-
B+ to B-
Below B-
Unrated
Sovereigns 0% 20% 50% 100% 100% 150% 100%
Banks
Option 1 20% 50% 100% 100% 100% 150% 100%
Option 2 ST 3m
20% 20%
50% 20%
50% 20%
100% 50%
100% 50%
150% 150%
50% 20%
Corporates 20% 50% 100% 100% 150% 150% 100%
Retail Portfolio 75%
Asset securitisation tranches
20% 50% 100% 350%1250
%1250
%1250%
Pillar 1 - IRB Approach
Under IRB approaches, capital charges are computed on basis of expected credit losses and unexpected credit losses.
Capital charges for expected losses are a function of the difference between the estimation of these losses and the general provisions constituted by the bank.
3 risk components for the computation of unexpected losses:
PD = probability of default: over a 1-year time horizon
LGD = loss given default: prediction of the economic loss after a default has occured
EAD = exposure at default: potential exposure of a credit facility at the moment of default
M = effective maturity
Pillar 1 - IRB ApproachIn
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Dec
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cap
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Summary of different approaches for credit risk exposure computations
Standardised Approach
IRB Foundation
IRB Advanced
Exposure x Risk Weight = RWA
EAD LGD MPD
MPDEAD LGD
External Valorisation rules – Defined by the Basle Committee and the supervisory authority
Internal Valorisation rules – Computed by the banks’ risk management system
Pillar 1 - Credit Risk – Risk Mitigation
Credit risk mitigation techniques are recognised and allowed by the regulator.
3 types of risk mitigation:
Transaction with collateral
Bank has a claim from a debitor that is fully or partially covered by a guarantee provided by the debitor
Simple or comprehensive approach
Netting
Bank’s loans and deposits with one signle counterparty are compensated
Guarantees and credit derivatives
Pillar 2 – Supervisory Review Process
The second pillar refers to the supervisory review process and risk management guidance. This applies to all risks that a financial institution is facing, regardless of whether there is a minimum capital requirement.
The supervisory review process requires regulators to ensure that each bank has a sound Financial Risk Management methodology, which enables such institution to be able to assess the adequate capital requirement.
Supervisors would be responsible for evaluating how banks are assessing their capital adequacy needs relative to their risks.
Supervisors should require remedial actions when capital requirements are not met. These could include: improve the Risk Management process, improve internal controls, or increase the regulatory capital.
Pillar 2 – Supervision Process
Four Key Principles
1. Banks should have an internal process for assessing their capital in relation to their risk profile.
2. Supervisors should review and evaluate banks internal process as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate action if they are not satisfied with the results of this process.
3. Supervisors should expect banks to operate above the minimum regulatory capital ratios.
4. Supervisors should seek to intervene at an early stage to prevent capital from falling below the minimum levels required.
Pillar 3 – Market Discipline
The third pillar of the new framework aims to bolster market discipline through enhanced disclosure by financial institutions.
Effective disclosure allows the stake-holders of financial institutions to better understand the risk profiles and to better assess the adequacy of capital reserves, of such institutions.
Disclosure of quantitative and qualitative information in four key areas:
Scope of application
Composition of capital
Risk exposure assessment & management processes (information per risk category)
Capital adequacy
Knowledge, is quite simply question of sharing.
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