Every bank has different LOBs and they have different functions. To aid the bank in its efficient management of regulatory calculations, the application has inbuilt portfolio definitions, concerning the banking book and trading book respectively. The different portfolio definitions help in the ease of calculations for the bank, and the parallel processing of the risk-weighted asset calculations. In many of the banks, the ownership of every portfolio might be different, and hence it becomes easier for the maintenance of the ownership for every data point and calculations. The data points concerning every portfolio are different.
The various portfolios concerning Credit Risk are
Credit Risk Non-Securitization
Banking Related Exposures
Investment Related Exposure (only belonging to banking book)
Counterparty Credit Risk – Non-Securitization
Derivative Related Exposures (both banking and trading book exposures)
Securities and Financing Transaction Related Exposures (Both banking and trading book exposures)
Credit Risk Securitization
Securitization Related Exposures (only belonging to banking book)
The portfolio of trading book exposures is the portfolio for Market Risk.
The Banking portfolio caters to the core banking activities of the bank – be it corporate banking or retail banking. This includes all the various banking activities in the form of loans provided by the bank, cards issued by the bank, commitments issued by the bank, overdraft provided by the bank, and other such core banking specific activities. Since this will be a mandatory portfolio for all the banks, this portfolio has its own RWA calculations.
The Investment portfolio caters to any of the investment activities of the bank, for which the bank holds the assets till maturity. These are the exposures that the bank will portray in the banking book. This includes all the investment in the form of any money market instruments or spot instruments or debt securities, held by the bank till maturity, and hence considered to be in the banking book. This also includes the bank’s investment in the form of fixed assets as well. This will be applicable only if the bank holds exposures in the form of investment related to the banking book.
The derivative portfolio caters to any of the derivative activities of the bank. These are the derivatives for which the bank is one of the counterparties or the bank acts as a clearing member or clearing member client. This includes derivatives in the form of credit derivatives, forwards, futures, options contracts, and swap contracts. This will include both the banking and trading book-related derivative exposures.
The Securities and Financing Transactions (SFT) portfolio caters to any of the securities financing activities of the bank. These are the SFT which the bank enters into, or the bank acts as a clearing member or clearing member client. This includes SFT in the form of repurchase agreements, reverse repurchase agreements, margin lending transactions, securities lending, and borrowing transactions. This will include both the banking and trading book-related exposures.
The Securitization portfolio caters to the securitization activities of the bank, wherein the bank either acts as an investor/ originator/ sponsor, or in the form of any other party wherein the bank provides some credit enhancement or commitment to the securitization transaction. This includes banking book-related exposures.
The Market risk related portfolio caters to all the trading book exposures. This includes all the exposures in the form of investments (including money market and spot transactions), derivative transactions, securitization transactions.
The Basel Committee (BIS) published guidelines that encompass guidelines for capital adequacy. Concerning Capital Adequacy, multiple guidelines have been published from Basel committee from time to time, and the OFS Basel Regulatory Capital complies with all the latest guidelines that must be complied with, by the bank. The various guidelines are the ones listed below:
· International Convergence of Capital Measurement and Capital Standards - June 2006
· Revisions to the Basel II market risk framework - December 2010
· Basel III: A global regulatory framework for more resilient banks and banking systems - December 2010
· Capital requirements for banks’ equity investments in funds - December 2013
· Basel III leverage ratio framework and disclosure requirements - January 2014
· The standardized approach for measuring counterparty credit risk exposures - March 2014
· Capital requirements for bank exposures to central counterparties - April 2014
· Supervisory framework for measuring and controlling large exposures - April 2014
· Revisions to the securitization framework - December 2014
· Minimum capital requirements for market risk - January 2016
The various functions that are encompassed as part of OFS Basel Regulatory Product are as follows:
Credit RWA is the calculation of Non-securitization RWA.
This includes the portfolio of banking and investment for the non-securitized exposures and securitization portfolio for the securitization positions. The application complies with the standardized approach and IRB approach of the credit risk calculations.
A few processes such as Credit Rating, Party Type Reclassification, and Mitigant Data Population are common between. Credit RWA and Counterparty Credit RWA.
This also includes the settlement risk calculation about the unsettled transactions depending on the number of days they are unsettled.
Counterparty Credit RWA is the calculation of the counterparty credit risk exposures. This includes the derivative portfolio and the Securities and Financing transaction portfolio. This also includes the exposures in both banking book and trading book.
A default fund contribution refers to the funds contributed, or commitments made by a clearing member to a Central Counterparty’s (CCP) equalized loss-sharing agreement. The purpose of such default funds is to provide capital, in addition to the collateral posted by participants and in addition to capital provided by the clearinghouse, as a safeguard against extraordinary losses that might occur in connection with. The application also helps in the computation of the default fund related capital charges.
The mark to market counterparty credit losses or the spread migration risk is captured with CVA, which was not directly capitalized before. CVA is the difference between the risk-free portfolio value and the true portfolio value that takes into account the possibility of the counterparty’s default. In other words, CVA is the market value of counterparty credit risk.
The application calculates CVA Charge for the OTC portfolio of a bank. When using the standardized approach, it is calculated at the portfolio level and for the advanced approach, it is calculated at the counterparty level. CVA Charge does not apply to the trades with the central counterparty and structured finance transactions. Structured financial transactions are applicable only if the supervisor specifically mentions the same.
The application also complies with the required calculations for the securitization portfolio. This is dependent on the revised guidelines for securitization, which focused on addressing the shortcomings of the existing guidelines. This calculation complies with the underlying securitization being part of the banking portfolio and being part of either bank’s assets or assets of other banks.
The Basel Committee had introduced Market Risk Capital Charge calculation in 1996 as an amendment to the earlier Basel accord by considering the risk borne by a financial institution having exposures in the trading book. BIS defines Market Risk as “the risk of losses in the on and off-balance-sheet positions arising from movements in market prices”. It is the risk that arises out of the adverse movements of the market factors. Market risk consists of the risk borne by the bank due to the positions in its trading book.
As per the Basel accord, “Operational Risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events”. External losses can occur due to theft of information or hacking of systems. The Basel accord has prescribed three methods for calculating Operational Risk capital charges and banks can use any of these methods to calculate capital charge:
· Basic Indicator Approach
· Standardized Approach
· Alternative Standardized Approach
During the economic crisis, the global banking system had an insufficient level of high-level quality capital. During the crisis, it was identified that there was inconsistency in the definition of capital across jurisdictions and lack of disclosure. To address this issue of inconsistency, the Basel committee has prescribed a new definition of capital to strengthen the global capital framework under Basel III.
As per the new definition in the Basel III accord, total capital consists of some of the following elements:
· Tier1 Capital that consists of
· Common Equity Tier 1
· Additional Tier 1
· Tier 2 Capital
Capital Buffer is calculated after the calculation of Capital Ratios, as they go as an input to Buffer calculation. The application complies with the various buffer calculations of Capital Conservation Buffer, Countercyclical Buffer, and GSIB Buffers.
The large exposure framework is a framework detailing how the banks have to manage their exposures to various parties both at the individual level, as well as to the group of connected clients’ level.
The large exposure framework has to have complied with the bank at both solo and consolidated level. As part of the solo execution, the bank has to identify its large exposures and comply within the required threshold limit. And as part of the consolidation execution, the bank has to identify the total large exposures at the consolidated level and comply within the required threshold limit.
The solo and consolidation are as per the regulatory definition, and the same as the one which is being used for the regular capital adequacy.
The large exposures are identified based on the comparison of the total individual party’s exposures to the Tier 1 Capital, which changes based on whether it is a solo execution or consolidation execution.
During the financial crisis, banking institutions built-up excessive on-balance sheet and off-balance sheet leverage which forced the banking sector to reduce its leverage. To prevent the building of excessive leverage on the institutions’ balance sheet, the BIS has introduced a non-risk-based leverage ratio which is a new regulatory tool supplementing risk-based capital requirement. The application calculates the leverage ratio for a reporting bank. The minimum required leverage ratio is 3%.
The leverage ratio is calculated by dividing an institution’s Tier 1 capital measure by the total leverage exposure measure.
