How comfortable can you afford to be Kostas

How comfortable can you afford to be? Kostas Kotsiopoulos

Agenda q. Overview q. Risk Rating q. Historical Data q. Iterative Approach q. Time Period q. INFORMER Solutions

Overview Pillar One Minimum Capital Requirements Standardised Approach Pillar Two Supervisory Review Pillar Three Market Discipline Operational Risk IRB Approach Trading Book Securitisation Framework Basel II introduce a unique opportunity for banks to evolve their risk methodologies, strategies and technology in order to control and manage credit, market and operational risk in an integrated way.

The three different approaches for Capital Adequacy 1. Standardised Approach 2. Foundation Internal Ratings Based Approach. Five years data, the exception can be 2 years. 3. Advanced Internal Ratings Based Approach. Five years for PD, seven years for LGD and EAD

Implementing BASEL II Solutions q. Bought in data q. Balance sheet analysis q. Sector analysis q. Credit history q. Etc. .

Risk Components Probability of Default (PD) Loss Given Default (LGD) Exposure at Default (EAD) Based upon the Internal Ratings How many models are required? Different sectors, different geographies?

Some Issues q Where to source the exposure data? q Where to source the mitigant data? q Is there common Counterparty identification? q Is there a common way of identifying internal organisation structures? q Can the mitigant data be joined to the exposure data? q Do we have netting arrangements in place?

Mitigation is the Key q. Can make a significant difference to the capital charge q. Is a sensitive way to manage risk q. May be: – Eligible financial collateral – Approved Guarantees – Eligible Credit Derivatives – Netting

Risk Rating Systems: Principle q Rating and risk estimation systems provide a meaningful way of ranking and quantifying risk q This provides a controlled way of categorising Obligor and Facility/transactional risk q The approaches must show a clearly defined and consistent approach to risk assessment, which is systemic in its application within a bank

Rating Systems ü All of the methods, processes, controls, data collection and IT systems that support the assessment of credit risk ü This in turn leads to the assignment of internal risk ratings and the quantification of loss estimates ü This underpins the whole of the BASEL II IRB approaches

Risk Rating Credit Scoring Solution Credit Rating Solution Customer and Transaction Rating Risk Pricing Model Disclosure of the bank’s Information will affect its own rating (PILLAR 3) § Operational Risk § Increase Provisions? § Increase the Cost of Fund? § § §

Regulatory and Economic Capital • The Pillar 2 wording from The Basel II Accord, makes it very clear that Banks should maintain a buffer over and above the minimum capital requirement

Reasons for the Capital Buffer § For the benefit of a bank’s own rating within the markets § The business mix will require adjustment beyond the capital calculated by the Basel II single factor model § As a reserve to avoid raising capital in poor market conditions § Prudence to avoid getting close to the regulatory capital minimum § The general point about the single factor model and other market correlations

Principle 2 • “Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process”

Historical Data § Availability of data – Efficient and Representative Data – Statistical Analysis § § Data Cleansing Consolidation of data Classification of data Is there any requirement for benchmarks?

Iterative Approach § § Simulations Select the appropriate Approach Combination of Approach Introduce the Appropriate Method for Internal Rating

Timetable Basel II is confirmed and the timelines will not slip, and not only for G 10 Ø National supervisors steadfast on deadlines Ø Parallel run commencing 2006 Ø Final going in position by 2007 The absolute minimum expectation is that banks should be able to implement the Standardised Approach by January 1 2007 Ø “Dry run” by mid 2006 latest Ø Consultation with supervisor by end 2005 latest Ø Commence programs for change (2 nd Iteration) by mid 2005 latest

Applying of the new framework in EE · Test and Parallel Run by the end of 2005 · End 2006 Standardised and IRBF · End 2007 IRBA · The banks that will choose the IRBA are able to remain at the current framework during 2007.

Basel II Accord – Challenges The task of implementing Basel II can be separated into the following challenges Ø Comprehending the type and format of data you need for Basel II Ø Consolidating, Standardising and Translating this data before it is usable for any Risk Calculations Ø Auditing, Validating and Correcting the End-to-End Credit Risk Management Process Ø Managing the evolution of Basel II compliance Ø BIS level – Basel III Ø National Supervisor Ø Business or product evolution

INFORMER § Extensive Experience in Banking Projects (Core banking, e-banking, Outsourcing, etc. ) § Vision of the Company is to offer Integrated Solutions to the Financial Sector § Building up the Competence of our personnel and partnership with specialised companies § A dedicated team for these projects

INFORMER’S SOLUTIONS Consulting Services (Training, Gap Analysis) Data Cleansing, Consolidation and Classification Interfaces with specialised solutions Credit Scoring and Rating Applications complementary to Core Banking Systems (T 24, Retail 24) § Specialised Solutions like Barracuda of TLC § Hardware Solutions § Software Solutions § §

FAQs – Why start now? Time to define your migration path to compliance and beyond Ø Correcting data and disparate legacy databases has business wide impact – it needs careful planning and time to test Ø Buy-in to process and procedure change is critical – allow time for change management Ø Set achievable iterations of improvement – understand communicate the results Impress the regulator with a clear picture of where you are and where you are going Ø Derive maximum pillar 1 value by focussing on “heat maps” of product and unit mix Ø Gain early competitive advantage Ø Reduce the risk of a penalty rate RUNNING BEHIND SCHEDULE?

Operational Risk "Defining and quantifying operational risk metrics that are tailored to individual lines of businesses will be a major challenge. Firms need to create the proper incentives so that management and other stakeholders not only develop the correct initial approach, but also ensure it incorporates the concept of continuous process improvement, “ Source: CELENT

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