Caiib Risk Manage Mod CD
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Transcript of Caiib Risk Manage Mod CD
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INDIAN INSTITUTE OFBANKING & FINANCE
RISK MANAGEMENT
MODULE C & D
ByM.Ravindran
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Syllabus
Module C: Treasury Management:Treasury management; concepts and functions; instruments in the
treasury market; development of new financial products; control
and supervision of Treasury management; linkage of domestic
operations with foreign operations.
Asset-liability management; Interest rate risk; interest rate futures;
stock options; debt instruments; bond portfolio strategy; risk
control and hedging instruments.
InvestmentsTreasury bills Money markets instruments such
as CDs, CPs, IBPs; Securitisation and Forfaiting; Refinance andrediscounting facilities.
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Syllabus
Module D
Capital Management and Profit Planning
Prudential Norms- Capital Adequacy-Basel II-
Asset Classification-provisioning
Profit and Profitability-Historical Perspective ofthe Approach of Banks to profitability-Effects of
NPA on profitability-A profitability Model-Shareholders value Maximization & EVA-ProfitPlanning-Measures to improve profitability
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FRONT OFFICE
BACK OFFICEMID OFFICE
Dealing
MIS
settlement
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Treasury
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Money Market
Certificate of Deposit (CD)
Commercial Paper (C.P)
Inter Bank Participation Certificates Inter Bank term Money
Treasury Bills
Call Money
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Certificate of Deposit
CDs are short-term borrowings in the form ofUsance Promissory Notes having a maturity ofnot less than 7 days up to a maximum of one
year. CD is subject to payment of Stamp Duty under
Indian Stamp Act, 1899 (Central Act)
They are like bank term deposits accounts.Unlike traditional time deposits these are freelynegotiable instruments and are often referred toas Negotiable Certificate of Deposits
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Features of CD
Issued by all scheduled commercial banksexcept RRBs
Minimum period 7 days
Maximum period 1 year
Minimum Amount Rs 1 lac and in multiples ofRs. 1 lac
CDs are transferable by endorsement CRR & SLR are to be maintained
CDs are to be stamped
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Commercial Paper
Commercial Paper (CP) is an unsecuredmoney market instrument issued in theform of a promissory note.
Who can issue Commercial Paper (CP)Highly rated corporate borrowers, primarydealers (PDs) and all-India financial
institutions (FIs)
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Eligibility for issue of CP
a) the tangible net worth of the company, as per thelatest audited balance sheet, is not less than Rs. 4
crore;b) the working capital (fund-based) limit of the
company has been sanctioned by banks
c) borrowal account of the company is classified as a
Standard Asset by the financing bank/s.
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Rating Requirement
All eligible participants should obtain the creditrating for issuance of Commercial Paper
Credit Rating Information Services of India Ltd.(CRISIL)
Investment Information and Credit RatingAgency of India Ltd. (ICRA)
Credit Analysis and Research Ltd. (CARE) Fitch Ratings Duff & Phelps Credit Rating India Pvt. Ltd. (DCR
India) The minimum credit rating shall be P-2 of
CRISIL or such equivalent rating by other
agencies
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Features
CP can be issued for maturities between aminimum of 7 days and a maximum uptoone year from the date of issue.
Minimum issue price Rs. 5 lakhs and inmultiples of Rs. 5 lakhs
Issued in demat form only
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To whom issued
CP is issued to
individuals,
banking companies, other corporate bodies registered or
incorporated in India and unincorporated
bodies, Non-Resident Indians (NRIs)
Foreign Institutional Investors (FIIs).
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CP-Yield calculation
Yield = (Face value-Price)*365*100
--------------------------------
Price *No of days to maturity
Face value 5 lakhs price 4,92,711 for 90 days
Find out yield
500000-492711*365*100---------------------------------= 6%
492711*90
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Calculation of price-CP
PRICE= Face Value
-------------
( 1+Yield *No of days
-----------------------365*100)
Face Value Rs.500000 for 90 days at 6%
500000------------
1(6*90/365*100) = Rs 492711
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Meaning of Repo
It is a transaction in which two parties agree tosell and repurchase the same securitya t amutually decided future date and a price
The Repo/Reverse Repo transaction can only bedone at Mumbai between parties approved byRBI and in securities as approved by RBI(Treasury Bills, Central/State Govt securities).
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Repo
Uses of RepoIt helps banks to invest surplus cashIt helps banks to raise funds at better rates
An SLR surplus and CRR deficit bank can use theRepo deals as a convenient way of adjustingSLR/CRR positions simultaneously.RBI uses Repo and Reverse repo as instruments
for liquidity adjustment in the system
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Coupon rate and Yield
The difference between coupon rate andyield arises because the market price of asecurity might be different from the face
value of the security.
Since coupon payments are calculated onthe face value, the coupon rate is different
from the yield.
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Example
10% Aug 2015 10 year Govt Bond
Face Value RS.1000
Market Value Rs.1200 In this case Coupon rate is 10%
Yield is 8.33% = 1200*10
---------------1000
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Call Money
The money that is lent for one day isknown as "Call Money",
If it exceeds one day (but less than 15 days)it is referred to as "Notice Money".
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Call Money Market
Banks borrow in this market for thefollowing purpose
To fill the gaps or temporary mismatches
in funds To meet the CRR & SLR mandatory
requirements as stipulated by the Central
bank To meet sudden demand for funds arising
out of large outflows.
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Factors influencing interest rates
The factors which govern the interest rates aremostly economy related and are commonlyreferred to as macroeconomic factors. Some ofthese factors are:
1) Demand for money2) Government borrowings3) Supply of money4) Inflation rate
5) The Reserve Bank of India and the Governmentpolicies which determine some of the variablesmentioned above.
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Gilt edged securities
The term government securities encompass allBonds & T-bills issued by the Central
Government, and state governments. Thesesecurities are normally referred to, as "gilt-edged" as repayments of principal as well asinterest are totally secured by sovereign
guarantee.
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Treasury Bills
Treasury bills, commonly referred to as T-Billsare issued by Government of India against theirshort term borrowing requirements with
maturities ranging between 14 to 364 days.All these are issued at a discount-to-face value.For example a Treasury bill of Rs. 100.00 facevalue issued for Rs. 91.50 gets redeemed at the
end of it's tenure at Rs. 100.00.
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Who can invest in T-Bill
Banks, Primary Dealers, StateGovernments, Provident Funds, FinancialInstitutions, Insurance Companies, NBFCs,FIIs (as per prescribed norms), NRIs &OCBs can invest in T-Bills.
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What is auction of Securities
Auction is a process of calling of bids withan objective of arriving at the market price.It is basically a price discovery mechanism
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Debenture
A Debenture is a debt security issued by acompany (called the Issuer), which offersto pay interest in lieu of the money
borrowed for a certain period. These are long-term debt instruments
issued by private sector companies. Theseare issued in denominations as low as Rs1000 and have maturities rangingbetween one and ten years.
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Difference between debenture andbond
Long-term debt securities issued by theGovernment of India or any of the StateGovernments or undertakings owned by
them or by development financialinstitutions are called as bonds.Instruments issued by other entities are
called debentures.
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Current yield
It is calculated by dividing the coupon rateby the purchase price of the bond .
For e. g: If an investor buys a 10% Rs 100debenture of ABC company at Rs 90, hiscurrent Yield on the instrument would becomputed as:Current Yield = (10%*100)/90 X 100 ,That is 11.11% p.a.
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Primary Dealers
Primary Dealers can be referred to as MerchantBankers to Government of India, comprising the
first tier of the government securities market.These were formed during the year 1994-96 tostrengthen the market infrastructure
What role do Primary Dealers
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What role do Primary Dealersplay?
The role of Primary Dealers is to;(i) commit participation as Principals inGovernment of India issues through
bidding in auctions(ii) provide underwriting services(iii) offer firm buy - sell / bid ask quotes
for T-Bills & dated securities(v) Development of Secondary DebtMarket
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OMO
OMO or Open Market Operations is amarket regulating mechanism oftenresorted to by Reserve Bank of India.
Under OMO Operations Reserve Bank ofIndia as a market regulator keeps buyingor/and selling securities through it's openmarket window. It's decision to sell or/and
buy securities is influenced by factors suchas overall liquidity in the system etc
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YIELD CURVE
The relationship between time and yieldon a homogenous risk class of securities is
called the Yield Curve. The relationshiprepresents the time value of money -showing that people would demand apositive rate of return on the money theyare willing to part today for a payback intothe future
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SHAPE OF YIELD CURVEA yield curve can be positive, neutral or flat.
A positive yield curve, which is most natural, is when theslope of the curve is positive, i.e. the yield at the longer end ishigher than that at the shorter end of the time axis. This results,as people demand higher compensation for parting their
money for a longer time into the future.A neutral yield curve is that which has a zero slope, i.e. is flatacross time. T his occurs when people are willing to acceptmore or less the same returns across maturities.
The negative yield curve (also called an inverted yield curve)is one of which the slope is negative, i.e. the long term yield islower than the short term yield
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Shape of Yield curve
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LIBOR
LIBOR stands for the London Interbank OfferedRate and is the rate of interest at which banksborrow funds from other banks, in marketablesize, in the London interbank market.
LIBOR is the most widely used "benchmark" orreference rate for short term interest rates. It is
compiled by the British Bankers Association as afree service and released to the market at about11.00[London time] each day.
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Calculation of Duration
Face Value Rs.100
Tenor 7 years Coupon 7%
Market Interest rate 8%
Answer:543.0642/94.7941= 5.72888 yrs
Calculation of Duration
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Calculation of DurationAnswer:543.0642/94.7941= 5.72888
Sl No Coupon Dis.Factor
At 8%
PV OFcOUPON Weightinyrs
PV*Wt
1 7 .9259 6.4813 1 6.4813
2 7 .8573 6.0011 2 12.0022
3 7 .7938 5.5566 3 16.6698
4 7 .7350 5.1450 4 20.5800
5 7 .6806 4.7642 5 23.8210
6 7 .6302 4.4114 6 26.4684
7 7 .5835 62.4345 7 437.0415
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CRR & SLR
The minimum and maximum levels of CRR areprescribed at 3% and 20% of demand and termliabilities (DTL) of the bank, respectively, under
Reserve Bank of India Act of 1934.The minimum and maximum SLR are prescribedat 25% and 40% of DTL respectively, underBanking Regulation Act of 1949.
The CRR and SLR are to be maintained onfortnightly basis.
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Demand and Time Liabilities
Main components of DTL are:
Demand deposits (held in current and savingsaccounts, margin money for LCs, overdue fixeddeposits etc.)
Time deposits (in fixed deposits, recurring deposits,reinvestment deposits etc.)
Overseas borrowings
Foreign outward remittances in transit (FC liabilitiesnet of FC assets)
Other demand and time liabilities (accrued interest,credit balances in suspense account etc. )
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SLR
SLR is to be maintained in the form of thefollowing assets:
Cash balances (excluding balancesmaintained for CRR)
Gold (valued at price not exceedingcurrent market price)
Approved securities valued as per normsprescribed by RBI.
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VaR
Value at Risk (VaR) is the most probable lossthat we may incur in normal market conditionsover a given period due to the volatility of afactor, exchange rates, interest rates or
commodity prices. The probability of loss isexpressed as a percentage VaR at 95%confidence level, implies a 5% probability ofincurring the loss; at 99% confidence level the
VaR implies 1% probability of the stated loss.The loss is generally stated in absolute amountsfor a given transaction value (or value of ainvestment portfolio).
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VaR
The VaR is an estimate of potential loss, always for a givenperiod, at a given confidence level.. A VaR of 5p in USD /INR rate for a 30- day period at 95% confidence levelmeans that Rupee is likely to lose 5p in exchange valuewith 5% probability, or in other words, Rupee is likely todepreciate by maximum 5p on 1.5 days of the period(30*5% ) . A VaR of Rs. 100,000 at 99% confidence levelfor one week for a investment portfolio of Rs. 10,000,000similarly means that the market value of the portfolio is
most likely to drop by maximum Rs. 100,000 with 1%probability over one week, or , 99% of the time theportfolio will stand at or above its current value.
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Exchange Rate Quotation
Exchange Quotations :
There are two methods
Exchange rate is expressed as the price per unit offoreign currency in terms of the home currency is known
as theHome currency quotation or Direct Quotation Exchange rate is expressed as the price per unit of home
currency in terms of the foreign currency is known astheForeign Currency Quotation or Indirect Quotation
Direct Quotation is used in New York and other foreignexchange markets and Indirect Quotation is used inLondon foreign exchange market.
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Principles
Direct Quotation: Buy Low, Sell High:
1USD= Rs.42.60 42.65
Indirect Quotation: Buy High, SellLow:
Rs.100 = USD 2.5600 2.5650
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Spot and Forward Transactions
A Bank agrees to buy from B Bank USD100000. The actual exchange ofcurrencies i.e. payment of rupees andreceipt of US Dollars, under the contractmay take place :
on the same day or
two days later or
some day later, say after a month.
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TT Buying Rate
TT Buying Rate (TT stands for TelegraphicTransfer)
This is the rate applied when the transaction
does not involve any delay in realization of theforeign exchange by the bank. In otherwords, the nostro account of the bank wouldalready have been credited. The rate is
calculated by deducting from the inter-bankbuying rate the exchange margin asdetermined by the Bank.
Bill B i R
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Bills Buying Rate
This is the rate to be applied when aforeign bill is purchased. When a bill ispurchased, the proceeds will be realized
by the Bank after the bill is presented tothe drawee at the overseas center. In thecase of a usance bill the proceeds will be
realized on the due date of the bill whichincludes the transit period and the usanceperiod of the bill.
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Problem
You would like to import machinery from USAworth USD 100000
to be payable to the overseas supplier on 31st Oct
[a] Spot Rate USD = Rs.45.8500/8600
Forward PremiumSeptember 0.2950/3000
October 0.5400/5450
November 0.7600/7650
[b] exchange margin 0.125%[c] Last two digits in multiples of nearest 25 paise
Calculate the rate to be quoted by the bank ?
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Solution
This is an example Forward Sale Contract .Inter Bank Spot Selling Rate Rs. 45.8600
Add Forward Margin .5450
--------------
46.4050
Add Exchange Margin .0580
---------------
Forward Rate 46.4630Rounded Off to multiple of 25 paise Rs.46.4625
Amount Payable to the bank Rs.46,46,250
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Swap
A swap agreement between two partiescommits each counterparty to exchangean amount of funds, determined by a
formula, at regular intervals, until theswap expires.
In the case of a currency swap, there is an
initial exchange of currency and a reverseexchange at maturity.
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Mechanics
Firm A needs fixed rate loan AAA rated
Firm B needs floating rate -A rated
Firm A enjoys an absolute advantageinboth credit markets.
11%9%
LIBOR+0.0%
LIBOR
+1%
Firm A Firm B
Fixed-rate
finance
Floating-rate
finance
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Mechanics
STEP !
Firm A will borrow at Fixed rate 9%
Firm B will borrow at floating rate (LIBOR +1)%
STEP 2Firm A will pay Floating rate [LIBOR] to Firm B
Firm B will Pay Fixed rate [9.5%] only
GainNet interest cost LIBOR- .5%
Net Interest cost 9+[ 1%+0.5%]=10.5%
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Mechanics
Gain
A B
Borrows at9.0%fixed
for 7 years
Borrows atLIBOR + 1%
floatingfor 7 years
9.5%
LIBOR
Interest payments to eachother in years t1 to t7.
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Basel I to Basel II
Minimum capital requirements
3 Pillars
New credit risk approaches
Market risk - unchanged
Add operational risk portion
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The Basel II Framework
Pillar 1:
Minimum capital
requirements
Pillar 2:Supervisory
review
Pillar 3:Market
discipline
A guiding
principle
for bankingsupervision
Credit Risk
Market Risk
Operational Risk
Disclosure
requirements
Pillar 1: Minimum Capital
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Pillar 1: Minimum CapitalRequirements
The calculation of regulatory minimumcapital requirements:
%8assetsweighted-riskTotal
capitalofamountthe
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The Capital and Assets
Definition of capital:
Tier 1 capital + Tier 2 capital +adjustments
Total risk-weighted assets are determinedby:
multiplying the capital requirements formarket risk and operational risk by 12.5
and adding the resulting figures to thesum of risk-weighted assets for credit risk.
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Credit Risk
Standardised Approach
Foundation IRB Approach
Advanced IRB Approach
Credit Risk
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Credit Risk -Standardised Approach
In determining the risk weights in thestandardised approach, banks may useassessments by external credit
assessment institutions.
AssetsofValusBookAssetsfortRisk Weigh
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Risk Weight for Assets
Credit
Assessment
Claims on sovereigns Claims on banks and securities firms
Claims on
corporatesECA risk
scores
Risk
Weight
Credit
assessment of
Sovereign
Credit assessment of Banks
Risk weight
Risk weight
for short-
term
AAA to AA- 1 0% 20% 20% 20% 20%
A+ to A- 2 20% 50% 50% 20% 50%
BBB+ to BBB- 3 50% 100% 50% 20% 100%
BB+ to BB- 4~6 100% 100% 100% 50% 100%
B+ to B- 4~6 100% 100% 100% 50% 150%
Below B- 7 150% 150% 150% 150% 150%
Unrated - 100% 100% 50% 20% 100%
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Credit Risk - IRB Approach
In the internal ratings-based(IRB)approach, its based on banks internalassessment.
The approach combines the quantitativeinputs provides by banks and formulaspecified by the Committee.
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Credit Risk - IRB Approach
Four quantitative inputs (risk components):
Probability of default (PD)
Loss given default (LGD)
Exposure at default (EAD)
Maturity (M)
Use formula of the Committee to calculatethe minimum requirements.
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Credit Risk - IRB Approach
Data Input Foundation IRB Advanced IRB
Probability of default
(PD)
From banks From banks
Loss given default
(LGD)Set by the Committee
From banks
Exposure at default
(EAD)Set by the Committee
From banks
Maturity (M) Set by the Committee or
from banks
From banks
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Market Risk
Standardised method
- the standards of the Committee
Internal models
- use banks internal assessments
- Value at Risk (VaR)
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Operational Risk
The risk of losses results from inadequateor failed internal processes, people andsystem, or external events.
Basic Indicator Approach
Standardised Approach
Advanced Measurement Approaches(AMA)
Operational Risk -
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Operational Risk -Basic Indicator Approach
GI = average annual gross income(threeyears, excepted the negative amounts)
= 15%
GIKBIA
Operational Risk -
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Operational Risk -Standardised Approach
GI 1-8 = average annual gross incomefrom business line from one to eight(three years, excepted the negative
amounts) = A fixed percentage set by the
Committee
81GIKTSA
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Beta of Business Lines
Business Lines Beta Factors
Corporate finance (1) 18%
Trading and sales (2) 18%
Retail banking (3) 12%
Commercial banking (4) 15%
Payment and settlement (5) 18%
Agency services (6) 15%
Asset management (7) 12%
Retail brokerage (8) 12%
Operational Risk - Advanced
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Operational Risk AdvancedMeasurement Approaches
Under the AMA, the regulatory capitalrequirement will equal the risk measuregenerated by the banks internal
operational risk measurement systemusing the quantitative and qualitativecriteria for the AMA.
Use of the AMA is subject to supervisoryapproval.
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Pillar 2: Supervisory Review
Principle 1: Banks should have a processfor assessing and maintaining their overallcapital adequacy.
Principle 2: Supervisors should review andevaluate banks internal capital adequacy
assessments and strategies.
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Supervisory Review
Principle 3: Supervisors should expectbanks to operate above the minimumregulatory capital ratios.
Principle 4: Supervisors should interveneat an early stage to prevent capital fromfalling below the minimum levels.
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Pillar 3: Market Discipline
The purpose of pillar three is tocomplement the pillar one and pillar two.
Develop a set of disclosure requirements
to allow market participants to assessinformation about a banks risk profile and
level of capitalization.
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Minimum Capital Adequacy Ratios
Tier one capital to total risk weightedcredit exposures to be not less than 4 %;
Total capital (i.e. tier one plus tier two less
certain deductions) to total risk weightedcredit exposures to be not less than 8%
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Calculation of Capital
Tier One Capital
the ordinary share capital (or equity) ofthe bank; and
audited revenue reserves e.g.. retainedearnings; less
current year's losses;
future tax benefits; and
intangible assets, e.g. goodwill.
f
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Calculation of Capital
Upper Tier Two Capital Un-audited retained earnings;
revaluation reserves;
general provisions for bad debts; perpetual cumulative preference shares (i.e.
preference shares with no maturity date whosedividends accrue for future payment even if the
bank's financial condition does not supportimmediate payment);
perpetual subordinated debt (i.e. debt with nomaturity date which ranks in priority behind all
creditors except shareholders).
l l f l
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Calculation of Capital
Lower Tier Two Capital
Subordinated debt with a term of at least5 years;
Sedeemable preference shares which maynot be redeemed for at least 5 years.
i i
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Restrictions
Tier two capital may not exceed 100% oftier one capital;
Lower tier two capital may not exceed
50% of tier one capital;
Lower tier two capital is amortized on astraight line basis over the last five years
of its life.
T l C i l
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Total Capital
This is the sum of tier 1 and tier 2 capitalless the following deductions:
equity investments in subsidiaries;
shareholdings in other banks that exceed10 percent of that bank's capital;
unrealized revaluation losses on securities
holdings.
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Module D
Capital Management
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Capital Management&
Profit Planning
B l II
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Basel II
Tier I-Core CapitalPaid up capital ,Free Reserves and unallocated surpluses
Tier II-Supplementary Capital
Subordinated debt of more than 5 years maturity ,loanloss reserve, revaluation reserve,investmentfluctuation reserve,limited life preference share-restricted to 100% of tier I capital
Tier III Capitalsubordinated debt with shot term maturity [min 2 years]
for market risk
T t l Ri k i ht d A t
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7/28/2019 Caiib Risk Manage Mod CD
85/95
Total Risk weighted Assets
Risk weighted assets of credit risk
plus
12.5* Capital requirement for market risk
plus
12.5* capital requirement for foroperational risk
Th ill
-
7/28/2019 Caiib Risk Manage Mod CD
86/95
Three pillars
First Pillar-minimum capital requirements
Second pillar-supervisory process
Third pillar-market discipline
C it l Ch f C dit Ri k
-
7/28/2019 Caiib Risk Manage Mod CD
87/95
Capital Charge for Credit Risk
Standardized Approach Internal rating basedapproach
[1]Foundation Approach
[2]Advanced IRBApproach
Credit rating of Risk weight for Risk weight for
-
7/28/2019 Caiib Risk Manage Mod CD
88/95
g
sovereign
g
sovereign
gbanks in thatcountry
AAA TO AA 0% 20%
A+ TO A 20% 50%
BBB+ TO BBB- 50% 100%
BB+ TO BB- 100% 100%
BELOW B- 150% 150%
Risk Weight
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7/28/2019 Caiib Risk Manage Mod CD
89/95
Retail & SME
EXPOSURE75%
Mortgage onResidential
Property
35%
Past Due Loans 150% When specific
provisions areless than 20%of the loanamount
-do- 100% If provision ishigher than20%
Capital Charge for Operational
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7/28/2019 Caiib Risk Manage Mod CD
90/95
p g pRisk
The Basic Indicator Approach
The Standardized Approach
Advanced Management Approach
Standardized Approachf
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7/28/2019 Caiib Risk Manage Mod CD
91/95
forOperational Risk
Beta factor- a fixed percentage set by Baselcommittee
Maximum 18%
Minimum 12%
Banks activities are divided into 8 business lines-corporate finance,trading,retail banking,commercial banking, payment &settlement,agency services, asset management, retailbrokering
Asset Classification
-
7/28/2019 Caiib Risk Manage Mod CD
92/95
Asset Classification
Standard Assets
Sub Standard Assets
Doubtful Assts
Loss Assets
Provisioning
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7/28/2019 Caiib Risk Manage Mod CD
93/95
Provisioning
Standard Assts 0.40%
Substandard-
Secured -provision 10%
Unsecured[realisable value is not morethan 10% of o/s]provision 20%
Provision
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7/28/2019 Caiib Risk Manage Mod CD
94/95
Provision
Doubtful I- first 12 monthsProvision 20% realizable value of security plus
100% shortfall of security
Doubtful II-further 24 months
Provision 30% realizable value of security plus100% shortfall of security
Doubtful III-for over 36 months
100% provisionLoss Assets 100%
Thank you
-
7/28/2019 Caiib Risk Manage Mod CD
95/95
Thank you
With Best Wishes