Capital Adequacy The Basel-II Overview

Module D: Balance Sheet Management

M S Ahluwalia

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Bank Financial Management: Capital Adequacy The Basel-II Overview

CAIIB SUPER NOTES

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Contents
Coverage: 1. Introduction 2. Basel II Revised

Framework 3. Scope of Application 4. Pillar 1: Minimum Capital Requirements

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1.

INTRODUCTION

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Introduction
BCBS released the International Convergence on June 26, 2004 of Capital

Measurement and Capital Standards: A Revised Framework

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

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2.

BASEL II REVISED FRAMEWORK

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The Revised Framework

Adoption of stronger risk management practices by Banks Greater use of assessment of Risk provided by Banks 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 Banks risk profiles Recognizes the role of home country supervisors in implementation
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The Three Pillars

Consists of three mutually reinforcing pillars:
Minimum Capital Requirements Supervisory Review of Capital Adequacy

Market Discipline

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The Three Pillars

Pillar I: Minimum Capital Requirement
Capital for Credit Risk
Standardised Approach Internal Rating Based Approaches Foundation Approach Advanced Approach

Pillar II: Supervisory Review

Pillar III: Market Discipline

Evaluate Risk Assessment

Enhanced Disclosures

Capital for Market Risk

Standardised Method Maturity Method Duration Method

Ensure soundness and integrity of Banks internal processes to assess the adequacy of capital Core disclosures and Supplementary Disclosures Ensure maintenance of minimum capital with PCA for shortfall Prescribe differential capital, where necessary i.e., where the internal processes are slack Disclosure Frequency: Half Yearly

Capital for Operational Risk

Basic Indicator Approach Standardised Approach Advanced Measurement Approach

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3.

SCOPE OF APPLICATION

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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

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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

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4.

MINIMUM CAPITAL REQUIREMENTS

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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)
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Capital The Three Tiers

Tier I or Core Capital
Tier II or Supplemental Capital Tier III Capital
Paid up Capital Free Reserves Unallocated surpluses Less specified deductions 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) Limited to 250% of banks Tier I capital required to support market risk Presently not allowed by RBI

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Do you have any questions or queries or some feedback to give? Just mark an email to super.msahluwalia@yahoo.com

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M S Ahluwalia, amongst other things, is a visual artist, blogger, blog designer and of course an MBA and Banker from New Delhi, India.
To know more about him you may visit his blog-site: Estudiante De La Vida

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