1. Future of Credit Risk Management: Supervisory Approach to Basel II CIA Annual Meeting Session 4405 Ben Gully Director, Basel Implementation Division Office of the Superintendent of Financial Institutions June 29, 2005

2. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 2 Basel II General Overview OSFI Approach to IRB Implementation Key Issues

3. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 3 Basel I “One-size-fits-all” Market risk and credit risk Basel II Tailored approach to internationally active or significant banks Market, credit and operational risk (all 3 risks are “explicit” in regulatory capital charges) ‘Advanced’ approach to credit risk Supervisory Review Process Market discipline Moving from CP1 (1999) to Basel II implementation (2007) and beyond Consultative period Parallel reporting Implementation Transition period Implications Financial institutions Rating agencies Supervision Market discipline Basel II: Background

4. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 4 Basel II: Structure Bank internal capital assessment (vs. risk profile) Comprehensiveness and conservatism Internal controls Monitoring and reporting Board and management oversight Supervisory review and intervention Minimum capital level Credit risk (Internal Ratings Based Approaches and Standardized Approaches) Internal ratings External ratings Credit risk mitigation Operational risk Market risk Pillar I Minimum Capital Requirements Pillar II Supervisory Review Pillar III Market Discipline Disclosure requirements Risk profile Capital adequacy and structure Risk management practices Basel II Framework

5. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 5 Basel II: Pillar I – Minimum Capital Requirements

6. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 6 Basel II: Three Approaches for Credit Risk Similarity with Basel 1 Risk Sensitivity Increasing levels of risk-sensitivity Note: “Internal estimates” means banks’ own estimates *PD – Probability of Default; LGD – Loss Given Default; EAD – Exposure at Default

7. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 7 Basel II: IRB Minimum Requirements Risk Rating Systems’ Design and Operations Broad definition of RRS Two dimensional RRS: Borrower – PD, and Facility – LGD Rating philosophy Rating process - independence and replicability Data maintenance of all material and relevant risk drives of credit risk Stress testing and capital adequacy Corporate Governance and Oversight Board and senior management Internal audit Independence of Credit Risk Control Unit (CRCU)

8. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 8 Basel II: IRB Minimum Requirements, cont’d Use of RRS Use of internal estimates Track record of use Risk quantification – predicting credit risk metrics based on internal experience Probability of Default (PD) Long-run average of one-year default rates for borrowers in a given grade Loss Given Default (LGD) LGD and economic loss LGD reflects downturn conditions Use and retention of historical experience Exposure at Default (EAD) Expected gross exposure of facility upon default of the borrower Use and retention of historical experience Validation Integrity of validation process Broad approach to validation Quantitative validation tools

9. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 9 Basel II: Complexity of IRB Implementation IRB approach uses parameters of banks’ credit risk rating systems to drive regulatory capital “The term “rating system” comprises all of the methods, processes, controls, and data collection and IT systems that support the assessment of credit risk, the assessment of internal risk ratings, and the quantification of default and loss estimates.” Basel II Multiple aspects of implementation: Organization (risk management, corporate governance and oversight) Credit risk processes and procedures Data IT systems Business operations Capital planning

10. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 10 Basel II: Key Steps of IRB Implementation Organization (risk management, corporate governance and oversight) Credit risk processes and procedures Data IT systems Business operations Capital planning Gap Analysis Scope Assessment Implementation Project Plan Rollout Plan Implementation Use Test Self-Assessment Approval Ongoing Monitoring

11. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 11 Basel II General Overview OSFI Approach to IRB Implementation Key Issues

12. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 12 PhaseDescriptionTime Phase 1: Monitoring Banks’ Implementation Efforts Part A: Preliminary bank self-assessment against AIRB minimum requirements and associated project planning Part B: Rollout plan for AIRB implementation Nov. 2004 to Jan. 2006 Phase 2: Formal Application and Preparation for ‘Meaningful’ Parallel Reporting Year 1 of parallel reporting period Submission of approval package to OSFI Review of banks’ application packages Feb. 2006 to Oct. 2006 Phase 3: ‘Meaningful Parallel Reporting and Completion of OSFI Review for Approval Year 2 of parallel reporting period Completion of monitoring of capital reporting and any outstanding approval work Nov. 2006 to July 2007 Phase 4: Bank Approval for Pillar 1 Credit Risk Capital Purposes Two-step approval decision 1.Conditional approval 2.Reconfirmed and final approval July 2007 to Dec. 2007 Phase 5: Monitoring of Ongoing Compliance Post approval and ongoing complianceAfter Jan. 2008 OSFI Approach: Five Phases

13. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 13 Basel II General Overview OSFI Approach to IRB Implementation Discussion Points

14. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 14 IRB Implementation: Discussion Points Overall Implementation Enterprise-wide implementation - business management, risk management, IT, internal audit, finance, etc. Implementation on a consolidated basis – all legal entities, asset exposures and jurisdictions Resource management Timelines Self-assessment Project Management Office Coordination of multiple stakeholders - business management, risk management, finance, IT, etc. Budget and resource planning Change management – internal and external stakeholders

15. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 15 IRB Implementation: Discussion Points, cont’d Corporate Governance and Oversight Role of internal audit Role of board and senior management and associated training Independence Reporting Cross-border Implementation: “Home/ Host” and “Host/ Home” Implementation across multiple jurisdictions Coordination of approval and ongoing supervision Materiality Information sharing

16. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 16 IRB Implementation: Discussion Points, cont’d Corporate and Retail Risk Rating Systems RRS metrics Rating philosophy – definition, documentation and operationalization Validation framework Use test Risk mitigation IT Identification of supporting architecture System integration and system updates Data marts and data migration Capital computation and management Data IRB data requirements – quality and quantity Historical retention of loss experience and data availability Risk quantification Reconciliation Data management framework

17. CIA Annual Meeting Session 4405 LOOKING BACK…focused on the future Page 17 Questions