B M MITTAL

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B.M.Mittal

Chief General ManagerPunjab National Bank

Head Office, New Delhi

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Overview of the Presentation

Assessment of Industrys readiness Survey by KPMG

Opportunities, Concerns and Challenges

What needs to be done to ensure effective implementation and

within the RBI time frame Action Points for effective

Implementation

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India: Ready for Basel II A Survey

Coverage of the Survey

Total 32 banks

9 public sector banks

6 new private sector banks

12 old private sector banks 5 foreign banks

Total Banking Assets:

61%

Total Profit (after tax):

68%

Key Aspects in the questionnaire

The Drivers Techonological readiness

The Project plan Resource Planning

Perceived benefits and challenges

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India: Ready for Basel II -- Survey Findings

Cricital Drivers for Basel II

Implementation

%age of

respondents

Compliance with regulation 46%

Enterprise risk management 32%

Internal commitment 17%

Perceived change in operational risk 5%

Reaction to external events 0%

Key Drivers

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Other Findings:

16% of the banks surveyed have commenced the process of

planning for the more advanced approaches of Basel II,

including collection of loss data, risk mitigation techniques and

capital modelling.

Compliance with regulation is driving the Basel IIimplementation programme in 46% of the banks surveyed.

New private sector banks ranked enterprise risk management

over compliance as their key driver.

89% of the banks surveyed indicated that they have adedicated team responsible for Basel II implementation.

However, very few banks have established the position of Chief

Risk Officer with a reporting line to the CEO/Board and whose

role has been defined with sufficient clarity.

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Credit Risk Preparedness

71% of the banks responded that they had made reasonable

progress with the initial stages (in the form of establishing the

team, conducting gap analysis, project planning and assessing

detailed requirements) of implementing a credit risk

programme.

The more advanced stages of credit risk preparedness have

shown minimal progress as well as varied understanding of the

implementation approach.

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Operational Risk Preparedness

Most banks have started work on the Basic Indicator Approach

(BIA) for operational risk management. However banks appear

to be unclear on their time frames for adopting more advanced

approaches. Appropriate guidance from the regulator could be

one of the reasons.

Technological adaptability could be one of the drivers that

would enable banks to implement the Standardised and

Advanced Measurement Approach for operational risk

management.

A large number of banks seem to have not yet fully understood

the complexities for Basel II compliance in respect of

operational risk.

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Technological Preparedness

There appears to be less clarity with regard to use of

technology in operational risk.

On a scale of 5, Credit risk technological preparedness range

between 3.0 to 3.5, Market risk technological preparedness

range between 3.2 to 3.5 and Operational risk technological

preparedness range between 2.0 to 2.5 among various public

and private sector banks.

90% of the banks intended to use a combination of in-house

development as well as external consultants to build

appropriate IT solutions.

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Opportunities for Banks

Measuring,Managing and Monitoring Risk in a scientific

manner

Risk Based Pricing

Optimum utilization of Capital

Effective Portfolio Management

Enhance shareholders value by generating risk adjusted

return on capital

Align risk appetite and business strategy

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Concerns and Challenges for Banks General Issues

Guidance and support from senior management is essential to

help ensure success of Basel II project. Without their supportand motivation, implementation can become difficult and time

consuming.

Good risk management involves a high degree of cultural

changes. Embedding good risk management practices into the

day to day business processes will be a daunting task.

Sophisticated risk management techniques, particularly under

the advanced approaches, require human resources withappropriate skill sets and proper training. With average age of

45 and above of Public Sector Bank officers, the task becomes

much more challenging.

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Concerns and Challenges for Banks General Issues

Capital requirement under Basel II will increase due to

additional capital charge for operational risk and increasedcapital requirement for market risk (already implemented wef

31.03.2006). The scarcity of resources (of raising capital) will

add to the existing competition of business growth. Highly

rated corporates (needing lower amount of capital) may exertpressure on already declining interest spread.

The models under advanced approaches require lot of

historical data. However, with no data warehouses in the banks

(especially Public Sector Banks), collection of data is a

formidable task.

Methodologies that work in a bank may not work in another

bank. Banks have to customize and tailor make the risk

products to suit their processes.

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Challenges for Banks Legal and Regulatory Infrastructure

Steps are required for adoption of internationally accepted

accounting standards, consistent, realistic and prudent rulesfor asset valuation and loan loss provisions reflecting realistic

repayment expectations.

Legal systems will require changes for speedier and effective

liquidation of collaterals

The laws governing supervisory confidentiality and bank

secrecy would require modifications to permit disclosure

envisaged under pillar III.

In view of predominant Government control over public sector

banks, preconditions such as operational autonomy, corporate

governance etc need to be addressed.

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Challenges for Banks External Credit Rating Agencies

Limited number of rating agencies and insignificant level ofpenetration of ratings.

The rating agencies in India have a good background in rating

issues such as corporate bonds, commercial papers and other

marketable instruments, but not in rating issuers/bankborrowers.

At present default rates are disclosed by CRISIL only and

other rating agencies are yet to declare the default rates,which

may create difficulties in mapping process and compliance withdisclosure criterion. Other rating agencies will have to disclose

the default rates if they want to be accredited by RBI.

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Challenges for Banks External Credit Rating Agencies

Banks are also awaiting detailed guidelines from the regulator

on matter involving regulatory discretion under Internal rating

based approach. Such guidelines are required to enable the

banks to start collecting the data properly and to design IRB

compliant risk management systems.

The capital requirements of banks under Standardised

approach will be less sensitive to credit risk compared to bankson advanced approaches, may result in higher risk loans going

to banks on standardised approach. This may lead to

concentration of high risk assets with banks adopting

standardised approach and low risk assets with banks adopting

IRB approach.

In India banks/ FIs are having stake in rating agencies that

may impact the independence of rating agencies.

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Challenges for Banks Development of market for Credit

derivatives and other credit mitigation products

Credit derivative products yet to be introduced in India.

Evolution of developed market for credit derivative is required to

mange credit risk effectively and to get full benefit of risk

mitigation.

Rigorous legal and regulatory framework and less developed

secondary market for bonds/ loans etc is a major impediment in

development of credit derivative markets.

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Challenges for Banks MIS and IT

Presently, no single IT supplier can provide all-round risk

management solutions. However, 100% internal developmentmay be too costly because risk management methodologies tend

to involve complex computation. Integrating various external

systems into one platform is the major challenge. Flexible

customization of external systems is important .

System integration, dedicated software for risk assessment and

management and setting up of enterprise wide integrated data

warehouse shall pose a formidable challenge for Indian banks.

Ensuring correct feeding of data from various sources and the

validation of information stored is a major challenge to be

overcome before the banks start making use of the information

in the data warehouse.

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Lack of data driven culture

Historical issues in getting reliable data.Only data that was necessary to ease operational processes

was captured.

Structured, data-backed decision-making has not been very

prevalent.Most of banks are having various banking solutions across

branches. Co-ordinating with multiple vendors each handling

different parts of the overall solution in the present system is a

daunting task.

Inadequacy of relevant and reliable data to estimate risk inputs

for advanced techniques shall make the implementation

difficult in Indian conditions.

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Short data history, and lesser number of data points in LGD,EAD and high impact low frequency events in operational risk

may give distorted results. Effort for creation of pooled data are

required to be made requiring collaborative efforts between

banks and supervisor.

Risk methodologies and business processes are evolving. The

technologies adopted must be flexible for future changes.

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Action Points for Effective Implementation

Grooming and Retaining Talent

Percolating risk culture across the organisation through frequent

communications, organizing seminars and training.

Setting up of Data Warehouse to provide risk management

solutions.

Integrating risk management with operational decision making

process by conducting periodic use tests.

Periodic backtesting and stress testing of the existing models totest their robustness in the changing environment and make

suitable amendments, if required.

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Adopting RAROC framework and moving from regulatory

capital to economic capital.

Putting in place a comprehensive plan of action to capture risks

not captured under Pillar I, through ICAAP framework.

Action Points for Effective Implementation

Handling interrelationship between businesses. Linkage needs to

be established between Funds Transfer Pricing, Asset and

Liability Management, Credit risk, Market risk and Operational

risk so that cost allocation can be done in a scientific manner.

For Pillar III requirements, banks should disclose information,

that are easily understood by the market players and gradually

move to disclosure of informations requiring advanced conceptsand complex analysis.

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B M MITTAL

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