Class 7

Class 7

Basal – A place near Zurich (Swiss) – Famous for chocolates. Many Pharmaceutical industries are located in Basal.

BIS - Bank for international settlement in Basal – Set up by Central banks of G-13 countries to facilitate settlement between Central Banks and to manage surplus in the banks.

Gold can be securitized (in London & basal Market – Highest liquidity for gold) to facilitate currency

As per Indian laws, not more than 15% of country’s gold can be outside India.

Core principle of banking supervision – 1^st set of principles to monitor banking system, voluntary in nature

RAROC – Capital left after incorporating losses – Risk adjusted return on capital

Steps in RAROC –

· Risk Event

ü Probability of risk occurrence

ü Risk event drivers

· Impact

ü Probability of Impact

ü Impact Drivers

· Losses

BASAL 1 – 1988 to 1992

1. If advances made by bank is sick, implies bank is sick

2. It only considers Credit risk & Market Risk

a. Credit Risk – Looks at if advances are realizable or not

b. Market Risk – It is because of changes in interest rates (yields)

3. Risk adjusted Ratio is 8%

a. Capital > (8% max) * Risk Weighted Asset (or RWA)

b. It means bank’s own equity in risk weighted asset is maximum of 8%

Shortcomings –

Reputation Risk was not covered. Example – Lehman brothers failed as everyone invested in it because of its reputation

1996-1998 – Received feedback that Market Risk is applied only to trading book (treasury books only) and not to entire position (like foreign exchange book)

(Available Capital / RWA) *100% >= 8%

BASAL 2

Concept of Operational Risk brought in BASAL 2. Example – Barings Bank Case – Risk of Process Failure

Types of Operational Risk –

· External Risk – Example - BPO outside country

· Internal Risk – Example - Strike of unions

New definition of Regulatory Capital included

Regulatory Capital (RC) (Entry Level Capital) – In terms of law, every bank must bring in some minimum capital which should always be there. Example – INR 300 crore (1 Crore = 10 million) for any new Indian Bank.

This capital must be in government securities and should be kept with RBI (for Repo and Reverse Repo)

Economic Capital – (Regulatory Capital – Risk of Loss) – RC value changes because of risk & losses, which is economic capital (Actual value of regulatory capital)

BASAL 2

1. Minimum Capital Requirements

a. Capital is now looked as dynamic, banking considered more unstable than before. Capital will assume losses in due course of time

b. Risk weighted assets now considers market risk, credit risk and operational risk

2. Supervisory Review

a. Role of RBI / Central Bank

3. Market Discipline

Shortcomings of BASAL 2 -

· Definition of operational Risk excluded strategic risk and reputation risk in BASAL 2

· Remuneration of directors / bank employees not included in BASAL 2

BASAL 3

Total Capital / (Credit Risk + Market Risk + Ops Risk) > 8%

Every bank should have a system audit report before Board of Directors

Best Practice – Bench-mark w.r.t other banks

Statutory Auditors – Approved by regulators & appointed by banks. No auditor can provide service to a bank for more than 3 consecutive years. Auditors are free to make notes.

Long Term Audit Report - Addresses limitations of Balance sheet