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Peru Basel II implementation Setiembre 2009 APEC.

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1 Peru Basel II implementation Setiembre 2009 APEC

2 Experience in Basel II implementation The SBS has reinforced a regulatory framework to enable firms making an appropriate identification, evaluation, treatment and control of risks. Basel II implementation process is progressing quite well in Peru: Changes in the General Law allow the application of capital requirements to credit, market and operational risk according to Basel II. A regulatory framework for the implementation of Basel II has been made available to the public (publications and pre announcing of new rules) 2

3 Main changes in Banking Law DL 1028 Minimum capital requirements for credit, market and operational risks (Pillar I of Basel II) Increase of the minimum capital ratio and maintenance of suitable additional buffer, according to entities’ risk profile and the business cycle (Pillar II of Basel II) Definition of capital structure and proposal of limits on its composition (Basel) Information transparency (Pillar 3 of Basel II) Transparency: Obligation to pre announce new rules regarding capital requirement and loan loss reserves.

4 Implementation Schedule April 2009 Opening application to Operational risk (OR) - ASA July 2009 Capital requirement: CR: no change MR: Standardized approach OR: Basic approach Opening application to advance models: VaR, IRB, AMA July 2010 Capital requirement: CR: standardized approach

5 Peru Basel II implementation: Pillar I: Credit risk

6 Definition of Portfolios Basel IIPeru Regulatory Portfolios Corporate+ 50MM€Corporate+ 200MMS/. of sales SME corp.between 5MM€ and 50MM€ Big firmsbetween More than 20MMS/. of sales and 200MMS/. of sales Medium firmsMore than 300MS/. of debt and until 20MMS/. of sales SME retailunder 5MM€ Small firmsBetween 20MS/. and 300MS/. of debt RetailUntil 20M S/. of. debt

7 Change of Weights Current Law: Basel I Basel II Peru CR regulation Commercial loans100%100% unless an issuer assessment applies. (20%) Leasing50%100% unless an issuer assessment applies. (20%) Special Regime until Dec-12 Debt instruments100%According to external ratings Retail, including Revolving consumption Non revolving consumption 100% Mortgage50%50%, until the guaranteed portion Shares100%300% - 400%

8 Change of Weights Current Law Basel I Basel II Peru CR regulation Peruvian sovereign in local currency and Central Bank exposures 0% Peruvian sovereign in foreign currency0%according to formula (do not include reserves in CB) Rest of sovereigns0% - 20%According to external ratings SUNAT100%20% Public and private Financial System institutions 20%According to external ratings Mivivienda (mortgage program supported by government) 0%20% stock. According to institutional external ratings for new credits

9 Other changes that affect capital requirement Current Law Basel I Basel II Peru CR Regulation Use of mitigatorsDo not allow its useRecognition of financial collaterals and guarantees Use of credit conversion factors Through internal rulesThrough public rules Recognition of provisions in capital Until 1% of standard credits 1.25% RWA Settlement and delivery risk-Between 100% and 1000% Default definition-90 days, affects risk weights (150% if specific loan loss reserves < 20% of debt, except mortgages) Use of internal models-Requires supervisor approval Fundamental and advanced models

10 Sovereign exposures Weight factors of Sovereign exposures of foreign countries are found in the Accord according to international risk rating agencies. Sovereign exposures referred only to Central Banks and Central Government exposures. The rest of public institutions will be treated as corporates. Peruvian local currency sovereign exposures, as well as local and foreign currency reserves and other Peruvian Central Bank operations have a weight factor of 0%. Peruvian foreign currency sovereign exposures (except reserves), will have a weight factor according to the following formula:

11 11 Credit conversion factors (CCF) Basel I Basel II Peru CR Regulation Confirmations of self-liquidating irrevocable trade letters of credit up to one year, when the issuing bank is a high rating foreign financial system institution according to the CB. Not clearly defined20% Performance bonds, bid bonds and warranties to guarantee satisfactory completion of a project Not clearly defined50% Guarantees, bank acceptances, rest of trade letters of credit, rest of letters of guarantee Not clearly defined (100%) 100% Credit lines0%Between 0% and 50%

12 The regulation considers fundamental IRB (FIRB) and advanced IRB (AIRB) Parameters are required to be calculated taking into account a complete business cycle (independently of the minimum period of observations) Internal Models (IRB)

13 Definition of Default Past due loan for more than 90 days Retail debtors: by operation Non retail debtors: by debtor Debt instruments are considered in default since the first day of delay after the settlement period. Change to a restructuring situation In the last 5 years, the debtor or the operation has registered more than one change in contract conditions (unless the firm can make a better estimation of its change to a default situation) The firm considers that the debtor is unable to partially or totally fulfill its obligations according to the agreement.

14 Leaving default From the moment of non default, punctually fulfillment of liabilities for 12 consecutive months. During this period, the debtor will be able to register a maximum delay of 7 consecutive days and a maximum accumulated delay of 25 days (unless the firm can make a better estimation of the change to a non default situation) The firm considers that the debtor is able to fulfill all its obligations. This condition will be valid only when the reason of non fulfillment is due to qualitative criteria.

15 Peru Basel II implementation: Pillar I: Market risk

16 Current Methodology Firms will be able to calculate capital requirement for market risks through one of the following ways: 1.Standardized Method 2.Internal Models 3.Combination of standardized method and internal models. It must be considered that each type of risk should be evaluated using only one method. Changes in regulation Inclusion of interest rate risk measurement in trading book and commodities risk measurement, as part of the standardized method. Use of internal models with previous authorization of the SBS.

17 Trading book for market risk capital requirement SBS will consider the following instruments as part of trading book: a) Instruments registered in trading book b) The following instruments registered in available-for sale category: Debt CDBCRP Sovereign bonds (VAC-bonds not included) Global bonds Brady bonds Equity: IGBVL shares Mutual funds (at least 70% of the fund in shares) a)Speculative derivatives b)Derivatives that hedge a and b investments c)Commodities

18 Peru Basel II implementation: Pillar I: Operational risk

19 Capital requirement for operational risk Firms must use one of the following methods. a. Basic indicator approach – BIA (function of net income) b.Alternative Standardized approach - ASA (function of net income by business lines, except retail and commercial banking lines) c.Advanced measurement approaches – AMA (probabilistic calculations) The use of ASA or AMA requires express authorization of the SBS Basel II established methodologies are followed.

20 Operational Risk Gradual implementation of operational risk requirement: SBS would expect that during the implementation, entities are able to meet the requirements to apply to ASA, and thus avoid the application of 100% according to BIA. Jul 2009Jul 2010Jul %50%100%

21 Peru: Implementation of pro-cyclical loan loss reserves

22 Regulatory reform of the SBS Foreign exchange credit risk regulation January 2005 Resolution N° Regulation for foreign exchange credit risk management Sets minimum prudential standards with respect to granting redits in foreign currency, as an additional component for defining the ability to pay. To that effect, minimum requirements in managing this risk are defined. In case of not satisfying those requirements, additional provisions are set. May 2005CIRCULARNº B F CM CR EAF EDPYME Over- borrowing regulation September 2006 S.B.S. Resolution Nº Regulation for retail debtors debt overhang risk management. Stipulates that firms must establish policies regarding granting, amendment and revision of revolving credit lines, including explicit standards and measures to include over-borrowing of retail debtors in credit evaluation. Additionally, sets minimum requirements for management of retail debtors over-borrowing. Additional provisions will be established on the unused portion of retail revolving credit lines if requirements are not fulfilled. August 2008 S.B.S. Resolution Nº New Regulation for retail debtors debt overhang risk management

23 How does Accumulation Rule work? The variable component of procyclical loan loss reserves will be activated in the following situation: The average GDP growth rate YoY of the last 30 months passes from less than 5% to 5% or more. When the average GDP growth rate YoY of the last 30 months is over 5%, and the average GDP growth rate YoY of the last 12 months is higher by 200 basic points to this same indicator calculated a year earlier. When the average GDP growth rate YoY of the last 30 months is over 5%, and 18 months had elapsed since the procyclical rule was deactivated

24 How does Decumulation Rule work? The accumulation rule will be deactivated in the following situations: The average GDP growth rate YoY of the last 30 months passes from a level equal or greater than 5% to one less than this threshold. The average GDP growth rate YoY of the last 12 months is lower by 400 basic points to this same indicator calculated a year earlier.

25 Reserve rates for credits in standard category Types of credit Fixed component Variable component Corporate credits0.7%0.4% Credits for large firms0.7%0.45% Credits for medium firms1.0%0.3% Credits for small firms1.0%0.5% Retail credits1.0%0.5% Revolving consumption credits1.0%1.5% Non revolving consumption credits1.0% Mortgage loans for housing0.7%0.4%

26 Procyclical rule evolution 30 months Average GDP growth rate 30 months Threshold 5%

27 Procyclical rule evolution 12 months -3.98% Threshold 2%Threshold -4%Average GDP growth rate 12 months

28 The Banking System has S/. 916 millions of loan loss reserve buffer and S/ millions of capital buffer

29 Peru Basel II implementation: Pillar II

30 Additional capital buffer In Peru, the additional buffer is a function of the type of institution (10.5% for commercial banks, 14% for microfinance institutions). This indicator is not very sensitive to risk. Regulatory capital should consist of: 1.Minimum capital : Pillar I 2.Additional capital: Should be determined based on the institution's risk and business cycle. 3.Additional capital according to ICAAP Business cycle indicator Decumulates Accumulates

31 How should the additional capital requirement be calculated in terms of risk profile and economic cycle? Business lines Participation (%) Risk weight by business line (according to stress testing) Risk indicator L1P1%W1P1%*w1 L2P2%W2P2%w2 L3P3%W3P3%w3 L4P4%W4P4%w4 ………… LnPn%WnPn%wn TOTAL100%-ΣPi%*wi = H Total indicator

32 How should the additional capital requirement be calculated in terms of risk profile and economic cycle? Ranges of HMinimum capital Requirement adjusted to risk (Base: 10%) Capital requirement according to supervisor assessment of ICAAP Good (I,II)Bad (III,IV,V) H1 – H211.5% 11.5%*(1+ α 1 ) H2 – H312% 12%*(1+ α 2 ) H3 – H413% 13%*(1+ α 3 ) H4 – H514% 14%*(1+ α 4 ) ………… H(n-1) – H(n)17% 17%*(1+ α n ) α i = weight adjustment according to ICAAP evaluation

33 Peru: Impact of Basel II implementation

34 Timing of implementation of law 1028 Today JUL 2009 JUL 2010 JUL 2010 JUL 2011 JUL 2011 JUL 2012 JUL 2012 JUL 2013 RWA adjustment (CR, MR) (OR) adjustment Ø Inverse of capital ratio including additional requirement 10.5 banks 11 ?? 14.3 IMFNB 14.3 ?? New methodology

35 Evolution of Capital Ratio (Banking sector) Rop Rop ajustado Ajuste APR OR Adjusted OR RWA adjustment Capital ratio Minimum ratio Prudential requirement Scheduled adjustment

36 Evolution of Capital ratio (microfinance institutions) Rop Rop ajustado Ajuste APR Adjusted OR OR RWA adjustment Capital ratio Minimum ratio Prudential requirement Scheduled adjustment

37 Banking sector capital (S/. MM) December 2008 Minimum req. 9,313,961 Additional req. 1,380,510 Minimum req. 9,831,794 Prudential req. 1,552,389 Additional Req. 864,188 Initial Situation Final Situation Required capitalregulatory capital Prudential req. 1,438,003

38 Microfinance institutions capital (S/. MM) December 2008 Minimum req. 766,574 Prudential req. 438,042 Additional req. 398,212 Minimum req. 825,874 Prudential req. 417,284 Additional req. 362,824 (December 2008) Initial Situation Final Situation Required capitalregulatory capital

39 Capital ratio according to portfolio growth scenarios: banking sector 0% 15% 42.63% Portfolio growth RWA (+ OR, +growth) Capital Ratio= Reg. capital (+ earnings capitalization +reserves of standard credits (+growth) ) Capital ratio Minimum ratio Prudential requirement

40 Capital ratio according to portfolio growth scenarios: microfinance institutions 0% 20% 43.83% Portfolio growth RWA (+ OR, +growth) Capital Ratio= Reg. capital (+ earnings capitalization +reserves of standard credits (+growth) ) Capital ratio Minimum ratio Prudential requirement

41 Peru Basel II implementation Setiembre 2009 APEC


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