Trading book and banking book rbi

Organizational set up 3. Liquidity Risk Management 4. Interest Rate Risk Management 5. Foreign Exchange Risk Management 6. In other words, it should be ensured that the bank is not exposed to Liquidity Risk. This Guidance Note would, thus, focus on the management of Liquidity Risk and Market Risk, further categorized into interest rate risk, foreign exchange risk, commodity price risk and equity price risk.

These aspects are elaborately discussed in the ensuing paragraphs. All Risk Taking Units must operate within an approved Market Risk Product Programme; this should define procedures, limits and controls for all aspects of the product.

New products may operate under a Product Transaction Memorandum on a temporary basis while a full Market Risk Product Programme is being prepared.

At the minimum this should include procedures, limits and controls. The final product transaction program should include market risk measurement at an individual product and aggregate portfolio level. All trading transactions will be booked on systems capable of accurately calculating relevant sensitivities on a daily basis; usage of Sensitivity and Value at Risk limits for trading portfolios and limits for accrual portfolios as prescribed for ALM must be measured daily.

Where market risk is not measured daily, Risk Taking Units must have procedures that monitor activity to ensure that they remain within approved limits at all times. Mandatory market risk limits are required for Factor Sensitivities and Value at Risk for mark to market trading and appropriate limits for accrual positions including Available-for-Sale portfolios. Requests for limits should be submitted annually for approval by the Risk Policy Committee. The approval will take into consideration the Risk Taking Unit's capacity and capability to perform within those limits evidenced by the experience of the Traders, controls and risk management, audit ratings and trading revenues.

Approved Management Action Triggers or Stop-loss are required for all mark to market risk taking activities. Risk Taking Units are expected to apply additional, appropriate market risk limits, including limits for basis risk, to the products involved; these should be detailed in the Market Risk Product Programme.

A rate reasonability process is required to ensure that all transactions are executed and revalued at prevailing market rates; rates used at inception or for periodic marking to market for risk management or accounting purposes must be independently verified. Financial Models used trading book and banking book rbi revaluations for income recognition purposes or to measure or monitor Price Risk must be independently tested and certified.

Stress tests must be trading book and banking book rbi preferably quarterly for both trading and accrual portfolios. Line Management must ensure that the software used in Financial Models that value positions or measure market risk is performing appropriate calculations accurately.

The Risk Policy Committee is responsible for administering the model control and certification policy, providing technical advice through qualified and competent personnel. It is left to the bank to trading book and banking book rbi any independent certification. Financial Models must be fully documented and minimum standards of documentation must be established.

Someone other than the person who wrote the software code must perform certification of models; testers must be competent in designing and conducting tests; records of testing must be kept, including details trading book and banking book rbi the type of tests and their results. Assumptions contained in the Financial Models must be trading book and banking book rbi as part of the initial certification and reviewed annually.

Trading book and banking book rbi parameter sourcing conventions require annual approval by the Risk Policy Committee. Any mathematical model that uses theory, formulae or numerical techniques involving more than simple arithmetic operations must be trading book and banking book rbi to ensure that the algorithm employed is appropriate and accurate.

Persons who are acceptable to the Risk Policy Committee and independent of the area creating the model must validate models in writing. It is left to the bank to decide on who should validate, whether internal or external, at the discretion of the Risk Policy Committee.

Models to calculate risk measures like Sensitivities to market trading book and banking book rbi either at transaction or portfolio level and Value-at-Risk should be validated independently. Unauthorised or unintended changes should not be made to the models. These standards should also apply to models that are run on spreadsheets until development of fully automated processors for generating valuations and risk measurements. Trading book and banking book rbi models should also be subject to model assumption review on a periodic basis.

The purpose of this review is to ensure applicability of the model over time and that the model is valid for its original intended use.

The review consists of evaluating the components of the financial model and the underlying assumptions, if any. Risk report should enhance risk communication across different levels of the bank, from the trading desk to the CEO. In order of importance, senior management reports should:.

The Boards should clearly articulate market risk management policies, procedures, prudential risk limits, review mechanisms and reporting and auditing systems. The operating prudential limits and the accountability of the line management should also be clearly defined.

Ideally, the organization set up for Market Risk Management should be as under: The Board should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks.

Trading book and banking book rbi will decide the policy and strategy for integrated risk management containing various risk exposures of the bank including the market risk. T he responsibilities of Risk Management Committee with regard to market risk management aspects include:. Setting policies and guidelines for market risk measurement, management and reporting. Reviewing and approving market risk limits, including triggers or stop-losses for traded and accrual portfolios. Ensuring robustness of financial models, and the effectiveness of all systems used to calculate market risk.

The role of the ALCO should include, inter alia, the following: Deciding on desired maturity profile and mix of incremental assets and liabilities. Articulating interest rate view of the bank and deciding on the future business strategy. The size number of members of ALCO would depend on the size of each institution, business mix and organisational complexity. In addition, the Head of the Technology Division should also be an invitee for building up of MIS and related computerisation.

Some banks may even have Sub-committees and Support Groups. Ideally this is a full time function reporting to, or encompassing the responsibility for, acting as ALCO's secretariat. It is a highly specialised function and must include trained and competent staff, expert trading book and banking book rbi market risk concepts.

The methodology of analysis and reporting will vary from bank to bank depending on their degree of sophistication and exposure to market risks. These same criteria will govern the reporting requirements demanded of the Middle Office, trading book and banking book rbi may vary from simple gap analysis to computerised VaR modelling.

Middle Office staff may prepare forecasts simulations showing the effects of various possible changes in market conditions related to risk exposures. Banks using VaR or modelling methodologies should ensure that its ALCO are aware of and understand the nature of the output, how it is derived, assumptions and variables used in generating the outcome and any shortcomings of the methodology employed.

Segregation of duties should be evident in the middle office which must report to ALCO independently of the treasury function. In respect of banks without a formal Middle Office, it should be ensured that risk control and analysis should rest with a department with clear reporting independence from Treasury or risk taking units, until formal Middle Office frameworks are established.

The Treasury Dealing Room within a bank is generally the clearing house for matching, managing and controlling market risks. It may provide funding, liquidity and investment support for the assets and liabilities generated by regular business of the bank. The Dealing Room is responsible for the proper management and control of market risks in accordance with the authorities granted to it by the bank's Risk Management Committee.

The Dealing Room also is responsible trading book and banking book rbi meeting the needs of business units in pricing market risks for application to its products and services. The Dealing Room acts as the bank's interface to international and domestic financial markets and generally bears responsibility for managing market risks in accordance with instructions received from the bank's Risk Management Committee. The Dealing Room may also have allocated trading book and banking book rbi it by Risk Management Committee, a discretionary limit within which it may take market risk on a proprietary basis.

For these reasons effective control and supervision of bank's Dealing Room activities is critical to its effectiveness in managing and controlling market risks. All dealers active in day-to-day trading activities must acknowledge familiarity with and provide an undertaking in writing to adhere to the bank's dealing guidelines and procedures.

Adherence to Internal Limits - All dealers must be aware of, acknowledge and provide an undertaking to adhere to the limits governing their authority to commit the bank to risk exposures as they apply to their own particular risk responsibilities and level of seniority. Adherence to RBI limits and guidelines - All dealers must acknowledge and provide an undertaking to adhere to their responsibility to remain within RBI limits and guidelines in their area of activity.

Dealing with Brokers - All dealers should be aware of, acknowledge and provide an undertaking to remain within the guidelines governing the bank's activities with brokers including conducting business only with brokers authorised by bank's Risk Management Committee on the bank's Brokers Panel. Trading book and banking book rbi their activities with brokers do not allow for the brokers to act as principals in transactions, but remain strictly in their authorised role as market intermediaries.

Requiring brokers to provide all broker notes and confirmations of transactions before close of business each day or exceptionally by the beginning of the next business day, in which case the note must be prominently marked by the broker as having been transacted the previous day, and the Back Office must recast the previous night's position against limits reports to the bank's Back Office for reconciliation with transaction data. Ensuring all brokerage payments and statements are received, reconciled and paid by the bank's Back Office department and under no circumstances authorised or any payment released by dealers.

Prohibiting dealers from nominating a broker in transactions not done through that broker. Dealing Hours - All Dealers should be aware of the bank's normal trading hours, cut off time for overnight positions and rules governing after hours and off-site trading if allowed by the bank.

Security and Confidentiality - All dealers should be aware of the bank's requirements in respect of maintaining confidentiality over its own and its customers' trading activities as well as the responsibility trading book and banking book rbi secure maintenance of access media, keys, passwords and PINS.

Staff Rotation and leave requirements - All dealers should be aware of the requirement to take at least one period of leave of not less than 14 days continuously per annum, and the bank's internal policy in regards to staff rotation.

The key controls over market risk activities, and particularly over Dealing Trading book and banking book rbi activities, exist in the Back Office. It is critical that both a clear segregation of duties and reporting lines is maintained between Dealing Room staff and Back Office staff, as well as clearly defined physical and systems access between the two areas.

It is essential that critical Back Office controls are executed diligently and completely at all times including:. The control over confirmations both inward and trading book and banking book rbi All confirmations for transactions concluded by the Dealing Room must be issued and received by the Back Office only. Discrepancies in transaction details, non-receipts and receipts of confirmations without application must be resolved promptly to avoid instances of unrecorded risk exposure.

The control over dealing accounts vostros and nostros - Prompt reconciliation of all dealing accounts is an essential control to ensure accurate identification of risk exposures. Discrepancies, non-receipts and receipts of funds without trading book and banking book rbi must be resolved promptly to avoid instances of trading book and banking book rbi risk exposure.

Unreconciled items and discrepancies in these accounts must be kept under heightened management supervision as such discrepancies may at times have significant liquidity impacts, represent unrecognised risk exposures, or at worst represent collusion or fraud. Revaluations and marking-to-market of market risk exposures: All market rates used by the bank for marking risk exposures to market, used to trading book and banking book rbi assets or for risk analysis models such as Value at Risk analysis, must be sourced independently of the Dealing Room to provide an independent risk and performance assessment.

If the bank has an established and independent Middle Office function, this responsibility may properly pass to the Middle Office. Monitoring and reporting of risk limits trading book and banking book rbi usage: Reporting of usage of risk against limits established by the Risk Management Committee as well as Credit Department for Counterparty risk limits should be maintained by the Back Office independently of the Dealing Room.

The Back Office must also undertake maintenance of all limit systems and access to limit systems such as counterparty limits, overnight limits etc.

Control over payments systems: The procedures and systems for making payments must be under at least dual control in the Back Office independent from the dealing function. Payments systems should be at all times secure from access or tampering by unauthorised personnel. It arises when the banks are unable to generate cash to cope with a decline in deposits or increase in assets.

MDG can be used to evaluate the impact on the MVE of the bank under different interest rate scenarios. The gap analysis measures mismatches between rate sensitive assets and rate sensitive liabilities by grouping them into various time buckets. Banks are also required to perform DGA vide circular dated November 4, The extant guidelines provide detailed guidance to banks to bucket various positions in different time bands depending on their interest rate risk sensitivity.

For certain types of deposits, like current deposits or savings bank deposits which are essentially Non Maturity Deposits NMDstrading book and banking book rbi are required to estimate behavioural patterns and place them into appropriate buckets. Banks, which are not able to estimate these behavioural patterns, are required to follow the standardised approach.

When interest rates change, the present value and timing of future cash flows change. As a part of Pillar 2 of Basel III Capital regulations, banks are required to identify the risks associated with the changing interest rates on its on-balance sheet and off-balance sheet exposures in the banking book from both, short-term and long-term perspective.

It is also mentioned that banks can decide, with the approval of the Board, on the appropriate level of interest rate risk in the banking book, which they would like to carry keeping in view their capital level, interest rate management skills and the ability to re-balance the banking book portfolios quickly in case of adverse movement in the interest rates. Banks, which have IRRBB exposure equivalent to less than 20 per cent drop in the MVE may be required to hold additional capital if the level of interest rate risk is considered, by the RBI, to be high in relation to their capital level or the quality of interest rate risk management framework obtaining in the bank.

Trading book and banking book rbi banks may on their own decide to hold additional capital towards IRRBB keeping in view the potential drop in their MVE, the IRR management skills and the ability to re-balance the portfolios quickly in case of adverse movement in the interest rates, the amount of exact capital add-on, if considered necessary, may have to be decided by the RBI as part of the SREP, in consultation with the bank trading book and banking book rbi.

IRRBB is an important risk that arises from banking activities, and is encountered by all banks. It arises because interest rates can vary significantly over time, while the business of banking typically involves intermediation activity that produces exposures to both maturity mismatch eg long-maturity assets funded by short-maturity liabilities and rate mismatch eg fixed rate loans funded by variable rate deposits.

In addition, there are optionalities embedded in many of the common banking products eg non-maturity deposits, term deposits, fixed rate loans that are triggered in accordance with changes in interest rates. Banks are required to implement these guidelines from April 1, Banks would continue to follow existing guidelines on IRR which is applicable to entire balance sheet. The risk appetite statement should lay down aggregate risk limit which is the amount of IRRBB acceptable to the Board for the consolidated bank level.

Risk limits may also be prescribed at the level of individual entities as well. The interest rate movements used in developing these limits should represent meaningful shock and stress situations, taking into account historical interest rate volatility and the time required by management to mitigate those risk exposures.

Banks should have clearly defined procedures to approve major hedging or risk-taking initiatives in advance of implementation. A trading book and banking book rbi set of risk limits should be developed to monitor the evolution of hedging strategies that rely on instruments such as derivatives, and to control mark-to-market risks in instruments that are accounted for at market value. There should be systems in place to ensure that positions that exceed, or are likely to exceed, limits defined by the Board should receive prompt management attention and be escalated without delay.

There should be a clear policy on who will be informed, how the communication will take place and the actions which will be taken in response trading book and banking book rbi such exceptions. Banks must identify the IRRBB inherent in all products and activities, and ensure that IRR is subjected to well-laid out effective risk management procedures which are consistent with these guidelines.

Significant hedging or risk management initiatives must be approved before being implemented. New products and activities must be analysed from the perspective of IRR before their roll out. Prior to introducing a new product, hedging or risk-taking strategy, adequate operational procedures and risk control systems must be in place. The extant guidelines issued by RBI are applicable to the computation of IRR for the entire bank and banks should continue to follow these guidelines.

Additionally for the purpose of computing, reporting, and disclosing risks separately for IRRBB from both earnings as well as economic value perspective, banks should follow the guidelines as given in the following paragraphs:.

Banks should measure their vulnerability to loss under stressful market conditions — including the breakdown trading book and banking book rbi key assumptions — and consider those results when establishing and reviewing their policies and limits for IRRBB.

Banks should also develop and implement an effective stress testing framework for IRRBB as part of their broader risk management and governance processes. These should feed into the decision-making process at the appropriate management level, including strategic decisions eg business and capital planning decisions of the Board or its committee. The stress testing framework for IRRBB should be commensurate with its nature, size and complexity as well as business activities and overall risk profile.

IRRBB stress tests should play an important role in the communication of risks, both within the bank and externally. The identification of relevant shock and stress scenarios for IRRBB, the application of sound modelling approaches and the appropriate use of the stress testing results require the collaboration of different trading book and banking book rbi within a bank e. A stress-testing programme for IRRBB should ensure that the opinions of the experts are taken into account.

The banks should determine, currency-wise, a range of potential interest rate movements against which they will measure their IRRBB exposures. Management should ensure that risk is measured under a reasonable range of potential interest rate scenarios, including some containing severe stress elements. In developing the scenarios, banks should consider a variety of factors, such as the shape and level of the current term structure of interest rates and the historical and implied volatility of interest rates.

In low interest rate environments, banks should also consider negative interest rate scenarios and the possibility of asymmetrical effects of negative interest rates on their assets and liabilities.

The scenarios should be sufficiently wide-ranging to identify parallel and non-parallel gap risk, basis risk and option risk. Banks should ensure that the scenarios are both severe trading book and banking book rbi plausible, in light of the existing level of interest rates and the interest rate cycle.

Special consideration should be given to instruments or markets where concentrations exist, because those positions may be more difficult to liquidate or offset in a stressful market environment. Banks should assess trading book and banking book rbi possible interaction of IRRBB with its related risks, as well as other risks eg credit risk, liquidity risk.

Banks having positions with significant option risk should include scenarios that capture the exercise of such options. For example, banks that have products with sold caps or floors should include scenarios that assess how the risk positions would change should those caps or floors move into the money.

Given that the market value of options also fluctuates with changes in the volatility of interest rates, banks should develop interest rate assumptions to measure their IRRBB exposures to changes in interest rate volatilities. Banks should specify, in building their interest rate shock and stress scenarios, the term structure of interest rates that will be incorporated and the basis relationship between yield trading book and banking book rbi, rate indices etc.

Banks should also estimate how interest rates trading book and banking book rbi are administered or trading book and banking book rbi by the management eg prime rates or retail deposit rates, as opposed to those that are purely market driven might change. Management should document how these assumptions are derived. Both economic value and earnings-based measures of IRRBB are significantly impacted by a number of assumptions made for the purposes of risk quantification, namely:.

In this context, all modelling assumptions should be conceptually sound and reasonable, and consistent with historical experience. Banks must carefully consider how the exercise of the behavioural optionality will vary not only under the interest rate shock and stress scenario but also across other dimensions. For instance, considerations may include:. Loan size, loan-to-value LTV ratio, borrower characteristics, contractual interest rates, seasoning, geographical location, original and remaining maturity, and other historical factors.

Other macroeconomic variables such as stock indices, unemployment rates, GDP, inflation and housing price indices should be considered in modelling prepayment behaviour. Deposit size, depositor characteristics, funding channel eg direct or brokered depositcontractual interest rates, seasonal factors, geographical location and competitive environment, remaining maturity and other historical factors.

Other macroeconomic variables such as stock indices, unemployment rates, GDP, inflation and housing price indices should be considered in modelling deposit redemption behavior. In addition, banks with positions denominated in different currencies can expose themselves to IRRBB in each of those currencies. Since yield curves vary from currency to currency, banks generally need to assess exposures in each currency. Further, banks should consider the materiality of the impact of behavioural optionalities within floating rate loans.

Banks should be able to test the appropriateness of key behavioural assumptions, and all changes to the assumptions of key parameters should be documented eg by comparing the economic value of equity measured under their internal systems with trading book and banking book rbi framework and caps prescribed given in Appendix 2.

Banks should periodically perform sensitivity analyses for key assumptions to monitor their impact on measured IRRBB. Sensitivity analyses should be performed with reference to both economic value and earnings-based measures. The most significant assumptions underlying the system should be documented and clearly understood by the Board or its committee.

As market conditions, competitive environments and strategies change over time, banks should review significant measurement assumptions at least annually and more frequently during rapidly changing market trading book and banking book rbi. For example, if the competitive market has changed such that consumers now have lower transaction costs available to them for refinancing their residential mortgages, prepayments may become more sensitive to smaller reductions in interest rates.

The banks should not rely on a single measure of risk, given that risk management systems tend to vary in how they capture the components of IRRBB.

Instead, banks should use a variety of methodologies to quantify their IRRBB exposures under both the economic value and earnings-based measures, ranging from simple calculations based on static simulations using current holdings to more sophisticated dynamic modelling techniques that reflect potential future business activities. There should be sufficient documentation of the major data trading book and banking book rbi used in the risk measurement process.

Data inputs should be automated as much as possible to reduce administrative errors. Data mapping should be periodically reviewed and tested against an approved model version. Banks should monitor trading book and banking book rbi type of data extracts and set appropriate controls. Wherever cash flows are slotted into different trading book and banking book rbi buckets eg for gap analyses or assigned to different vertex points to reflect the different tenors of the interest trading book and banking book rbi curve, the slotting criteria should be stable over time to allow for a meaningful comparison of risk figures over different periods.

The policy should specify the management roles and designate who is responsible for the development, implementation and use of models.

In addition, the model oversight responsibilities as well as policies including the development of initial and ongoing validation procedures, evaluation of results, approval, version control, exception, escalation, modification and decommission processes need to be specified and integrated within the governance processes for model risk management.

In addressing trading book and banking book rbi expected initial and ongoing validation activities, the policy should establish a hierarchical process for determining model risk soundness based on both quantitative and qualitative dimensions such as size, impact, past performance and familiarity with the modelling technique employed.

Model risk management for IRRBB measures should trading book and banking book rbi a holistic approach that begins with motivation, development and implementation by model owners and users.

Prior to receiving authorisation for usage, the process for determining model inputs, assumptions, modelling methodologies and outputs should be reviewed and validated independently of the development of IRRBB models.

The review and validation results and any recommendations on model usage should be presented to and approved trading book and banking book rbi the Board or its committee. Upon approval, the model should be subject to ongoing review, process verification and validation at a frequency that is consistent with the level of model risk determined and approved within banks. Clear version control authorisations should be designated, where appropriate, to model owners.

With the passage of time and due to observations and new information gained over time, an approved model may be modified or decommissioned. Banks should articulate policies for model transition, including change and version control trading book and banking book rbi and documentation. IRRBB measurement method might include those developed by third-party vendors.

Model inputs or assumptions may also be sourced from related modelling processes or sub-models both in-house and vendor-sourced and should be included in the validation process. Banks should document and explain model specification choices as part of the validation process.

Banks that purchase IRRBB models should ensure there is adequate documentation of their use of those models, including any specific customisation. If vendors provide input for market data, behavioural assumptions or model settings, banks trading book and banking book rbi have a process in place to determine if those inputs are reasonable for its business and the risk characteristics of its activities.

Internal audit should review the model risk management process as trading book and banking book rbi of its annual risk assessment and audit plans.

The audit activity should not duplicate model risk management processes, but should review the integrity and effectiveness of the risk management system and the model risk management process. Banks should include all cash flows from all interest rate-sensitive assets, liabilities and off-balance sheet items in the banking book in the computation of their exposure. Banks should disclose whether they have excluded or included commercial margins and other spread components in their cash flows.

Cash flows should be discounted using either a risk-free rate or a risk-free rate including commercial margins and other spread components only if the bank has included commercial margins and other spread components in its cash flows. Banks should disclose whether they have discounted their cash flows using a risk-free rate or a risk-free rate including commercial margins and other spread components.

Banks should include expected cash flows including commercial margins and other spread components arising from all interest rate-sensitive assets, liabilities and off-balance sheet items in the banking book.

The reporting of risk measures to the Board, it committees and other senior management committees should be regular and should compare current exposure with policy limits.

In particular, reporting should include the results of the periodic model reviews and audits as well as comparisons of past forecasts or risk estimates with actual results to inform potential modelling shortcomings on a regular basis.

Reports detailing the IRRBB exposures should be provided to the Board and other committees on a timely basis and reviewed trading book and banking book rbi.

Minimum capital requirements, which seek to refine the present measurement framework. Skip to main content. Search the Website Search.

Glossary Capital Capital Funds Equity contribution of owners. The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. For supervisory purposes capital is split into two categories: Tier I and Tier II.

Tier I Capital A term used to refer to one of the components of regulatory capital. It consists mainly of share capital and disclosed reserves minus goodwill, if any. Tier I items are deemed to be of the highest quality because they are fully available to cover losses Hence it is also termed as core capital.

Tier II Capital Refers to one of the components of regulatory capital. Also known as supplementary capital, it consists of certain reserves and certain types of subordinated debt. Tier II items qualify as regulatory capital to the extent that they can be used to absorb losses arising from a bank's activities.

Tier II's capital loss absorption capacity is lower than that of Tier I capital. Revaluation reserves Revaluation trading book and banking book rbi are a part of Tier-II capital.

These reserves arise from revaluation of assets that are undervalued on the bank's books, typically bank premises and marketable securities. The extent to which the revaluation reserves can be relied upon as a cushion for unexpected losses depends mainly upon the level of certainty that can be placed on estimates of the market trading book and banking book rbi of the relevant assets and the subsequent deterioration in values under difficult market conditions or in a forced sale.

Leverage Ratio of assets to capital. Capital reserves That portion of a company's profits not paid out as dividends to shareholders. They are also known as undistributable reserves and are ploughed back into the business. Deferred Tax Assets Unabsorbed depreciation and carry trading book and banking book rbi of losses which can be set-off against future taxable income trading book and banking book rbi is considered as timing differences result in deferred tax assets.

The deferred Tax Assets are accounted as per the Accounting Standard Deferred Tax Liabilities Deferred tax liabilities have an effect of increasing future year's income tax payments, which indicates that they are accrued income taxes and meet definition of liabilities. Subordinated debt Refers to the status of the debt. In the event of the bankruptcy or liquidation of the debtor, subordinated debt only trading book and banking book rbi a secondary claim on repayments, after other debt has been repaid.

Hybrid debt capital instruments In this category, fall a number of capital instruments, which combine certain characteristics of equity and certain characteristics of debt. Each has a particular feature, which can be considered to affect its quality as capital. Where these instruments have close similarities to equity, in particular when they are able to support losses on an ongoing basis without triggering liquidation, they may be included in Tier II capital. The Committee is a forum for discussion on the handling of specific supervisory problems.

It coordinates the sharing of supervisory responsibilities among national authorities in respect of banks' foreign establishments with the aim of ensuring effective supervision of banks' activities worldwide. BASEL II is based on three mutually reinforcing pillars hat allow banks and supervisors to evaluate properly the various risks that banks face.

These three pillars are: Minimum capital requirements, which seek to refine the present measurement framework supervisory review of an institution's capital adequacy and internal assessment process; market discipline through effective disclosure to encourage safe and sound banking practices Risk Weighted Asset The notional amount of the asset is multiplied by the risk weight assigned to the asset to arrive at the risk weighted asset number.

Risk weight for different assets vary e. CRAR Capital to Risk Weighted Assets Ratio Capital to risk weighted assets ratio is arrived at by dividing trading book and banking book rbi capital of the bank with aggregated risk weighted assets for credit risk, market risk and operational risk. The higher the CRAR of a bank the better capitalized it is. Credit Risk The risk that a party to a contractual agreement or transaction will be unable to meet its obligations or will default on commitments.

Credit risk can be associated with almost any financial transaction. Internal rating based approach IRB - The IRB approach, on the other hand, allows trading book and banking book rbi to use their own internal ratings of counterparties and exposures, which permit a finer differentiation of risk for various exposures and hence delivers capital requirements that are better aligned to the degree of risks. The IRB approaches are of two types: The requirements for this approach are more exacting.

The adoption of advanced approaches would require the banks to meet minimum requirements relating to internal ratings at the outset and on an ongoing basis such as those relating to the design of the rating system, operations, controls, corporate governance, and estimation and trading book and banking book rbi of credit risk components, viz. In India, banks have been advised to compute capital requirements for credit risk adopting the SA.

Market risk Market risk is defined as the risk of loss arising from movements in market prices or rates away from the rates or prices set out in a transaction or agreement. There are two methodologies available to estimate the capital requirement to cover market risks: This method, currently implemented by the Reserve Bank, adopts a 'building block' approach for interest-rate related and equity instruments which differentiate capital requirements for 'specific risk' from those of 'general market risk'.

The 'specific risk charge' is trading book and banking book rbi to protect against an adverse movement in the price of an individual security due to trading book and banking book rbi related to the individual issuer.

The 'general market risk charge' is designed to protect against the interest rate risk in the portfolio. This method enables banks to use their proprietary in-house method which must meet the qualitative and quantitative criteria set out by the BCBS and is subject to the explicit approval of the supervisory authority.

This approach sets a charge for operational risk as a fixed trading book and banking book rbi "alpha factor" of a single indicator, which serves as a proxy for the bank's risk exposure. This approach requires that the institution separate its operations into eight standard business lines, and the capital charge for each business line is calculated by multiplying gross income of that business line by a factor denoted beta assigned to that business line.

Under this approach, the regulatory capital requirement will equal the risk measure generated by the banks' internal operational risk measurement system. The ICAAP is required to form an integral part of the management and decision-making culture of a bank. ICAAP document is required to clearly demarcate the quantifiable and qualitatively assessed risks. The ICAAP is also required to include stress tests and scenario analyses, to be conducted periodically, particularly in respect of the bank's material risk exposures, trading book and banking book rbi order to evaluate the potential vulnerability of the bank to some unlikely but plausible events or movements in the market conditions that could have an adverse impact on the bank's capital.

Supervisory Review Process SRP Supervisory review process envisages trading book and banking book rbi establishment of suitable risk management systems in banks and their review by the supervisory authority.

The objective of the SRP is to ensure that the banks have adequate capital to support all the risks in their business as also to encourage them to develop and use better risk management techniques for monitoring and managing their risks. Market Discipline Market Discipline seeks to achieve increased transparency through expanded disclosure requirements for banks. Credit risk mitigation Techniques used to mitigate the credit risks through exposure being collateralised in whole or in part with cash or securities or guaranteed by a third party.

Mortgage Back Security A bond-type security in which the collateral is provided by a pool of mortgages. Income from the underlying mortgages is used to meet interest and principal repayments. Derivative A derivative instrument derives its value from an underlying product. There are basically three derivatives a Forward Contract- A forward contract is an agreement between two parties to buy or sell an agreed amount of a commodity or financial instrument at an agreed price, for delivery on an agreed future date.

Future Contract- Is a standardized exchange tradable forward contract executed at an exchange. In contrast to a futures contract, a forward contract is not transferable or exchange tradable, its terms are not standardized and no margin is exchanged. The buyer trading book and banking book rbi the forward contract is said to be long on the contract and the seller is said to be short on the contract. The buyer pays the seller an amount called the premium in exchange for this right.

This premium is the price of the option. Typically one cash flow is based on a variable price and other on affixed one. Duration Duration Macaulay duration measures the price volatility of fixed income securities. It is often used in the comparison of interest rate risk between securities with different coupons and different maturities. It is defined as the weighted average time to cash flows of a bond where the weights are nothing but the present value of the cash flows themselves.

It is expressed in years. The duration of a fixed income security is always trading book and banking book rbi than its term to maturity, except in the case of zero coupon securities where they are the same. Non Performing Assets NPA An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.

It is a mechanism to nurture an otherwise viable unit, which has been adversely impacted, back to health. Substandard Assets A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months.

Such an asset will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. Doubtful Asset An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, with the added characteristic that the weaknesses make trading book and banking book rbi or liquidation in full, - on the basis of currently known facts, conditions and values - highly questionable and improbable.

Loss Asset A loss asset is one where loss has been identified by the bank or internal or trading book and banking book rbi auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.

Off Balance Sheet Exposure Off-Balance Sheet exposures refer to the business activities of a bank that generally do not involve booking assets loans and taking deposits. Off-balance sheet activities normally generate fees, but produce liabilities or assets that are deferred or contingent and thus, do not appear on the institution's balance sheet until and unless they become actual assets or liabilities. Current Exposure Method The credit equivalent amount of a market related off-balance sheet transaction is calculated using the current exposure method by adding the current credit exposure to the potential future credit exposure of these contracts.

Current credit exposure is defined as the sum of the positive mark to market value of a contract. The Current Exposure Method requires periodical calculation of the current credit exposure by marking the contracts to market, thus capturing the current credit exposure.

Potential future credit exposure is determined by multiplying the notional principal amount of each of these contracts irrespective of whether the contract has a zero, positive or negative mark-to-market value by the relevant add-on factor prescribed by RBI, according to the nature and residual maturity of the instrument. Total operating expenses Sum of interest expended, staff expenses and other overheads.

Operating profit before provisions Net of total income and total operating expenses. Net operating profit Operating profit before provision minus provision for loan losses, depreciation in investments, write off and other provisions. It is computed by dividing net income by average total assets.

Here the equity refers to share capital reserves and surplus of the bank. Net Interest Margin Net interest margin is the net interest income divided by average interest earning assets. Cost income ratio Efficiency ratio The cost income ratio reflects the extent to which non-interest expenses of a bank make a charge on the net total income total income - interest expense. The lower the ratio, the more efficient is the bank.

High Cost Deposit Deposits accepted above card rate for the deposits of the bank. Liquid Assets Liquid assets consists of: It also deals with liquidity management, funds management, trading and capital planning.