Basel II PDF

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on
Bangladesh Development Bank Limited
Internship Report on
Basel II Implementation as a Statutory

Requirement of Bangladesh Bank: A Study
on Bangladesh Development Bank Limited

Prepared By:
Kazi Khairul Kabir
ID NO. 15050 (BBA), 271 (MBA)
MBA 15th Batch, Section C
Department of Accounting & Information Systems
University of Dhaka
Supervised By:
Amirus Salat
Associate Professor
University of Dhaka
Date of Submission: 6th
July, 2014

Letter of Transmittal
6th July, 2014
Amirus Salat
Associate Professor
University of Dhaka
Subject: Submission of internship report
Dear Sir,
It is a great pleasure for me to submit the report on Basel II Implementation as a Statutory
Requirement of Bangladesh Bank: A Study on Bangladesh Development Bank Limited. I am
submitting this report as part of my internship in Bangladesh Development Bank Limited. The
purpose of the report is based on my working experience in Bangladesh Development Bank
Limited and how the bank has implemented the Basel Accords following the guidelines of
Bangladesh Bank.
I believe the knowledge and experience I gathered during the internship period will be extremely
helpful in my future professional life. I will be grateful to you if you accept the report.
Thanking you.
Sincerely,
___________________
Kazi Khairul Kabir
ID: 271 (MBA)

Acknowledgement
First of all, I would like to convey my cordial thanks for almighty Allah whose uniqueness,
oneness, and wholeness are unchallenged to guide us in difficult circumstances. All respects are
for his holy prophet Hazrat Muhammad (SM) Peace be upon him, who enable us to recognize
the oneness my creator.
I would like to thank Amirus Salat, my university supervisor, for guiding me in planning and
composing the report. He was always available to provide me with his supervision and guidance
during the entire course. Therefore, I express colossal appreciation for his aid.
I am very grateful to Professor Santi Narayan Ghosh, Chairman Bangladesh Development

Bank Limited, for managing the internship for me and directing me by giving his valuable advice.
I also express my gratitude to Syed Md. Nazrul Islam, Deputy General Manager of Risk
Management Department, for teaching me the critical issues of Basel II.
My most heartfelt gratitude goes to all the employees of Bangladesh Development Bank Limited,
Head office and Kawran Bazar Branch, for making it a good practical and learning experience.
From the early hours of the morning to the sunset of the evening they have guided me through
various operations of the bank and provided me with essential support for my internship report.
I pray to Allah that He be merciful to all of these people.
Last but not the least thanks goes to my parents for bearing the tension, frustration and all the
hard work along with me through the entire BBA program.
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Executive Summery
This internship report is based on the three months long internship program that I have
successfully completed in Bangladesh Development Bank Limited under five distinct
departments from April 1, 2014 to June 30, 2014. As a course requirement of MBA program of
the department of Accounting & Information Systems I prepare the report. Although, I worked
in five departments of BDBL, my focal point was the compliance issue regarding Basel II of Risk
management department.
I mainly worked in risk management department which is the responsible wing for implementing
Basel II in BDBL. My faculty advisor and Deputy General Manager of Risk Management
Department helped me choose the topic- Basel II Implementation as a Statutory Requirement of
Bangladesh Bank: A Study on Bangladesh Development Bank Limited.
The internship report is mainly divided into two segments. In the very first portion, all the
necessary calculations related with the regulatory requirements of Basel II are calculated (such
as- Capital Adequacy Ratio, Tire 1 Capital, Tire 2 Capital, Tire 3 Capital and Risk Management
Mechanisms). In the later portion, a checklist is prepared to show the compliance issue of Basel
II and a comparison is made between the regulatory compliance reported by BDBL and Sonali
Bank Limited. It is seen that although BDBL complies all the requirements but SBL does not
conform to some of the major requirements of Basel II.
Basel II is a complex yet very important international requirement for banks. The value of the
knowledge attracted me the most. Bangladesh Bank is the governing body of all the commercial
banks in this country. To be in line with the international standard for regulation of banking
industry (Basel Accord), BB has introduced Risk Based Capital Adequacy guideline relating to
Basel II. All banks have to follow this guideline and report to BB effective from 1st January,
2010. The guidelines are structured in three aspects or pillars: (1) banks should have minimum
capital to guard against different kinds of risks (credit, market and operation risk); (2) assessing
capital adequacy with risk profile of the bank and capital growth plan and (3) public disclosure
of banks position on risk, capital and management.
The three main risks that a commercial bank faces are: Credit risk, Market risk and Operational
risk. Credit risk is the risk that arises from the probability that the borrowers of the bank will not
pay back. Market risk is the risk that puts the bank in adverse situation when interest rate, foreign
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exchange or equity price move in unfavorable direction. Operational risk stems from the internal
environment, occurring when internal processes, people or system fail. The banks can become
resilient and fend off these risks with adequate capital. This is where the regulatory guidelines
come to play.
BB categorizes capital into three tiers. Tier 1 Capital, also known as the Core Capital, which are
the top quality capital for the bank. The Components include: Paid up capital, general and
statutory reserves, retained earnings, minority interest, non-cumulative preference shares, etc.
Tier 2 Capital, also known as supplementary capital, supports Tier 1 capital. Components
include: general provision; revaluation reserves for Fixed Assets, Securities and equity
investments; other preference shares and subordinated debt. Tier 3 Capital, also known as
additional supplementary capital, whose components include: short term subordinated debt to
solely guard against market risk. There are more specific guidelines for eligibility of the capital
tiers. To measure adequacy; Capital Adequacy Ratio (CAR) is calculated with Risk Weighted
Asset (RWA) on the basis of credit, market and operational risk.
Banks have to follow the regulatory rules; otherwise BB can impose penalty and/or punishment
as per Bank Company Act of 1991.
Bangladesh Development Bank Limited fulfilled all major requirements of Basel II in the three
consecutive years starting from 2010. It has been maintaining a CAR ratio of above 10%
requirement for the last three years of the compliance. In June 2012 Basel II report to BB,
recorded CAR ratio of 27.26% on actual capital. According to the same report, it has a total
eligible capital of nearly BDT 11,025 million and a Total RWA of nearly BDT 40576 million
whose 10% must be kept as capital, i.e. BDT 4057 million. Thus BDBL has a surplus of capital.
Most of its Tier 1 capital is covered by paid up capital which is high quality and major part of its
Tier 2 capital consists of subordinated debt. BDBL can smoothly implement all the pillars of
Basel II further if the impediments are removed. Data and reporting should be centralized;
reasonable time should be given for report submission, unnecessary complex measures can be
neglected to help banks adopt Basel II.
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Table of Contents
Letter of Transmittal ...................................................................................................................... i
Acknowledgement ........................................................................................................................ ii
Executive Summery..................................................................................................................... iii
Chapter 1: Introduction ................................................................................................................. 1
1.1 Introduction ......................................................................................................................... 2
1.2 Problem Statement .............................................................................................................. 2
1.3 Scope of the report .............................................................................................................. 2
1.4 Objective ............................................................................................................................. 3
1.5 Methodology ....................................................................................................................... 3
1.6 Limitations of the Study...................................................................................................... 4
Chapter 2: Overview of BDBL ..................................................................................................... 5
2.1 BDBL at A Glance .............................................................................................................. 7
2.2 Vision of BDBL .................................................................................................................. 9
2.3 Mission of BDBL ................................................................................................................ 9
2.4 Strategic priorities of BDBL ............................................................................................... 9
2.5 Values of BDBL ............................................................................................................... 10
2.6 Management of BDBL ...................................................................................................... 10
2.7 Functions of BDBL ........................................................................................................... 10
2.8 Organizational Structure ................................................................................................... 11
Chapter 3: Literary Review ........................................................................................................ 12
Chapter 4: Basel II Framework .................................................................................................. 15
4.1 Structure of Basel II .......................................................................................................... 17
4.1.1 Pillar 1 Minimum Capital Requirements ................................................................ 18
4.1.2 Pillar 2 Supervisory Review Process ...................................................................... 18
4.1.3 Pillar 3 Market Discipline ....................................................................................... 18
4.2 Scope of Application......................................................................................................... 19
4.3 Pillar I-Minimum Capital Requirements .......................................................................... 19
4.3 Conditions for Maintaining Regulatory Capital ............................................................... 21
4.4 Eligible Regulatory Capital............................................................................................... 21
4.5 Minimum Capital Requirement (MCR) ............................................................................ 22
4.6 Total Risk Weighted Assets (RWA) ................................................................................. 22

4.7 Capital Charge against Credit Risk ................................................................................... 23
4.8 Capital Charge against Market Risk ................................................................................. 23
Measurement Methodology................................................................................................. 24
Capital charges for Specific risk ......................................................................................... 24
Capital charge for General Market risk ............................................................................... 24
Capital Charges for Equity Position Risk ........................................................................... 24
Capital Charges for Foreign Exchange Risk ....................................................................... 25
4.9 Capital Charge against Operational Risk .......................................................................... 25
Measurement Methodology................................................................................................. 25
4.10 Pillar-II Supervisory Review Process ............................................................................. 26
4.11 Internal Capital Adequacy Assessment Process (ICAAP).............................................. 26
4.12 Supervisory Review Evaluation Process (SREP) ........................................................... 27
4.13 Stress Testing .................................................................................................................. 27
4.14 Pillar 3 Market Discipline ............................................................................................... 29
Disclosure Requirements..................................................................................................... 29
Chapter 5: Mechanisms for Measuring Credit, Market and Operational Risk ........................... 30
5.1 Bangladesh Bank guideline regarding Basel-II ................................................................ 31
5.2 Credit Risk ........................................................................................................................ 31
Standardized approach: ....................................................................................................... 32
5.3 Operational Risk ............................................................................................................... 34
Basic indicator approach or BIA: ........................................................................................ 35
5.4 Market risk ........................................................................................................................ 35
Value at Risk: ...................................................................................................................... 35
Chapter 6: Analysis of Basel II Components in the Annual Report of BDBL ........................... 37
6.1 Tier 1 capital ..................................................................................................................... 39
6.2 Tier 2 Capital .................................................................................................................... 39
6.3 Tier 3 Capital .................................................................................................................... 40
6.4 Capital Adequacy of BDBL .............................................................................................. 40
Yearly change of CAR ........................................................................................................ 41
6.5 Capital Adequacy to guard against three risks .................................................................. 41

Chapter 7: Compliance of Financial Disclosure with Basel II ................................................... 43

7.1 Regulatory capital ............................................................................................................. 44
7.2 Capital and capital adequacy ............................................................................................ 45
7.3 Mechanism used for risk weights ..................................................................................... 46
7.4 Pillar-2 (Supervisory review) ............................................................................................ 46
7.5 Pillar-3 (Market Disclosure) ............................................................................................. 47
Analysis of Findings ................................................................................................................... 48
Conclusion & Recommendation ................................................................................................. 49
References ................................................................................................................................... iv
Appendix ...................................................................................................................................... v

List of Acronyms
Abbreviation
Full Form
BB
Bangladesh Bank
RBCA
Risk Based Capital Adequacy
BDBL
Bangladesh Development Bank Ltd.
SBL
Sonali Bank Ltd
SA
Standard Approach
VaR
Value at Risk
CAR
Capital Adequacy Ratio
RWA
Risk Weighted Asset
DSE
Dhaka Stock Exchange
CSE
Chittagong Stock Exchange
BSB
Bangladesh Shilpa Bank
BSRS
Bangladesh Shilpa Rin Songstha

Chapter 1:
Introduction
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1.1 Introduction
Bangladesh Bank (BB) is the central bank of Bangladesh and governs all the active performing
commercial banks in the country. Considering the persistent complexity and diversity in the
banking industry and to make the banks capital more risk sensitive and shock absorbent,
Bangladesh Bank has introduced Risk Based Capital Adequacy guideline relating to the Basel II
Accord. In compliance to international standards Bangladesh Bank has made the guidelines
statutory for all scheduled banks in Bangladesh from January 01, 2010. These guidelines are
structured on three Pillars namely Pillar 1: Minimum capital requirements to be maintained by a
bank against credit, market, and operational risks, Pillar 2: Process for assessing the overall
capital adequacy aligned with risk profile of a bank as well as capital growth plan, Pillar 3:
Framework of public disclosure on the position of a bank's risk profiles, capital adequacy, and
risk management system. There are three main risks that a commercial bank faces- Credit risk,
Market risk and Operational risk. In the report, I use the Basel II framework for analyzing the
compliance issue of BDBL and compare it with another bank.
1.2 Problem Statement

From January 10, 2010, Bangladesh Bank has made the guidelines to follow the Basel II accord
a statutory requirement for all scheduled banks in Bangladesh. It was instructed by the central
bank to maintain a capital of 10% against its risk weighted assets to guard itself against the risk
of credit, market and operations. This report is done to figure out how Basel II is implemented
by BDBL following the guidelines provided by Bangladesh Bank.
1.3 Scope of the report

This report only talks about Basel II implementation of BDBL. This report has been prepared
using utmost caution, but the complexity of Basel II regulation is very well known. The report
can be a primary reading for anyone who is new to banking industry or wants to know about
regulatory requirement or someone who wants to study Basel II.
Under no circumstances can this report be the sole material or absolute alternative to the original
BB requirement for anyone who wants to know the ins and outs of Basel II or work with Basel
II regulation. For full knowledge of Basel II, the reader must refer back to Guidelines on Risk
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Based Capital Adequacy (Revised Regulatory Capital Framework for banks in line with Basel
II), the main text released by BB in December, 2010.
1.4 Objective
The primary objectives of the report are to fulfill the academic requirement of preparing an
internship report during my internship which is required for the completion of MBA degree under
Dhaka University, and to enhance my knowledge base by probing into the details of Basel II
accord and how BDBL sails through the required criterias, and how the central bank of
Bangladesh regulates the industry through Basel II. The report goes into explaining the ways
BDBL allocates its credit capital, disclosure of market information and the coordination of Risk.
Some Specific objectives of the report are:
Learning the regulatory requirements of Basel II and having an working experience in the
Risk Management Department of BDBL
Applying the acquired knowledge of Basel II in the preparation of Basel II report of

BDBL which needs to be reported in BB in a regular interval
Knowing the mechanisms of calculating different types of capital (such as-tire 1, tire2
and tire 3) and analyze the financial statement of BDBL
Learning the methodologies of enumerating risks (such as- credit risk, market risk and
operational risk) to analyze the financial report of BDBL
Having a knowledge to calculate risk weighted asset according to Bangladesh Bank

guidelines which is regarded as a basement for calculating Capital Adequacy Ratio
Compare the compliance of Basel II of BDBL with SBL
1.5 Methodology
For my internship report I have collected data from both the Primary sources and the secondary
sources.
Primary data: I got the data or information through the following ways
Directly from the employees
The head of the departments, and
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Basel II Implementation by BDBL following the statutory requirements of Bangladesh

Bank by observing the environmental behavior, facts, record and present condition of the
industry.
Secondary data: I have collected the secondary data through annual reports of BDBL, market
disclosure reports of BDBL, annual reports of SBL, online newspaper articles from The Daily
Star and The Financial Express, various informative websites etc.
1.6 Limitations of the Study

I have dedicated my entire efforts to enrich and complete this report although there are some
limitations which are as follows:
Basel II is a comparatively newer regulation posed on banks compared to the others

regulations from Bangladesh Bank; therefore few employees have sufficient information
about it.
Basel III has not been yet proposed for implementation by Bangladesh Bank.
Bank employees are extremely busy with transactions and other purposed therefore the
time that could be managed from was not enough.
Unfortunately due to the Banks limitations (business secrecy and confidentiality), I was
unable to acquire sufficient information.
Personal barriers such as inability to understand some official terms, office decorum
created a few problems for me.
Time was also a limitation. Gathering such an amount of information by only working
for three months was an extremely difficult job.
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Chapter 2:
Overview of BDBL
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Non- Bengali entrepreneurs and the public sector nearly monopolized economic activity in
Pakistan era. Of the very few business professionals are active in East Pakistan fewer yet
survived after the war. Post- independence Bangladesh therefore presented a unique set of
opportunities and the problems for the private sector. The good news was that without the
stranglehold of the elite Pakistan business family the field was wide open for the development
of a homegrown Bengali private sector, but that both a capital base and an entirely new
entrepreneurial class would have to be development out of an economic vacuum.
Capital formation rapidly occurred and the newly nationalized banks found themselves with
serious asset management problem because there were few professional entrepreneurial risk
takers with business skills and proven track records to which this capital could be made
available under normal and prudent banking practice.
Under this sort of circumstances, the former Industrial Development Bank of Pakistan (IDBP)
and the Equity Participation Fund (EDF) both of which were established for the industrial
development of Pakistan were converted into singles institution named Bangladesh Shilpa Bank
come to existence on October 31, 1972 by the promulgation of Bangladesh Shilpa Bank order
1972 (presidents order no 129 of 1972). The BSB order, 1972 was amended subsequently
by the parliament to provide more operational autonomy to its management.
BSB & BSRS have played an important role for industrializing the country from 1972 to 31
November 2009. At present in rival banking sector, there is no substitute way without
making versatility in the customer service along with long term loan facilities. It is hoped that by
joining this two institutions via lending activity by making BDBL to achieve Economies of
scale to spread market boundary to increase rivalry & liquid State of money will be
sustainable.
Bangladesh Development Bank Limited has been established to give short term & long term
loan for the development of communication & utility, to develop infrastructural facilities &
to keep role in international business according to t h e company act 1991. It is not only a
development bank but also a commercial bank. So it would execute its activities under the
companys law &banking companies act.
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Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on Bangladesh

Development Bank Limited
Bangladesh Development Bank Limited (BDBL) is fully state owned commercial Bank of
Bangladesh. BDBL has been created through the merger Bangladesh Shilpa Bank (BSB) &
Bangladesh Shilpa Rin Songstha (BSRS), signing vendors agreement among the Government &
Government nominated executive board of directors at 21 December 2009. The assets, manpower
and loan of dissolved institutions have been assigned to new organization of BDBL. BDBL has
been enlisted to the register of joint stock companies and certificate of incorporation and certificate
of commencement of business has been issued by the register of joint stock companies.
Bangladesh Bank has issued a banking license to BDBL.
2.1 BDBL at A Glance

Name
Bangladesh
Development
commercial
Bank
Bank,
(formed
through
state
owned
merger
of
Bangladesh Shilpa Bank& Bangladesh Shilpa Rin

Legal Status
Date of incorporation
Sangetha).
Public Limited Company.
November 16, 2009.
Banking License Obtained
November 19, 2009 issued by Bangladesh Bank.
Vendors Agreement Signed
December 31, 2009 between the Government and Board
Formal Inauguration
of Directors
January
03, 2010
of BDBL nominated by the Government.
Registered Office
BDBL Bhaban, 8, Rajuk Avenue, Dhaka- 1000.
Logo
Authorized Capital
Tk. 10000 million.
Paid Up Capital
Tk. 4000 million.
Reserve (As on 01.01.2010)
Tk. 2270 million.
Total Assets (As 01.01.2010).
Tk. 16747 million.
Total Human Resource
781(existing 764)
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Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on Bangladesh

Development Bank Limited
Number of Zonal office
Number of Branch office
18
Membership
Dhaka Stock Exchange & Chittagong Stock exchange
Web site
www.bdbl.com.bd
Telephone No :
Ltd.
+9563476
Fax No:
+88-02-9562061
E-mail
md@bdbl.com.bd
Table 1: BDBL at a Glance

Source: http://www.bdbl.com.bd
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2.2 Vision of BDBL

To emerge as the country prime financial institution for supporting private sector industrial
and other projects of great significance to the countrys economic development. Also
be active in commercial banking by introducing new lines of product and providing
excellent services to the customers.
2.3 Mission of BDBL
To be compete with other banks &Financial institutions in rendering services
To contribute to the countrys socio economic development by identifying

new profitable areas for investment.
To mobilize deposit for productive investment.
To expand branch network in commercially & geographically important places.
To employ quality human resources &enhance their capability through motivation

& right type of training at home &abroad.
To delegate maximum authority ensuring proper accountability.
To maintain continuous improvement & up gradation in business polices

& procedures.
To adopt &adapt new technology.
To maximize profit by strong, efficient & prudent financial performance &
To introduce new product lines according to new market needs.
2.4 Strategic priorities of BDBL

Bangladesh Development Bank Limited invest in Eco-friendly industries that help mitigate
environment degradation by lending more for renewable energy and effluent treatment plants
another project that employ energy efficient low-emission technologies including agro- based
industries, small power project, ICT , transport and infrastructure projects.
BDBL select and invest industrial projects where locating advantages like local
availability of raw material, good infrastructural facilities (road construction, road
communication and transport facilities) and utilities (power, gas, water etc.) shall be
available.
Project loans of BDBL are restricted to TK.15 core maximum and TK. 2 core minimum
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(for large Project). It arranges and participates in syndicated loan for projects above
TK.15 core.
BDBL identify prospective and potential entrepreneurs and investors or clients and
motivate, guide and help them select profitable industrial ventures for investment.
Economic and research department publish financial disclosures regularly.
It undertakes from time to time SWOT analysis for reviewing banks market position
2.5 Values of BDBL
Customer focus- provides smart, efficient, transparent and courteous services.
Social responsibilities- practice corporate social responsibility.
2.6 Management of BDBL

The overall policy formulation and the general direction of Banks operation is vested in a
board of directors appointed by the Government. This Board of Directors consists of nine
members including the Chairman and the Managing Director. The Managing Directors is the
Chief Executive Officer (CEO) of the Bank. The General Manager assist the Managing
Director in conducting the overall business of the bank.
2.7 Functions of BDBL

BDBL extends term loan facilities in local and foreign currencies to industrial projects (both
new and BMRE) in the private and public sectors. Besides Bank also performs the following
activities:
Provides working capital loans to industrial projects
Provides equity support in the form of underwriting and bridge finance to public
limited companies
Issues guarantees on behalf of borrowers for repayment of loan
Extend commercials banking services along with deposit mobilization
Purchases and sales shares/securities for BDBL and on behalf of customers as member
of DSE Ltd. and CSE Ltd. for capital market development; and
Conducts projects promotional activities along with preparation of various sub-sector

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study reports.
2.8 Organizational Structure
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Chapter 3:
Literary Review
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In a report titled, Implementation of Basel II and Basel III on Bank Asia Limited Following the
Statutory Requirement of Bangladesh Bank Mustaba Risalat Rahman analyzes the compliance of
Basel II and Basel III with the financial report of Bank Asia limited. Historical records of capital
adequacy ratio, risk classification and risk weighted asset calculation is shown in the report.
Capital to guard against three risks is also shown in the report. After analyzing the topic it is
recommended that it is a very complex set of instructions and mathematical terms which demands
a separate department in the bank for its integration purpose and the instructions are very hard to
understand about the global standard regulatory policy or the whole banking industry.
Saif Hossain in the report titled, Basel II Implementation in BRAC Bank Limited: Risk Based
Capital Adequacy Requirement of Bangladesh Bank analyze the Pillars of Basel II. He showed
the variations in the historical record to show the variations in keeping capital according to Basel
II accord. The report also discussed some impediments in the compliance with Basel II of BRAC
Bank limited. After analyzing the report the author finds the problems like- Internal data and
reports are not centralized, some of the reporting parts are done by Finance Department and others
are done by the Operational Risk Management (ORM). This issue raises problem in calculation of
various ratios and measures. There is no software specifically modified for Basel II reporting.
Deloitte in the report titled, Understanding the Framework: Adopting the Basel II accord in Asia
Pacific shows the regulatory framework of Basel ii. In the report it is shown that although Basel
II is primarily intended for internationally active banks among the G101 countries, many
countries have announced their intention to adopt the Basel II Capital Accord. Bank regulatory
bodies around the world have been studying how Basel II can be incorporated into national
regulations and are developing implementation guidelines and timeframes for compliance. After
analyzing the topic it is shown that Asia Pacific presents a relatively unique situation from a
banking regulation perspective, both in a regional and global context.
In an article by Oracle white paper titled, Key Challenges and Best Practices for Basel II
Implementation some major implementation challenges and suggests some of the best practices
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that banks can adopt in their pursuit of Basel II compliance and offers recommendations to avoid
the pitfalls. Some major challenges like Multi-jurisdiction Reporting, Data Gap Analysis Study,
Data Quantity Checks and Comprehensive Approach are identified in the report. Basel II
implementation is an opportunity for a bank to improve risk management and ultimately economic
capital management. As stated above, there are many challenges along the way, including
multijurisdictional reporting, data availability and quality, experienced IT resources, solution
completeness, data transparency, solution scalability, flexibility and business intelligence.
Annual disclose of Basel II of some banks like One Bank, DBBL, HSBC and some other banks
show the followings:
Disclosure of three tires of capital
Measurement mechanism of risks
Qualitative and quantitative disclosure of Basel II
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Chapter 4:
Basel II Framework
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Basel-II is a recommendatory framework for banking supervision, issued by the Basel Committee
on Banking Supervision in June 2004. Basel II is claimed by The Basel Committee on Banking
Supervision (BCBS) to be an improved capital adequacy framework intended to foster a strong
emphasis on risk management not only on credit risk management and to encourage ongoing
improvements in banks risk assessment capabilities. It also seeks to provide a `level playing field
for international competition and attempts to ensure that its implementation maintains the
aggregate regulatory capital requirements as obtaining under the current accord. The new
framework deliberately includes incentives for using more advanced and sophisticated approaches
for risk measurement and attempts to align the regulatory capital with internal risk measurements
of banks subject to supervisory review and market disclosure. The objective of Basel-II is as
follows:
Convergence
Bringing about international convergence of capital
measurement
Standardization in the banking system
Risk Management
Emphasis on credit risk management issues
Improvements in risk assessment capabilities
Bangladesh Bank issued Basel II Road Map in 2007 in a Banking Regulation and Policy
Department (BPRD) Circular Implementation of Basel II in Bangladesh started from January 2009.
Both the existing capital requirement rules on the basis of Risk Weighted Assets and revised Risk
Based Capital Adequacy Framework for Banks as per Basel II were followed simultaneously
initially for one year. For the purpose of statutory compliance during the period of parallel run i.e.
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2009, the computation of capital adequacy requirement under existing rules prevailed. On the other
hand, revised Risk Based Capital Adequacy Framework as per Basel II had been practiced by the
banks during 2009 so that Basel II recommendation could effectively be adopted from 2010. From
January 2010, Risk Based Capital Adequacy Framework as per Basel II have been fully practiced
by the banks replacing the previous rules under Basel-I. This has begun an endeavor towards more
improved and risk sensitive capital requirement than the previous regulation.
4.1 Structure of Basel II

The guideline is structured around the following three aspects or pillars of Basel-II:
Pillars of Basel-II
Pillar-I
Minimum Capital
Requirement
Pillar-II
Pillar-III
Supervisory Review
Market Discipline
The objectives of this three pillars framework are: a more risk sensitive capital allocation (Pillar
1 Minimum Capital Requirements), a more detailed regulatory assessment of risks associated
with credit exposure (Pillar 2 - Supervisory Review Process) and increased market transparency
(Pillar 3 Market Discipline).
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4.1.1 Pillar 1 Minimum Capital Requirements The first pillar deals with minimum capital
requirements in respect of credit, market and operational risk. Each of which has to be calculated
using an approach which is suitable and sufficient for the individual bank.
Operational
Risk
Credit Risk
Market Risk
Standardized
Approach
Standardized
Approach
Basic
Indicator
Approach
Internal
Rating Based
Approach
Internal
Models
Approach
Standardized
Approach
Advanced
Measurement
Approach
4.1.2 Pillar 2 Supervisory Review Process Pillar 2 requires the banks to have procedures for the
evaluation and assurance of an adequate capitalization in relation to the risk profile as well as of a
strategy concerning the preservation of the level of own funds (Internal Capital Adequacy
Assessment Process ICAAP).
The pillar 2 has two key elements:
A Financial Institution specific internal assessment and management of capital adequacy.
Supervisory review of this internal capital assessment and the robustness of risk
management processes, systems and controls.
4.1.3 Pillar 3 Market Discipline
Taking account of execution of Pillar 1 (Minimum Capital Requirements) and Pillar 2 (Supervisory
Review Process), Pillar 3 aims to increase market transparency by providing information on the
scope of application, regulatory capital, risk positions, risk measurement approaches equity, risk
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positions, the IRB (Internal Rating Based)-Approach and as a result the capital requirements of a
bank.
4.2 Scope of Application

This Risk Based Capital Adequacy framework applies to all banks on Solo as well as on
Consolidated basis where
Solo Basis refers to all position of the bank and its local and overseas branches/offices.
Consolidated Basis refers to all position of the bank (including its local and overseas
branches/offices) and its subsidiary company(s) like brokerage firms, discount houses, etc.
(if any).
4.3 Pillar I-Minimum Capital Requirements

Basel Committee and Bangladesh Bank agree that some minimum capital must be maintained to
make banks and depository institutions more risk sensitive and shock resilient. Bangladesh Bank
laid out guidelines about the capital that can be and should be counted in calculating Capital
Adequacy Ratio (CAR).
Capital Base
Basel-II accord describes three-tier capital concept with a view to complying with the requirements
which are designed to encourage the banks to strengthen their capital positions considering their
risk, supervisory review process and market discipline. In Basel-II accord, the total capital of a
banking company has been segregated as Tier - I capital, Tier - II capital and Tier - III capital.
19 | P a g e

Regulatory Capital
For the purpose of calculating regulatory capital requirement, capital is categorized into the
following three tiers:
Tier-I Core Capital

Constituents
Amount
Paid-up capital / capital deposited with BB
XXX
Non-repayable share premium account
XXX
Statutory Reserve
XXX
General Reserve
XXX
Minority Interest in Subsidiaries
XXX
Non-Cumulative Irredeemable Preference Shares
XXX
Dividend Equalization Account
XXX
Retained Earnings
XXX
Tier I Capital XXX
Tier-II Supplementary Capital

Constituents
Amount
General Provision
XXX
Asset Revaluation Reserves
XXX
All other Preference Share
XXX
Subordinated Debt over five year maturity
XXX
Exchange Equalization Account
XXX
Revaluation Reserves for Securities
XXX
Revaluation Reserves for Equity Instruments
XXX
XXX
Tier II Capital
20 | P a g e

Tier III Additional Supplementary

Capital (for Market Risk only)
Short term subordinated debt
(2 years<= maturity<= 5 years)
4.3 Conditions for Maintaining Regulatory Capital
Tier 2 capitals cannot be more than Tier-I capitals.
Only 50% of Revaluation reserves for fixed assets and securities will be counted as
Tier-II capital.
Only 10% of Revaluation reserves for equity securities will be counted as Tier-II
capital.
Subordinated debt can be maximum 30% of Tier-I capital to be considered in CAR
calculation.
Tier-I capital must cover at least 28.5% of market risk. Supporting of Market Risk from
Tier-III capital must be limited to 250% of Tier-I capital that remains after meeting
credit risk capital requirement by Tier-I
4.4 Eligible Regulatory Capital

In order to obtain the Eligible Regulatory Capital for the purpose of calculating Minimum Capital
Requirements (MCR), banks are required to make following deductions from their Tier-I capital:
Book value of goodwill.
Shortfall in provisions required against classified assets.
Remaining deficit on account of revaluation of investments in securities after netting off
any other surplus on the securities.
Eligible Tier-II capital will be derived after deducting components, if any, qualified for deduction.
Total Eligible Regulatory Capital = (Eligible Tier-I Capital + Eligible Tier-II Capital +
Eligible Tier-III Capital)
21 | P a g e

4.5 Minimum Capital Requirement (MCR)

Minimum Capital Requirement (MCR) is 10% of total Risk Weighted Assets (RWA) with core
capital (Tier-1) not less than 5 percent of RWA. Thus, Capital Adequacy Ratio (CAR) should be:
=
(, , )
%
()
%
4.6 Total Risk Weighted Assets (RWA)

Risk must be taken into consideration while calculating the capital needed to meet Bangladesh
Bank requirements. Bangladesh Bank provides a list of assets and necessary weights based on their
respective risk. The basic RWA calculation is as below:
Risk Weighted Assets (RWA)

A
Amount
XXXXX
Credit Risk
On-Balance Sheet (Exposure types*Risk Weights)
XXX
Off-Balance Sheet (Exposure types*Risk Weights)
XXX
Market Risk (Capital charges for Market Risk*10)**
XXXXX
Operational
XXXXX
Risk
(Capital
charge
for
Operational
Risk*10)**
Total RWA (A+B+C)
XXXXX
** Capital charge for market risk and operational risk are multiplied by 10(reciprocal of minimum
capital adequacy ratio of 10%)
As per Bangladesh Banks guidelines RWA for Credit Risk includes both On Balance Sheet and
Off-Balance Sheet exposures. The RWA is again subdivided under Banking Book and Trading
Book. For calculating Capital Charge on Market Risk, Trading Book outstanding is used.
22 | P a g e

4.7 Capital Charge against Credit Risk

Basel II allows three ways to calculate credit risk and any one can be followed. Three approaches
are available for the firms. The Choose of an option is dependable upon the condition of the
particular bank.
1. Standard Approach (SA): It calls for the use of external credit rating by External Credit
Assessment Institutions (ECAIs). The ECAI determined risk weights for counterparty will
be used in credit risk calculation. ECAIs will also determine similar counterparty groups
and apply standard risk weightings to those categories.
2. Internal Ratings Based (IRB): This approach allows banks to use their internal assessment
of counterparty regarding the Probability of Default (PD) but requires them to use standard
supervisory parameters regarding Exposure at Default (EAD) and Loss Given Default
(LGD).
3. IRB Advanced approach: This approach allows banks to use their own internal assessment
in determining PD and quantifying EAD and LGD. Bangladesh Bank has mapped its risk
grading (ranging from 1 to 6, where 1 is the highest grading) with that of recognized ECAIs.
Where an exposure is secured by guarantee or eligible financial collateral, it may reduce
its capital charge by taking benefit of the risk mitigation described in the guidelines of
Bangladesh Bank. However, in the absence of credit rating the Risk Weight against loans
and advances would be 125 percent.
4.8 Capital Charge against Market Risk

Market risk is the possibility of losses of assets in balance sheet and off-balance sheet positions
arising out of volatility in market variables i.e., interest rate, exchange rate and price. Allocation
of capital is required in respect of the exposure to risks deriving from changes in interest rates and
equity prices in the banks trading book, in respect of exposure to risks deriving from changes in
foreign exchange rates and commodity price in the overall banking activity. The total capital
requirement for banks against their market risk shall be the sum of capital charges against.
I.
II.
III.
Interest rate risk

Equity position risk
Foreign exchange (including gold) position risk throughout the banks balance sheet.
23 | P a g e

Measurement Methodology
As banks in Bangladesh are now in a stage of developing risk management models, Bangladesh
Bank suggested the banks for using Standardized Approach for credit risk capital requirement for
banking book and Standardized (rule based) Approach for market risk capital charge in their
trading book. Maturity Method has been prescribed by Bangladesh Bank in determining capital
against market risk. In Standardized (rule based) Approach the capital requirement for various
market risks (interest rate risk, price, and foreign exchange risk) is determined separately. The total
capital requirement in respect of market risk is the sum of capital requirement calculated for each
of these market risk sub-categories. e.g.
a) Capital Charge for Interest Rate Risk = Capital Charge for Specific Risk + Capital Charge
for General Market Risk
b) Capital Charge for Equity Position Risk = Capital Charge for Specific Risk + Capital
Charge for General Market Risk
c) Capital Charge for Foreign Exchange Risk = Capital Charge for General Market Risk
d) Capital Charge for Commodity Position Risk = Capital Charge for General Market Risk
The methodology to calculate capital requirement under Standardized (rule based) Approach for
each of these market risk categories is as follows:
Capital charges for Specific risk
Capital charge for specific risk against interest related instruments is designed to protect against
an adverse movement in the price of an individual security owing to factors related to the individual
issuer.
Capital charge for General Market risk
The capital requirement for general market risk is designed to capture the risk of loss arising from
changes in market interest rates.
Capital Charges for Equity Position Risk
I. As with debt securities, the minimum capital standard for equities is expressed in terms of
two separately calculated charges the specific risk and the general market risk for the
holdings.
II. The capital charge, for both specific risk and the general market risk charge will be 10
percent.
24 | P a g e

Capital Charges for Foreign Exchange Risk
The capital charge for foreign exchange risk will be 10 percent of banks overall foreign exchange
exposure. The overall foreign exchange exposure is measured by aggregating the sum of the net
short positions or the sum of net long positions; whichever is the greater, regardless of sign. The
capital charge will be 10 percent of the overall net open position.
4.9 Capital Charge against Operational Risk

Operational Risk is defined as the risk of losses resulting from inadequate or failed internal
processes, people and systems or from external events. This definition includes legal risk, but
excludes strategic and reputation risk.
Measurement Methodology
Banks operating in Bangladesh shall compute the capital requirements for operational risk under
the Basic Indicator Approach (BIA). Under BIA, the capital charge for operational risk is a fixed
percentage, denoted by (alpha) of average positive annual gross income of the bank over the past
three years. Figures for any year in which annual gross income is negative or zero, should be
excluded from both the numerator and denominator when calculating the average. The capital
charge may be expressed as follows:
K = [(GI 1 + GI2 + GI3)*]/n
Where,
K = the capital charge under the Basic Indicator Approach
GI = only positive annual gross income over the previous three years (i.e., negative or zero gross
income if any shall be excluded)
= 15 percent (as per guideline)
n = number of the previous three years for which gross income is positive.
Total Profit/Loss before tax
XX
(+) Total Provision
XX
(+)
Total Operating Expenses
XX
(-)
Realized profit/losses from sale of securities
XX
(-)
Extra ordinary/irregular items
XX
(-)
Income derived from insurance
XX
Gross Income (GI)
XXXX
25 | P a g e

4.10 Pillar-II Supervisory Review Process

The main theme of Pillar 2 is that,
1. Banks have to have a process, a Risk Management Unit (RMU), to assess their own
risk profile and calculate adequate capital
2. They must have a strategy to maintain the level of adequate capital required in the
future.
Banks should also have Supervisory Review Process (SRP) team which will manage all the risks
a bank faces, develop and implement better risk management techniques.
4.11 Internal Capital Adequacy Assessment Process (ICAAP)

The supervisory process is a tool for the regulators to ensure adequate capital of banks to guard
against risks. It also delegates responsibility to top management of the institutions to make certain
of the implementation of the laws. The management must analyze their risks internally, make plan
on capital and maintain proper internal control process. Supervisory review process will address:
1. Risk that are not covered by Pillar-I (risks other than credit, market and operation)
2. External risk factors to the bank that are not captured by Pillar-I
Management must take steps to plan for achieving proper capital target and to gradually use
advance process of calculating RWA and CAR. The five main features of effective review process
are:
1. Board and senior management oversight
2. Sound capital assessment
3. Comprehensive assessment of risks
4. Monitoring and reporting
5. Internal control review
The SRP team is responsible for making and applying Internal Capital Adequacy Assessment
Process (ICAAP). The ICAAP is an important part of Pillar 2 because it helps the bank in risk
measurement and capital planning process. It is basically an internally created guideline regarding
risk assessment and reporting process to be followed when considering the amount and type of
capital the bank should maintain to support its business.
26 | P a g e

4.12 Supervisory Review Evaluation Process (SREP)

BB Basel II implementation cell reviews each banks supervisory review process. This cell
evaluates the banks SRP and then arranges dialogue/ discussion session with that banks SRP
team. BB SREP team will analyze banks review process. BB expects banks to operate above
minimum capital standards. BB, through SREP, will intervene at an early stage if they feel that the
bank would falter in meeting minimum capital requirement. The frequency of meeting will depend
on banks activities and the difference between capital requirement assessed by the bank and BB
team. Usually, the SRP-SREP Dialogue takes place in BB once every year.
4.13 Stress Testing

Stress testing is a kind of sensitivity analysis or what-if-analysis for banks. The purpose of this
test program is to find out how shock absorbent a bank is. Basically, the test calls for changing a
single variable at a time and observing what the result bring to the banks assets, profitability,
liquidity and other measures. The variables are changed to test forward looking scenario a bank
might face. This will measure the vulnerability and exposure to rare, exceptional but potential
events.
The five different risk factors that are used in stress testing are:
1. Interest rate
2. Forced sale value of collateral
3. Non-performing loan (NPL)
4. Share price
5. Foreign exchange rate
Stress test on liquidity must be done separately. The three levels of shocks are: Minor (e.g. only
1% change in interest rate), Moderate (e.g. a 3% change in interest rate) and Major (e.g. 5% or
more change in interest rate).
After BB collects information from banks and finishes the dialogue, the bank and BB will set the
total capital requirement for the bank corresponding to the risks they face. The general format of
additional capital is given below:
27 | P a g e

Particulars of risks against which capital required
Required Capital
Credit Risk
XX
Market Risk
XX
Operational Risk
XX
A) Capital Requirement against Credit, Market & Operational

risks
Residual risk
XXXX
XX
Evaluation of Core Risk management
XX
Credit concentration risk
XX
Interest rate risk in the banking book
XX
Liquidity risk
XX
Reputation risk
XX
Settlement risk
XX
Strategic risk
XX
Environmental & Climate change risk
XX
Other material risk
XX
B) Requirement of additional capital under SRP

Total Capital Requirement (A+B) for the year
XXXX
XXXXX
28 | P a g e

4.14 Pillar 3 Market Discipline

This pillar is present in Basel II framework to complement the other two pillars. This pillar requires
the bank to disclose information to public and be more transparent to the financial market and the
participants. Current and potential stockholders, depositors and borrowers will want to know the
banks strengths and potential loss of assets.
Disclosure Requirements
Banks must have a formal disclosure framework approved by the Board or CEO of the bank.
The banks must follow the disclosure format provided by BB.
The disclosed information must be consistent to the audited financial statements. The information
must be material and omission of important and relevant data must be avoided. Banks have to
submit the data along with annual financial statements to BB by the end of March every year.
Banks can disclose the Basel II information in their Annual Report and/or on their website. In case
of Annual Report, a separate section must be utilized to report information. In case of website, the
Basel II information must be provided in the home-page. The historical information must be
maintained in the website for 4 years. The components must be disclosed in tabular form and in
quantitative and/or in qualitative form regarding the topics mentioned below:
1. Scope of application
2. Capital structure
3. Capital adequacy
4. Credit Risk
5. Equities: disclosures for banking book positions
6. Interest rate risk in the banking book (IRRBB)
7. Market risk
8. Operational risk
29 | P a g e

Chapter 5:
Mechanisms for Measuring Credit,
Market and Operational Risk
30 | P a g e

5.1 Bangladesh Bank guideline regarding Basel-II

To cope with the international best practice and to make the banks capital more risk sensitive
quantitative and qualitative information are prepared by banks based on the audited financial
position of the Bank under the revised Risk Based Capital Adequacy Guideline (RBCA)
introduced by the central Bank of Bangladesh. Banking Supervisions (BCBS) capital framework
was published in 1988. Capital Maintenance requirement based on risk weighted assets was set
up. Banks operating in Bangladesh have been maintaining these provisions in line with the Basel
Committee. Bangladesh Bank issued Basel-II guidelines for all scheduled banks on Risk Based
Capital Adequacy (RBCA) to report their capital requirements which came fully into effect since
January 01, 2010, in December 2008. It is actually subsequent supplements/revisions replacing
the previous rules under Basel-I. The guidelines have been devised to make the regulatory
requirements more appropriate and also to assist the banks to follow the instructions more
efficiently for smooth implementation of the Basel II framework in the banking sector. The major
highlights of the Bangladesh Bank regulations in this regards are:
To maintain capital adequacy ratio (CAR) at a minimum of 10% (9% for 2010) of Risk
Weighted Assets.
To adopt the Standardized Approach for credit risk for implementing Basel II.
To adopt Standardized (Rule Based) Approach for market risk.
To adopt Basic Indicator Approach for operational risk.
To submit the returns to Bangladesh Bank on a quarterly basis.
5.2 Credit Risk

Credit risk refers to the risk that a borrower will default on any type of debt by failing to make
payments which it is obligated to do. The risk is primarily that of the lender and includes lost
principal and interest, disruption to cash flows, and increased collection costs. Credit default risk,
Concentration risk, Country risk are different types of Credit risk. The loss from credit risk may
be complete or partial and can arise in a number of circumstances. For example:
31 | P a g e

A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit,
or other loan
A company is unable to repay amounts secured by a fixed or floating charge over the assets
of the company
A business or consumer does not pay a trade invoice when due
A business does not pay an employee's earned wages when due
A business or government bond issuer does not make a payment on a coupon or principal
payment when due
An insolvent insurance company does not pay a policy obligation
An insolvent bank won't return funds to a depositor
A government grants bankruptcy protection to an insolvent consumer or business
According to the BB requirement, Standardized Approach is followed to calculate credit risk.

Standardized approach: The term standardized approach refers to a set of credit risk measurement
techniques proposed under Basel II capital adequacy rules for banking institutions. Under this
approach the banks are required to use ratings from External Credit Rating Agencies to quantify
required capital for credit risk. In many countries this is the only approach the regulators are
planning to approve in the initial phase of Basel II Implementation. The Basel Accord proposes to
permit banks a choice between two broad methodologies for calculating their capital requirements
for credit risk. The other alternative is based on internal ratings.
Summary of risk weights in standardized approach: There are some options in weighing risks
for some claims, below are the summary as it might be likely to be implemented.
Claims on sovereigns
Credit
Assessment
Risk Weight
AAA
AA0%
to A+ to BBB+
ABBB20%
50%
to BB+ to Below
BB100%
150%
unrated
100%
32 | P a g e

Claims on banks and securities companies related to assessment of sovereign as banks and
securities companies are regulated.
Credit
Assessment
Risk Weight
AAA
AA20%
to A+ to BBB+
ABBB50%
100%
to BB+ to Below
BB100%
150%
unrated
100%
Claims on corporates
Credit Assessment AAA to AA- A+ to A- BBB+ to BB- Below BB- unrated
20%
50%
100%
150%
100%
Risk Weight
Risk weight on some other claim is as follows:
Particulars
Claims on retail products
Risk Weight
75%
Claims secured
property
Claims secured by commercial real 100%

estate
Overdue loans more than 90 days other 150% for provisions that are less than 20% of
the outstanding amount
than residential mortgage loans
by
residential 35%
100% for provisions that are between 20% 49% of the outstanding amount
100% for provisions that are no less than 50%
of the outstanding amount, but with
supervisory discretion are reduced to 50% of
the outstanding amount
0%
Cash
Claims on the BIS, the IMF, the 0%

ECB, the EC and the MDBs
33 | P a g e

NOTE: For some "unrated" risk weights, banks are encouraged to use their own internal-ratings
system based on Foundation IRB and Advanced IRB in Internal-Ratings Based approach with a
set of formulae provided by the Basel-II accord. There exist several alternative weights for some
of the above claim categories published in the original Framework text.
5.3 Operational Risk

The Basel II Committee defines operational risk as: The risk of loss resulting from inadequate or
failed internal processes, people and systems or from external events. However, the Basel
Committee recognizes that operational risk is a term that has a variety of meanings and therefore,
for internal purposes, banks are permitted to adopt their own definitions of operational risk,
provided that the minimum elements in the Committee's definition are included. The Basel II
definition of operational risk excludes, for example, strategic risk - the risk of a loss arising from
a poor strategic business decision. Other risk terms are seen as potential consequences of
operational risk events. For example, reputational risk (damage to an organization through loss of
its reputation or standing) can arise as a consequence (or impact) of operational failures - as well
as from other events. The following lists the official Basel II defined event types with some
examples for each category:
Internal Fraud - misappropriation of assets, tax evasion, intentional mismarking of
positions, bribery
External Fraud- theft of information, hacking damage, third-party theft and forgery
Employment Practices and Workplace Safety - discrimination, workers compensation,
employee health and safety
Clients, Products, & Business Practice- market manipulation, antitrust, improper trade,
product defects, fiduciary breaches, account churning
Damage to Physical Assets - natural disasters, terrorism, vandalism
Business Disruption & Systems Failures - utility disruptions, software failures, hardware
failures
Execution, Delivery, & Process Management - data entry errors, accounting errors, failed
mandatory reporting, negligent loss of client assets
34 | P a g e

For operational risk, basic indicator approach is used,

Basic indicator approach or BIA: Regulatory minimal capital requirements for operational risk is
calculated as follows:
Capital charge under the Basic Indicator Approach= average annual gross income over the
previous three years
Where, =15% (set by the Committee based on CISs)
5.4 Market risk

Market risk is the risk of losses in positions arising from movements in market prices. Some market
risks include:
Equity risk, the risk that stock or stock indexes (e.g. Euro Stoxx 50, etc.) prices and/or their
implied volatility will change.
Interest rate risk, the risk that interest rates (e.g. Libor, Euribor, etc.) and/or their implied
volatility will change.
Currency risk, the risk that foreign exchange rates (e.g. EUR/USD, EUR/GBP, etc.) and/or
their implied volatility will change.
Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil, etc.) and/or
their implied volatility will change.
As with other forms of risk, the potential loss amount due to market risk may be measured in a
number of ways or conventions. Traditionally, one convention is to use Value at Risk. The
conventions of using Value at risk are well established and accepted in the short-term risk
management practice.
Value at Risk: In financial mathematics and financial risk management, Value at Risk (VaR) is a
widely used risk measure of the risk of loss on a specific portfolio of financial assets. For a given
portfolio, probability and time horizon, VaR is defined as a threshold value such that the
probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this
value (assuming normal markets and no trading in the portfolio) is the given probability level. For
example, if a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 0.05 probability
35 | P a g e

that the portfolio will fall in value by more than $1 million over a one day period if there is no
trading. Informally, a loss of $1 million or more on this portfolio is expected on 1 day out of 20
days (because of 5% probability). A loss which exceeds the VaR threshold is termed a VaR
break. Thus, VaR is a piece of jargon favored in the financial world for a percentile of the
predictive probability distribution for the size of a future financial loss. In other words if you have
a record of portfolio value over time then the VaR is simply the negative quartile function of those
values. VaR has four main uses in finance- risk management, financial control, financial reporting
and computing regulatory capital. VaR is sometimes used in non-financial applications as well.
36 | P a g e

Chapter 6:
Analysis of Basel II Components in the
Annual Report of BDBL
37 | P a g e

To be more risk sensitive and shock resilient against credit, market and operational risk, the
depository institutions are asked by the Bangladesh Bank to maintain some minimum Capital
against its assets. Bangladesh Bank put on guidelines on how to calculate the Bankss Capital
Adequacy Ratio (CAR).
The data that has to be collected for evaluating the BASEL II implementation of Bangladesh
Development Bank Limited are as follows as well as the format of the data that has to be collected
along with the formulas, fields, charts and mathematical variables (Discussed in Framework
Chapter). Quantitative data analysis of BDBL are as follows:
Amount in 000 Tk
Total Eligible Capital
The Amount of Tire 1 Capital

Paid up Capital
Non- repayable share premium account
4000,000
-
Statutory reserve
1419400
General reserve
1760000
Retained earnings
112900
Minority Interest in Subsidiaries
Non- cumulative irredeemable preference shares
Total Tier 1 Capital
7292300
The Amount of Tire II capital

General Provision
135700
Asset Revaluation Reserve
3,597,300
Total Tire II Capital
3,733,000
The Amount of Tier 3 Capital

Long Term Subordinated Debt
Total amount of Tier II & Tier III Capital
Other deduction from Capital
Total eligible capital
3733000
11,025,300
Table 2: Total Eligible Capital

Source: Annual Report of BDBL
38 | P a g e

6.1 Tier 1 capital

BDBLs Core Capital comprises of the elements discussed in the Framework of Basel II Chapter
except for Non-repayable share premium account, Minority interest in subsidiaries Noncumulative irredeemable preference shares and Dividend Equalization Account.
COMPOSITION OF TIER 1 CAPITAL

Retained earnings
2%
General reserve
24%
Paid up Capital
55%
Statutory reserve
19%
Chart 1: Composition of Tire 1 Capital; Source: Annual Report of BDBL
6.2 Tier 2 Capital

The Bank's Tier 2 capital comprises of General provision and Asset Revaluation reserves among
Chart 2: Composition of Tire 1 Capital; Source:
the elements discussed in chapter 1.
Annual Report of BDBL
Composition of Tier 2 Capital

4%
General Provision
96%
Asset Revaluation Reserve
39 | P a g e

6.3 Tier 3 Capital

Tier 3 capital called Additional Supplementary Capital consists of short-term subordinated debt
(original maturity less than or equal to five years but greater than or equal to two years) would be
solely for the purpose of meeting a proportion of the capital requirements for market risk. BDBL
has no Tier 3 capital as mentioned earlier.
6.4 Capital Adequacy of BDBL

Bangladesh Bank did not make any certain amount of Capital target. A bank should weight its
assets according to its risk exposure and thus maintain sufficient capital to protect itself through
any shock. The assets should be weighted with risk factors and calculate Total Risk Weighted
Asset (RWA). According to the central banks regulation 10% of the RWA must be backed by the
Tier 1, 2 and 3 capitals. Also a minimum of 5% of the risk weighted assets should be backed by
Tier 1 capital (core capital).
Capital Adequacy
Requirement under
December
December
December
Ratio
Basel II
2010
2011
2012
On Core Capital
6%
15.93
18.43%
18.1%
10%
28.08%
28.9%
27.26%
(Tier 1)
On Total Eligible
Capital
Table 3: Historical Capital Adequacy of BDBL
As per Basel II report for the year Ended 2012, the Capital Adequacy Ratio of BDBL Ltd.s Capital
Adequacy Ratio dropped at 27.26% which was 28.08% in the year end 2011. Risk Weighted Assets
(RWA) registered to TK 40576 million compared to TK 35655 million in the period of 2011. The
total capital stood at TK 11097 million against the minimum Capital requirement (MCR) of 4057
million i.e. TK 7025 million capital is surplus to meet Stress Test and ICAAP requirement. Tier I
capital adequacy ratio is 18.1% against the minimum regulatory requirement of 6.00%. The Bank
policy is to manage and maintain its capital with the objective of maintaining strong capital ratio
and high rating.
40 | P a g e

Yearly change of CAR
CAR OF BDBL
CAR on Core Capital
CAR on Total Capital
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
JAN-10
JAN-11
JAN-12
Chart 3: Historical Record of CAR
6.5 Capital Adequacy to guard against three risks

000 TK
000 TK
2011
2012
Capital requirement for credit Risk
2320211
2805424
Capital requirement for Market Risk
1002400
952677
Capital requirement for Operational Risk
242100
31126
Total Required Capital
3564710
4069366
Total RWA
35647100
40693664
Capital Adequacy Ratio
28.09%
27.26%
Core Capital to RWA
18.43%
18.01%
Supplementary Capital to RWA
10.47%
9.25%
Capital Adequacy
Table 4: Capital Adequacy to guard against Risks

Source: Annual report of BDBL
41 | P a g e

The chart below shows the capital requirement to guard against the three risk- Credit, Market and
Operational Risks.
Capital Against Three Major Risk

3000000
2500000
2000000
1500000
1000000
500000
0
Capital requirement for
credit Risk

Market Risk
2011

Operational Risk
2012
Chart 4: Capital to guard against Risk
42 | P a g e

Chapter 7:
Compliance of Financial Disclosure with Basel II
(A Comparative Picture of BDBL and SBL)
43 | P a g e

To determine the compliance issue with Basel II, I took the following five elements of Regulatory
Framework of BB Risk Based Capital Adequacy Guidelines:
Regulatory Capital: Four specific requirements of Basel II is considered in the case likeTier-2 plus Tier-3 capital of tier-1 capital, Revaluation reserve for fixed assets and
securities eligible for tire-2 capital, Revaluation reserve for equity instruments eligible for
tire-2 capital and Portion of subordinated debt of tier-1 capital
Capital and Capital Adequacy: Total capital of risk weighted asset and core capital of
risk weighted asset are considered in the case
Mechanism Used for Risk Weights: in the case, it is analyzed whether mechanisms
according with guideline of RBCA are followed
Supervisory review: the supervisory process like having separate committee for
supervision, Have process for assessing overall capital adequacy and Monitoring and
ensuring compliance with regulatory capital ratio is analyzed
Market disclosure: Exposure of risk, Exposure of risk assessment process and Exposure
on application of capital is taken into account in the case.
7.1 Regulatory capital
Particulars
Percentage
Compliance with
Basel II
Tier-2 capital of tier-1 capital
51%
Revaluation reserve for fixed assets and
50%
50%
0%
securities eligible for tire-2 capital

Revaluation reserve for equity instruments
eligible for tire-2 capital
Portion of subordinated debt of tier-1 capital
These are the four requirements of BB RBAC completely followed by both the Banks.
44 | P a g e

7.2 Capital and capital adequacy
Particulars
Percentage
Compliance with
Basel II
BDBL
SBL
BDBL
SBL
Total capital of RWA
27.9%
7.59%
Tier-1 capital of RWA
18.1%
3.8%
According to the requirement of BB RBCA, the following two must be maintained:
Core capital must be 10% of total risk weighted asset
Tier 1 capital must be 5% of total risk weighted asset
A measure of a bank's ability to meet its obligations relative to its exposure to risk. The capital a
dequacy ratio exists toensure that a bank is able to handle losses and fulfill its obligations to acco
unt holders without ceasing operations
Although, BDBL follows two of the requirements but SBL does not conform to the requirements.
Therefore, the financial condition of SBL is not safe and investors are not safe. Capital adequacy
ratio provides regulators with a means of establishing whether banks and other financial
institutions have sufficient capital to keep them out of difficulty.
45 | P a g e

7.3 Mechanism used for risk weights
Approach
BDBL
Compliance
SBL
BDBL
Credit Risk
Standard
Market risk
Standardized rule based
Operational risk
Basic indicator
SBL
7.4 Pillar-2 (Supervisory review)
Particulars
Position of BDBL
Compliance with
Basel II
Have separate committee for
BDBL
SBL
BDBL
SBL
RMD
NA
Have
Have
Monitor &
Monitor
supervision
Have process for assessing
overall capital adequacy
Monitoring and ensuring

compliance with regulatory
Ensure
capital ratio
Although SBL has a process of risk management but no separate division is there to oversee the
whole process. At the same time, the Bank fails to ensure the regulatory capital ratio.
46 | P a g e

7.5 Pillar-3 (Market Disclosure)
Particulars
Position
Compliance with Basel II
Exposure of risk
Expose
Exposure of risk assessment process
Expose
Exposure on application of capital
Expose
47 | P a g e

Analysis of Findings
After meticulously probing through the Annual Report of BDBL, SBL and the Bangladesh
Banks guidelines on Risk based Capital Adequacy (Revised regulatory capital Framework
for banks), I found that it is a very complex set of instructions and mathematical terms
which demands a separate department in the bank for its integration purpose. The
instructions are very hard to understand about the global standard regulatory policy or the
whole banking industry.
The Capital Adequacy Ratio (CAR) of BDBL reached- 27.26% on actual capital which is
greater than the ratio of 18.5% of the year ended 2010. The required Capital Adequacy
Ratio required to maintain is above 10%, and therefore Bank Asia LTD has successfully
fulfilled the criteria. But, SBLs CAR is 7.59% and the ratio of core capital to RWA is
3.8%. This means the bank holds a serious threat to its investors and can be in danger.
Basel II is a complex set of standard. Without training, it is very difficult to grasp the global
standard regulatory policy for the whole banking industry. In fact, in BDBL the risk
management department seems a one man army committee to me where only one principle
officer Md. Faisal work for the teams and all others clap at his success.
After learning the theoretical framework of the mechanisms of calculating risks, it seems
to me that implementing the work is quite difficult. A strong infrastructure equipped with
software and backed by BB is a must for them. Data should be centralized, a program or
software should be in place to get the Basel reporting done and banks should be helped
more by BB. It is still very early stage for BBL and other banks to fully implement all the
policies.
48 | P a g e

Conclusion & Recommendation

The international community is now recognizing the importance of effective supervision of
banking industry because if this industry is left to act on its own, it can take down the global
economy. Basel III is in the making where banks must follow stricter policies and report to the
proper authority in more rigor and transparency. Basel II in our country is being followed with
enthusiasm and BDBLs Risk Management gracefully taking every effort to implement Basel II in
the bank. Theoretically the 10% CAR should be enough for banks to be shock resilient and fend
off adverse business environment in Bangladesh. It remains to be seen in real world whether the
adequate capital can save a bank or not. Still there is no harm in maintaining the eligible capital as
per BB guidelines and be prepared for any economic disaster. Prevention is better than cure- a
proverb the rest of the world is pondering about now. By analyzing the topic I like to put the
following recommendations:
Separate risk management team for individual banks should be made mandatory
BB should work as a web to maintain the regulation of risk management
Risk management department should be backed by strong software system
Immediate action should be taken against firms not maintaining CAR to avoid further
hazards
BB should organize training program at a regular interval to keep the human resource of
the commercial banks updated regarding Basel II regulation
49 | P a g e

References
An Oracle White Paper. (August 2009). Key Challenges and Best Practices for Basel II
Implementation.
BIS. (2013). Basel II: Revised international capital framework.
BIS. (2014). Capital requirements for bank exposures to central counterparties - final standard.
Deloitte. (2010). Understanding the Framewok.
Mahmud, A. (2011). Basel II Implementation in BRAC Bank Limited: Risk Based Capital
Adequacy Requirement of Bangladesh Bank. BRAC University, BRAC Business School,
Dhaka.
Rahman, M. R. (Nov, 2012). IMPLEMENTATION OF BASEL II AND BASEL III ON BANK
ASIA
LIMITED
FOLLOWING
THE
STATUTORY
REQUIREMENT
OF
BANGLADESH BANK. INDEPENDENT UNIVERSITY, BANGLADESH, Finance,

Dhaka.
iv

Appendix
Interview Questions on Basel II
1. Why Basel II over Basel I?
2. What are the 3 pillars?
3. What counts as capital?
4. How capital against Credit risk, Market risk and Operational risk is measured?
5. Why are there 3 different possible approaches for measuring risk?
6. How does an institution choose which will be better for it?
7. Why do financial institutions need to hold capital in different tires?
8. How much capital, and of what type, do institutions have to hold under Basel II?
9. How to calculate risk weighted asset?
10. How are lenders using any capital released as a result of the move to Basel II?
11. Does Basel II have any practical implications for consumers? If so, what are they?
12. What impact has the financial crisis had on Basel II?

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Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Bangladesh Development Bank Limited

Basel II Implementation as a Statutory

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Date of Submission: 6th

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Subject: Submission of internship report

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

I am very grateful to Professor Santi Narayan Ghosh, Chairman Bangladesh Development

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Chapter 7: Compliance of Financial Disclosure with Basel II ................................................... 43

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Risk Based Capital Adequacy

Bangladesh Development Bank Ltd.

Sonali Bank Ltd

Capital Adequacy Ratio

Risk Weighted Asset

Dhaka Stock Exchange

Chittagong Stock Exchange

Bangladesh Shilpa Bank

Bangladesh Shilpa Rin Songstha

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

1.2 Problem Statement

1.3 Scope of the report

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Some Specific objectives of the report are:

Applying the acquired knowledge of Basel II in the preparation of Basel II report of

Having a knowledge to calculate risk weighted asset according to Bangladesh Bank

Compare the compliance of Basel II of BDBL with SBL

Directly from the employees

The head of the departments, and

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation by BDBL following the statutory requirements of Bangladesh

1.6 Limitations of the Study

Basel II is a comparatively newer regulation posed on banks compared to the others

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on Bangladesh

2.1 BDBL at A Glance

Bangladesh Shilpa Bank& Bangladesh Shilpa Rin

Banking License Obtained

November 19, 2009 issued by Bangladesh Bank.

Vendors Agreement Signed

December 31, 2009 between the Government and Board

BDBL Bhaban, 8, Rajuk Avenue, Dhaka- 1000.

Tk. 10000 million.

Tk. 4000 million.

Reserve (As on 01.01.2010)

Tk. 2270 million.

Total Assets (As 01.01.2010).

Tk. 16747 million.

Total Human Resource

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on Bangladesh

Number of Branch office

Dhaka Stock Exchange & Chittagong Stock exchange

Table 1: BDBL at a Glance

Basel II Implementation as a Statutory Requirement of Bangladesh Bank: A Study on