Basel II -RBI Guidelines

8/21/2019 Basel II -RBI Guidelines

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Basel II- RBI Guidelines

Usha Janakiraman

NIBM Pune


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Scope of application

All commercial banks ( except LAB and RRBs)

Both at solo ( global position ) and at consolidated level

Consolidated bank is defined as a group of entities where a

licensed bank is the controlling entity

Consolidated bank includes all group entities under its control

except entities engaged in:

Insurance business

Business not pertaining to financial services

Consolidated bank to maintain minimum capital adequacy ratio

as applicable to solo bank on ongoing basis


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Capital Funds

Minimum 9% CAR to be maintained on an ongoing basis

Role of Pillar 2 to be critical:

RBI to take into account internal capital adequacy assessments

of individual banks to ensure adequacy of capital

commensurate with risk profile

Banks to effectively manage other risks interest rate risk inbanking book, liquidity risk, concentration risk and residual risk

Higher than minimum capital ratio for individual banks can be

prescribed by RBI if warranted by individual risk profiles and

risk management

Banks expected to operate at a level above the minimum

requirement


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Capital Funds

On implementation of Basel

II, minimum capital shall be

subjected to a prudentialfloor

Adequacy & need for

capital floors to be

reviewed periodically

Prudential Floor

Minimum capital as per

Basel II

Specified

percent

of minimum capital as

per Basel I ( credit & market)

as below

March 2008/09

100%

March 2009/10

90%

March 2010/11

80%


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Capital Funds

Banks encouraged to maintain Tier 1 CAR of at least

6% both at solo and consolidated level; banks below

this must attain this by March 2010

Capital Funds= Tier I + Tier II

CAR= Capital Funds/ Credit Risk RWA+ Market Risk RWA+Op Risk RWA


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Capital Charge for Credit Risk-StandardisedApproach

All commercial banks in India to adopt StandardisedApproach (SA) for credit risk

Under SA, rating assigned by eligible external creditrating agencies will largely support the measure of

credit risk

Exposures to be risk weighted net of specific

provisions Exposures not explicitly addressed to retain current

treatment


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Standardised Approach-RBI Guidelines

Off-

Balance

Sheet

Other Assets

Specified

Higher RiskCategories

NPAs

CommercialReal Estate

Residential

Property Regulatory

Retail

Corporates

PDs

Banks

MDBs, BIS &

IMF

PSEs

ForeignSovereigns

Domestic

Sovereigns

SA


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Standardised Approach-RBI

Guidelines- Domestic Sovereigns

Claims on central government( FB & NFB): 0% RW

Central government guaranteed claims: 0% RW Investment in state government securities: 0% RW

State government guaranteed claims: 20% RW

Others:

Claims on RBI, DICGC, CGTSI: 0% RW

Claims on ECGC: 20% RW

Above risk weights apply only for standard performing loans;otherwise risk weights as applicable to NPAs will apply


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Guidelines- Foreign Sovereigns

Risk weights

as per rating

assigned to the

sovereigns/sovereign claims

by rating

agencies

S&P/Fitch AAA

To

AA

A BB

B

BB to

B

< B Unrated

Moodys Aaa

To

Aa

A Ba

a

Ba to

B


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Standardised Approach-RBI:

Public sector entities

Domestic PSEs: Risk weighted in the same manner as

corporates

Foreign PSEs: Risk weighted as per rating assigned byinternational rating agencies:

S&P/FITCH AAA to

AA

A BBB


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Claims on BIS , IMF & eligible MDBs

Similar to claims on scheduled banks

Uniform risk weight of 20%


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Standardised Approach-RBI: Claims on

Banks:

Banks incorporated in India & foreign bank branches in India Excludes investment in equity shares and other instruments eligible for capital

status

Claims on scheduled banks complying with minimum CAR & RRBs-20% RW Claims on non-scheduled banks complying with minimum CAR-100% RW

Claims on banks not complying with minimum CAR : ( includes equity & otherinstruments eligible for capital status )

CAR (%)As on d ate of last fu l l audit*

Scheduled Banks RW Non-scheduled banks

RW

6 to < 9 50% 150%

3 to < 6 100% 250%

0 to < 3 150% 350%

negative 625% 625%* Fresh subs equent capital ra ised can be reckoned


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Standardised Approach-RBI: Claims

on Banks:

Foreign banksAs per the ratings assigned by international rating agencies

Claims on a bank in domestic foreign currency met out of resources in the same currency

raised in that jur isdict ion w il l be risk w eighted at 20% prov ided the bank meets the prescr ibed

min imum CAR of that coun try; i f host supervisor requires a more conservat ive treatmentfor suc h cla ims in the boo ks of foreign branch es of Indian banks, that should p revai l .

S&P/FITC

H

AAA to

AA

A BBB BB to B


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Standardised Approach-RBI: Claimson Primary Dealers:

Shall be risk weighted in a manner

similar to corporates


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Standardised Approach-RBI: Claimson Corporates:

Corporates:

Shall include all exposures (FB & NFB) other than

those qualifying for inclusion under sovereign; bank;

regulatory retail; residential mortgage; non-performing

assets & specified category all of which are separately

addressed


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Standardised Approach-RBI: Claimson Corporates:

To be risk weighted as per the rating agencies

registered with SEBI and chosen by RBI

Risk weights for long term & short term claims on

corporates specified under the guidelines: 20%; 30%;

50%;100%; 150%. Unrated claims upto threshold level:

100%


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Standardised Approach-RBI: Claimson Corporates: UNRATED CLAIMS

No claim on unrated corporate to given a risk weight preferentialto that assigned to the sovereign of incorporation

RBI may increase the standard risk weights for unrated wherewarranted by overall default experienceUnder Pillar 2, RBI would consider whether unrated corporateclaims of individual banks warrant a standard RW higher than100%

Thresholds* for 150% RW for unrated exposures to corporates: For F.Y. 2008-09: all fresh sanctions/renewals of unrated

corporates >Rs. 50 crore will have a RW of 150% From April 1, 2009: all fresh sanctions/renewals of unrated

corporates > Rs. 10 crore will have a RW of 150%Thresho ld ( Rs. 50/Rs. 10 crore) with r eference to aggregate exposu reon a singlecoun terparty for bank as a whole


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Standardised Approach-RBI: Claimson Corporates: UNRATED CLAIMS

Unrated standard restructured loans to corporates to

be assigned a higher RW of 125% until satisfactory

performance under the revised payment schedule forone year from the due date of payment of first interest

/principal under the revised schedule.

St d di d A h RBI G id li


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Standardised Approach-RBI Guidelines:RATED CORPORATES

Domestic credit rating agencies identified by RBI:

Credit Analysis and Research Limited (CARE)

CRISIL Limited

FITCH India

ICRA Limited

International credit rating agencies identified by RBI:

FITCH

Moodys

Standard & Poors


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Standardised Approach-RBI Guidelines: Scope of External Ratings

Banks to choose the rating agencies

Banks to use chosen credit rating agencies ratings consistently

for each type of claim-for risk weighting & risk management

purposes No cherry pickingassessments of different rating agencies-

picking the most favourable rating

Banks to disclose the names of rating agencies proposed to be

used for risk weighting assets by type of claim


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How to avoid inconsistency and cherry picking?

Nominate one or more rating agencies whose ratings will be used by

the bank for deriving risk weights for exposures in each of the external ratings-based portfolios- bank to take into account whether the

nominated rating agency can provide reasonable coverage on banks exposureswithin portfolios in terms of types of counterparties, and geographical regions

Formalise /document the above and obtain Board /Top Management approval forapplication of external rating agencies to each of the banks external-ratingbased portfolios

Use the ratings of the nominated rating agencies within each of the externalrating-based portfolios consistently; seek approval of Board/Top Management forany subsequent changes

If bank has exposure to a person and the exposure or the person does not havea rating assigned by the agency chosen by the bank, treat the exposure or theperson as unrated for risk weighting purposes

Unless exposures are rated by only one of the nominated credit rating agencies,do not use one agencys rating for one corporate bond and another agency foranother exposure to the same customer


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Other issues:

A rating for one entity within a group cannot be used to risk

weight other entities in the group

To be eligible, rating has to be in force; confirmed from the

monthly bulletin of the rating agency Rating agency to have reviewed the rating at least once in the last

15 months

The credit assessment to be publicly available; to be included in

the rating agencys transaction matrix.

Assets with contractual maturity of less than or equal to one

year- short term ratings accorded by rating agencies relevant.

Cash credits-to be reckoned as long-term exposures and long

term ratings accorded by rating agencies relevant


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Standardised Approach-RBI Guidelines: External Ratings

LONG TERM RATINGS: ( MAPPED BY RBI TO THE RISK

WEIGHTS UNDER THE STANDARDISED APPROACH)

Longterm Ratings SA Risk

Weights

AAA 20%

AA 30%

A 50%

BBB 100%

BB & Below 150%

Unrated 100%*

If issuer has an external long term/short term rating warranting a RW of 150%, all unrated claims (ST & LT)

shall receive 150% RW ( unless recognised CRM are available)


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SHORT TERM RATINGS

Issue-specific ; can be used only for the rated facility; ST ratingcannot be generalised for other ST exposures

Cannot be applied to unrated long-term claim in any case

Can be used for short-term claims against banks and

corporates Points to be noted:

Unrated ST claim on borrower to attract RW at least one level higher

then rated ST claim on same borrower

Unrated claims, ST or LT on a borrower shall receive 150% RW , if the

borrower/issuer has a ST exposure with an external ST rating

warranting a RW of 150%, unless recognised CRM techniques are

available


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Standardised Approach-RBI Guidelines: External

Ratings

SHORT TERM

RATINGS: (

MAPPED BY RBI

TO THE RISK

WEIGHTS UNDER

THE

STANDARDISED

APPROACH)

Shortterm Ratings SA Risk

Weights

PR1+,P1+,F1+,A1+ 20%

PR1,P1,F1,A1 30%

PR2, P2,F2,A2 50%

PR3, P3, F3, A3 100%PR4&PR5;P4& P5;B, C, &D;

A4& A5150%

CARE, CRISIL, FITCH & ICRA

RW mapping of both LT & ST of these rating agencies to be reviewed annually by RBI


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Exposures/Borrowers with multiple rating assessments

If one rating available: use the rating to determine the RW

If two different ratings available: apply higher RW If three or more ratings available: apply the second lowest RW


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Applicability of issue specific rating to issuer/other claims or issues

Specific issue rating ( mapping into a lower RW) can apply to

the banks unrated claim :

Unrated claim ranks paripassu or senior Maturity of unrated claim is not later than the maturity of above

( not applicable to rated short term issues)

Issuer/Issue Rating maps to a risk weight =/> unrated

claims, then the unrated claim will also have the same risk

weight unless it is senior to rated claim


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Use of unsolicited ratings

What is a solicited rating?

Issuer has requested rating agency for the rating and has acceptedthe rating assigned

Banks to use only solicited ratings from chosen agencies

Unsolicited ratings not to be considered for RW calculation

under SA


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Standardised Approach-RBI: Claimson Corporates: Non-resident

corporates

Non-resident corporates: Risk weighted as per the ratings assigned by

international rating agencies approved by RBI:

*Unrated exposures could carry higher risk weight of 150%. Thresholds* for 150% RW for unrated

exposures to corporates:

For F.Y. 2008-09: all fresh sanctions/renewals of unrated corporates >Rs. 50 crore will have a

RW of 150%

From April 1, 2009: all fresh sanctions/renewals of unrated corporates > Rs. 10 crore will have

a RW of 150%

Threshold ( Rs. 50/Rs. 10 crore) with reference to aggregate expos ure on a s ingle co unterparty fo r bank as a

whole

S&P/FITCH AAA toAA

A BBB


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Standardised Approach-RBI: RegulatoryRetail Portfolios

To qualify as retail claims for regulatory capital

purposes, exposures (FB & NFB) to meet all four

criteria:

Orientation criteria

Product criterion

Granularity criterion

Low value of individual exposures

Standardised Approach-RBI: Regulatory


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Orientation criteria

Exposure is to an individual person or persons or to

small business Person as above would mean any legal person ( individ ual, HUF,partnership, f i rm, trust , pr ivate l imited com panies, publ ic l imited com panies,

coo perative soc iet ies, etc.)

Small business is one where the total average annual turnover is < Rs. 50 crore:

Existing entities: average of the last 3 years

New entities: Projected turnover

Entities yet to complete three years: Both Actual & Projected



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Product criteria

Exposure takes the form of : Revolving credits

Lines of credits

Overdrafts

Term Loans ( installment loans, student loans)

Small business facilities & commitments



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Granularity criteria

Exposure is sufficiently diversified : Aggregate exposure to one counterpart not to exceed 0.2% of the

overall regulatory retail portfolio

Aggregate exposure: Gross Amount ( excluding CRM)

One counterpart: one or several entities which can be considered as a

single beneficiary; banks can use group exposure concept

NPAs under retail loans to be excluded from the overall RR portfolio when

assessing granularity criterion



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Individual exposure criteria

Maximum aggregated exposureto one counterpart

not to exceed Rs. 5 crore Exposure means sanctioned limit or actual outstanding,

whichever is higher , for all FB & NFB, including Off-

Balance Sheet exposures

For Term Loans- exposure shall mean actual outstanding



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RBI to play a crucial role under Pillar 2 in respect of

risks in the RR portfolio of individual banksIf warranted, may mandate a RW higher than 75% for

individual banks

Standardised Approach-RBI: Claims secured


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Standardised Approach-RBI: Claims securedby residential property

Loans to individuals for acquiring residential property fully

secured by mortgages on residential property that is/will be

occupied by borrower, or rented

Shall be Risk Weighted as below:

Amount of loan upto Rs. 20 lakh -50%

Amount of loan Rs. 20 lakh & > -75%

Subject to:

Loan to Value rat io is no t mo re than 75%

Board approved valuat ion pol icy

LTV: Total o/s in acco unt: (Pr inc ipal + Acc rued interest+ other

charges )/ Realisable value of pro perty mortg aged

All other claims secured by residential property would attract :

RW applicable to counterparty or to the purpose for which bank

has extended finance, whichever is higher.

Standardised Approach-RBI: Claims secured


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Standardised Approach RBI: Claims securedby commercial real estate

Exposures ( FB & NFB) secured by mortgages on

commercial real estate: office buildings, retail space;

multi-purpose commercial premises; multi-familyresidential buildings; multi-tenanted commercial

premises; industrial or warehouse space; hotels; land

acquisition; development and construction, etc.Also

includes exposures to entities for setting up SEZs or foracquiring units in SEZs which includes real estate

Such exposures to attract RW of 150%

Standardised Approach-RBI: Non-Performing


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Standardised Approach RBI: Non PerformingAssets

NPA ( other than a qual i fy ing RM addressed separately)willcarry RW as below:

Unsecured Portion, net of specific provisions & partial write-offs:

150% RW: Specific Provisions


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Standardised Approach RBI: Non PerformingAssets

Additionally,

RW 100% may apply , when provisions reach 15% of

outstanding amount if NPA is secured fully by the

following collateral ( not eligible CRM) either alone or with

other eligible collateral:

Land & Building ( valuation not more than 3 years old)

Plant & Machinery ( value not higher then depreciated value

reflected in the audited balance sheet of the borrower, not

more than eighteen months)

Clear title available; well documented

Claims secured by residential property:

RW 100% net of specific provisions

If specific provisions are >/= 20% but /=50%, RW: 50%

Standardised Approach-RBI: Specified


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Standardised Approach RBI: Specifiedcategories

High risk exposures:

Consumer credit-personal loans & credit cardreceivables :

RW of 125% More , if warranted by external rating of the counterparty

Loans u pto Rs. 1 lakh against go ld & si lver ornaments :con cession al RW of 50%

Capital market exposures & claims on non-deposit

taking systemically important NBFCs: RW of 125% More , if warranted by external rating of

the counterpartySystemically Important NBFCs-ND: a non-deposit taking NBFC with anasset size of Rs. 100 crore or more as per the latest audited balance

sheet

Standardised Approach-RBI: Specified


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Standardised Approach RBI: Specifiedcategories

High risk exposures: Contd

Investments in paid-up equity of non-financial entities not

consolidated for capital purposes to attract 125% RW

Investment up to 30% in paid up equity of financial entities not

consolidated for capital purposes: RW: 125% or RW warranted byexternal rating) or as determined in Para 5.6 whichever is >

Investment in paid up equity of financial entities specifically

exempt from capital market exposure: RW 100%

Investment in IPDI (eligibel Tier 1), Debt capital instruments

(eligible Tier II ) of other banks/FIs to attract RW as per ratings

assigned to the instruments or RW warranted by external rating of

counterparty ( or lack of it) or as determined in para 5.6, whichever

is >.


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Standardised Approach-RBI: Other Assets

Loans & Advances to banks own staff fully covered by

superannuation benefits/ mortgage of flat/house: RW

20%

Other loans & advances to bank staff: eligible for

inclusion under RR : RW 75%

All other assets: RW 100%

Standardised Approach-RBI: Off-balance


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Standardised Approach RBI: Off balancesheet items

Total RW OffBalance Sheet Credit Exposure:

RW amount of market related + RW amount of non-

market related Off-balance sheet itemsRisk Weighted amount of credit exposure of off-balancesheet item is calculated as below:

Calculate Credit Equivalent Amount: (CEA)

Notional amount * specified CCF OR by applying the

Current Exposure Method Multiply CEA by RW applicable to counterparty/purpose of

finance/type of asset, whichever is higher

If item is secured by eligible collateral or guarantee,credit risk mitigation can be applied.


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Standardised Approach-RBI: Off-balancesheet items : Non-market related

Broadly categorised into direct credit substitutes , trade &performance related contingent items & other commitments,Multiply contracted amount by relevant CCF

If item is an undrawn or partially drawn facility, amount ofundrawn commitment to be included in the above category is:maximum unused portion of commitment that could be drawnduring the remaining period to maturity; Drawn portion would beon-balance sheet credit exposure

Irrevocable commitments: original maturity would be from thecommencement of commitment until the time the associatedfacility expires. Irrevocable commitments to provide off-balancesheet facilities should be assigned the lower of the two applicableCCFs


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CCFs range from 0 to 100%

CCF: 100%in respect of the following instruments:

Direct credit substitutes: risk of loss depends on creditworthiness ofcounterparty or the party against whom a potential claim is acquired e.g.financial guarantees, credit enhancements, liquidity facilities forsecuritisation transactions & acceptances-CCF 100%

Sale & repurchase agreement and asset sales with recourse where creditrisk remains with the bank : risk weighted according to tyoe of asset andnot the type of counterparty

Forward asset purchases, forward deposits, partly paid shares 7 securities:represent commitments with certain drawdown: risk weighted according totype of asset & not type of counterparty-CCF 100%

Lending of banks securities/posting of securities as collateral by banks,including repo style transactions ( repurchase/reverse repurchase andsecurities lending/borrowing transactions)

Commitments with certain drawdown

Unconditional take-out finance in the books of taking-over institution


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CCF: 50 %in respect of the following instruments:

Transaction-related contingent items: performance bonds, bid

bonds, warranties, indemnities and standby L/Cs related to

particular transaction

Note issuance facilities and revolving underwriting facilities

Other commitemnts ( e.g. formal standby facilities and credit lines )

with original maturity of over one year. Conditional take-out finance in the books of taking-over institution


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Trade letters of credit arising from movement of goods for both

issuing bank and confirming banks-short term and self liquidating:

e.g. documentary credits collaterised by underlying shipment

Other commitments (e.g. formal standby facilities and credit lines )

with an original maturity of upto one year


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Other commitments ( eg. Formal standby facilities and credit lines)

which are unconditionally cancellable at any time by banks:

without prior notice or

Effectively provide for automatic cancellation due to deterioration in

credit worthiness of borrower


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Standardised Approach-RBI: Off-balance sheet items : Market related

Examples of market related off-balance sheet items:

Interest rate contracts-single currency interest rate swaps,

basis swaps, FRAs, interest rate futures Foreign exchange contracts- cross currency swaps, forward

forex contracts, currency futures & options

Any other market related contracts allowed by RBI giving

rise to credit risk

Bank to include all market-related transactions held in bankingand trading book which give rise to off-balance sheet credit risk

Credit risk in such items is the cost of replacing the cash flow

specified by the contract in the event of default of the counterparty.

Factors responsible: maturity of contract, volatility of rates

underlying the type of instrument etc.


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Standardised Approach-RBI: Off-balance sheet items : Market related

Exemptions from capital requirements:

Forex ( except gold) contracts having an originalmaturity of


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Standardised Approach-RBI: Off-

balance sheet items : Market related

Current Exposure Method

Current Credit Exposure (CCE) + Potential Future Credit Exposure (PFCE) CCE: Sum of positive mark-to-market value of these contracts

PFCE: Notional Principal amount of each of these contracts ( whether +ve, -ve or 0M-T-M)* Add-on Factor prescribed:

Residual

Maturity

Add-on

Factor:

interest rate

contract

Add-on

Factor: Gold

& Exchange

rate contract

1 year 5 years 1.5% 7.5%

an ar se pproac - : re sMi i i


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ppMitigation

Wider range of credit risk mitigants

recognised

Applicable to banking book exposures and

also for calculation of the counterparty riskcharges for OTC and repo-style transactions

in the trading book.

an ar se pproac - : re sMiti ti


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ppMitigation

Some general principles for use of CRM

Effects of CRM will not be double counted.

Principal only ratings not allowed within CRM .

Disclosure requirements to be observed. Policies & procedures for collateral valuation &

management

Description of main types of collateral taken by the bank

Main types of guarantor counterparty and their credit

worthiness Information about concentrations within the mitigation

taken

Minimum standards for legal documentation to bemet.



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ppMitigation

What is a collateralised transaction?

Bank has a credit exposure that is

hedged by collateral posted by the

counterparty ( to whom bank has a

credit exposure-on or off-balance

sheet) or a third person on his behalf.

Bank has a specific lien on the

collateral

Requirements of legal certainty are met



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ppMitigation

Framework

Simple Approach: risk weight of the

collateral substituted for the risk weight

of the counterparty for the collateralised

portion-similar to 1988 Accord

Comprehensive Approach: allows fuller

offset of collateral against exposures



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ppMitigation

Some minimum conditions

Only eligible financial collateral

Allowed only on account-by-account basis , even

within regulatory retail portfolio Credit quality of counterparty and value of collateral

not to have a material positive correlation

Clear and robust procedures for timely liquidation ofcollateral

If held by custodian, bank to ensure segregation ofassets

Capital requirement to be applied to bank on eitherside of the collateralised transaction



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ppMitigation

Eligible financial collateral

Cash, certificate of deposits or instruments issued by lending bank ondeposit with the bank

Gold: (Bullion & jewellery): value of collateralised jewellery to bearrived at after notionally converting to 99.99 purity.

Central & State Government Securities

KVP & NSC: no lock-in-period and can be encashed within the holdingperiod

Life Insurance Policy with a declared surrender value

Debt securities rated ( subject to certain conditions)-next slide

Debt securities not rated, where issued by a bank( subject to certainconditions)-next slide

Listed equities-including convertible bonds ( listed on a recognisedstock exchange ans included in the BSE-SENSEX & BSE 200 of BSE;S& P CNX NIFTY and Junior NIFTY of NSE and tha main index of anyother recognised stock exchange, in the jurisdiction of banksoperation)

Mutual Fund investments regulated by securities regulator (price forthe units is publicly quoted daily i.e., where the daily NAV is available

in public domain; and the mutual fund is limited to investing in theeligible instruments,.i.e. investments listed in eligible financial



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ppMitigation

Eligible financial collateral

Debt securities rated by a chosen credit rating agencyandsufficiently liquid attracting 100% or lesser risk weight: at least BBB (-) or

at least PR3/P3/F3/A3 for short-term debt instruments

Debt securities not rated by a chosen Credit RatingAgency and sufficiently liquid where these are:

issued by a bank; andlisted on a recognised exchange; and

classified as senior debt; and all rated issues of the sameseniority by the issuing bank that are rated at least BBB(-) orPR3/P3/F3/A3 by a chosenCredit Rating Agency; andthe bankholding the securities as collateral has no information to suggestthat the issue justifies a rating below BBB(-) or PR3/P3/F3/A3and;there is sufficient confidence about the market liquidity ofthe security

an ar se pproac -C dit Ri k Miti ti


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ppCredit Risk Mitigation

Comprehensive approach

Application of haircuts to exposure and collateral: haircut forexposure will be a premium and for the collateral will be adiscount

Additional downward adjustment for the collateral if exposureand collateral held in different currencies

Calculation of capital for a collateralised transaction:E* = max {0, [E x (1 + He) - C x (1 - Hc - Hfx)]}

where:

E*= the exposure value after risk mitigation

E = current value of the exposure

He= haircut appropriate to the exposureC= the current value of the collateral received

Hc= haircut appropriate to the collateral

Hfx= haircut appropriate for currency mismatch between the collateral andexposure

The exposure amount after risk mitigation will be multiplied by the risk weight ofthe counterparty to obtain the risk-weighted asset amount for thecollateralised transaction.



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Mitigation

Comprehensive approach: Haircuts

Standard Supervisory Haircuts:

Parameters set out in the Accord

Own-estimate Hair cuts: Banks own

internal estimates of market price

volatility

Banks in India to use only the former for

both exposure and collateral

an ar se pproac - : re sMitigation


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Mitigation

Comprehensive approach: Standard

Supervisory Haircuts:

Assumptions:

Daily mark-to-market

Daily re-margining 10 business day

holding period ( time normally

required for realising the collateral value)

Unrated bank exposures or bank lends

non-eligible instruments, eg.NI grade corp

sec, haircut on exposure to be same as forequity traded on recognised SE not part

of main index,i.e 25%

Standardised Approach-RBI: Credit RiskMiti ti


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Mitigation

Comprehensive approach: Standard Supervisory Haircuts:

Prescribed haircuts would apply to security w.r.t rating of theissuer and to exposure w.r.t rating of the counterparty

Exposure/Eligible unrated securities issued by Central or StateGovernments: same as AAA debt

Sovereign to include RBI, DICGC, CGTSI

Haircut will be determined by: Maturity of exposure

External rating assigned to exposure

Counterparty category

NSC, KVP, SV of LIP, Banks own deposits as collateral: 0haircut

HC for currency risk: 8% ( daily m-t-m & 10business dayholding period)

Standardised Approach-RBI: Credit RiskMiti ti


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Mitigation

Comprehensive approach: Standard Supervisory

Haircuts: contd

If collateral is a basket of assets, haircut on basket:

where ai= weight of the asset ( measured by units of currency)

& hi= haircut applicable to that asset

Standardised Approach-RBI: Credit Risk Mitigation:Haircuts contd


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Haircuts contd

10-business day haircuts to be the basis ; haircut to be scaled up or

down depending on:

Type of transaction

Frequency of remargining or revaluation

Formula:

H=haircut

H10=10 business day standard sup ervisory haircut for in strum ent

NR= actual no. of bus iness days b etween remargin ing fo r capita l

market transact ions or revaluat ion for secured transact ions

TM= minim um ho lding period for the type of transact ion

( adjust ing for di f ferences in h old ing per iod and

revaluat ion frequency)

Standardised Approach-RBI: Credit Risk Mitigation:


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On-balance sheet netting

Confined to loans/advances and deposits, where : Netting arrangements are legally enforceable: specific lien;

proof of documentation Capital requirements can be calculated on basis of net credit

exposures subject to:

Well-founded legal basis for netting/offsetting regardless ofbankruptcy/insolvency of counterparty

Able to determine at any time loans/advances & depositswith the same counterparty subject to netting

Relevant exposures monitored and controlled on net basis

Same formula as earlier; loans & advances would beexposure and deposits would be collateral; haircuts will be0 except for currency mismatch. Other conditions apply.

Standardised Approach-RBI: Credit Risk Mitigation:d


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Guarantees

Direct, explicit, irrevocable & unconditional can be treated ascredit protection

Whose guarantees are recognised? Entities with lower risk weight than counterparty

Sovereigns, sovereign entities( BIS, IMF, European central banks,MDBs, ECGC & CGTSI), banks & PDs with lower risk weight

Other entities rated AA (-) or better. Includes guarantee of parent,subsidiary & affiliate companies having a lower risk weight

Guarantor rating should be an entity rating: factoring all liabilities &

commitments of the entity Substitution approach-same as 1988 Accord; protected portion

of the counterparty exposure : RW of guarantor; uncoveredportion: risk weight of underlying counterparty:

Exposures covered by state government guarantees to attract a riskweight of 20%

If credit protection is denominated in a different currency, amount of

exposure deemed to be protected to be reduced by application of ahaircut Hfx: 8%

Standardised Approach-RBI: Credit Risk Mitigation:td


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Guarantees: Operational requirements

Must represent a direct claim on protection provider

Explicitly referenced to specific exposures or pool of exposures:

extent of cover clearly defined Irrevocable: no clause for unilateral cancellation of cover of for

increase in effective cost of cover on deterioration of creditquality of guaranteed exposure

Unconditional: no clause that could prevent the guarantor formobligation to pay in a timely manner in the event of

counterparty's default When exposure is classified as non-performing: guarantee shall

cease to be a credit risk mitigant

Explicitly documented

Guarantee to cover all types of payments governing thetransaction: notional amount, margin payments, etc. If

guarantee covers principal only, interests and uncoveredpayments to be treated as unsecured amount



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Collaterals: Maturity Mismatch

When residual maturity (RM) of collateral < RM of underlying exposure

Conservative definition of maturity of both exposure & collateral:

Exposure maturity: longest possible remaining time beforeobligation is scheduled to be fulfilled, including grace period

Collateral maturity: shortest possible taking into accountembedded options which may reduce its term

Maturity relevant is residual maturity

When is CRM not recognised, when mismatch exists?

If there is a maturity mismatch & CRM has an original maturity


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Collaterals: Maturity Mismatch

Adjustment to be applied for maturity mismatch with recognisedCRM ( collateral , on-balance sheet netting & guarantees):



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Collaterals: Treatment of pools of CRM:

Multiple collaterals covering a single exposure

Subdivide the exposure into portions covered by each CRM

RW assets of each portion to be calculated separately If credit protection of a single provider has different maturities,

subdivision into separate protection required.

Documents

Basel II -RBI Guidelines