1. Basel 3 – A Practical Look
Rules of the Game – Three Distinct Areas of Regulation
Changing Dynamics: Bank of the Future
Association of Professional Bankers, 22nd November, 2017

2. Agenda Why were the Basel 3 regulations needed?
What does Basel 3 mean for Banks?
What are the most common challenges in implementing Basel 3?
How does Basel 3 impact capital planning for Banks?
21 November 2017

3. Why were the Basel 3 regulations needed?
15 January 2019
Presentation title

4. Evolution of Regulatory Capital Guidance A look across the changes across time
21 November 2017

5. Increasing Coverage of the Basel Guidance Regulatory capital by risk factor
21 November 2017

6. Basel 3 Objectives
21 November 2017

7. Basel 3 Objectives
21 November 2017

8. What does Basel 3 mean for Banks?
15 January 2019
Presentation title

9. The Basel 3 Framework A look at the key components
21 November 2017

10. The Basel 2 Framework How the components stacked up
Tier I Capital+ Tier II Capital
Capital Adequacy Ratio +
Tier I 5%
Tier II 5%
RWA( Credit Risk + Market Risk+ Operational Risk)
10%
21 November 2017

11. The Basel 3 Framework How the components now stack up
Tier I Capital (CET I+ AT I)+ Tier II Capital +CCB + DSIB
Tier I – 6%
Capital Adequacy Ratio
AT I 1.5%
CET I 4.5%
Tier II 4%
RWA( Credit Risk + Market Risk+ Operational Risk)
CCB
14%
2.5%
DSIB
1.5%
21 November 2017

12. The Basel 3 Framework The timelines for the staggered targets
Minimum Ratios %
Basel 2
Basel 3
Jul ’17
Jan ’18
Jan ‘19
Tier I Capital Requirement 5 6
Minimum Ratio of Total Capital 10
11.75
12.875
14.00
Capital Conservation Buffer
N/A
1.25
1.875
2.50
Capital surcharge for DSIB
0.50
1.000
1.50
Counter Cyclical Buffer
As and when required 0-2.5
21 November 2017

13. The Basel 3 Framework The key revisions
Under Basel II all claims on government of Sri Lanka were risk weighted at 0%, under Basel III CBSL has introduced 20% risk weightage for foreign claims on government of Sri Lanka from
LTV Ratio (%)
Risk Weight (%)
Less than or equal 70
Over 70 and below 100 20
Over 100
100
Further, CBSL has introduced the following risk weightages for gold backed lending based on the Loan To Value (LTV) ratio.
Criteria
Basel 2
Basel 3
Maximum Credit Exposure
<200 Mn
<250 Mn
Annual turn over
<600 Mn
<750 Mn
Qualifying criteria for SME exposure
Risk weight for SME Exposures
Basel % for all SME exposure
Basel % for SME exposure secured on immovable property.
75% for other SME exposure.
21 November 2017

14. What are the most common challenges in implementing Basel 3?
15 January 2019
Presentation title

15. Key Challenges A look at the main issues across five dimensions
Data
Missing data and poor data quality
Small sample size or lack of “bad” cases
Methodology
Lack of standard methodologies for model development
Common lack of trust in statistical methodology considering issues with quality data at many banks
Human Resource
Lack of personnel with sufficient knowledge and experience in model development
Lack of formally established model development / validation teams which are staffed with these specific objectives
21 November 2017

16. Key Challenges A look at the main issues across five dimensions
Senior management awareness and endorsement
Board of Directors
Incomplete appreciation of the benefits of risk quantification, and lacks orienting direction to the whole system.
Not assigned specific responsibilities to personnel
Senior Management:
Model deployment is time-consuming, which adversely impacts planned time
New models may detect high-risk customers, however, given that traditional criteria may be ignored, this may lead to challenges
Credit Analyst
Additional responsibilities in model usage and maintenance
Use Test
Credit team are concerned about asking customers for additional documents
Lack of continuous / on-going support, when there are issues faced in model usage
21 November 2017

17. How does Basel 3 impact capital planning for Banks?
15 January 2019
Presentation title

18. Basel Capital Planning Capital optimisation across risk types
Opportunity
Market Risk
Limited opportunity – VaR already perceived as low
Operational Risk
Limited opportunity – AMA models complex and whilst capital may be exaggerated, the cost benefit is not attractive
Credit risk
Lots of opportunity – many components of RW calculation, subjectivity in models, significant regulatory ambiguity, clear links with business processes, significant percentage of bank capital requirement...

19. Basel Capital Planning The denominator: Where do RWA figures come from?

20. Basel Capital Planning Optimising RWA on standardised portfolios
Missing ratings
Matching limits to exposures
CCFs – allocation to categories
Collateral – eligibility for recognition
Credit risk mitigation
Maturity calculations
Exposure classes
Retail / SME, central banks, government agencies
Use of short term ratings

21. Basel Capital Planning Optimising Probability of Default (PD) in IRB
Many choices / options in modelling PD
Definition of default
Defining data sample – use of external rating agency data
Segmentation
Calibration approach – PiT / TTC considerations, scalar methodology
Treatment of missing fields
Use of rating grade mappings and master scales
Obligor level or grade level feed into RWA calculator
Treatment of missing ratings

22. Basel Capital Planning Optimising Loss Given Default (LGD) in IRB
Many choice / options in modelling LGD
Typical components – haircuts, LTV, possession / liquidation roll-rates, time to liquidation, time to write-off, recovery rate...
Segmentation
Types of averaging – default weighted, exposure weighted, PD weighted etc.
Downturn methodology
Calibration of components or overall LGD – compounding conservatism
Severe outcome in benign period as a proxy for expected outcome in a downturn period –bad proxy

23. Thank you