BASEL III

Abdullah Al-Mamun Sarker

Risk Management Division
Objectives
• To familiarize Basel Accord
• Credit, market, Operation Risk
• Calculation of Capital Charge
• Risk Weight
• Credit Risk Mitigation
• Credit Conversion Factor
• Borrower Categorization
• Funded
• Non-Funded
• Exposure Categorization
• Total Regulatory Capital
Basel III
A global regulatory framework for more resilient banks and
banking systems
• The objective of the reforms are:
• Improving banking sector’s ability to absorb shocks arising from
financial and economic stress,
• Reducing the risk of spillover from the financial sector to the real
economy.
• Improving risk management and governance as well as strengthen
banks’ transparency and disclosures.
• Also addressed the lessons of the financial crisis.
Basel Accord
3 ‘Mutually Reinforcing’ Pillars

Scope of Application: Individual, Sub-consolidated & Consolidated Basis

Pillar 1 Pillar 2 Pillar 3

“Quantitative” “Qualitative” “Market Forces”

Minimum Capital Supervisory Market

Requirements Review Process Discipline

• Overview of supervisory • Improvement of

• Calculation of capital disclosure requirements
review
requirements for • Capital structure
• Key principles • Risk exposures
• Credit risk • Capital management • Capital adequacy
• Market Risk (Trading processes (allocation of
• Market participants
book changes) capital)
should be able to assess
• Interest rate risk in the a bank’s capital adequacy
• Operational risk
banking book
Capital to Risk-weighted Asset Ratio (CRAR)

The Capital to Risk-weighted Asset Ratio (CRAR) is

calculated by taking eligible regulatory capital as
numerator and total RWA as denominator.
Components of Capital

The capital of bank is classified into two tiers:

1. Tier 1 Capital (going-concern capital)
a) Common Equity Tier 1
b) Additional Tier 1
2) Tier 2 capital (gone-concern capital)

Tier 3 capital is eliminated from the capital

components

6
Components of Capital (Cont’d)

Common Equity Tier 1 Capital

• For the local banks, Common Equity Tier 1 (CET1)
capital shall consist of sum of the following items:
• a) Paid up capital
• b) Non-repayable share premium account c)
Statutory reserve
• d) General reserve
• e) Retained earnings
• f) Dividend equalization reserve
• g) Minority interest in subsidiaries7
• Less: Regulatory adjustments applicable on CET1
Components of Capital (Cont’d)
For the foreign banks operating in Bangladesh, Common Equity Tier 1
(CET1) capital shall consist of sum of the following items:
I. Funds from Head Office for the purpose of meeting the capital
adequacy
II. Statutory reserves kept in books in Bangladesh
III. Retained earnings
IV. Actuarial gain/loss kept in books in Bangladesh
V. Non-repatriable interest-free funds from Head Office for the
purpose of acquisition of property and held in a separate
account and have the ability to absorb losses regardless of their
source
Less: Regulatory adjustments applicable on CET1
Components of Capital (Cont’d)

Additional Tier 1 Capital

• For the local banks, Additional Tier 1 (AT1) capital
shall consist of the following items:
– Instruments issued by the banks that meet the
qualifying criteria for AT1
– Minority Interest i.e. AT1 issued by consolidated
subsidiaries to third parties (for consolidated
reporting only)
Less: Regulatory adjustments applicable on AT1
Capital
Components of Capital (Cont’d)
Tier 2 capital, also called ‘gone-concern capital’,
represents other elements which fall short of some of
the characteristics of the core capital but contribute
to the overall strength of a bank. For the local banks,
Tier 2 capital shall consist of the following items:
– General Provisions 8
– Subordinated debt / Instruments issued by the banks
that meet the qualifying criteria for Tier 2 capital
– Minority Interest i.e. Tier 2 issued by consolidated
subsidiaries to third parties

Less: Regulatory adjustments applicable on Tier 2 capital

Risk Weighted Asset

Balance sheet
– Credit Risk
– Market Risk
– Operation Risk
Pillar I: Minimum Capital Requirements

Credit Risk
• Standardized Approach
• Internal Rating Based Approach (IRB)
• Advanced Internal Rating Based Approach
Pillar I: Minimum Capital Requirements

Market Risk
• Standardized Measurement Approach
- Interest Rate Risk
- Equity Position Risk
- Foreign Exchange Risk
- Commodities Risk
• Internal Models Approach
Pillar I: Minimum Capital Requirements

Operational Risk

• Basic Indicator Approach

• Standardized Approach
• Advanced Measurement Approach
Credit Risk Capital Charge

 Risk weights for different “On Balance Sheet” and “Off Balance
Sheet” assets are fixed by Bangladesh Bank.
 Use of External Credit Assessment Institution (ECAI) Ratings
prescribed
 ECAIs (External Credit Assessment Institutions) :
Eligible International or Domestic External Rating agencies as
defined by Local Regulatory Authorities for a country.
 Under the Standardized Approach, risk weights are assigned on the
basis of external ratings given by eligible credit rating agencies.
Thus the risk weighted exposure of such assets would be different
on corporate depending on the external rating of the obligor.
 All the exposures which are not rated have an assigned Fixed risk
weight determined by Bangladesh Bank e.g retail, consumer
finance, residential mortgage etc.
Asset Classification
Fund-based Assets:
 Advances & Loans like Cash Credits, Overdrafts, Revolving Credits, Term
Loans, Demand Loans, Credit Lines etc.
 Bills/Cheques purchased/discounted/negotiated etc.
Non-fund based Assets:
 Guarantees Issued.
 Letters of Credit Issued.
 Other Contingent Liabilities like
Standby Letters of Credit, Acceptances, Endorsements,
 Unutilized Limits:
Unutilized Limit of CCC/OD/Revolving Credit,
Undisbursed portion of Term Loan and
Undrawn portion of Committed Credit Line/
Line of Credit.
Risk weights (Fund Based)
 Residential Mortgage / Home Loans - 50% (fixed)
 Commercial Mortgage - 100% (fixed)
 Consumer finance – 100% (fixed)
 Retail Loan – (Personal term loan, OD, Credit Card) <75 lac - 75% (fixed)
 Claims on SME
 SME 1-0.20
 SME 2-0.40
 SME 3-0.60
 SME 4-0.80
 SME 5-1.20
 SME 6-1.50
 Unrated (small enterprise &<BDT 3.00m)-0.75
 Unrated (small enterprise having ≥ BDT 3.00m & Medium Enterp.)-1.00
 Claims on Corporate (excluding Equity Exposure)
 1-0.20
 2-0.50
 3,4-1.00
 5,6-1.50
 Unrated-1.25
 NPAs with provisions <20%  150%
20 to < 50%  100%
50% and above  50%
Borrower Categorization
Claims categorized as retail portfolio:
Claims (including both fund and non-fund based) that meet all
the four criteria listed below may be considered as retail claims
for regulatory capital purposes and included in a regulatory retail
portfolio.
Qualifying criteria for the retail portfolio are as follows:
• Orientation criterion: The exposure to an individual person or
persons
Exposure limit: The maximum aggregate exposure to a person(s)
will be limited to BDT 1.00 (One) crore.
Claims on SME:
Small and Medium Enterprises (SMEs) will be defined in line with the
Industrial policy 2010 and Bangladesh Bank’s SME & SPD circular no.1
dated 19th June, 2011 or any changes thereof made from time to
time.

Consumer Finance
Loans and advances to individuals for meeting their
personal, family or household needs that includes
credit cards, auto/vehicle loans for personal use,
personal loans, and any purpose loan etc.
 Claims secured by residential property

Lending fully secured by mortgages on residential

property that is or will be occupied by the
borrower or that is or will be rented. Loans for the
purpose of constructing/purchasing/renovating
of house/apartment provided to individuals will
fall under this category. Loans secured by
residential real estate for business purpose will
not fall under this category.
Claims secured by commercial real estate

Lending fully secured by mortgages on commercial real

estate that will be occupied or rented or sold by the
borrower. The mortgages may be used for office and/or
multipurpose commercial premises and/or multi-
tenanted commercial premises etc. Industrial or
warehouse space, hotels, land acquisition
for/development/construction of residential real estate
by real estate companies, and exposures to entities for
setting up special economic zones will also be treated as
commercial real estate.
Capital market exposures

Claims against investor account holder or margin account holder

of the subsidiary companies (Merchant banking/Brokerage
house) of the bank will fall under this category.
Claims on corporate

Loans and advances to and investments (excluding equity exposure) in

corporate. “Corporate” refers to any proprietorship, partnership or
limited company that is neither PSE, bank, NBFI nor borrower within
the definition of retail portfolio and SME (having exposure within the
limit stipulated).
 Credit Rating-Why?
According to Bangladesh Bank instruction we are
following standardized approach to calculate credit
risk where credit rating plays an important role.
Standardized approach recognizes that different
counterparties within the same loan category present
different risks to the institution.
Therefore, instead of placing all commercial loans in the
same risk weight basket, the Standardized Approach takes
into account the credit rating of the borrower.
Where Rating Applicable?
1. Banks
2. NBFIs
3. Multilateral Development Banks (MDBs)
(Other then IBRD, IFC, ADB, AFDB, EBRD, IADB, EIB, EIF, NIB, CDB, IDB, CEDB)

4. Corporate and SME Clients

Impact of Rating (On Balance Sheet)

Figure in crore Taka

Customer Outstanding Risk RWA=RW* Total Capital

Rating MCR(%)
Title Balance Weight Assets Requirement

W & Co AAA 100 20% 20 10% 2

X & Co A 100 50% 50 10% 5
Y & Co BB 100 100% 100 10% 10
Z & Co B- 100 150% 150 10% 15
A & Co Unrated 100 125% 125 10% 12.50
Eligible Basel Collaterals

 Comprehensive approach of Credit Risk Mitigation adopted.

 Exposure on a borrower will be calculated after deducting the market value

of the following eligible collaterals as per Bangladesh Bank Guidelines:

– Cash
– Gold
– Debt Securities (meeting certain criteria)
– Equities (DSE 20 and CSE 20)
– Mutual Funds
– Such deduction is subject to use of some regulatory formula known as “haircut”
(duly explained in the Basel-II guideline) and such process of deduction is called
“Credit Risk Mitigation” technique. In addition the collateral must be legally
enforceable, and the bank must ensure robust monitoring process.
Non Fund Based Assets

• Contingent Liabilities
– Acceptance and endorsement
– Letter of Guarantee
– Irrevocable letters of credit
– Bills for collection
– Value of Bangladesh Sanchaypatra
Conversion to On-Balance Sheet Asset

• Direct Credit Substitute

• Performance Related Contingencies
• Short Term self-liquidating Trade letters of
credit
• Lending of securities or posting of securities as
collateral
 Direct Credit Substitute

Acceptance and Endorsement Payment Guarantees

 Performance Related Contingencies

Bid Bond Performance Guarantee

Short Term self-liquidating Trade letters of

credit

Deferred Payment L/C

Lending of securities or posting of securities as
collateral

Treasury Bills or Bonds

Conversion Factors

NAME OF TRANSACTION CCF

Direct Credit Substitute 100%

Performance Related Contingencies 50%

Short Term self-liquidating Trade letters of credit 20%

Lending of securities or posting of securities as 100%

collateral
Pillar I : Market Risk Capital Charge

Standardized Measurement Approach

• Interest Rate Risk (Govt. approved securities in HFT)
- Specific Risk - Specified
- General Market Risk - Specified

• Equity Position Risk

- Specific Risk – 10%
- General Market Risk – 10%

• Foreign Exchange Risk – 10% of added long/short whichever is higher

•Commodities Risk – At present not available in our country

Pillar I : Operational Risk Capital Charge

Basic Indicator Approach

(newly introduced)

• 15% of Average Positive Annual Gross Income of Last 3 Year