Overview of the New Basel Capital Accord - Basel Committee on Banking Supervision

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Overview of the

New Basel Capital

Accord

Basel Committee on Banking

Supervision

R94723073

陳世樺

R93723093

蘇郁惠

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2

Agenda

Capital Adequacy

Review of Basel I

Overview of Basel II

Implementation and future prospect

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Capital Protects

Against Insolvency

Importance of Capital Adequacy

Protection from Credit and Interest Rate Risks

ASSETS

ASSETS LIABILITIESLIABILITIES

Long-Term Securities Long-Term Securities Long-Term Loans Long-Term Loans $80 $80 20 20 $100 $100 Liabilities (Deposits) Liabilities (Deposits) Net Worth Net Worth $90 $90 10 10 $100 $100 ASSETS

ASSETS LIABILITIESLIABILITIES

Long-Term Securities

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4

Enforcement of

Capital Adequacy

Two Capital Requirements

-Leverage Ratio

-Risk-Based Capital Ratio

Leverage Ratio = Core Capital / Assets

Risk-Based Approach implemented by

Bank of International Settlements (BIS)

-Basel Agreement

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Basel I to Basel II

Basel I’ s Risk Assessment

-Market Risk

-Different Credit Risks of Assets

Basel II

-3 Pillars

-Unchanged – Market Risk

-Reassessed Credit Risk Methods

*Standardised Approach / Internal Ratings

Based / Securitisation

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Outline of the Basel II

Framework

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3 Pillars

Pillar 1

Pillar 1 Pillar 2Pillar 2 Pillar 3Pillar 3

Calculation of regulatory Calculation of regulatory minimum capital minimum capital requirements requirements Regulatory supervisory Regulatory supervisory review so as to review so as to

complement and enforce complement and enforce

minimum capital minimum capital requirements calculated requirements calculated under Pillar 1 under Pillar 1 Requirements on rules Requirements on rules for disclosure of capital for disclosure of capital structure, risk exposures structure, risk exposures and capital adequacy so and capital adequacy so as to increase FI as to increase FI transparency and transparency and enhance market/investor enhance market/investor discipline discipline 1. Credit Risk 1. Credit Risk 2. Market Risk 2. Market Risk 3. Operational Risk 3. Operational Risk

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Market Risk

Standardised Method

-BIS Standards -BIS Standards

Internal Models

-Regulatory Approval -Regulatory Approval

-Risk Metrics / History / Monte Carlo

Simulation

-Subject to Audits and Reviews

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Core (Tier I) and Supplementary (Tier II) Capital

On Balance Sheet and Off Balance Sheet Assets

Assigns risk weighting to different asset classes to

obtain a Credit Risk Adjusted Asset Value

Assets Adjusted Risk Credit Capital Total Ratio Capital Based Risk 

Credit Risk - Basel I

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Credit Risk - Capital

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Credit Risk – On

Balance Sheet

i n i i

a

w





1

Credit Risk Adjusted

On Balance Sheet Assets

w

w_i_i = Risk Weight of Asset = Risk Weight of Asset

a

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12

On BS Weightings –

Basel I

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On BS Weightings –

Basel II

Basel I categories too broad

Standardised Approach

Better differentiation of assets

Introduces external credit rating (S&P)

Improves Risk Sensitivity

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On BS Weightings –

Basel II

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Credit Risk – Off

Balance Sheet

Contingent, not actual claims

Not Face Value, but an amount equivalent to

an eventual on-balance-sheet credit risk

-Convert to Credit Equivalent Amount (CEA)

-Conversion Factors

Guaranty Contracts

Basel II introduces Derivative Contracts

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Off BS – Guaranty

Contracts

Face Value * Conversion Factor = CEA

CEA * Risk Weight = Risk Adjusted Value

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Off BS Conversion

Factors

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Guaranty Contracts -

Basel II

Unused portion of loan commitments

with original maturity of one year or

less will be 20%. (Previously 0%)

Uses the Basel II assigned credit risk

weights

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Derivative Contracts -

Basel II

FI is exposed to “Counterparty Credit

Risk”

Distinction between Exchange Traded

and Over-the-Counter contracts

Credit Risk of Exchange-Traded

Derivatives is ~zero

OTC Contract Credit Risk in two element

Potential Exposure / Current Exposure

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CEA for Derivative

Contract

Potential ($) + Current ($) = CEA

CEA * Risk Weight = Risk Adjusted Value

Current Exposure, if Replacement Value is –ve,

then zero. If +ve, then use that value

Conversion for Potential Exposure

Remaining Maturity

Remaining Maturity Interest Rate ContractsInterest Rate Contracts Exchange Rate ContractsExchange Rate Contracts

Less than one year

Less than one year 00 1.0%1.0%

One to five years

One to five years 0.5%0.5% 5.0%5.0%

Over five years

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Assets Adjusted Risk Credit Capital Total Ratio Capital Based Risk 

Credit Risk – Risk

Based Ratio

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IRB Approach

Banks’ internal assessment

Some risk weights and formulas still

given

Covers a range of portfolios with different

exposures.

-Corporate, Bank and Sovereign Exposures

-Retail Exposure -Retail Exposure -Specialized Lending -Specialized Lending -Equity Exposures -Equity Exposures

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IRB – Data Inputs

Probability of Default (PD)

Loss Given Default

Exposure at Default

Maturity

Provided by bank based on own estimates

Supervisory values set by the Committee

Foundation IRB – Use BIS values (except PD)

Advanced IRB – Use own estimates

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IRB – Implementation

Relies on internally generated inputs

Still a minimum standard to ensure

comparability across banks

Requires bank have strong control

environment and process to collect data

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Securitization

absorb losses on the underlying pool exposure

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Treatment of the

securitisation exposures :

recognition of risk

transfer

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Rating based

approach

External Rating Base risk weight

AAA 12% AA 15% A 20% BBB+ 50% BBB 75% BBB- 100% BB+ 250% BB 425%

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Supervisory Formula

Approach

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Inputs for the

Supervisory formula

Credit enhancement level (L)

Degree of the exposure (T)

Capital requirement for the underlying

assets (

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Operational Risk

(

(Def) risk of Def) risk of loss from inadequate or failed loss from inadequate or failed ‧

‧ internal processesinternal processes ‧

‧ peoplepeople ‧

‧ systemssystems ‧

‧ external eventsexternal events

Basic Indicator Approach Standardised Approach

Advanced Measurement

Approach (AMA)

(more risk sensitive FI’s)

Internal Measurement Approach (IMA)

Loss Distribution Approach (LDA) Scorecard Approach (SA)

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Basic Indicator

Approach

_{Operational capital =}

_

_{* I}

 =0.15=0.15

I = Gross income (Avg. over the previous 3 years)I = Gross income (Avg. over the previous 3 years)

Standardized

Approach

Proxy for risk exposure (scale of business operation)

Operational capital =





_i_i

* I

_i_i

i=1,2,…,8 (business lines) _{i=1,2,…,8 (business lines)}



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Business lines

(Standardised Approach)

Business Business units

units Business lines

Business lines FactorsFactors

Investment

Banking

Banking Corporate FinanceCorporate Finance ββ11

Trading and Sales

Trading and Sales _β_β

2

Banking

Banking Retail BankingRetail Banking _β_β

3 3 Commercial Commercial Banking Banking ββ44 Payment and Payment and Settlement Settlement ββ55 Agency Services Agency Services and Custody and Custody ββ66 Others

Others Retail BrokerageRetail Brokerage _β_β

7 7 Asset Management Asset Management _β_β 8 8

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Recent modification

after QIS3

QIS3 (Quantitative Impact Study 3)

：

_：

– – the most recent quantitative exercisethe most recent quantitative exercise

– – conducted in 2002conducted in 2002

– – gather information from banks of varying sizegather information from banks of varying size

from more than 40 countriesfrom more than 40 countries

on the impact of Basel proposals on the impact of Basel proposals

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Modification to the

Pillar One

1.

1. Recognition of provisions (for IRB)Recognition of provisions (for IRB)

‧

‧provision(P)= general provision + specific provisionprovision(P)= general provision + specific provision ‧

‧expected loss(EL)= 12.5*PD*LGD(%)*EADexpected loss(EL)= 12.5*PD*LGD(%)*EAD

(1) (1) general provisions will be removed from the numeratorgeneral provisions will be removed from the numerator

(2) Let k = EL – P(2) Let k = EL – P

If k<0 (provision shortfall)If k<0 (provision shortfall)

0.0.5*|k| deducted from Tier 1 capital, 5*|k| deducted from Tier 1 capital, 0.0.5*|k| deducted from 5*|k| deducted from Tier 2

Tier 2 capitalcapital

If k>0 (provision excess)If k>0 (provision excess)

amount of k added to Tier 2 capitalamount of k added to Tier 2 capital

(up to a limit of 0-6% of the risk-weighted assets at (up to a limit of 0-6% of the risk-weighted assets at national discretion)

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Each year, recognize Loan Loss Provision

(

( 提列壞帳損失提列壞帳損失 ₎₎_{and Allowances for Loan}_{and Allowances for Loan} Loss (

Loss ( 備抵壞帳備抵壞帳 , _,same as Loan Loss same as Loan Loss Reserve

Reserve 壞帳準備壞帳準備 ₎₎_{on a accrual basis.}_{on a accrual basis.}

Loan loss expenseLoan loss expense XXXXXX Allowances for Loan Loss

Allowances for Loan Loss XXXXXX

When actual loan loss occurs

Allowances for Loan Loss XXX

Loan

Loan XXXXXX

Expense

Reduction of net loan asset

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Recent modification

after QIS3

2.

Recognition of provisions (for standardized)Recognition of provisions (for standardized)

-different risk weights for past due loans with -different risk weights for past due loans with

specific provisionspecific provision (Ex)

(Ex)

Specific provision level of

the past due loan

the past due loan Risk weight

Risk weight

≧

≧ 20%_20% 100%100%

none

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Recent modification

after QIS3

3.

3. Operational risk: partial adoption of AMA

Operational risk: partial adoption of AMA

-

Advanced Measurement Approach is required Advanced Measurement Approach is required for large international banks and banks with

for large international banks and banks with

significant risk exposures

- allowed partial adoption: partially AMA, partially - allowed partial adoption: partially AMA, partially basic indicator approach or standardized

basic indicator approach or standardized

approach

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Recent modification

after QIS3

4.

4. Operational risk: risk reduced by

Operational risk: risk reduced by

insurance (for AMA)

- recognition of insurance as risk mitigant

- recognition of insurance as risk mitigant _：_：

insurance amount deducted from capital insurance amount deducted from capital requirement (up to 20% of total operational

requirement (up to 20% of total operational

risk capital requirement

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Pillar 2

：

_：

Supervisory

_Supervisory

review

Guiding Principals

--For BanksFor Banks ：： assess their capital adequacy positions assess their capital adequacy positions

relative to their overall risks.

-For Supervisors

-For Supervisors _：_： review and take appropriate actions review and take appropriate actions in response to those assessments.

in response to those assessments.

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Principle 1: Banks should have a process for

assessing their overall capital adequacy in

relation to their risk profile and a strategy for

maintaining their capital levels.

Principle 2: Supervisors should review and

evaluate banks’ internal capital adequacy

assessments and strategies, as well as their

ability to monitor and ensure their compliance

with regulatory capital ratios. Supervisors

should take appropriate supervisory action if

they are not satisfied with the result of this

process.

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Principle 3: Supervisors should expect banks to

operate above the minimum regulatory capital ratios

and should have the ability to require banks to hold

capital in excess of the minimum.

Principle 4: Supervisors should seek to intervene at

an early stage to prevent capital from falling below

the minimum levels required to support the risk

characteristics of a particular bank and should

require rapid remedial action if capital is not

maintained or restored.

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

_{Update of Pillar 2}

-stress testing

Estimate the extent to which the IRB capital requirements

could increase during a stress scenario.

-banks’ review of concentration risks and the treatment

of residual risks that arise from the use of collateral,

guarantees and credit derivatives.

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Pillar 3

：

_：

Market

_Market

discipline

Purpose

--Complement the minimum capital requirements of Pillar 1 Complement the minimum capital requirements of Pillar 1

and the supervisory review process addressed in Pillar 2.and the supervisory review process addressed in Pillar 2.

Disclosures requirements

-allow market participants to assess key information about a

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Table

Table _：_： Disclosures in the New AccordDisclosures in the New Accord

Subject Type Location in Supporting Document

Scope of Application Strong recommendations Pillar 3 Capital Strong recommendations Pillar 3 Credit Risk-general Strong recommendations Pillar 3 Credit Risk-Standardised

Approach Requirements and strongrecommendations Pillar 3 Credit Risk Mitigation

Techniques

Requirements and strong recommendations

Pillar 3 Credit Risk-IRB Approaches Requirements Pillar 3 Market Risk Strong recommendations Pillar 3 Operational Risk Strong recommendations

and, in future, requirements

Pillar 3

Interest Rate Risk in the

Banking Book Strong recommendations Pillar 3 Capital Adequacy Strong recommendations Pillar 3

Asset Securitization Requirements Asset Securitization ECAI Recognition Requirements Standardized Approach Supervisory Transparency Strong recommendations Standardized Approach and

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Dialogue with market participants and

supervisorssupervisors

--avoid potentially flooding the market with information that would be hard to use in avoid potentially flooding the market with information that would be hard to use in understanding a bank’s actual risk profile

understanding a bank’s actual risk profile..

Align with national accounting standards

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Implementation of

New Accord

Transition to New Accord Transition to New Accord

-Committee members within the G10-Committee members within the G10

Implementation date for New Accord of year-end 2006.Implementation date for New Accord of year-end 2006.

-outside the G10-outside the G10

*The minimum capital requirements will be implemented after year-end 2006.*The minimum capital requirements will be implemented after year-end 2006.

*The first priority is implementing key elements of the supervisory review and market discipline components of *The first priority is implementing key elements of the supervisory review and market discipline components of the New Accord.

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Forward looking aspects

-AIG (the Accord Implementation Group)-AIG (the Accord Implementation Group)

for national supervisors to exchange information on for national supervisors to exchange information on

the practical implementation challenges of Basel 2 and the practical implementation challenges of Basel 2 and

on the strategies they are using to address these issues.on the strategies they are using to address these issues.

-CTF (Committee’s Capital Force)-CTF (Committee’s Capital Force)

responsible for considering substantive modifications responsible for considering substantive modifications

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-reconciling any major unintended inconsistencies in the

treatment of similar exposures.treatment of similar exposures.

-close any loopholes and unintended effects of the new

framework.framework.

-banks adopting the more advanced approaches to risk

assessment will be required to run them in parallel with the

existing Accord for 1 year prior to the implementation of

Basel

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Cross-border implementations

-enhance cooperation between supervisors on a practical-enhance cooperation between supervisors on a practical

basis.basis.

-supervisors should avoid performing uncoordinated approval-supervisors should avoid performing uncoordinated approval

and validation work in order to reduce the implementationand validation work in order to reduce the implementation

burden for banks.burden for banks.

-the legal responsibilities of supervisors for the regulation of-the legal responsibilities of supervisors for the regulation of

their domestic banking organizations and the arrangementstheir domestic banking organizations and the arrangements

of consolidated supervision will not change.of consolidated supervision will not change.

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Conclusion

Capital adequacy Capital adequacy

-capital requirement-capital requirement

Basel I to Basel II

Pillar1

Pillar1 _：_： minimum capital requirementsminimum capital requirements

- Credit Risk- Credit Risk

*On BS *On BS & & Off BS Off BS

*IRB APPROACH*IRB APPROACH

*Securitization*Securitization

**Rating based approachRating based approach

(51)

-Market Risk-Market Risk

*Standardised Method*Standardised Method

*Internal Models*Internal Models

-Operational Risk-Operational Risk

**Basic Indicator ApproachBasic Indicator Approach

*Standardized Approach*Standardized Approach

-Recent modification after QIS3-Recent modification after QIS3

Pillar2

Pillar2 _：_： Supervisory review Supervisory review Pillar3

Pillar3 _：_： Market disciplineMarket discipline

Implementation of New Accord