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Credit Risk
Market Risk
Liquidity
Interest rate
Foreign exchange
Operational Risk
Credit Risk
Credit risk is defined as the possibility of losses
associated with diminution in the credit quality of
borrowers or counter-parties. In a banks portfolio,
losses stem from outright default due to inability or
unwillingness of a customer or counter-party to meet
commitments in relation to lending, trading, settlement
and other financial transactions.
Alternatively, losses result from reduction in portfolio
value arising from actual or perceived deterioration in
credit quality.
Market risk
Fraud
Cause Definition
Internal Losses from failed transactions, client accounts,
Processes settlements and every day business processes.
People Losses caused by an employee or involving employees
(intentional or unintentional), or losses caused through the
relationship or contact that a firm has with its clients,
shareholders, third parties, or regulators.
Systems Losses arising from disruption of business or system
failure due to unavailability of infrastructure or IT.
External Losses from the actions of 3rd parties including external
Events fraud, or damage to property or assets, or from change in
regulations that would alter the firms ability to continue
doing business.
Approaches to measure different risk
under new accord
Approaches to measure Credit risk
Standardized approach
Foundation
Advanced
Approaches to measure Operational risk
Basic Indicator Approach
Internal Model
Approaches to Credit Risk
Management under Basel II
ADVANCED Banks use internal
estimations of PD,
INTERNAL RATING loss given default
BASED (LGD) and exposure at
INCREASED SOPHISTICATION
20
65 60
40
Minimum requirements
Internal Rating Based Approach
The underlying concepts and approaches prescribed in IRB have
been developed based on credit risk measurement techniques
being used by sophisticated banks for ascertaining their capital
requirements.
The Capital required is derived from an estimate of potential
losses for a credit portfolio over one year time horizon with 99.9%
confidence level.
99.9% confidence level implies that there is only one chance in
1000 that the losses will be larger than the regulatory capital.
The credit risk on an asset, reflected in UL & EL, increases as PD,
LGD, EAD or M increases.
Foundation IRB Vs Advanced IRB
Approach
Foundation IRB Approach Advanced IRB Approach
Values for Loss given default (LGD) and Values for Loss given default (LGD)
exposure at default (EAD) are provided by and exposure at default (EAD) are
the regulatory authority. determined by each bank through
internal modeling with a data of 5-7
years.
Assessment of values of credit mitigants is Banks may assess the value of its credit
done by the regulatory authority. mitigants.
8.00%
7.53%
7.00%
6.00% Unexpected loss
Loan losses
5.00%
4.58%
4.00% 3.93%
3.52% 3.32%
3.00%
2.21% 2.30%
2.00% 1.96%
1.21% 1.41% Expected loss
1.00% 0.56%
0.44% 0.27% 0.42%
0.00%
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Time (Year)
Capital Requirement under IRB
Borrower Transaction
Internal Rating Collateral Maturity
80
70 A rating
60
POPULATION
50 D rating
AA rating
40
30
20 Random
10
0
0 10 20 30 40 50 60 70 80 90 100
GINI Coefficient = 0.63
% CUMULATIVE POPULATION
Probability of default of PNB Vs Crisil
32.00%
28.00%
Probability of Default
24.00%
CRISIL Exponential
20.00% fiiting
16.00%
12.00%
8.00%
4.00% PNB
0.00%
AAA AA A BB BB C D
Rating Grades
Comparative average annual default rate
(Up to 31.03.06)
PNB S&P Moody CRISIL
AAA 0.00 AAA 0.00 Aaa 0.00 AAA 0.00
AA 0.00 AA 0.00 Aa 0.02 AA 0.00
A 0.40 A 0.06 A 0.00 A 1.01
BB 0.77 BBB 0.18 Baa 0.15 BBB 3.47
B 2.35 BB 1.06 Ba 1.29 BB 15.85
C 6.40 B 5.20 B 6.81 B 30.30
D 13.21 C 19.79 C 24.06 C 28.57
Impact of Basel II on Capital Requirement
Existing Standardised
Approach -
Particulars Basel II
Total Capital (A) 12831.85 12831.85
Min. Capital Requirement (@ 9%) (@ 9%)
Credit Risk 8001.22 7813.69
Market Risk 1075.90 1075.90
Operational Risk 0.00 855.90
Total Capital Required (B) 9077.12 9745.49
CRAR = [(A)/(B)]*0.09 12.72 11.85
Risk Weighted Assets
Credit Risk 88902.46 86818.76
Market Risk 11954.44 11954.44
Operational 0.00 9510.03
Total Risk Weighted Assets 100856.90 108283.23
Road Map for Basel II Implementation
Approach RBIs Indication Banks Preparedness
Credit Risk
Standardized 31.03.08 Parallel run started w.e.f 1.4.06
IRB Foundation Not Indicated March 2009 (Subject to RBI approval)
IRB Advanced Not Indicated March 2010 (Subject to RBI approval)
Market Risk
Standardized 31.03.06 Already implemented
Internal Risk
Management
Model Method Not Indicated March 2008 (Subject to RBI approval)
Operational Risk
Simple approach can be implemented
Basic Indicator 31.03.08 immediately (Subject to RBI approval)
Standardized Not Indicated March 2009 (Subject to RBI approval)
Advanced Not Indicated March 2010 (Subject to RBI approval)
Benefits of moving to Advanced approaches