Basel II & Credit Risk Management A Presentation on

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Basel II Credit Risk Management

• A
• Presentation
• on
• Implementation Aspects

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Banking on Risk

• Banking is an art science of measuring
  managing risks in lending and investment
  activities for commensurate profits based on the
  risk perceptions.

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Presentation Plan

• Basel II Credit Risk
• Why is Basel II important?
• Standardised Approach
• IRB Risk Measures
• Credit Risk Mitigation
• MIS Reporting Systems
• Clarifications Discussions

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Why is Basel II Important ?

• For strong , sound and stability of international
  banking systems
• More risk sensitive
• New paradigm for allocating regulatory capital

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• What is Credit Risk?
• Credit Risk is the potential of loss arising out
  of the inability or unwillingness of a customer
  or counterparty to meet its commitments in
  relation to lending, trading, hedging, settlement
  and other financial transactions
• Philosophy behind Credit Risk Management Higher
  the risk, higher the expected reward

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Banking Assets to GDP Ratio
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Performance of Banking Systems
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Basel II Pillars

• Basel II framework rests on 3 mutually
  supportive pillars which are
• I -Sets out minimum capital requirements
• II -Supervisory Review of Capital Adequacy
• III -Market Discipline
• The II III Pillars are complementary to I
• Regulatory Capital Charge for risk
• Credit, Market Operational Risks
• Evolutionary in Risk Sensitivity to Capital
  Regime
• Transparency in Public Reporting

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Basel I to Basel II
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Capital Charge on Credit Risk

• Standardised Approach
• RW based on external assessment
• Credit Risk Mitigation
• Internal Rating Based Approach
• Foundation IRB
• Advanced IRB

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Credit Risk Basel II Approaches

• Asset Category Risk Weights

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Capital Charge on Credit Risk -STD

• Standardised approach establishes fixed RW
  corresponding to degree of risk in each asset
  category.
• Makes use of external credit assessment RBI
  approved Rating Agencies.
• No provision for unrated exposures.
• CCF used for off-bal sheet items like LC/ BG etc.
  based on original maturity residual period.
• CRM securities value assessed on nature,
  maturity, residual maturity etc.

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Risk Weights for NPAs
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Capital Charge on Credit Risk -IRB

• IRB approach exposures grouped under six
  categories
• Sovereign /PSE
• Other Banks
• Corporates
• Retails
• Project finance
• Equity investment

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Capital Charge on Credit Risk -IRB

• Computation is a function of
• Probability of Default (PD)
• Loss Given Default (LGD)
• Exposure at Default (EAD)
• Maturity

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Capital Charge on Credit Risk -IRB

• Capital Charge is determined through the
  combination of quantitative inputs from bank/
  regulator specified formulae.
• In advanced IRB the inputs are Bank generated but
  approved by supervisor.

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Capital Charge on Credit Risk -IRB

• Rating systems
• Corporate, Banks, Sovereign exposures
• Each borrower to be given rating
• Risk of borrower default
• Transaction specific factors LGD
• Min of seven for STD borrower one for NPA
  borrower

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Capital Charge on Credit Risk -IRB

• Retail exposures
• Each retail exposure will be assigned to a
  particular pool.
• Pool to reflect homogenous exposures, meaningful
  risk differentiation.
• Allow for accurate consistent estimate of loss
  characteristics.

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Credit Risk
Credit Risk consists of two components

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Concentration Risk -
RISK CAUSING FACTORS
Concentration Risk results from having in the
portfolio a number of borrowers whose fortunes
are affected by a common factor
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Portfolio Concentration Risk
Diversification is particularly important in the
context of credit portfolios
Large possibility of small gains
Small possibility of enormous losses
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Capital Charge on Credit Risk -IRB

• Credit risk Assessment Process Best Practices
• Separate Rating for borrower category .
• Mapping of scales to common scale
• Store internal migration data for PD
• Internal scoring / rating for LGD
• IT systems for assessment of Credit Risk
  quantification of default and loss estimates.
• Credit VAR frame work for computing EL UL

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Credit Loss Distribution

• The Probability Density Function

Probability Density
Amount of Loss
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Risk Measures
Standard Deviation Measures the absolute
deviation from the average value
Percentile Level 99th percentile Loss gives the
Maximum Loss that will occur 99 times out of 100
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Capital Charge on Credit Risk -IRB

• Expected Losses (EL) indicates the average loss
  that the Bank might incur on a portfolio.
• EL PD x LGD x EAD
• Unexpected losses (UL) is the uncertainty around
  EL. It is the SD of EL .

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Applications - Provisioning
Probability Density
Amount of Loss
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Economic Capital
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Applications - Risk Mitigation
Marginal Risk is defined as the Credit Risk
which is added to a portfolio when a new borrower
is added to the portfolio
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Credit Risk Management - A Map
Credit Risk Model
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Basel II Credit Risk

• Data requirement
• Do we have that ?
• How do we collate?
• Do we have necessary IT infrastructure?
• How do we commence?
• Can we graduate?

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Robust MIS
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The way that risk is managed in any particular
institution reflects its position in the
marketplace, the products it delivers and
perhaps, above all, its culture.
Thanks! VK Sudhakar, D2K
Technologies d2k_at_d2kindia.com ,
09820004783, 09322296799