minimum capital requirement

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Capital Requirements UnderBasel - II with Exercises

Dr. Prashanta K. BanerjeeSenior Associate Professor andDirector (RD&C) , BIBM



Minimum Capital Requirement (MCR)

( Credit + Market Risk+ Operational Risk)

Risk Weighted Amount Cr. Tk.

For Credit Risk

For Market Risk ............ ×10 = ..............

For Operational Risk .............. × 10 =..................

Total: RWA ..................

Minimum Capital

Requirement (MCR)

10% of RWA

=.................× 10%=............



Assets to be defined by type of claims andother category under Standardized Approach

• Claims on Bangladesh Govt. and Bangladesh Bank• Claims on other sovereigns and central banks• Claims on Multilateral Development Banks (MDBs)• Claims on Public Sector Entities (other than Government)

in Bangladesh

• Claims on Banks• Claims on corporates• Claims included in the retail & Small portfolios (excluding

consumer Finance)• Consumer Finance

• Claims secured by residential property• Claims secured by commercial real estate• Other Categories:• Past due loans• Other assets• Off-balance sheet items



Assets to be Segregated intoTrading & Banking Books

• Trading Issues

• Held for trading (HFT) Available for sale (AFS)

• Equities• Foreign Exchange held throughout the both trading & banking

book

• Commodities held throughout the both trading & banking book

• Banking Issues

• All other except trading book issue



RISK MITIGATION

• Basel II permits reducing exposure by value of eligible collateral

• ‘Haircut' is providing for fluctuation in value of collateral (reduced

realizable value at the point of realization) and/ or of exposure

(increase in exposure due to interest, legal costs, etc, once

default occurs)

• Guarantors risk weight can be taken where lower than the

borrowers risk weight



Credit Risk Mitigation – Guarantees

Guarantees given by :

• Govt. or Central Bank eligible for lesser RW than borrower-

constituent.

• Schedule Banks eligible for lesser RW than borrower-constituent.

• BIS/IMF/ eligible for lesser RW than borrower-constituent.

• Other counter-parties Rated AA or better.

Note: Guaranteed portion of outstanding will be shown in respective

bucket of the Guarantor. Unguaranteed portion will be shown in the

respective bucket of the counterparty/borrower-constituent.



Haircuts – Formulae

New concept born out of Basel IIHaircut is intended to increase the value of the Exposure and reducethe value of the CollateralE* = max { 0, [E x (1 + He) — C x (1- He — Hfx)] }, whereE* = the Exposure value after Risk MitigationE = current value of the Exposure for which the Collateral qualifies as

a Risk Mitigant.C = current value of the Collateral heldHe = haircut appropriate to the Exposure (%)Hc = haircut appropriate to the Collateral (%)Hfx = haircut appropriate to the Collateral for Currency

Mismatch between the Collateral and Exposure (%)This formula can be further sub-divided into 2 parts, one for theExposure (E) and another for Collateral (C) as under:• Value of Exposure after Haircut = E x (1+He)• Value of Collateral after Haircut = C x (1 - He - Hfx)



Example-1 (contd.)Trading Book

(Tk. in Crore)

SI. No. DetailsTk. in

Crore

1. F. Cy clearing A/c 20

2. Balance with banks abroad (Nostro A/C) 10

3. Investments: Market Value 1100

Held for Trading (HFT) 500

Other (HFT) 300

Equities 300

4. Export & other foreign bill (Purchase/Dis) 100

5. Total Investment in trading 1230



Example-1 (contd.)Banking Book : RWA for Credit Risk

(Tk. in Crore)

Sl.No. Details Book Value

1. Cash and Balance with BB (Less F. Ex) 180

2. Bank Balances (At) 190

3.

Investments: Held to Maturity

(HMT)

- Government 500

500

4. Advances 2700

5. Other Assets 200

6. Total Assets: 3770



Credit Risk:Calculation of Risk Weighted Asset on Banking Book

• Credit risk is defined as the risk of losses in both on & off

balance sheet positions of banking book arising from violation of

agreement by a counterparty

• Risk Weighted Asset (RWA) to be calculated taking factors in

consideration under Standardized Approach

• Risk weight mapped against Different ratings of ECAls

• Credit Risk Mitigation (applying Haircut on Exposures & Eligible

Collateral Values)

• Eligible Guarantor &

• Specific Provision



Table no. 1(Mapping ECAI’s Rating with BB)

BB Rating

Grade

Equivalent Rating of CRAB

**

Equivalent Rating of

CRISL **

1 AAA AAA

2 AA1,AA2 AA +, AA

3 AA3,A1,A2,A3 AA-, A+, A, A-

4 BBB 1,BBB2,BBB3 BBB+, BBB etc.

5 BB 1, BB2, BB3, B1 etc. BB+, BB etc.

6 CCC3, CC, C, D) CC+, CC etc.



Table-2: Rating mapped with risk weight(Possible scenario)

Counter-parties

Credit Assessment Rating-

1 2,3 4 5 6 Unrated

Claims on Government &Central Bank

0% 20% 50% 100% 150% 100%

Claims on

Banks & Fls

Opt 120% 50% 100% 100% 150% 100%

1 2 3,4 5,6 Unrated

Corporate 20% 50% 100% 150% 100%



Continuation of Table-2 : Other Category of Assets(As stated in Basel II document)

Category of Assets Risk Weight

Cash items 0%

Claims secured by cash or Gold 0%

Claims secured by residential Property 75%

Retail & Small Portfolio (excluding consumer financing) 75%

Consumer financing 100%

Claims secured by real estate 100%

Past due loan, Specific provisions<20% of the outstanding

amount

100%

Past due loan, Specific provisions>20% of the outstanding

amount

75%



Table-3 : Haircuts for ExposuresHaircuts for Exposures expressed as percentages

( to be fixed by supervisory authority) may be as follows:

Exposures Residual Maturity Sovereigns Other issuers

1 ≤ 1 year 0.5 1

>1 year, ≤ 5 years 2 4

> 5 years 4 8

2,3 ≤ 1 year 1 2


> 5 years 6 12

4 ≤ 5 years 9 12

> 5 years 12 15

5,6 and unrated All 1525



Table-4 : Haircuts for CollateralHaircuts for Collateral expressed as percentages

( to be fixed by supervisory authority) may be as follows:

Issue rating for debt

securities

Residual Maturity Sovereigns Other Issues

1 & S1 ≤ 1 year 0.5 1

> 1 year, ≤ 5 years 2 4

> 5 years 4 8

2,3,S2 & S3 ≤ 1 year 1 2


> 5 years 6 12

4, 5.6, S4 & Unrated All 15

Continued to next slide




(Tk. In Crore)

Sl. No. Details Book Value RW (%) RWA

1. Cash and Balance with BB (Less F. Ex) 180 0 0

2. Bank Balances (1) 190 20 38

3.Investments: Held to Maturity (HMT)

- Government 500

500 0

4. Advances 2700 Next Slide 1985

5. Other Assets 200 100 2006. Total Assets: 3770

7. Total RWA 2223




(Tk. In Crore)SI. No. Details

Book

Value

RW

(%)RWA

4. Advances

4.a Corporate

Claims Secured by Res-property (Rate-2)Claims Secured by Real-estate (Rate-2) 200

27575100

150275

4.c 7 Cases (secured by financial collateral ) 700calculation

sheet259

4.d Retail & Small (excluding consumer) 300 75 225

4.e Consumer financing 725 100 725

4.f Classified

•Secured & kept provision (26 Cr.) <20%

•Secured & kept provision (64 Cr.) > 20%

200

300

100

75

174

177

Total: 2700 1985



Calculation Sheet(7 cases of credit exposure secured by Financial Collateral)

Case-1 Case-2 Case-3 Case-4 Case-5 Case-6 Case-7

Amount 100 100 100 100 100 100 100

Maturity of Exposure (Yrs) 2 3 6 2 3 3 3

Nature of Exposure Corp Corp Corp Corp Corp Corp Corp

Currency BDT BDT USD BDT BDT BDT BDT

Rating of Exposure 4 2 4 Unrated 1 5 5

Haircut of exposure

(From Table-3)0.12 0.06 0.12 0.25 0.04 0.25 0.25

Case 4, 6 & 7 : The haircut for the exposure is the highest as applicable to other equities



Calculation Sheet - contd.(Financial Collateral received to secure 7 cases respectively)


Amount 100 100 100 100 125 100 100

Maturity of collateral (vro 2 3 6 - - 3 0.5

Nature of collateral

PSE

Bank

Bond

Corp

Bond

Equity

outside

mainindex

Equity

in mainindex

Corp

Bond

Corp

Bond

Currency BDT BDT BDT BDT BDT BDT BDT

Rating of collateral 3titivate

d2 - - 1 s3

Haircut of collateral (From Table-4)

0.03 0.06 0.12 0.15 0.12 0.04 0.06Haircut for currency mismatch

(From Table-4)0.08

Case 5 : As value of the collateral is higher than the exposure after haircuts, the exposure is zero



Calculation Sheet- contd.(Net Exposure & calculation of RWA)


Exposure after haircutE × (1 + He)

112 106 112 125 104 125

Collateral after haircutC × (1 — 11c- 11fx )

97 94 80 75 110 96

Net Exposure 15 12 32 50 0 29 100

Risk weight 100% 50% 100% 125% 20% 150% 100%

RWA 15 6 32 62.5 0 43.5 100

Total RWA = 259

E*= max {0, [E ×(1 + He) – C ×(1 - He - Hfx)]}

where:

E* = Exposure value after risk mitigation, E = Current value of the exposure, He = Haircut

appropriate to the exposure, C= Current value of the collateral received. He = Haircut appropriate to the

collateral. Hfx = Haircut appropriate for currency mismatch between the collateral and exposure

Case-1 : E* = 100 ×(1 + 0.12) – 100 × (1- 0.03) = 112 - 97 = 15

Case 7 : Ineligible for CRIvt since the maturity of the collateral is less than one year and rating is B -






For Credit Risk 2223.00

For Market Risk ………..× 10 =…………

For Operational Risk ………..× 10 =…………

Total: RWA…………

Minimum Capital Requirement

(MCR)10% of RWA

=………..× 10%

=…………



Trading Issues & Market Risk

• Market risk is defined as the risk of losses in bothon & off balance sheet positions arising from movements in

market prices• The market risks subject to the capital requirement understandardized approach include:

a) the risk pertaining to Interest rate instruments in the trading bookb) the risk pertaining to equities in the trading bookc) foreign exchange risk throughout the bank andd) commodity risk throughout the bank.



Capital Charge for Market Risk Components

•In Standardized Approach the capital requirement for various marketrisks is determined separately. Market Risk Components are:•Interest Rate risk

-Specific Risk-General Market Risk•Equity Price risk -Specific Risk-General Market Risk•Exchange Rate risk- General Market Risk•Commodity Price risk -General Market Risk



Table-5: Specific risk capital charge forInterest Rate Instrument

CategoriesExternal

Rating GradeSpecific risk capital charge

Government

( Domestic Currency)

- 0%

Government

( Other than Domestic

Currency)

1 0%

2-3 0.25% (residual term to final maturity

6 months or less)

1.00% (residual term to final maturity

greater than 6 and up to and including

24 months)1.60% (residual term to final maturity

exceeding 24 months)

4-5 8%

6 12%




Table-5: Specific risk capital charge (contd.)

Categories External Rating Grade Specific risk capital charge

Qualifying 2-3 0.25% (residual term to final maturity 6 months or less)

1.00% (residual term to final maturity greater than 6 and

up to and including 24 months)

1.60% (residual term to final maturity exceeding 24months)

Other 1 2%

2,3 6%

4 10%

Below 4 12%

Unrated 10%



Clarification

• The category "government" will include all the existing approvedgovernment securities and such other government securities asmay be notified by BB from time to time.

• All BDT denominated government securities will be risk weighted atzero percent while for foreign currency denominated securities

whether issued by domestic or foreign governments, the criteriagiven in the above table would apply.• Qualifying Category:• Debt securities issued by public sector entities and multilateral

development banks, and other securities that is recognized by BBfor including in this category.

• A debt security rated by at least two credit rating agencies of theapproved panel of BB and if both rating is equivalent and rated atleast 3 or S3



Table-6: Maturity Method: Time bands and weights(Used to calculate General Market Risk of Interest Rate Instruments)

Coupon 3% or

more

Coupon Less than

3%

RWAssumed Changed

in Yield

1 month or less 1 month or less 0.00% 1.00

Over 1 to3 months Over 1 to3 months 0.20% 1.00

Over 3 to 6 months Over 3 to 6 months 0.40% 1.00

Over 6 to12 months Over 6 to12 months 0.70% 1.00

Over 1 to 2 Years Over 1 to 2 Years 1.25% 0.90

Over 2 to 3 Years Over 2 to 3 Years 1.75 % 0.80Over 3 to 24 Years Over 3 to 24 Years 2.25 % 0.75




Table-6: Maturity Method: Time bands and weights (contd.)

Coupon 3% or more Coupon Less than 3% RWAssumed

Changed in Yield

Over 4 to 5 Years Over 3.6 to 4.3 Years 2.75% 0.75

Over 5 to 7 Years Over 4.3 to 5.7 Years 3.25 % 0.70

Over 7 to 10 Years Over 5.7 to 7.3 Years 3.75% 0.65

Over 10 to l5Years Over 7.3 to 9.3 Years 4.50% 0.60

Over 15 to 20Years Over 9.3 to 10.6 Years 5.25% 0.60

Over 20 Years Over 10.6 to 12 Years 6.00% 0.60

Over 12 to 20 Years 8.00% 0.60

Over 20 Years 12.50% 0.60



Example-1 (contd.)Trading Book

(Tk. in Crore)

Sl. No. Details Tk. in Crore

1. F. Cy clearing A/c 20

2. Balance with banks abroad (Nostro A/C) 10

3.

Investments: Market Value

Held for Trading-Goyt. (HFT) 500

Other (HFT) 300

Equities 300

1100

4. Export & other foreign bill (Purchase/Dis) 100

5. Total Investment in trading 1230



Example -1 (contd.) Capital Charge for Specific risk against Interest rate

instruments

Counter Party Maturity

Amount

(Market Value)

(Tk in cr.)

Weight

(%)

(From Table-5)

Capital

Charge

(Tk in cr.)

Govt. 2 months 200 0 0

Govt. 12 years 300 0 0

Qualifying 2 months 100 0.25 0.25

Qualifying 4 years 90 1.60 1.44

Qualifying 6 years 70 1.60 1.12

Other (unrated) 3 months 30 10 3.00

Other (unrated) 5 months 10 10 1.00

Total: 800 6.81



Example -1 (contd.) Calculation of General Market Risk against Interest rate

instruments(Maturity Method) Counter

PartyMaturity

Amount

(Market Value)

Weight(%)

(From fable 6)

Weighted

Position

Govt. 2 months 200 0.20 0.40

Govt. 12 years 300 4.50 13.5

Qualifying 2 months 100 0.20 0.20

Qualifying 4 years 90 725 2.025

Qualifying 6 years 70 3.25 2275

Other 3 months 30 0.20 0.06

Other 5 months 10 0.40 0.04

Total: 800 18.50



Calculation of Capital charge

for Equities from Example-1

• There are equity instruments in the trading book. Amount of Equities as

mentioned in the banking companies balance sheet is Tk 300 Crore.

• Therefore, Specific Risk for equities is 10% of 300= Tk. 30.00 crore and

• General Market Risk for equities is 10% of 300 = Tk. 30.00 crore



Example-1 (contd.)

Capital Charge on FCy. Positions

US DollarLong/Short position

in USD equivalent (inn)Taka Equivalent

(mn)

US dollar USD -18 -1080

Japanese yen JPY +5 +300Swiss franc CHF - -

Pound Sterling GBP +15 +900

Euro EUR +10 +600

Canadian Dollar CAD - -

Australian Dollar AUD -2 -120

Singapore dollar SGD -3.5 -210

Other Currencies - -



Example-1 (contd.)

Capital Charge on FCy. Positions

US DollarLong/Short position

in USD equivalent (mn)

Taka Equivalent

(mn)

Sum of the net long position +30 +1800

Sum of the net short position -23.5 -1410

Overall net position* 30 1800

Risk weight 10% 10%

Capital charge for FX Exposure 3.0 180

•The overall net position shall be greater one of the absolute value of the sumof the net long or the sum of short position.•The example assumes a current spot market exchange rate of Taka 60 per US$ 1.



From Example-1 Total Capital Charge for Market Risk

(Without derivatives in trading book)

Details Capital Charge for

Specific Risk (Cr)

Capital Charge for

General Market Risk (Cr)

Interest Rate Related 6.81 18.50

Equities 30.00 30.00

FOREX Position-

18.00

Total: 36.81 66.50

Total Charge Amount 36.81 +66.50 = 103.31 Cr. Tk.







For Market Risk 103.31 × 10 =1033.10

For Operational Risk ……….× 10 =............

Total: RWA ……………..

Minimum Capital Requirement (MCR) 10% of RWA

=………..× 10%

=………..



Operational Risk: Basic Indicator approach

•KBIA = [∑(GI1---n × α1----n)]/n •Where KBIA = the capital charge under the Basic Indicator Approach

GI = annual gross income, where positive, over the previousthree years

n = number of the previous three years for which gross incomeis positive

α =15%,which is set by the BCBS



Capital charge for Operational Risk

• Suppose last 3 years GIs are as follows:

• GI 1 = 174.00 Cr. Tk.

• GI 2 = 52.00

• GI 3 = 155.00

• Capital charge for Operational Risk:

K = [(GI 1 + GI2 + GI3)* α]/n

= [(174.00+ 52.00+155.00) ×15%]/3

= [(381.00) ×15%]/3

= 57.15/3

= 19.05 Crore







For Market Risk 103.31 × 10 =1033.10

For Operational Risk 19.05 × 10= 190.50

Total: RWA 3446.60

Minimum Capital Requirement

(MCR)

10% of RWA

= 3446.60 × 10%

= 344.66 Cr. Tk.

minimum capital requirement

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