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APPENDIX

Master Circular Prudential Guidelines on Capital Adequacy and Market Discipline Implementation of the New Capital Adequacy Framework (NCAF) (As on June 30, 2008)

RESERVE BANK OF INDIA MUMBAI

RBI/2008-09/68 DBOD.No.BP.BC. 11 /21.06.001/2008-09 July 1, 2008 All Commercial Banks (excluding Local Area Banks and Regional Rural Banks) Dear Sir, Master Circular - Prudential Guidelines on Capital Adequacy and Market Discipline Implementation of the New Capital Adequacy Framework (NCAF) Please refer to the circulars DBOD.No.BP.BC.90/20.06.001/2006-07 dated April 27, 2007 and DBOD.No.BP.BC.66/21.06.001/2007-08 dated March 26, 2008, in terms of which the Guidelines on the implementation of NCAF' and Guidelines for Pillar 2 - Supervisory Review Process under the NCAF', respectively, were issued. In order to enable the banks to have access to all the existing instructions on the subject, in a single document, a Master Circular has been prepared, and is furnished in the Appendix. It incorporates the Pillar 2 guidelines and the amendments / clarifications issued on the subject till June 30, 2008. A glossary of some of the terms used in this circular has been provided in Annex - 15. This Circular has also been placed on the website of the Bank (www.rbi.org.in). 2. We advise that this Master Circular consolidates the modifications / clarifications issued vide

circulars /mailbox clarifications listed in Annex - 16. Yours faithfully, (Prashant Saran) Chief General Manager-in-Charge

TABLE OF CONTENTS Part A : Minimum Capital Requirement (Pillar 1) 1 2 3 4 Introduction Approach to Implementation, Effective Date & Parallel Run Scope of Application Capital Funds 4.1 4.2 4.3 4.4 5 General Elements of Tier 1 Capital Elements of Tier 2 capital Deductions from Capital

Capital Charge for Credit Risk 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.10 5.11 5.12 5.13 5.14 5.15 General Claims on Domestic Sovereigns Claims on Foreign Sovereigns Claims on Public Sector Entities Claims on MDBs, BIS and IMF Claims on Banks Claims on Primary Dealers Claims on Corporates Claims included in the Regulatory Retail Portfolios Claims secured by Residential Property Claims secured by Commercial Real Estate Non-Performing Assets Specified Categories Other Assets Off-Balance Sheet Items 5.15.1 5.15.2 5.15.3 5.15.4 5.15.5 5.16 General Non-Market-related Off-balance Sheet items Market-related Off-balance Sheet items Current Exposure Method Failed Transactions

Securitisation Exposures 5.16.1 5.16.2 5.16.3 5.16.4 General Deduction of Securitisation Exposures from Capital Funds Implicit Support Application of External Ratings

5.16.5 5.16.6 5.16.7 5.16.8 6

Risk-weighted Securitisation Exposures Off-balance Sheet Securitisation Exposures Recognition of Credit Risk Mitigant Liquidity Facilities

External Credit Assessments 6.1 6.2 6.3 6.4 6.5 6.6 6.7 6.8 Eligible Credit Rating Agencies Scope of Application of External Ratings Mapping Process Long Term Ratings Short Term Ratings Use of Unsolicited Ratings Use of Multiple Rating Assessments Applicability of Issue rating to Issuer/other claims

7

Credit Risk Mitigation 7.1 7.2 7.3 General Principles Legal certainty Credit Risk Mitigation techniques Collateralised Transactions 7.3.2 7.3.4 7.3.5 7.3.6 7.3.7 7.3.8 7.4 7.5Overall framework and minimum conditions The Comprehensive Approach Eligible Financial Collateral Calculation of Capital Requirement Haircuts Capital Adequacy Framework for Repo-/Reverse Repo-style Transactions.

Credit Risk Mitigation techniques Onbalance Sheet techniques Credit Risk Mitigation techniques Guarantees 7.5.4 7.5.5 7.5.6 7.5.7 7.5.8 7.5.9 7.5.10 Operational requirements for Guarantees Additional operational requirements for Guarantees Rangel of Eligible Guarantors (counter-guarantors) Risk Weights Proportional Cover Currency Mismatches Sovereign guarantees and counter-guarantees

7.6

Maturity Mismatch 7.6.2 7.6.3 Definition of Maturity Risk weights for Maturity Mismatches

7.7

Treatment of pools of CRM Techniques

8

Capital Charge for Market Risk 8.1 8.2 8.3 8.4 8.5 8.6 Introduction Scope and Coverage of Capital Charge for Market Risks Measurement of Capital Charge for Interest Rate Risk Measurement of Capital Charge for Equity Risk Measurement of Capital Charge for Foreign Exchange Risk Aggregation of the Capital Charge for Market Risk

9

Capital charge for Operational Risk 9.1 9.2 9.3 Definition of Operational Risk The Measurement Methodologies The Basic Indicator Approach

10 11

Part B : Supervisory Review and Evaluation Process (Pillar 2) Introduction to Supervisory Review and Evaluation Process (SREP) Guidelines for SREP of the RBI and the ICAAP of the Banks 11.1 11.2 11.3 11.4 The Background Conduct of the SREP by the RBI The Structural Aspects of the ICAAP Select Operational Aspects of the ICAAP

12.

Part c Market Discipline 12.1 12.2 12.3 12.4 12.5 12.6 12.7 12.8 12.9 12.10 12.1 General

: Market Discipline (Pillar 3)

Achieving Appropriate Disclosure Interaction with Accounting Disclosure Scope and Frequency of Disclosures Validation Materiality Proprietary and Confidential Information General Disclosure Principle Scope of Application Effect Date of Disclosures The Disclosure Requirements Scope of Application Capital Structure Capital Adequacy Credit Risk: General Disclosures for All Banks Credit Risk: Disclosures for Portfolios subject to the

Table DF - 1 Table DF 2 Table DF 3 Table DF 4 Table DF 5

Table DF 6 Table DF 7 Table DF 8 Table DF 9 Table DF 10 Annex 1 Annex 2 Annex 3 Annex 4 Annex 5 Annex 6 Annex 7 Annex 8 Annex 9 Annex10 Annex 11 Annex 12 Annex 13 Annex 14 Annex 15 Annex 16

Standardised Approach Credit Risk Mitigation: Disclosures for Standardised Approach Securitisation: Disclosure for Standardised Approach Market Risk in Trading Book Operational Risk Interest Rate Risk in the Banking Book (IRRBB)

Annexures Terms and Conditions applicable to Innovative Debt Instruments for inclusion as Tier 1 capital Terms and Conditions applicable to Perpetual Non-Cumulative Preference Shares (PNCPS) Terms and Conditions applicable to Debt Instruments to qualify for inclusion as Upper Tier 2 capital Terms and Conditions applicable to PCPS / RNCPS / RCPS as part of Upper Tier 2 capital Issue of Subordinated Debt for raising lower tier 2 capital Extracts from the guidelines on Securitisation of Standard Assets Illustrations on Credit Risk Mitigation Measurement of capita charge for Market Risks in respect of Interest Rate Derivatives. An Illustrative Approach for Measurement of Interest Rate Risk in the Banking Book (IRRBB) under Pillar II The Standardised interest Rate Shock

An example of a Standardised Framework Interest Rate Risk Measurement Techniques Monitoring of Interest Rate Risk by Supervisory AuthoritiesAn Illustrative outline of the ICAAP Glossary List of Circulars Consolidated

Master Circular on Prudential Guidelines on Capital Adequacy and Market Discipline Implementation of New Capital Adequacy Framework Part A : Guidelines on Minimum Capital Requirement 1. 1.1 Introduction With a view to adopting the Basle Committee on Banking Supervision (BCBS)

framework on capital adequacy which takes into account the elements of credit risk in various types of assets in the balance sheet as well as off-balance sheet business and also to strengthen the capital base of banks, Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure. Essentially, under the above system the balance sheet assets, nonfunded items and other off-balance sheet exposures are assigned prescribed risk weights and banks have to maintain unimpaired minimum capital funds equivalent to the prescribed ratio on the aggregate of the risk weighted assets and other exposures on an ongoing basis. Reserve Bank has issued guidelines to banks in June 2004 on maintenance of capital charge for market risks on the lines of Amendment to the Capital Accord to incorporate market risks issued by the BCBS in 1996. 1.2 The BCBS released the "International Convergence of Capital Measurement and

Capital Standards: A Revised Framework" on June 26, 2004. The Revised Framework was updated in November 2005 to include trading activities and the treatment of double default effects and a comprehensive version of the framework was issued in June 2006 incorporating the constituents of capital and the 1996 amendment to the Capital Accord to incorporate Market Risk. The Revised Framework seeks to arrive at significantly more risksensitive approaches to capital requirements. The Revised Framework provides a range of options for determining the capital requirements for credit risk and operational risk to allow banks and supervisors to select approaches that are most appropriate for their operations and financial markets. 2. 2.1 Approach to implementation, Effective date and Parallel run The Revised Framework consists of three-mutually reinforcing Pillars, viz. minimum

capital requirements, supervisory review of capital adequacy, and market discipline. Under Pillar 1, the Framework offers three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk. These options for credit and operational risks are based on increasing risk sensitivity and allow banks to select an approach that is most appropriate to the stage of development of bank's operations. The options available for computing capital for credit risk are Standardised Approach, Foundation Internal Rating Based Approach and Advanced

1

DBOD MC on Basel II - 2008

Internal Rating Based Appro