DEFINITION OF RISK:
1. Risk in finance is defined in terms of the variability of actual returns on an investment, around an expected return, even when those returns represent positive outcomes.
2. The decisions on how much risk to take and what type of risks to take are critical to the success of the business.
3. The essence of good management is making the right choices when it comes to dealing with different risks.
4. In banking, the risk is the possibility that a borrower or counterparty will fail to meet its obligations in accordance with the agreed terms, both in terms of time and quantity.
5. Risk does not come alone – the default of one ...view middle of the document...
New Capital Adequacy framework
b. Capital requirement for operational risk management
c. Guidelines for supervisory review process and market discipline
4. In 2009, Basel II framework was modified with following changes
d. Changes to capital requirements for complex and illiquid credit products, certain complex securitisations etc.
e. Exposures to off-balance sheet items were proposed
5. In 2010, Basel III guidelines were issued.
6. Basel III strengthens bank capital requirements and introduces new regulatory requirements on liquidity management and leverage.
7. Basel III reforms are the response of Basel Committee on Banking Supervision (BCBS) to improve the banking sector’s ability to absorb shocks arising from financial and economic stress.
8. Basel III continues with the three pillars, viz., -
f. Minimum Capital Requirements
g. Supervisory Review
h. Market Discipline
DEFINITION OF REGULATORY CAPITAL:
1. Banks are required to maintain a minimum Pillar 1 capital to Risk Weighted Assets Ratio (CRAR) of 9 % on an on-going basis (other than capital conservation buffer and countercyclical capital buffer).
2. The RBI will take into account the relevant risk factors and the internal capital adequacy assessments of each bank to ensure that the capital held by a bank is commensurate with the bank’s overall risk profile.
3. RBI will consider prescribing a higher level of minimum capital ratio for each bank under the Pillar 2 framework on the basis of their respective risk profiles and their risk management systems.
4. Further, in terms of the Pillar 2 requirements of the New Capital Adequacy Framework, banks are expected to operate at a level well above the minimum requirement.
SUMMARY OF BASEL III CAPITAL REQUIREMENTS:
1. Present capital requirements of a bank are –
a. Bank’s capital comprises Tier 1 and Tier 2 capital
b. Tier 2 capital cannot be more than 100 % of Tier 1 capital
c. Innovative instruments are limited to 15 % of Tier 1 capital
d. Perpetual Non-cumulative Preference shares alongwith innovative Tier 1 instruments should not exceed 40 % of total Tier 1 capital at any point of time.
e. Within Tier 2 capital, subordinated debt is limited to a maximum of 50 % of Tier 1 capital.
2. Capital requirements under Basel III –
f. With a view to improve the quality of capital, Tier 1 capital will predominantly consist of common equity.
g. Qualifying criteria for instruments to be included in Additional Tier 1 capital outside the Common Equity element and under Tier 2 capital will be strengthened.
h. Thus there will be Tier 1 capital with Common Equity Element, Additional Tier 1 capital and Tier 2 capital.
COMPONENTS OF CAPITAL UNDER BASEL III :
1. Tier 1 capital (going-concern capital)
a. Common Equity Tier 1
b. Additional Tier 1
2. Tier 2 capital...