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Risk Management Credit Suisse
Basel I
The reason was to create a level playing field
for internationally active banks
Banks from different countries competing for the
same loans would have to set aside roughly the
same amount of capital on the loans
The purpose was to prevent international banks
from building business volume without adequate
capital backing
The focus was on credit risk
Set minimum capital standards for banks
Became effective at the end of 1992
Risk Management Credit Suisse
Capital Requirements for Basel I
Basel-I was hailed for incorporating risk into
the calculation of capital requirements.
Cooke Ratio
Capital/ Risk Weighted Assets 8%
Definition of Capital
Capital= Core Capital
+ Supplementary Capital
- Deductions
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Risk Management Credit Suisse
Capital Requirements for Basel I
Capital was set at 8% and was adjusted by a
loans credit risk weight
Credit risk was divided into 5 categories: 0%,
10%, 20%, 50%, and 100%
Commercial loans, for example, were assigned to
the 100% risk weight category
Risk Management Credit Suisse
Capital Requirements for Basel I
0%Risk Weight
Cash, Claims on central governments and central banks
denominated in national currency and funded in that currency.
20%Risk Weight
Claims on multilateral development banks and claims
guaranteed or collateralized by securities issued by such banks
Claims on, or guaranteed by, banks incorporated in the OECD
50 %Risk Weight
Loans fully securitized by mortgage on residential property that
is or will be occupied by the borrower or that is rented.
100%Risk Weight
Claims on the private sector
Claims on banks incorporated outside the OECD with residual
maturity of over one year
Claims on central governments outside the OECD (unless
denominated and funded in national currency)
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Risk Management Credit Suisse
Criticism on Basel I
Risk weights were based on what the parties to the Accord
negotiated rather than on the actual risk of each asset
Risk weights did not flow from any particular insolvency
probability standard, and were for the most part, arbitrary.
The requirements did not explicitly account for
operating and other forms of risk that may also be
important
Except for trading account activities, the capital standards
did not account for hedging, diversification, and
differences in risk management techniques
Risk Management Credit Suisse
Overview of Basel II
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The new Basel Accord is comprised of three pillars
Pillar I
Minimum Capital
Requirements
Establishes minimum standards for
management of capital on a more
risk sensitive basis:
Credit Risk
Operational Risk
Market Risk
Pillar II
Supervisory Review
Process
Increases the responsibilities and
levels of discretion for supervisory
reviews and controls covering:
Evaluate Banks Capital
Adequacy Strategies
Certify Internal Models
Level of capital charge
Proactive monitoring of capital
levels and ensuring remedial
action
Pillar III
Market Discipline
Bank will be required to increase
their information disclosure,
especially on the measurement of
credit and operational risks.
Expands the content and improves
the transparency of financial
disclosures to the market.
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Risk Management Credit Suisse
Overview of Basel II
Pillar 1 Pillar 2 Pillar 3
The three pillars of Basel II and their principles
Basel II
Supervisory review
process
How will supervisory
bodies assess,
monitor and ensure
capital adequacy?
Internal process for
assessing capital in
relation to risk profile
Supervisors to review
and evaluate banks
internal processes
Supervisors to require
banks to hold capital in
excess of minimum to
cover other risks, e.g.
strategic risk
Supervisors seek to
intervene and ensure
compliance
Market disclosure
What and how should
banks disclose to
external parties?
Effective disclosure of:
- Banks risk profiles
- Adequacy of capital
positions
Specific qualitative and
quantitative disclosures
- Scope of application
- Composition of capital
- Risk exposure
assessment
- Capital adequacy
Minimum capital
requirements
How is capital adequacy
measured particularly
for Advanced
approaches?
Better align regulatory
capital with economic risk
Evolutionary approach to
assessing credit risk
- Standardised (external
factors)
- Foundation Internal
Ratings Based (IRB)
- Advanced IRB
Evolutionary approach to
operational risk
- Basic indicator
- Standardised
- Adv. Measurement
I
s
s
u
e
P
r
i
n
c
i
p
l
e
Continue to promote
safety and soundness in
the banking system
Ensure capital adequacy
is sensitive to the level
of risks borne by banks
Constitute a more
comprehensive
approach to addressing
risks
Continue to enhance
competitive equality
Objectives
Risk Management Credit Suisse
Overview of Basel II Approaches (Pillar I)
Approaches that can be
followed in determination
of Regulatory Capital
under Basel II
Total Reg
Capital
Operational
Risk
Capital
Credit
Risk
Capital
Market
Risk
Capital
Basic Indicator
Approach
Standardized
Approach
Advanced
Measurement
Approach (AMA)
Standardized
Approach
Internal Ratings
Based (IRB)
Foundation
Advanced
Standard
Model
Internal
Model
Score Card
Loss Distribution
Internal Modeling
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Risk Management Credit Suisse
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Credit risk
Basel II approaches to Credit Risk
Standardised Approach
Foundation
Advanced
Internal Ratings Based (IRB) Approaches
Evolutionary approaches to measuring Credit Risk under Basel II
RWA based on externally
provided:
Probability of Default (PD)
Exposure At Default (EAD)
Loss Given Default (LGD)
RWA based on internal
models for:
Probability of Default (PD)
RWA based on externally
provided:
Exposure At Default (EAD)
Loss Given Default (LGD)
RWA based on internal
models for
Probability of Default (PD)
Exposure At Default (EAD)
Loss Given Default (LGD)
Limited recognition of
credit risk mitigation &
supervisory treatment of
collateral and guarantees
Limited recognition of
credit risk mitigation &
supervisory treatment of
collateral and guarantees
Internal estimation of
parameters for credit risk
mitigation guarantees,
collateral, credit derivatives
Basel II provides a tailored or evolutionary approach to banks that is sensitive to their credit
risk profiles
Increasing complexity and data requirement Increasing complexity and data requirement
Decreasing regulatory capital requirement Decreasing regulatory capital requirement
Risk Management Credit Suisse
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Credit Risk Linkages to Credit Process
Transaction
Credit Risk
Attributes
Exposure at
Default
Loss Given Default
Probability of
Default
Exposure Term
Economic loss or severity of
loss in the event of default
Likelihood of borrower default
over the time horizon
Expected amount of loan when
default occurs
Expected tenor based on pre-
payment, amortization, etc.
CREDIT POLICY
RISK RATING /
UNDERWRITING
COLLATERAL /
WORKOUT
LIMIT POLICY /
MANAGEMENT
MATURITY
GUIDELINES
INDUSTRY /
REGION LIMITS
BORROWER
LENDING LIMITS
Portfolio
Credit Risk
Attributes
Relationship to other assets
within the portfolio
Exposure size relative to the
portfolio
Default
Correlation
Relative
Concentration