Basel - II - Market Discipline (Third Pillar)

8/10/2019 Basel - II - Market Discipline (Third Pillar)

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Dr K Sat anara ana, NIBM, Pune

BASEL- II - Market Discipline (Third Pillar)

- RBI Guidelines (April 2007)

A) Introduction

- Complementary to other two pillars i.e. Minimum Capital Requirement

and Supervisory Review Process

- AIM : To encourage market discipline through a set of disclosure

requirements so as to enable market participants like investors to have

information about banks risk exposures, risk assessment processes,

capital and capital adequacy position besides Scope of Application

- Disclosures should be consistent with the way senior management of

bank and Board of Directors assess and manage various risks of the

Bank.


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B) Achieving Appropriate Disclosure

- Desirable to have a common framework for all banks so as to achieveconsistent, comprehensive and comparable disclosure standards.

- Market discipline can contribute to safe and sound banking

environment

- Effective from 31-3-2008 / 31-3-2009

- Non-compliance with the prescribed disclosures shall attract in addition

to general intervention, penalty including financial though not directly in

the form of additional capital:

e.g. denying a legitimate lower risk weight or specific methodology

under Pillar-I


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C) Interaction with Accounting Disclosures

- To ensure that such disclosure requirements do not clash with:

Accounting Standards

Proprietary information disclosure which may undermine banks

competitive position in products, systems etc. I.e. rendering

investment in such products & systems less valuable to the bank

Obligation to maintain customers confidentiality or such other

terms of legal agreement or counterparty relationship


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D) Materiality

- Materiality concept shall be the guiding principle of disclosure to decideupon the need or relevance of disclosure

Informationwould be regarded as material if its omission or mis-statementcould change or influence the assessment or decision of a user relying onthat information for the purpose of making economic decisions

- Such definition is consistent with international accounting standards as

well as national accounting framework RBI advocates user test as bench mark for achieving sufficient

disclosure threshold levels in this context

User test is whether a user of financial information would consider theitem to be material or not.

RBI has also prescribed materiality thresholds for certain limiteddisclosures

- Banks are encouraged to make disclosures even below the specifiedthresholds also.


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E) Frequency of Disclosures

- Quantitative and Qualitative disclosures as on March end each year

along with annual financial statements making them available in the

annual reports and websites.

- Banks with capital funds of Rs. 100 crores and above should make

certain interim quantitative disclosures on a stand-alone basis through

their websites as at the end of September each year.

- However qualitative disclosures that provide a general summary of

banks risk management objectives and policies, reporting system,

definitions etc. may be done only on annual basis.

- In tune with the risk sensitivity of Basel II and also general trend of

more frequent reporting in capital markets, all banks with a capital

funds of Rs. 500 crores and above and their significant banksubsidiaries must disclose on quarterly basis the following :

TierI Capital

Total Capital

Total Required Capital

TierI Ratio

Total Capital Adequacy Ratio


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- Website disclosures should be under the title Basel II disclosures with a

link to home page prominently.- Each of Capital Adequacy disclosures pertaining to a financial year

should be available on the website until disclosure of third subsequent

annual (March end) disclosure is made.

e.g. Disclosure of financial year ending March 31, 2009 (i.e.

June/September/December 2008 and March 2009) should be

retained in the website until disclosure as on March 2012.


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F) Need for proper validation of disclosures :

- No need for formal audit or external audit of Pillar IIIdisclosures. However information disclosed shall be consistent

with :

Audited Financial Statements

Systems of Internal scrutiny, verification etc.

Management discussion and analysis after sufficient scrutiny

Internal control assessments

If there is any stand alone report or any other part of website not

subject to the above validation regime, then managementshould ensure appropriate verification in accordance with

general disclosure principle.


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G) General disclosure principle :

A formal disclosure policy to be duly approved by banks Board

covering :

- Approach to determine what should be disclosed.

- Disclosure process including internal control over such process.

- System of assessing appropriateness of disclosures including

validation and frequency of such disclosures.


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H) Scope of application of Pillar III disclosures

- All those banks required to adopt Basel II i.e. ASCBs (except

RRBs and LABs) both solo as well as consolidated as the case

may be.

- In other words exclude RRBs, LABs, insurance companies and

companies whose business is not financial services in case of

consolidated entity.

- In consolidated case, disclosures related to individual banks

within a group would not generally be required to be made by

parent bank except :

Total and Tier I ratios of significant subsidiaries so as to reflect

possible implications or limitations on the transfer of funds orcapital within the group.

Individual banks need to make Pillar III disclosures on a stand

alone basis when they are not the top consolidated entity in the

banking group.


10/39Dr K Sat anara ana, NIBM, Pune

I) What market wants to know?

- The risks to which banks are exposed to :

Credit Risk, Market Risk, IRR in Banking Book andOperational Risk

- The techniques that banks use to identify, measure, monitor and

control those risks.

- Risk hedging and or mitigation (especially credit risk) routes,

including assets securitisation which alters the risk profile of a

bank.

- Where applicable, separate disclosures are to be set out for

banks using different approaches to the assessment of

regulatory capital.



J) General Qualitative Disclosure Requirement

Under general qualitative disclosure requirement banks are expected to

indicate their risk management objectives and policies covering :

- Strategies and processes

- The structure and organisation of the relevant risk management

function.

- The scope and nature of risk reporting and or measurement

system.

- Policies for hedging and or mitigating risk and strategies and

processes for monitoring the continuing effectiveness of

hedges/mitigants.



Information provided especially for credit risk need not necessarily be

based on information prepared for regulatory purposes.

Disclosures on the capital assessment techniques shall giveinformation on :

- The specific nature of exposures

- The means of capital assessment

- The data to assess the reliability of the information disclosed.



K) List of Prescribed Formats for Disclosures

1) Table DF1 : Scope of application

2) Table DF2 : Capital structure

3) Table DF3 : Capital adequacy

4) Table DF4 : Credit risk (including equities) generaldisclosures for all banks

5) Table DF5 : Credit Risk : Disclosures for portfolios

subject to the standardised approach

5) Table DF6 : Credit risk mitigation : disclosures for

standardised approaches



List of Prescribed Formats for Disclosures

7) Table DF7 : Securitisation : Disclosure for standardisedapproach

8) Table DF8 : Market risk in trading book : Disclosure for

banks using the standardised duration

approach

9) Table DF9 : Operational risk

10) Table DF10 : Interest rate risk in the banking book



L) Prescribed Formats for Disclosures

1) Table DF1 : Scope of Application

Qualitative : a) Name of the top bank in the group to which

Disclosures the framework applies

b) An outline of differences in the basis of

consolidation for accounting and regulatory

purposes with a brief description of the

entities* within the group that are: Fully consolidated (As-21 i.e. subsidiaries)

Prorata consolidated (As27-J.V) for

accounting

Given a deduction treatment

Neither consolidated nor deducted (eg.

where the investment is risk weighted).

______________________* securities, insurance and other financial subsidiaries, commercial subsidiaries,

significant minority equity investments in insurance, financial and commercial

entities.



Quantitative : c) Aggregate amount of capital deficiencies** in all

Disclosures subsidiaries not included in the consolidation that

are deducted and the names of such subsidiaries

d) The aggregate amounts (e.g. : current book value)

of the bankstotal interest in the insurance entities

which are risk weighted as well as their name,

their country of incorporation of residence, the

proportion of ownership interest and if different,the proportion of voting power in these entities. In

addition, indicate the quantitative impact on

regulatory capital of using this method versus

using the deduction.

_________________________** A capital deficiency is the amount by which actual capital is less than

the regulatory capital requirement. Any deficiencies which have been

deducted on a group level in addition to investment in such

subsidiaries are not to be included in the aggregate capital deficiency.



Prescribed Formats for Disclosures

2) Table DF2 : Capital Structure

Qualitative : a) Summary information on the terms and

conditions of the main features of capital

instruments and especially Tier I and

upper Tier II.

Quantitative: b) Total amount of Tier I Capital (of which)

Paid up share capital

Reserves

Innovative Instruments

(eg. : perpetual debt)

Other capital instruments

Deductions like goodwill, investments

in subsidiaries etc. from Tier I

P ib d F t f Di l




2) Table DF2 (contd.): Capital Structure

Quantitative: c) Total amount of Tier II capital

Net of deductions from Tier II

d) Debt capital instruments eligible for upper

Tier II

Total amount outstanding

Of which raised in current year

Amount eligible to be reckoned as capital

funds

e) Subordinate debt eligible for inclusion

in lower Tier II capital

Total amount outstanding

Of which raised during current year

Amount eligible to be reckoned as

capital funds

f) Other deductions from capital if any

g) Total Eligible Capital




3) Table DF3 : Capital Structure

Qualitative: a) A summary of discussion of banks

approach to assessing the adequacy of

its capital to support current and future

activities

Quantitative: b) Capital requirements for credit risk

Portfolios subject to standardised

approach

Securitisation exposures




3) Table DF3 (contd.) : Capital Structure

Quantitative: c) Capital requirements for Market Risk :

Standardised Duration Approach

Interest Rate Risk

FEX Risk including gold

Equity Risk

d) Capital requirement for Operational

Risk :

Basic Indicator Approach

e) Total and TierI Capital Ratio

For the top consolidated group

For significant bank subsidiaries (stand

alone or sub-consolidated depending on

how the framework is applied).




4) Table DF4 : Credit Risk : General disclosures for all

banks

Qualitative : a) The general qualitative disclosure

requirement with respect to credit risk,

including :

Definitions of past due and impaired (for

accounting purposes);

Discussion of the banks credit risk

management policy;




4) Table DF4 (contd.) : Credit Risk : General disclosures for all

banks

Quantitative : b) Total gross credit risk exposures1 ,

Fund based and non-fund based2,

separately.

c) Geographic distribution of exposures3,

Fund based and non-fund based

separately

Overseas

Domestic

1. That is outstanding, after accounting offsets in accordance with the applicable

accounting regime and without taking into account the effects of credit risk

mitigation techniques, eg. Collateral and netting.

2. At actuals, before application of CCFs.

3. That is, on the same basis as adopted for Segment Reporting adopted for

compliance with AS 17.





banks

Quantitative : d) Industry4 type distribution of

exposures, fund based and non-fund

based separately

e) Residual contractual maturity

breakdown of assets5,

4. The industry-wise break-up may be provided on the same lines as under DSB

returns at present. If the exposure to any particular industry is more than 5%of the gross credit exposure as computed under (b) above it should be

disclosed separately.

5. Banks shall use the same maturity bands as used for reporting positions in

the ALM returns.





banks

Quantitative : f) Amount of NPAs (Gross)

Substandard

Doubtful 1

Doubtful 2 Doubtful 3

Loss

g) Net NPAs

h) NPA Ratio

Gross NPAs to gross advances

Net NPAs to net advances





banks

Quantitative : i) Movement of NPAs (Gross)

Opening balance

Additions

Reductions Closing balance

j) Movement of provisions for NPAs

Opening balance Provisions made during the period

Write-off/write-back of excess

provisions

Closing balance





banks

Quantitative : k) Amount of Non-Performing Investments

l) Movement of provisions for depreciation

on investments

Opening balance

Provisions made during the period

Write-off/write-back of excess

provisions Closing balance




5) Table DF5 : Credit Risk : disclosures for portfolios


Qualitative : a) For portfolios under the standardised

approach

Names of credit rating agencies used,

plus reasons for any changes; Types of exposure for which each

agency is used; and

A description of the process used to

transfer public issue ratings onto

comparable assets in the bankingbook;




5) Table DF5 (contd.) : Credit Risk : disclosures for portfolios


Quantitative : b) For exposure amounts defined in DF4

after risk mitigation subject to the

standardised approach, amount of a

banks outstandings (rated and unrated)in the following major risk bucket, as well

as those that are deducted;

Below 100% risk weight

100% risk weight

More than 100% risk weight Deducted

P ib d F f Di l




6) Table DF6 : Credit Risk Mitigation : Disclosures for standardised

approaches1

Qualitative : a) The general qualitative disclosure requirement

with respect to credit risk mitigation including :

Policies and processes for collateral

valuation and management;

A description of the main types of collateraltaken by the bank;

The main types of guarantor counter-

party and their creditworthiness; and

Information about (market or credit) risk

concentrations within the mitigation taken_____________________

1. At a minimum, banks must give the disclosures below in relation to credit risk mitigation

that has been recognised for the purposes of reducing capital requirements under the

framework. Where relevant, banks are encouraged to give further information about

mitigants that have not been recognised for that purpose.


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6) Table DF6 (contd.) : Credit Risk Mitigation : Disclosures for

standardised approaches

Quantitative : b) For disclosed credit risk portfolio under

the standardised approach, the totalexposure that is covered by :

Eligible financial collateral after the

application of haircuts.



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7) Table DF7 : Securitisation : Disclosure for standardised

approach

Qualitative : a) General Qualitative Disclosure including

Disclosures discussion of :

The banks objectives in relation to

securitisation activity including the extent

to which these activities transfer credit riskof the underlying securitised exposures

away from the bank to other entities.

The roles played by the bank in the

securitisation process (i.e. as originator,

investor, servicer, provider of creditenhancement, liquidity provider, swap

provider) and an indication of the extent of

banks involvement in each of them.

The regulatory capital approach that the

bank follows for its securitisation activities.



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7) Table DF7 (contd.): Securitisation : Disclosure for standardised

approach

Qualitative b) Summary of the banks accounting

Disclosures (contd.): policies for securitisation activities

including :

Recognition of gain on sale

Key assumptions for valuing retained

interests including any significant

changes since the last reporting

period and the impact of such

changes

c) Names of ECAIs used for securitisation

and the types of securitisation exposure for

which each agency is used.


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approach

Quantitative d) The total outstanding exposures

Disclosures : securitised by the bank and subject to

the securitisation framework by

exposure type (eg. credit cards, home

equity, auto, etc.). Securitisation

transactions in which the originating

bank does not retain any securitisation

exposure should be shown separatelybut need only be reported for the year

of inception.


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approach

Quantitative e) For exposures securitised by the bank and

Disclosures : subject to the securitisation framework where

relevant, banks are encouraged to differentiate

between exposures resulting from activities inwhich they act only as sponsors, and

exposures that result from all other bank

securitisation activities that are subject to

securitisation framework.

Amount of impaired/past due assets securitised

Losses recognised by the bank during the

current period broken down by exposure type

(eg.: wirteoffs/provisions (if the assets remain on

the banks balance sheet or write-downs of 1/0

strips and other residual interests).



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approach

Quantitative f) Aggregate amount of securitisation exposures

Disclosures : retained or purchased (which include but are

not restricted to securities, liquidity facilities,

other commitments and credit enhancements

such as 1/0 strips, cash collateral amounts and

other subordinated assets) broken down by

exposure type.

g) Aggregate amount of securitisation exposures

retained or purchased broken down into meaningful

number of risk weight bands. Exposures that havebeen deducted entirely from TierI capital, credit

enhancing 1/0, deducted from total capital and

other exposures deducted from total capital should

be disclosed separately by type of underlying

exposure type.



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approach

Quantitative h) Summary of securitisation activity presenting

Disclosures : a comparative position for two years as part

of the notes on accounts to the balance sheet :

Total number and book value of loan assets

securitisedby type of underlying assets. Sale consideration received for the securitised

assets and gain/loss on sale on account of

securitisation.

Form and quantum (outstanding value) of

services provided by way of creditenhancement, liquidity support, post

securitisation asset servicing etc.


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8) Table DF8 : Market risk in trading book : disclosure for

banks using the standardised durationapproach.

Qualitative : a) The general qualitative disclosure

requirement for market risk including the

portfolios covered by the standardisedapproach.

Quantitative : b) The capital requirements for :

Interest rate risk;

Equity positionrisk;

Foreign exchange risk;


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9) Table DF9 : Operational Risk

Qualitative : In addition to the general qualitative

disclosure requirement, the approaches

for operational risk capital assessment

for which the bank qualifies.


(IRRBB)

Qualitative : a) The general qualitative requirement

Disclosures including the nature of IRRBB and key

assumptions, including assumptions

regarding loan prepayments and

behaviour of non-maturity deposits and

frequency of IRRBB measurement


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(IRRBB)

Quantitative : b) The increase or decline in earnings and

Disclosures economic value (or relevant measure

used by management) for upward and

downward rate shocks according tomanagementsmethod for measuring

IRRBB, broken down by currency

(where the turnover is more than 5% of

the total turnover).

Documents

Basel - II - Market Discipline (Third Pillar)