NEW CAPITAL ACCORD

1
NEW CAPITAL ACCORD
WWW.BIS.ORG
2
Objectives of the revision

• Better assessment of capital adequacy in relation
  to a banks true risk profile
• Taking into account hedging strategies
• Coverage of credit, market and operational risk
• Portfolio diversification is taken into account
• Possible arbitrage of regulatory capital
  requirements are tackled

3
Applicability

• For internationally active banks and on a
  consolidated basis on holding companies that are
  parents of banking groups

4
Difficulties

• National characteristics
• National accounting requirements
• National market conditions
• National loan loss provisions

5
Structure of the new AccordThree pillars

• First pillar minimum capital requirement
• Second pillar supervisory review process
• Third pillar market discipline

6
PILLAR 1Capital Adequacy

• Total
  Capital
• Capital ratio ----------------------------------
  -----------
• Credit risk Market risk
  Operational risk

7
Approaches

• Menu of approaches to measure credit risk
• Standardised Approach
• Foundation Internal Rating Based Approach
• Advanced Internal Rating Based Approach
• Menu of approaches to measure market risk
• Standardised Approach
• Internal Models Approach
• Menu of approaches to measure operational risk
• Basic Indicator Approach
• Standardised Approach
• Advance Measurement Approach

8
Standardised Approach
9
IRB approach

• Categorization of exposures
• Risk components
• Risk weight function
• Minimum requirements

10
Categorization of exposures

• Corporate portfolio
• Retail portfolio
• Sovereign portfolio
• Bank portfolio
• Equity portfolio
• Project finance portfolio
• each portfolio subject to own methodology

11
Credit risk components

• (PD) gt bank own assessment
• (LGD) gt foundation or advanced
• (EAD) gt foundation or advanced
• (M) gt foundation or advanced

12
Minimum requirements for rating

• Meaningful differentiation of risk
• Completeness and integrity of rating assignments
• Oversight
• Criteria and orientation
• Estimation of PD
• Data collection and IT
• Use of internal rating
• Internal validation
• Disclosure

13
PD estimation

• Own estimates (default experience, mapping
  external data, external models) subject to
• floor of 3 basis points (0.03)
• average PD for each borrower grade
• one year time horizon
• forward looking

14
PD estimation

• Definition of default
• Default has occurred if one of the following
  events has taken place
• firm is unlikely to pay its debt obligations
• credit loss event associated with any obligation
  of the firm
• firm past due more than 90 days
• firm has filed for bankruptcy or similar
  protection

15
LGD estimation

• Foundation approach
• Claims without collateral ? LGD 50
• Subordinated claims without collateral
• ?
  LDG 75
• Credit mitigation

16
EAD estimation

• Foundation approach
• On balance sheet ? nominal amount
• Off balance sheet ? adjustments
• Transactions with uncertain future drawdown ?
  100 drawn amount
• 75
  undrawn
• OTC derivatives ? credit risk equivalent
  

17
Risk weights estimation

• Foundation methodology
• RWcmin (LGD/50) x BRWc(PD) , 12.5 x LGD
• BRWc(PD)corporate benchmark risk weight
• associated with a given PD

18
Risk weights versus PD
19
Example

• Loan 100 E 100 E committed
• PD0.5
• LGD50
• then EAD175E
• risk weight (50/50)x7474
• or 12.5 x 50 625
• RWA 74 x 175 129,5 E

20
Credit mitigation

• Recognized in
• Risk Weights in standardized approach
• PD estimation in IRB approach
• LGD estimation in IRB approach

21
Credit mitigation techniques

• Collateral
• Netting
• Guarantees and credit derivatives
• Mismatched exposures

22
Haircuts

• A haircut H will be applied to market value of
  collateral in order to protect against price
  volatility
• A haircut is applied to all non-cash collaterals
• Adjusted value the value of the collateral
  adjusted for the haircut(s)
• Haircuts calculation supervisory, own estimates

23
Haircuts

• Adjusted value CA
• C collateral value
• HE haircut for exposure
• HC haircut for collateral
• HFXhaircut for currency mismatch

24
Asset securitisationThe concept

• Securitisation Assignment of market value to an
  illiquid instrument
• Securitisation Structural transaction in which
  an institution transfers credit risk associated
  with a specified pool of assets to a third party
  (SPV)

25
The concept

• Traditional securitisation legal or economic
  transfer of assets or obligations to a third
  party (SPV) that issues asset-backed securities
  (ABS) that are claims against specific asset
  pools.
• Synthetic securitisation structured
  transactions in which banks use credit
  derivatives to transfer the credit risk of a
  specified pool of assets to third parties.

26
Traditional Securitisation
1.5 bn cash
BANK 1.5 bn credit portfolio
SPV
1.5 bn cash
Credit portfolio
1.5 bn notes
Y years notes
X years notes
27
Synthetic Securitisation
1.5 bn cash
BANK 1.5 bn credit portfolio
SPV Holds portfolio of CLNs
1.5 bn cash
1.5 bn CLN issued by bank
1.5 bn notes
Y years notes
X years notes
28
Credit derivatives
29
Operational riskDefinition

• The risk of direct or indirect loss resulting
  from inadequate or failed internal processes,
  people and systems or from external events
• Definition that focuses on the causes
• No strategic or reputational

30
Basic Indicator Approach

• Capital a x Gross income
• a17-20 (provisional)
• Gross income Net interest income net
  non-interest income

31
Standardised Approach

• Bank activities are divided into standardised
  business units and lines
• For each business unit and line an indicator is
  extracted to serve as a proxy for the amount of
  operational risk and a beta factor for the
  sensitivity

32
Standardised Approach
33
Standardised Approach

• K retail brokerage b retail brokerage x Gross
• 
  Income
• Total Capital S K1-8

34
PILLAR 2SUPERVISORY REVIEW PROCESS

• Four key principles
• Banks Own Assessment of Capital Adequacy
• Supervisory Review Process
• Capital Above Regulatory Minima
• Supervisory Intervention

35
PILLAR 3Market Discipline

• the ability of the market to accurately assess
  the condition of the bank
• the ability of the market to cause subsequent
  managerial actions to reflect those assessments