4. 4
The Basel II Framework
ď§ Pillar 1
â Minimum Capital Requirement Calculation
ď§ Credit Risk
ď§ Market Risk (little changes vs. Basel I)
ď§ Operational Risk
â Regulatory Reporting
ď§ Pillar 2
â Internal Capital Adequacy Assessment Process
ď§ Capital requirement vs. capital estimates
ď§ Risk Management
â Pillar 1 Risks
â Credit risk concentration
â Interest Rate Risk in the banking book
â Other Risks : Liquidity, Reputation, Strategic, âŚ
â Supervisory Review Process
ď§ Audit (External, Internal)
ď§ Regulatory Supervision
ď§ Pillar 3
â Firms will have to publish their risk profile and risk data
ď§ Supplementary Pillar III reporting, Annexes of Balance Sheet, âŚ
6. 6
PILLAR 1 PILLAR 3PILLAR 2
Increased
Supervisory
Power
Increased
Disclosure
Requirements
Minimum
Capital
Requirement
Market
Discipline
Requirements
Supervisory
Review
Process
Rules
To Calculate
Required Capital
New Regulatory Structure Based on Three Pillars
Capital
Adequacy
Basel II â the Three Pillars
7. Basel II 3 Pillar Analytics
Pillar I : Capital Adequacy Calculations
Credit Risk Market Risk Operational Risk
Calibration
of
EAD
Calculation
of
Risk Weights
Based on PD & LGD
Limits and
Collateral
System
-Counterparty Risk
-Country & Corporate
Concentration Risk
ALM Stress testing
Financial Projection
Models
Upgrade Internal
Rating Systems
Prudential Limit
Global Limit
Country Limit
Private sector Limit
Portfolio and Asset
Concentration Risk
Interest Rate
Risk and Basis Risk
Support for all 3
approaches
Basic Indicator Approach: Capital
Calculated as a percentage of Gross
Income
Standardised Approach: Line of
Business Based Exposure Indicators
Advanced Measurement
Approach: Capital computation as
per Opsrisk Loss Data Approach
Approach:
Internal Ratings Based Approach (Advanced): IRBA
Standardised
Measurement
Methods
Pillar II : Supervisory Oversight Pillar III : Market Discipline
Usage of Metadata ICAAP, Economic Capital,
RAROC*
Rules Based Engine
Capital Adequacy Reporting
Quantitative DisclosuresRisk Assessment Reports
Flexible Reporting
Qualitative Disclosures
Equity Position
Risk
Currency
Risk
Liquidity
Risk
VaR
Calibration
of
PDâs / LGDâs
Definition
of
RWA
*Risk-Adjusted Return on Capital (RAROC)
8. 8
Basel II Risk Analytic Coverage
Basic
Indicator
Standardised
Advanced
Foundation
Standardised
IRB
Operational
Credit
Pillar 2
Regulatory Review
Pillar 3
Market Discipline
Pillar 1
Capital Requirements
Market
Advanced
9. 9
Approaches Risk Components Mitigation
Basel I ď§ Counterparty Nature
(Sov, Corp, OECD country etc)
ď§ Supervisory values
ď§ Limited set of eligible risk mitigants
ď§ Substitution of RW
Basel II
Standardised
ď§ External Ratings
ď§ Supervisory values
ď§ Limited set of eligible risk mitigants
Basel II
IRB Foundation
ď§ PD : by the bank
ď§ LGD, EAD : fixed
ď§ More eligible mitigants
ď§ Apply on PD, LGD, EAD
Basel II
IRB Advanced
ď§ PD, LGD EAD : by the
bank
ď§ Even more eligible mitigants
ď§ Apply on PD, LGD, EAD
Basel Credit Risk Approaches Overview
10. 10
Changed Capital Requirement
Minimum Regulatory
Capital
Capital
(Credit & Market) Risk adjusted assets
= ďł 8%
Minimum Regulatory
Capital
Capital
Credit
risk
Operational
risk
Market
risk
=
+ +
ďł 8%
Basel II
Basel I
11. 11
Credit Risk
⢠Basel II places emphasis on improving the management and
measurement of credit risk
⢠The measurement of credit risk implies assessing the borrowerâs
creditworthiness.
12. 12
1. What is the probability of a
counterparty going into default?
2. How much will that customer
owe the bank in the case of
default? (Expected Exposure)
3. How much of that exposure
is the bank going to lose?
âProbability of Defaultâ
âLoan Equivalencyâ
(Exposure at Default)
âSeverityâ
(Loss Given Default)
PD
LGD
EaD
=
=
=
X
X
Size of Expected Loss âExpected Lossâ EL=
=
Components of Credit Risk
13. 13
Expected Loss
(EL) =
Probability of
Default
(PD)
Severity of Loss
(LGD)
Exposure at
Defaultxx
Standardise = External x Regulatory x Regulatory
Rating Imposed Imposed
IRB = Proprietary x Regulatory x Regulatory
Foundation Rating Imposed Imposed
IRB = Proprietary x Proprietary x Proprietary
Advanced Rating Severity Exposure
Credit Risk Components
14. Credit Risk â Functional Architecture
1
4
Evolution of regulatory framework has added to the complexity of models requiring banks to further
their:
ď§ Risk Control and reporting process
ď§ Data Management
ď§ Processing capabilities of the systems
16. Market Risk
16
Experience Snapshot
ď§ Process Consulting for
VaR Calculation for
leading bank in Singapore
ď§ Portfolio Assessment
Modeling for large hedge
fund
ď§ Performance Evaluation
System for One of the top
US Investment
Consultants
ď§ Strategic Exposure Limits
Management for One of
the Largest Investment
Banks
ď§ Client Information
Management System
(CIMS) for Leading US
West Coast Bank
18. 18
Operational Risk
⢠Capital requirement for Operational Risk (OR) introduced
⢠Banksâ OR models not as developed as for Credit Risk
⢠Operational Risk (OR) will add to banksâ regulatory capital
requirements
⢠Increased cost for OR might offset any capital savings on Credit Risk
⢠Operational risk is not restricted to banks, itâs present in all
organisations including yours
19. Operational Risk Application
19
Experience Snapshot
ď§ Operational Risk Data
Capture for Large
European Bank
ď§ Capital Charge
Calculation & Reporting
for Large Canadian
Bank
ď§ Operational Risk
Management System for
Reputed Bank in
Scotland
ď§ Operational Risk Data
Capture & Reporting for
Premier Provider of
Asset Servicing, Fund
Admin & Investment
Mgmt.
20. Liquidity Risk Framework
20
Liquidity Risk
Governance &
Oversight
Measurement
Management
R
eporting
Systems &
Controls
O
ff-
Balance
SheetItem
s
Asset-
Liability
M
ism
atch
Regulatory
Reporting
ContingencyFunding Plan
Diversification of
Sources of Funds
Liquid Asset
Buffer
Emergency Day â to - Day
Models
Metrics
Early
W
arning
Indicators
Probabilistic
Behavioural
Scenario
21. 21
Internal Capital Adequacy Assessment Process
ď§ Emphasis is on âPâ â Process
ď§ Confusingly, ICAAP now also refers to the calculated capital figure
ď§ A process by which a firm assesses its risks and mitigation for its
business and sets appropriate levels of risk capital
ď§ An ICAAP is specific to each firm
â Minimum standards apply
â Fit for its purpose
â Appropriate to the risks assumed
ď§ There is no prescriptive definition of an ICAAP.
â senior management ownership and responsibility for own process
â FSA will review through ARROW assessments.
22. 22
Overview of Pillar 2 and ICAAP
CAPITAL: Relationship between Pillar 1, Pillar 2 and the ICAAP
ď¸ minimum capital
requirement;
ď¸ calculated using
prescribed parameters
(advanced or
standardised).
Pillar 1 Pillar 2 ICAAP
ď¸ the firm's own assessment
of its capital needs;
ď¸ need not be calculated by
reference to regulatory
capital (firms which use
economic capital models
will express their capital
using a variety of measures
e.g. tier 1, shareholders
funds).
ď¸ supervisory assessment of
the amount of regulatory
capital necessary to cover:
ď¸ Pillar 1 risks (including any
uncertainties in their
calculation); and
ď¸ risks not included in Pillar 1.
ď¸ calculated on a forward-
looking basis through, at
least, an economic
downturn.
23. 23
ICAAP should covers âŚ
Other Risk Types
ď§Interest rate risks in the banking book
âMaturity transformation
ď§Pension risk
âLiabilities
ď§Business risk
âMarket volume volatility
âCompetition
ď§Liquidity risks
âFunding & Refinancing
ď§Strategic risks
âPolitical / Legal / Social
Risk types in pillar 1
ď§Counterparty risks
âCredit risk
âSettlement risk
âCountry risk
âEquity risk
ď§Operational risks
âRisks caused by persons,
processes, technology and external
impacts
ď§Market risks in the trading book
âInterest rate risks
âSpecial risks
âCurrency risks
âCredit spreads
26. Integrated Risk & Finance Analytics View
Covering RAROC, VaR, RWA, Operational, Market & Credit Reporting
Data Warehouse: The Bank wide data warehouse stores the raw and processed
data from the calculation engines. It holds transaction level data and enables
views of the data by multiple dimensions e.g. counterparty, general ledger
account, functional organization, product etc. data is extracted from the business
units specific systems as frequently as is required to provide timely and
meaningful bank wide views of risk
RAROC
Capital
ELELExpensesvenue CROR
ď˝
ďďďďďďďRe
Credit
Data
Integration&enrichment
Risk & FINANCE DW (Economic Data)
-Loans & Borrowings
-Economic Capital
-Revenue
-Expense
-Budgets
-Risk Capital charges
Risk & FINANCE DW
-Risk Capital- Prudential Limits (RWA)
-RWA for exposures
-Investment Portfolio
-Expected Loss EL
META DATA & BUSINESS RULES
SUPPORT
-Common meta data
-Business rules definitions & support
Integration&enrichment
RWA (Regulatory) Engines
Analytics Engines
EOD Calculators
-VaR
-Stress Testing
-Back Testing
-Prudential Limits
-Operational Risk (via
Dashboard)
INTRADAY Calculators
-VaR
-Trade position
-Real Time Limits
-Desk Level Analytics
-Operational Availability
(via dashboard)
Accounting Engine
-P&L
-RAROC
-Other Accounting Measures GL
Data Mart
(Regulatory
Reporting)
Data Mart
(Economic
Reporting)
Data Mart
(Operational Risk
Dashboard)
Reporting
Architecture
Reporting
Engine
Reporting
Engine
ServicesAPIs
RISK DIMENSIONS:
-Market Risk
-Credit Risk
-Operational Risk
-Prudential & Operational Limits
-Risk Capital Charges
& Measures
1
2
3
1. Example RAPM equation for illustration
2. This represents a shared architecture for both EOD & intraday pre deal analytics 3. RISK DASHBOARD for operational quantitative & graphical risk evaluations
Financial
Data
Client risk
Data
Market risk
Data
ODSâs
Data
Business
Actors
Traders
Debt
Managers
Operations
Accounting
Management
Regulators
Compliance
Pre deal RWA
Intraday / pre
deal
analytics