1. Basel-II Implementation & Implication BASEL II ACCORD Implications & Implementation by M. Saeed Sajid Institute of Chartered Accountant of India Riyadh Chapter August 2009

2. Basel-II Implementation & Implication 2 PRESENTATION OUTLINE Basel – II Accord Historical Perspective Objectives/Rationale Three Pillar Approach Advanced Approaches Implementation Challenges – Saudi Perspective Future Outlook Questions & Answers

3. Basel-II Implementation & Implication 3 HISTORICAL PERSPECTIVE

4. Basel-II Implementation & Implication 4 HISTORICAL PERSPECTIVE Basel Committee Objectives Consolidated supervision International cooperation among supervisory authorities Stability of the Financial System by ensuring stability of each individual bank Recommendations on Banking Laws/Regulations Ensure Banks hold adequate Capital Reserves

5. Basel-II Implementation & Implication 5 HISTORICAL PERSPECTIVE 1975 Basel Concordat, regulating international cooperation between supervisor authorities 1988 First Basel Capital Accord (Basel-I) 1996 Market Risk Amendment 1999 First Consultative Paper on Basel-II 2004~06 Adoption of Basel-II (Final Accord) 2006~08 Transition to Basel-II framework 2009~12 Implementation of Advanced Approaches Basel Accords

6. Basel-II Implementation & Implication 6 OBJECTIVES/ RATIONALE

7. Basel-II Implementation & Implication 7 OBJECTIVES/ RATIONALE Ensure sufficiency of Bank’s CAPITAL Capital / Risk Weighted Assets >= 8% Higher the Bank's CAPITAL Lower the FAILURE RISK

8. Basel-II Implementation & Implication 8 OBJECTIVES/ RATIONALE WHY cannot banks keep on increasing the CAPITAL ? WHAT is the Restraint ? Shareholder’s requirements (Dividends) OR Return On Equity (ROE) Higher the CAPITAL Lower the ROE Critical Role of Capital

9. Basel-II Implementation & Implication 9 OBJECTIVES/ RATIONALE Capital VS. ROE

10. Basel-II Implementation & Implication 10 OBJECTIVES/ RATIONALE Why Basel - II One-size fits ALL (Simple Risk Weightings) No appropriate risk differentiation –(STC vs. Road-side Baqala both rated 100% RW) OECD- Club Introduction of innovative banking products (ABS) Banks found ways to manage capital (off-balance sheet) IMPROVED RISK MANAGEMENT TECHNIQUES

11. Basel-II Implementation & Implication 11 BASEL – I RISK WEIGHTINGS CategoryClassification Criteria 0%Cash, Claims on OECD govt., Local Currency claims on non- OECD govt. 20%Claims on OECD banks 50%Residential Mortgages, Local govt. bonds 100%All other claims CREDIT CONVERSION FACTORS 0%Commitment up to 1 year, unconditionally cancelable 20%Commercial LC 50%Commitment beyond 1 year, Performance-related LGs 100%Direct Credit Substitute

12. Basel-II Implementation & Implication 12 Basel-II Risk Weightings – Standardized Approach CategoryAAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Un- Rated Sovereigns0%20%50%100%150%100% Banks (1 st option) Rating of Country 20%50%100% 150%100% Banks (2 nd option) Rating of Bank 20%50% 100%150%50% Banks (2 nd option) Claims < 3 months 20% 50%150%20% Corporate20%50%100%150%100% Retail75%

13. Basel-II Implementation & Implication 13 THREE PILLAR APPROACH

14. Basel-II Implementation & Implication 14 THREE PILLAR APPROACH Basel – II Accord

15. Basel-II Implementation & Implication 15 THREE PILLAR APPROACH Pillar - I Credit risk (more risk sensitive) Market risk (no major change) Operational risk (new addition) Basel Committee specified/recommended methodology for capital calculations under Standardized Approaches Bank specific model-based methodology under Advanced approaches

16. Basel-II Implementation & Implication 16 THREE PILLAR APPROACH Pillar – II (Supervisory Review) Assessment of all type of risks not covered under Pillar – I –Reputational, Strategic, Global –Concentration, IRRBB, Liquidity Bank specific methodology to be agreed with Central bank Difficult to measure/estimate ICAAC/ICAAP Supervisory oversight

17. Basel-II Implementation & Implication 17 THREE PILLARS APPROACH Pillar – III (Market Disclosure) Risk based disclosures Complement Accounting Disclosures Stakeholders be aware of methods/approach used by bank Comparison with peer banks User test

18. Basel-II Implementation & Implication 18 ADVANCED APPROACHES

19. Basel-II Implementation & Implication 19 ADVANCED APPROACHES Options for measuring Credit Risk –Standardised Approach (Credit Risk Weighting) –Internal Rating Based (IRB) Approach Foundation - Combination of parameters from Bank & Regulator for quantifying required capital Advanced - All parameters are derived by the Bank and used for quantifying required capital

20. Basel-II Implementation & Implication 20 ADVANCED APPROACHES Options for Market Risk - Standardized Approach(Current Exposure Method) - Internal Rating Model (IM) Approach Value at Risk (VaR) Qualitative & Quantitative Standard Stress Testing

21. Basel-II Implementation & Implication 21 ADVANCED APPROACHES Options for Operational Risk - Standardized / Alternative Standardized (Gross Income based Approach) - Advanced Measurement Approach (AMA) Framework only Statistical Approach Loss Data Management

22. Basel-II Implementation & Implication 22 IMPLEMENTATION CHALLENGES

23. Basel-II Implementation & Implication 23 IMPLEMENTATION CHALLENGES Under Standardized Approahes Internal Ownership Data Issues Lack of external ratings for Corporate customers How to estimate capital for Pillar-II risks Operational Risk Awareness BOD/Senior Management Awareness Stress Testing

24. Basel-II Implementation & Implication 24 IMPLEMENTATION CHALLENGES Under Advanced Approaches BOD/Senior Management Awareness Problems posed by new Pillar-II risks Model Development for Advanced Approaches Low Credit Defaults Low frequency, high severity losses are seldom Corporate Governance Stress Testing

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27. Basel-II Implementation & Implication 27 FUTURE OUTLOOK

28. Basel-II Implementation & Implication 28 FUTURE OUTLOOK Focus on single view of risk across bank (economic capital) – Basel-III ?? Re-assessment of capital for structured products More focus on Liquidity Management Stress testing - severe economic conditions Regulation for external rating agencies Corporate Governance

29. Basel-II Implementation & Implication 29 FUTURE OUTLOOK CORPORATE GOVERNANCE Decision Making Process Needs to Change Documentation Is Vital Communication & Training Senior Management / BOD Awareness

30. Basel-II Implementation & Implication 30 THANK YOU Q & A