1. While preparing for Basel II implementation...
20 października 2004 roku
Maciej Majewski
Partner
Deloitte & Touche Sp. z o.o.

2. What Credit Risk Officer should be aware of?
On 26 June 2004 the Basel Committee, after many consultations and analyses, presented the final version of the New Capital Accord.
It is aimed at maintaining the current level of the capital (Pillar I) in the system, with simultaneous consideration of:
The better approach to the evaluation of the credit risk (e.g. use of internal ratings-based methods);
The operational risk (NCA introduces capital requirements with respect to this risk);
Importance of the control exercised by the regulator (Pillar II) and provision of appropriate information on the risk management methods to external recipients (Pillar III).
The Committee has no formal power with respect to supervisions responsible for setting up local regulations but most of them (Group of Ten countries, EU countries, etc.) have already decided to implement Basel II. For implementation in the European Union, this will require a new Capital Adequacy Directive, CAD3 (starting December 2006), to overwrite the existing rules and to extend the scope of the new Basel regime to all credit institutions and investment firms.

3. Are you aware of a limited time left in order to meet Basel II implementation requirements?
The timetable for implementing the IRB approaches for credit and operational risk capital is tight given the amount of work that still needs to be undertaken:
At the end of 2005 Bank will have to start calculating capital requirement using IRB approach and current Accord
Credit risk
Transition1
Data set
with 5 years
of history (PD)
and IRB retail (PD/LGD/EAD)
Data set with
7 years of history
(PD,LGD, EAD)
– IRB advanced
non-retail
Use credit scoring (rating) system for 3 years before the transition process
Earliest date for
Foundation IRB
2 years of data required for IRB before entering transition period
Operational risk
2004
2005
2006
2007
2008
2009
2010
2011
2012
Transition
Key:
1. Transition: During the transition period the data requirements for the IRB and AMA approaches will be relaxed. This is conditional on banks making steady progress during this period.
PD – Probability of Default
LGD – Loss Given Default
EAD – Exposure at Default
Systems
in place and
operating for
Basic, Standard
and AMA
approaches
5 years of data required for AMA
3 years data required for
Advanced Measurement Approaches

4. Have you checked your compliance with Basel II requirements in the area of Credit Risk?
Does your segmentation and methodologies allow for proper risk identification?
Does your organizational structure reflect proper Credit Risk Management functions?
Have you introduced a default definition?
Do you perform PD/LGD/EAD/ estimations?
Are you able to satisfy the supervisor that your credit risk assessment model / procedure has a good predictive power and that regulatory capital requirements will not be distorted as a result of its use?
Do you have detailed review procedures to ensure your systems and controls are adequate to serve as the basis for the IRB approach?
Are you also aware that for the duration of non compliance, supervisors may require to hold additional capital under Pillar 2?
Compliance ü
Gap Analysis

5. Have you checked your compliance with Basel II requirements in the area of Operational Risk?
Gap Analysis
Compliance ü
Have you identified and defined operational risk in your organisation?
Have you developed operational risk management strategy and set up organizational structure that reflects proper Operational Risk Management functions?
Does your segmentation allow for proper identification of operational risk categories and can you map Bank’s business and gross income to business lines defined by Basel II?
Do you apply adequate risk quantification methods and management tools?
Do you have in place operational risk measurement system and capital calculator?
Have you ensured proper operational risk mitigation tool?
Have you implied operational risk limits and thresholds?

6. Are you able to evidence your compliance with the minimum standards in the following area?
Segmentation by asset classes
Independent credit
risk
control unit
Operating procedures
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Group approach/ business lines
Management oversight of the rating process
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
EAD, M calculation
Quantification techniques: KRI, scorecard, self-assessment
Basic indicator, standardised method,
AMA
Operational risk definition, segmentation, categories
Default definition
Responsibilities of parties that rate borrowers and facilities
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
PD estimations
Internal rating system
IT solutions supporting credit process
Capital calculation engine
Minimum number of borrower rating grades
Collateral
Management
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Haircuts
RAROC,
RORAC
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis
Gap Analysis

7. Do you realize the complexity in closing of any identified gap?
Does your Independent credit risk control unit cover the following responsibilities?
Testing and monitoring of credit assessment models in order to improve their performance; therefore, emphasis is to be placed on default cases which should be examined thoroughly before and after the event of default (in non-retail customers) The testing and monitoring will help detect the models’ weaknesses;
Preparation and analysis of summary reports from the Bank’s rating system which should include historical default data sorted by rating at the time of default and one year prior to default, grade migration analyses and the monitoring of trends in key rating criteria;
Implementing procedures which would verify whether the rating definitions are consistently applied across departments and geographic areas;
Reviewing and documenting any changes to the rating process, including the rationale for the changes;
Reviewing/documenting the rating criteria or individual rating parameters in order to evaluate whether they remain predictive of risk; and
Supervising any models used in the rating process.
Independent credit
risk
control unit

8. Are you aware of costs scale and structure related to Basel II requirements implementation?
A significant portion of outlays is assigned for investments related to credit risk Operational risk investments account for only 15%.
Operational risk
15%
Other costs 40%
IT costs 60%
Credit risk
85%

9. Do you realise what are your benefits from Basel II implementation?
Your capital level
is adequate to
the level of bared risk
well evaluated by
You are
external rating agencies
Shareholder
Value
You are recognized by
your customers
and investors
You manage your Bank
in accordance with
Best Practice
Your local and
international regulators
have appreciation for
your effort

10. We can help you!
Services for Banks related to the Basel II requirements:
Costs and benefits analysis of implementing various Basel II approaches.
Assessment of readiness for implementation of Pillar I requirements – for all approaches to credit risk operational risk and market risk.
Assessment of Pillar II and Pillar III compliance.
Assessment of data availability in information systems for selected approaches to credit, operational and market risks.
Development and implementation of strategy to close gaps in the area of credit, operational and market risk management.
Development and implementation of Basel II solutions: e.g. proper scoring/rating methodologies, calculation packs for PD, LGD and EAD, operation risk management tools - loss database, KRI (key risk indicators), process maps, risk maps, self-assessment processes.
IT systems for Basel II selection and implementation support.
Other services for Banks related to the Basel II:
Credit risk management organizational structure design.
Credit and collection processes reengineering.
Design of operational risk management organizational structure, including description of roles and responsibilities.
Development of operational risk management strategy.
Design and implementation of unexpected losses (economic capital) and expected losses calculations covering all risk types, i.e. credit, operational and market risk.
Design and implementation of the strategy/financial planning process based on RAROC and EVA concepts (including FTP and ABC methodologies).
Selection and implementation of IT infrastructure supporting calculation and reporting of risk-based profitability.

11. Member of
Deloitte Touche Tohmatsu
Deloitte & Touche Sp. z o.o.