Revised Process Document May 2013.pdf

Revised Process Document for

SRP-SREP Dialogue on ICAAP (Implementation of 2nd Pillar of Basel II)

May 2013

Bangladesh Bank

Basel-II Implementation Cell, Banking Regulation and Policy Department, Bangladesh Bank www.bb.org.bd

Basel II Implementation Cell Banking Regulation & Policy Department Head Office

1

INTRODUCTION

Supervisory Review Process (the Second Pillar of Basel-II and III) of Risk Based

Capital Adequacy Framework is intended not only to ensure that banks have adequate capital

to support all the risks in their business, but also to encourage banks to develop and use better

risk management techniques in monitoring and managing their risks. The key principle of the

supervisory review process (SRP) is that “banks have a process for assessing overall capital

adequacy in relation to their risk profile and a strategy for maintaining their capital at an

adequate level”. Banks must be able to demonstrate that chosen internal capital targets are

well founded and that these targets are consistent with their overall risk profile and current

operating environment. Bank management will clearly bear primary responsibility and Board

of Directors hold the tertiary responsibility for ensuring that the bank has adequate capital to

support its risks. The main aspects of a rigorous review process are as follows:

a) Board and senior management oversight,

b) Sound capital assessment,

c) Comprehensive assessment of risks,

d) Monitoring and reporting and

e) Internal control review.

A sound and vibrant SRP for a bank requires three layer structure:

i) Strategic Layer: The audit committee of board will be responsible on behalf of the

Board of Directors to implement SRP in banks. The committee will monitor the managerial

layer. The agenda of each meeting of the audit committee must include the SRP

implementation in bank.

ii) Managerial Layer: Banks must have an exclusive body naming SRP team which

will be constituted by the concerned departmental heads of a bank and headed by Managing

Director. The formation and modification of SRP team and it’s terms of reference (ToR) must

be approved by the Board of Directors and to be notified to Bangladesh Bank. The SRP must

meet at least bi-monthly to monitor the implementation of SRP. Banks must have also a

document (called Internal Capital Adequacy Assessment Process-ICAAP) for assessing their

overall risk profile, and a strategy for maintaining adequate capital. This document is also to

be approved by the Board of Directors.

iii) Operational Layer: The banks must have an operational unit in this respect which

will be responsible for collecting information from concerned departments and branches,

regulatory correspondences, compiling the required calculations of ICAAP reporting and the

tasks assigned by the SRP team.

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Supervisory Review Evaluation Process (SREP) of Bangladesh Bank includes

dialogue between BB and the bank’s SRP team followed by findings/evaluation of the bank’s

ICAAP. Principles of SREP include-

1. The review and evaluation of banks’ ICAAP and strategies, as well as their ability

to monitor and ensure their compliance with minimum Capital Adequacy Ratio

(CAR).

2. The banks are expected to operate above the minimum regulatory capital ratios

and should have the ability to require banks to hold capital in excess of the minimum.

3. The regulatory intervention at an early stage to prevent capital from falling below

the minimum levels required to support the risk profile of a particular bank and will

take rapid remedial action if capital is not maintained or restored.

SRP-SREP dialogue stands for an exclusive meeting between the SREP team of BB

and SRP team of a bank. The objective of the dialogue is to determine the adequate level of

capital needed for a bank by reviewing the ICAAP and strategies of the bank. The dialogue

aims to review the process by which a bank assesses its capital adequacy, risk position,

resulting capital levels, and quality of capital held. The intensity and frequency of the

dialogue depends on the level of complexity and magnitude of the banks’ activities as well as

the difference between the capital requirements assessed by the bank and BB. Terms of

reference of the dialogue will be:

(1) Minimum capital requirement against credit, market and operational risks.

(2) Risks to be covered under SRP e.g. residual risk, concentration risk, interest rate

risk in the banking book, liquidity risk, reputation risk, strategic risk, settlement risk,

appraisal of core risk management practice, environmental and climate change risk as

well as other material risks,

(3) Adequate capital against comprehensive risks.

(4) Stress testing exercises and results.

To facilitate the overall process, the banks must submit their ICAAP reporting

(reporting format and the list of supplementary documents to be submitted are given in

Annexure 12 and 1) to Banking Regulation and Policy Department in both hard and soft

format within May 31 of every year. The ICAAP reporting must be approved by the Board of

Directors of the banks before submitting to BB. The information provided in the ICAAP

reporting will verified by Inspection Departments of BB.

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RESIDUAL RISK Risk Based Capital Adequacy (RBCA) framework and other supervisory regulations

on credit risk management allow banks to offset credit or counterparty risk with collateral

along with the legal and financial documents. While banks use different techniques to reduce

their credit risk, improper application of these techniques give rise to additional risks that may

render the overall risk management less effective. Accordingly, these additional risks (e.g.

documentation risk, valuation risk) are termed as Residual Risks. Apart from the capital

maintained against credit risk under Pillar 1 (Minimum Capital Requirement) of RBCA,

additional capital requirement is to be estimated against different aspects of residual risk

related to the loans & advances portfolio of banks.

In the context of Bangladesh, Bangladesh Bank (BB) has observed that Residual Risk

arises mainly out of the following situations:

1. Error in Documentation

2.

: Banks collect and preserve documents against loans and

advances to have legal protection in case of adverse events like default of loan. Lack of

required and duly filled-up documents and erroneous or fake or forged documents will lead to

the amplification of overall risk aspects of loan portfolio and the reduction in the strength of

legal shield that slacks the ownership of the bank on collateral and consequently hinders the

recovery of loan.

Error in valuation of collateral: Banks require appropriate valuation of collateral

(both physical1

i. Provision (general/specific) kept against the loan,

and financial) and guarantee (bank guarantee and personal guarantee) against

loans and advances for mitigation of default probability. The improper valuation or

overvaluation of collateral can lead to overstated scenario of risk mitigation for collateralized

loan. That will raise the default probability of the loan.

For computing capital charge against residual risk, first considerable issue is to

determine base for capital charge of a particular loan account. For determining the base for

capital charge, following factors are to be adjusted with the outstanding amount of any loan

account:

ii. Minimum capital already maintained under Pillar I,

iii. Value of Collateral (Qualified financial collateral)

Computation of Capital Charge against Residual Risk:

1 ‘Physical Collateral’ refers to land, building, apartment, moving vehicles, machineries.

Capital charge for each account

of loans and advances has to be calculated separately at branch level which will be

consolidated at head office level. Banks must preserve the records of capital calculation in this

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regard in both branches and head office which will be verified by BB inspection team. Capital

charge will be the multiplied value of base for capital charge and factor weight for

documentation error or valuation error. The factor weight will be at the rate of existing

minimum CAR set by Bangladesh Bank from time to time.

To avoid duplication in capital calculation, when capital charge is imposed for error in

documentation on a loan account, no capital charge is required for error in valuation of

collateral on that loan account. Yet, if any loan account contains error in valuation of

collateral, prudent measures will be taken by the Bangladesh Bank depending on the gravity

of the error.

The accounts which are fully covered2 by qualified financial collateral (defined and

listed in Annexure-3) that are properly executed3

The calculation methodology

in favor of bank will not be considered for

capital charge. Moreover, written off loans will not be considered for capital charge in this

regard.

A standard documentation checklist is put into Annexure-4. If any loan account lacks

any or more duly filled-up document specified in the checklist or any or more document of

any loan account is found in erroneous or fake or forged shape, that loan account must be

considered for capital charge.

For loan accounts covered by collateral and free from documentation error, valuation

of collateral will be the key consideration. If overvaluation of collateral of any loan account is

identified, that account must be reckoned for capital charge. In this regard, each scheduled

bank must have own valuation methodology for all types of collateral (physical and

financial) which is to be approved by the Board of Directors. Banks will be required to

maintain additional capital to minimize valuation error if they do not have own valuation

methodology. 4

Base for Capital Charge = Outstanding Amount - Provision (General/Specific) - Minimum

Capital Requirement

for capital charge against residual risk is as follows:

5 -Value of qualified financial collateral6

Capital requirement for each loan account will have to be summed up for determining

total capital charge against residual risk that will be reported during ICAAP reporting.

.

Capital Requirement against Residual Risk = Base for Capital Charge × Factor weight for

documentation error or valuation error.

2 ‘Fully covered’ means the value of collateral equals the outstanding amount of loan. 3 ‘Properly executed’ document refers to properly lien marked document. 4 Sample calculation demonstration is in Annexure-5. 5 MCR of any loan account= Outstanding amount × Corresponding risk weight × Minimum CAR set by BB 6 It is applicable when the value of qualified financial collateral is less than the outstanding amount of loan.

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CONCENTRATION RISK Concentration risk arises when any bank invests its most or all of the assets to single

or few individuals or entities or sectors or instruments. That means when any bank fails to

diversify its loan and investment portfolios, concentration risk emerges. Downturn in

concentrated activities and/or areas may cause huge losses to a bank relative to its capital and

can threaten the bank’s health or ability to maintain its core operations. In the context of

Pillar-2, concentration risk can be of following two types:

I. Credit Concentration Risk: When the credit portfolio of a bank is concentrated

within a few individuals or entities or sectors, credit concentration risk arises.

II. Market Concentration Risk: When the investment portfolio of a bank is

concentrated within a few instruments or any instrument of few companies or any

instrument of few sectors, market concentration risk arises.

I. Assessment of Credit Concentration Risk:

1. Sector

To assess the credit concentration risk,

following aspects of bank’s loan portfolio will be considered: 7

2. Group

wise exposure, 8

3. Single borrower wise exposure (Outstanding amount more than),

wise exposure (Outstanding amount more than),

4. Top borrower wise exposure (Top 10-50 borrowers will be counted)

II. Assessment of Market Concentration Risk:

1. Instrument (financial securities) wise investment

To assess the market concentration risk,

following aspects of a bank’s investment portfolio will be evaluated: 9

2. Sector

, 10

3. Currency wise investment of foreign exchange portfolio.

wise investment in listed instruments,

As there is no unanimously agreed tools to measure the concentration risk, following

indicators11

(a) Herfindahl Hirschman Index (HHI),

will be applied on the above stated aspects (except top borrower wise exposure)

for having comparative picture:

7 List of sectors is given in Annexure-6. 8 Definition of group is given in Annexure-7. 9 List of Instruments is provided in Annexure-8. 10 List of sectors will be same as sector classification by Dhaka Stock Exchange and is given in Annexure-9. 11 Brief literature and calculation formula of the indicators are described in Annexure-10.

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(b) Simpson’s Equitability Index (SEI),

(c) Shannon's Index (SI),

(d) Gini Coefficients (GC)

Determination of Capital Charge against Concentration Risk: Assessing concentration

by a single indicator may lead to erroneous alley. Thus, the results of above stated indicator

for all aspects of Credit and Market Concentration Risk for any banks will be evaluated by

Bangladesh Bank. As high concentration does not always necessarily imply high risk, the

SREP team of Bangladesh Bank would apply prudence in evaluating the outputs of the

indicators. If all of at least two of the indicators show adverse result (high concentration12

12 Minimum benchmark of concentration for each indicator is shown in Annexure-10.

) for

at least three aspects, capital charge will be applied at rate of 10% of MCR on the bank

against concentration risk.

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INTEREST RATE RISK IN THE BANKING BOOK (IRRBB) IRRBB is the current or potential risk to the interest rate sensitive assets and liabilities

of a bank’s balance sheet as well as the off-balance sheet items arising out of adverse or

volatile movements in market13 interest rate. Volatile movements of market interest rate

adversely affect the value of interest rate sensitive assets and liabilities that consequentially

results in the loss of equity value.

In the context of Pillar 2, the assessment of loss of equity value due to IRRBB is vital

as this is the outcome of poor asset liability management that shows the inefficiency of the

risk management framework of the bank. Although currently in Bangladesh, there is no

efficient and active secondary market for any type of debt instrument (interest bearing

financial instrument), the evaluation of IRRBB on the basis of hypothetical scenarios is

essential for the appraisal of asset-liability management and effectiveness of the risk

management framework of a bank.

The susceptibility of banks to IRRBB can be estimated through Simple Sensitivity

Analysis and Duration Gap Analysis.

1. Calculate all on-balance sheet Rate Sensitive Assets (RSA) and Rate Sensitive

Liabilities (RSL),

The Steps for conducting Simple Sensitivity Analysis:

2. Plot the RSA and RSL into different time buckets on the basis of their maturity,

3. Calculate the maturity gap by subtracting RSL from RSA (GAP= RSL-RSA),

4. Calculating the changes in the Net Interest Impact (NII) by multiplying the

changes in interest rate with the Gap14.

1. Estimate the market value

The Steps for conducting Duration Gap Analysis: 15

2. Calculate the durations of each class of asset and the liability of the on‐balance

sheet portfolio,

of all on‐balance sheet rate sensitive assets and

liabilities of the bank/NBFI to arrive at market value of equity,

3. Arrive at the aggregate weighted average duration of assets and liabilities,

13 Market refers to the fully active efficient secondary market of interest bearing instruments like bills, bonds, debentures, commercial paper etc. 14 GapiNII ×∆=∆ 15 Market value of the asset or liability shall be assessed by calculating its present value discounted at the prevailing interest rate. The outstanding balances of the assets and Liabilities should be taken along with their respective maturity or re-pricing period, whichever is earlier.

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4. Calculate the duration GAP by subtracting aggregate duration of liabilities from

that of assets,

5. Estimate the changes in the economic value of equity due to change in interest

rates on on‐balance sheet positions along with the three interest rate changes,

6. Calculate surplus/ (deficit) on off‐balance sheet items under the interest rate

change,

7. Estimate the impact of the net change (both for on‐balance sheet and off‐balance

sheet) in the market value of equity on the capital adequacy ratio (CAR),

(A brief literature on Duration Gap Analysis and the concerned mathematical

formulas are placed into Annexure-11)

As long as any efficient, vibrant and active secondary market for any debt instrument

would be not established, capital charge is not required for the negative change in the value of

based on hypothetical assessment against IRRBB. When required capital charge against

IRRBB will be the loss of equity value due to changes in the market interest rate. The capital

charge will be calculated by netting off the capital charge for interest rate related instrument

under Market Risk of Pillar-1.

Yet, BB will keenly analyze the result of Simple Sensitivity Analysis and Duration

Gap Analysis of banks. If any adverse output would be observed even from hypothetical

scenarios, prudent measures will be taken by the Bangladesh Bank.

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LIQUIDITY RISK

Liquidity risk is the risk that a given security or asset cannot be traded quickly enough

in the market to prevent a loss (or make the required profit) or when a bank is unable to fulfill

its commitments in time when payment falls due. Thus, liquidity risk can be of two types: 1. Funding liquidity risk: the risk that a firm will be unable to meet its current and future

cash flow and collateral needs without affecting its daily operations or its financial

condition

2. Market liquidity risk: the risk that a firm cannot easily offset or sell a position without

incurring a loss because of inadequate depth in the market

In context of Pillar 2 (Supervisory Review Process) of RBCA, the necessity of proper

assessment and management of liquidity risk carries pivotal role in ICAAP of banks. In the

perspective of Bangladesh, identifying and monitoring the driving factors of liquidity risk is

viewed from the following aspects:

i. Regulatory Liquidity Indicators (RLIs):

- Cash Reserve Requirement (CRR),

- Statutory Liquidity Ratio (SLR),

- Medium Term Funding Ratio (MTFR),

- Maximum Cumulative Outflow (MCO),

- Advance Deposit Ratio (ADR)/Investment Deposit Ratio (IDR),

- Liquidity Coverage Ratio (LCR),

- Net Stable Funding Raito (NSFR).

ii. Bank’s own liquidity monitoring tools16

- Wholesale Borrowing and Funding Guidelines,

:

- Liquidity Contingency Plan,

- Management Action Trigger (MAT).

If any bank stands beyond or above the regulatory range in any of the RLIs stated

above thorough out the reporting year, capital charge will be imposed to the bank which will

be the multiplication of the MCR of the bank and the minimum CAR set by BB from to time.

Besides that, any adverse scenario on RLIs of any bank observed by the SREP team of BB,

required measures will be taken depending on the gravity of the adversity. Apart from that, if

any bank fails to develop any of the own monitoring tools stated above, it will be penalized by

capital charge which will be determined by the SREP team of BB.

Computation of Capital Charge against Liquidity Risk:

16 Monitoring tools suggested in “Managing Core Risks In Banking: Asset-Liability Management (ALM)” guidelines issued in 2003.

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REPUTATION RISK

Reputation risk is the current or prospective risk to earnings and capital that arise from

decline in the customer base, costly litigation due to adverse perception of the stakeholders. It

can originate from the lack of compliance with industry service standards or regulation,

failure to meet commitments, inefficient and poor quality customer service, lack of fair

market practices, unreasonably high costs and inappropriate business conduct. In a nutshell,

“reputation risk arises from the failure to meet stakeholders’ reasonable expectation of an

organization’s performance and behavior”

Reputation risk is a subset of operational risk which can adversely affect the capital

base if the driving forces of the risk turn worse. Consequentially, ICAAP of bank must

include rigorous process to measure and manage the risk. In context of Bangladesh, the key

driving forces of reputation risk in banks are the followings:

1. Credit Rating conducted by ECAIs

2.

: Credit rating of the bank in the reporting year

mapped with the BB rating grade will be assessed. If the rating grade of any bank is below 2

of BB rating grade, bank will be required to maintain additional capital which will be the

multiplication of the MCR with 20% of minimum CAR set by BB from time to time.

Internal fraud

3.

: Number of internal fraud and the total value in taka will be

evaluated. If the case is such that total value in taka from internal fraud in a year (reporting

year) cannot be recovered fully or partially by a bank, it will be required to maintain

additional capital which will be equal to the unrecovered amount.

External fraud

Banks have to formulate their own Fraud (both internal and external) Management

Process to prevent measure, manage and treat internal fraud and external fraud properly. If

any bank fails to do so, it will be penalized by capital charge which will be determined by the

SREP team of BB.

: Number of external fraud and the total value in taka will be

evaluated. If the total value in taka from external fraud in a year (reporting year) cannot be

recovered fully or partially by bank, it will be required to maintain additional capital which

will be equal to the unrecovered amount.

4. Non-payment or delayed17

17 Delayed means payment not disbursed within the agreed stipulated time according to the documents or existing rules.

payment of accepted bills (foreign & domestic):

Number of such cases and the total value in taka will be examined. If the total value in taka

from such cases in a year (reporting year) is greater than or equal to 10% of the total loans and

advances, the bank will be required to maintain additional capital charge will be imposed

11

which is the multiplication of the MCR with 20% of minimum CAR set by BB from time to

time.

5. Quality of customer service:

As there is no unanimously accepted guidance to

quantify customer service quality of the bank, no direct capital charge would be applied. BB

expects that banks will develop their own methodology to assess the quality of customer

service and conduct yearly evaluation based on that methodology. If any bank fails to do so,

the SREP team of BB will apply it’s prudence to determine capital charge for non assurance

of quality customer service.

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STRATEGIC RISK Strategic risk means the current or prospective risk to earnings and capital arising from

imperfection in business strategy formulation, inefficiencies in implementing business

strategy, non-adaptability/less adaptability with the changes in the business environment and

adverse business decisions. Strategic risk induces operational loss that consequentially

hampers the capital base.

In this context, strategic risk possesses a significant space in the ICAAP of the banks.

The stirring aspects of strategic risk in respect of Pillar 2 of RBCA are as follows:

1. CAMELS rating

2.

: CAMELS rating report prepared by BB will be considered. If the

rating of any bank falls below 2, banks will be required to maintain additional capital which

will be the multiplication of the MCR with 10% of minimum CAR set by BB from time to

time.

Operating expenses

3.

: Operating expenses as % of operating income will be

examined. If this percentage exceeds 45% for any bank, it will required to maintain additional

capital which will be the multiplication of the MCR with 10% of minimum CAR set by BB

from time to time.

Classified loans ratio

4.

: Classified loans as % of total outstanding loans will be

evaluated. If this percentage exceeds 5% for any bank, it will be required to maintain

additional capital which will be the multiplication of the MCR with 10% of minimum CAR

set by BB from time to time.

Recovery of classified loan

5.

: Classified loan recovery as % of total classified loans

will be assessed. If this percentage falls below 20% for any bank, it will be required to

maintain additional capital which will be the multiplication of the MCR with 10% of

minimum CAR set by BB from time to time.

Written-off Loans

6.

: Classified loan recovery as % of total classified loans will be

assessed. If this percentage falls below 20% for any bank, it will be required to maintain

additional capital which will be is the multiplication of the MCR with 10% of minimum CAR

set by BB from time to time.

Interest Waiver:

7.

Interest waiver as % of total classified loans will be evaluated. If

this percentage exceeds 5% for any bank, it will be required to maintain additional capital

which will be the multiplication of the MCR with 10% of minimum CAR set by BB from

time to time.

Cost of Fund: Banks must develop their own methodology of calculating weighted

average cost of fund for their business and submit that along with the SRP reporting. If any

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bank fails to do so, it will require maintaining additional capital which will be determined by

the SREP team of BB. To determine the cost of fund, the bank must consider the following

components:

i. Cost of Deposit,

ii. Operating/Administrative Cost,

iii. Cost of Equity,

iv. Cost of Lending.

8. Strategic Plans:

i. Deposit growth plan,

Apart from the quantifiable aspects, strategic risk assessment

process requires the following elements:

ii. Loans/advances growth plan,

iii. Profit growth plan.

Banks must prepare these for at least 3 year time span which will be based on sufficient

justification. If any bank fails to prepare any of the above stated document, it will require

maintaining additional which will be determined by the SREP team of BB.

9. Rescheduling of loans and advances:

According to the BRPD Circular No.

15/2012 dated 23.09.2012, no loans can be rescheduled for more than 3 times. If any bank

reschedules any of the loan accounts for more than 3 times, capital charge will imposed

against that loan account by netting of provision, MCR, value of qualified financial collateral

and capital charge against residual risk. Capital charge will be imposed at the rate of 10% on

the residual amount after netting off.

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SETTLEMENT RISK Settlement risk arises when an executed transaction is not settled as the standard

settlement system suggests or within predetermined method. The banks pose to the risk when

it fulfills its contractual obligations (payment or delivery), but the counterparty fails or

defaults to do the same. Non-receiving or delayed18

18 Delayed means payment not realized within the agreed stipulated time according to the documents or existing rules.

receiving of receivable bills (foreign &

domestic) will be evaluated to assess settlement risk. Number of such cases and the total value

in taka will be examined. If total value in taka from such cases in a year (reporting year)

equals at least 10% of the total loans and advances, capital charge will be imposed which is

the multiplication of the MCR with 10% of minimum CAR set by BB from time to time.

As reputation risk, strategic risk and settlement risk are part of operational risk, to

avoid duplication in capital calculation, if sum of capital charge against reputation risk,

strategic risk and settlement risk becomes greater than the capital charge against operational

risk under Pillar 1, netting off the capital charge will be required. In this case, capital charge

against operational risk will be deducted from the sum of capital charge against reputation

risk, strategic risk and settlement risk to calculate additional capital requirement under Pillar

2.

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APPRAISAL OF CORE RISK MANAGEMENT PRACTICE Bangladesh Bank introduced core risk management system for assessing the risk management

environment and practices in banks in 2003. In that respect, BB identified 6 (six) risk areas

which are termed as core risks through issuing industry best practices framework. Those

frameworks provided benchmark to be followed by the banks and suggested the banks to

develop own assessment methodology for each core risks as well as to calculate own risk

rating at least once a year. Thus, rigorous risk management framework of banks would require

own assessment methodology and annual review. To ensure the stability of the business

model and the soundness of the operational structural, appraisal of risk management structure

of a bank is necessary. In this respect, banks must develop their own methodology for

assessing each core risk separately which will be approved by Board of Directors. Based on

these approved methodologies, each bank will conduct rigorous review on annual basis and

derive rating for each risk. Based on these approved methodologies, BB appraisal process will

evaluate the risk ratings of the banks and capital charge will be imposed for the below

“Satisfactory” ratings. The capital charge19

• Capital charge will be applied for each risk separately,

against Appraisal of Core Risk Management

Methodology will be as follows:

• No capital charge will be imposed for risk ratings of 1 (Strong) and 2 (Satisfactory),

• For risk ratings of 3 (Fair), 4 (Marginal) and 5 (Unsatisfactory); capital charge will be

derived by multiplying the MCR with 15% of minimum CAR set by BB from to time.

If any bank fails to develop its own assessment methodology for each core risks and to

conduct annual review, it will require maintaining additional capital for regulatory non-

compliance. This additional capital will be in excess of the capital charge against Appraisal of

Core Risk Management Methodology. Apart from that, core risk ratings of Inspection

Departments of BB20

19 See example in Annexure-12. 20 Inspection Departments of BB refers to Department of Banking Inspection-1, 2 & 3; Bangladesh Financial Intelligence Unit, Department of Foreign Exchange Inspection.

will also be considered during the process. If any adverse deviation

observed between two ratings i.e. rating of BB inspection and that of bank’s evaluation,

supervisory discretion would be applied to determine capital charge in this context.

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ENVIRONMENTAL AND CLIMATE CHANGE RISK Environmental and climate change risk refers to the uncertainty or probability of

losses that originates from any adverse environmental or climate change events (natural or

manmade) and/or the non-compliance of the prevailing national environmental regulations.

This is a facilitating element of credit risk arising from environmental issues. These can be

due to environmental impacts caused by and / or due to the prevailing environmental

conditions. These increase risks as they bring an element of uncertainty or possibility of loss

in the context of a financing transaction. Environmental and climate change risk can hamper

the business stability of the borrowers in respect of both- i) profitability and ii) reputation.

Consequentially, the extent of risk for the banks will be higher.

To evaluate this risk, Sector Environmental Due Diligence (EDD) Check List

specified in Guidelines on Environmental Risk Management (ERM) issued vide BRPD

Circular No. 01/2011 dated 30/01/2011 will be used. For the loans under the sectors specified

in the guidelines and which will have EnvRR21

21 EnvRR- Environmental Risk Raitng

of ‘High (H)’will be considered for the capital

charge against this risk. Base for capital charge will be:

Outstanding Amount - Provision (General/Specific) - Minimum Capital Requirement-

Value of qualified financial collateral- Capital Charge against Residual Risk (if any)- Capital

Charge against Strategic Risk (if any).

Bank will require maintaining additional capital at the rate of 10% on the base for

capital charge.

If 50% or more of the loans which are eligible for EnvRR are found unrated in the

reporting year, the SREP team of BB will determine the additional capital charge appropriate

for the bank.

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OTHER MATERIAL RISK SRP requires that the bank’s internal capital allocation process should cover all risks

which have not been identified earlier but are material for the institution. The institution needs

to consider all risks not specified above but it can be captured in the institution’s operation

and can be regarded as material. Risks may be appeared which are specific to the institution

and derived from its non-standard activities or clientele but fall outside the scope of specified

risk definitions under Pillar 1 and 2. The institution is free to use its own terminology and

methodology to identify and charging capital for other material risks, although it should be

able to explain these to BB in detail, along with the related risk measurement and

management procedures. The responsibility of bank is to map out other relevant risk factors to

elaborate an adequate risk identification mechanism. The institution needs to examine the

materiality of the identified risk and the result of the assessment. In the context of an

institution’s activities, all risks which affect the achievement of business objectives should be

considered material. Other risks (such as Accounting Risk, Human Resources Risk, Natural

Disaster Risk) are usually difficult or impossible to quantify, thus their measurement and

management typically call for qualitative methods. Therefore, institutions are advised to

elaborate detailed methodologies for their evaluation and management which enable the

revealing of risks and help to keep them under control. BB would take a stand on this matter

in during SRP-SREP dialogue on the basis of submitted documentation.

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CAPITAL PLANNING

Capital planning is a dynamic and ongoing process that, in order to be effective, is

forward-looking in incorporating changes in a bank’s strategic focus, risk tolerance levels,

business plans, operating environment, or other factors that materially affect capital adequacy.

Capital planning assists the bank’s Board of Directors and senior management to:

i) identify risks, improve their understanding of the bank’s overall risks, set risk

tolerance levels, and assess strategic choices in longer-term planning,

ii) identify vulnerabilities such as concentrations and assess their impact on capital,

iii) integrate business strategy, risk management, capital and liquidity planning

decisions, including due diligence for a merger or acquisition,

iv) have a forward-looking assessment of the bank’s capital needs, including capital

needs that may arise from rapid changes in the economic and financial environment.

The most effective capital planning considers both short- and longer-term capital

needs and is coordinated with a bank’s overall strategy and planning cycles, usually with a

forecast horizon of at least five years. Banks need to factor events that occur outside of the

normal capital planning cycle into the capital planning process; for example, a natural disaster

could have a major impact on future capital needs.

The capital planning process should be tailored to the overall risk, complexity, and

corporate structure of the bank. The bank’s range of business activities, overall risks and

operating environment have a significant impact on the level of detail needed in a bank’s

capital planning. A more complex institution with higher overall risk is expected to have a

more detailed planning process than an institution with less complex operations and lower

risks. While the exact content, extent, and depth of the capital planning process may vary, an

effective capital planning process includes the following components:

1. Identifying and evaluating risks

2. Setting and assessing capital adequacy goals that relate to risk

3. Maintaining a strategy to ensure capital adequacy and contingency planning

4. Ensuring integrity in the internal capital planning process and capital adequacy

assessments.

Banks are required to submit capital growth plan22

22 Format for Capital Growth Plan is provided in Reporting Format

of next 5 (five) years as part of their

ICAAP reporting to Bangladesh Bank. The capital growth plan must be well justified and

approved by the Board of Directors.

19

STRESS TESTING

Impact on capital of stress testing will be detected through stress testing and it would

be included in risk profile of a bank. The comparison between the regulatory capital

(minimum as well as adequate) requirement and the results of stress testing of the banks

would be made. Stress test is used to measure the vulnerability or exposure to the impacts of

exceptional, rare but potentially occurring events like - interest rate changes, exchange rate

fluctuations, changes in credit rating, events which influence liquidity, etc. The following

methods can be employed for measuring the impact of the above factors in an SRP context:

a) Simple sensitivity tests determine the short-term sensitivity to a single risk factor,

b) Scenario analyses involve risk parameters (with low but positive probability)

which change along a pre-defined scenario and examine the impact of these parameters.

As a starting point the scope of the stress test may be limited to simple sensitivity

analysis. Following different risk factors can be identified and used for the stress testing :

a) interest rate,

b) forced sale value of collateral,

c) non-performing loans (NPLs),

d) share prices,

e) foreign exchange rate and

f) liquidity

Stress test shall be carried out assuming three different hypothetical scenarios:

a) Minor level shocks: These represent small shocks to the risk factors. The level for

different risk factors can, however, vary.

b) Moderate level shocks: It envisages medium level of shocks and the level is

defined in each risk factor separately.

c) Major level shocks: It involves big shocks to all the risk factors and is also

defined separately for each risk factor.

20

ANNEXURE- 1: Supplementary Documents

(1) Internal Audit Report of bank,

(2) Capital growth plan,

(3) Valuation methodology,

(4) Assessment Procedure and evaluation report of Each Core Risk,

(5) Wholesale Borrowing and Funding Guidelines,

(6) Liquidity Contingency Plan,

(7) Management Action Trigger (MAT),

(8) Fraud Detection and Management Process,

(9) Methodology of assessing customer service and Evaluation report

(10) Methodology for calculating weighted average cost of fund,

(11) Deposit growth plan,

(12) Loans/advances growth plan,

(13) Profit growth plan,

(14) Stress Testing Report (Soft copy),

(15) Copy of the Board Resolution through which the Statements on ICAAP under

Supervisory Review Process have been approved.

21

ANNEXURE-2: Qualified Financial Collateral

In the context of Pillar 2, following instruments/items will be treated as Qualified

Financial Collateral:

1. Cash,

2. Fixed Deposit Receipt (FDR)/Mudarabah Term Deposit Receipt (MTDR),

3. Gold,

4. Treasury Bill,

5. Treasury Bond,

6. Savings Certificate,

7. Any other financial instrument which is readily encashable in full value.

22

ANNEXURE-3: Documentation Checklist “Documentation” should be viewed as a process of ensuring shield against risk of non-

repayment of loan comprehensively in 03 (three) dimensions:

i) The Type of Borrower

ii) The Type of Loan or credit facilities &

iii) The Type of Security Arrangement

General Documents:

1. Demand Promissory Note

In General, required papers and documents to be obtained/maintained

irrespective of type of borrower, loan and security are:

2. Letter of Authority

3. Letter of Arrangement

4. Letter of Disbursement

5. Letter of Revival

6. Personal Networth statement

7. Copy of National ID

8. Credit Approach in Business Pad of the Borrower

9. Credit Application in prescribed format duly filled in

10. Photograph of the Borrower

11. Up to date CIB Report

12. Credit report of the Borrower/Supplier

13. Liability Declaration of the borrower along with an Undertaking that they have no

liability with any bank or financial institution excepting as declared.

14. Undertaking stating that, they will not avail any credit facility from any other bank or

financial institution without prior consent of the bank.

15. Undertaking stating that customer does not have any relationship as Director or

Sponsor with the bank.

16. Undertaking stating that customer shall not sell or transfer the ownership of the

business/factory/shop until bank dues are fully paid or without NOC of the bank.

17. Credit Risk Grading Score Sheet (CRGS)

18. Post-dated cheque covering the credit facility

19. Acceptance of the Borrower to the Sanction Letter

20. Proper Stamping

23

A. As per type of Borrower:

Specific Charge Documents and Papers to be obtained:

SL Type of Borrower Document 1. Individual Borrower : • Letter of Guarantee of a Third Person

• Personal Net-Worth Statement (PNS) of Guarantor • Personal Net-Worth Statement (PNS) of the Borrower • Letter of Guarantee of the Spouse of the Borrower

2. Proprietorship Firm : • Trade License (up to date) • Personal Net-Worth Statement (PNS) of Proprietor

3. Partnership Firm : • Trade License (up to date) • Partnership Deed (Registered) • Letter of Guarantee of the partners • Personal Net-Worth Statement (PNS) of Partners • Letter of Partnership. • Partnership Account Agreement.

4. Limited Company : • Trade License (up to date) • Memorandum & Articles of Association (Certified by RJSC) • List/Personal profile of the Directors • Certificate of Incorporation • Form XII Certified by RJSC (Particulars of Directors) • Board Resolution in respect of availing loans & execution of

document with Bank • Letter of Guarantee of the Directors • Personal Net-Worth Statement (PNS) of Directors • Deed of Mortgage & Hypothecation for creation of Charge

on fixed & floating assets (existing & future) with RJSC • Modification of charge with RJSC through form 19. • Certified copy of charge creation certificate from RJSC • Undertaking stating that the borrower shall not make any

amendment or alteration in Memorandum & Article of Association without prior approval of Bank.

• Approval of the Bank for any inclusion or exclusion of Directors in & from the company

• Certificate of Commencement (In case of Public Limited Company)

• Joint venture Agreement (In case of Joint Venture company) • BOI Permission (In case of Joint venture company)

24

B. As per type of Loan / Credit facility:

SL Type of Loan Document 1. CC (Hypo) : • Letter of Hypothecation of stock in Trade

• Supplementary Letter of Hypothecation • IGPA to sale Hypothecated goods • Letter of Continuity • Periodical Stock Report • Letter of Disclaimer form the owner of rented Warehouse • Insurance Policy cover note

2. CC (Pledge) : • Letter of Pledge • IGPA to sale Pledged goods • Letter of Continuity • Periodical Stock Report • Letter of Disclaimer form the owner of rented Warehouse • Insurance Policy cover note

3. Overdraft (General)

: • Letter of Continuity • Insurance Policy cover note

4. SOD (Work Order)

: • Bid Document/ Tender Notice • Letter of Awarding • Assignment of Bills against work order

5. SOD (FO) : • The Financial Instrument duly discharged on the Back • Lien on the Financial Instrument • Letter of Continuity

6. SOD (Scheme Deposit)

• Lien on the Scheme Deposit • Letter of Continuity

7. Term Loan : • Term Loan Agreement • Letter of Installment • Letter of Undertaking • Amortization Schedule • Insurance Policy cover note

8. Home Loan for purchase of Flat or Floor Space

: • Power of attorney for developing the property • Letter of Installment • Letter of Undertaking • Amortization Schedule • Letter of Allotment of Flat or Floor Space • Tripartite Agreement among Purchaser, Developer and Bank (If

under construction) • Undertaking of the borrower to the effect that he will mortgage the

flat/floor space favg the Bank at the moment the same is registered in his name by the seller.(If Under construction)

• Agreement between Land Owner & Developer • Sharing Agreement between Land Owner & Developer • Copy of approved plan of construction from concerned authority.

9. Consumers’ loan/ Personal Loan

: • PNS of the Borrower • PNS of the Guarantor • Letter of Guarantee of the Guarantor • Letter of Guarantee of the Spouse of the Borrower

25

• Insurance Policy cover note 10. SME/Small Loan : • As per type of borrower & nature of security 11. Lease Finance : • Lease Agreement

• Lease Execution Certificate • Quotation / Price Offer duly accepted by borrower • BRTA Registration Slip (In case of Motor Vehicle) • Insurance Policy cover note

12. Hire Purchase Loan

: • Hire Purchase Agreement • Quotation / Price Offer duly accepted by borrower • BRTA Registration Slip (In case of Motor Vehicle) • Insurance Policy cover note

13. House Building Loan

: • Letter of Installment • Letter of Undertaking • Amortization Schedule • Approved Plan form the competent authority

14. House Building Loan(To Developer)

• Power of Attorney for development of property • Agreement between Land owner & Developer • Sharing Agreement between Land owner & Developer • Copy of approved plan of construction from concerned authority • Letter of Installment • Letter of Undertaking • Amortization schedule • Copy of Title deed of the property on which construction will be

made • Copy of Bia deed (previous deed in support of Title deed)

15. IDBP : • Acceptance of L/C issuing Bank (duly verified) • Letter of Indemnity

16. Guarantee Facility

: • Counter Guarantee • Bid Document or the document where requirement of Guarantee

stated 17. Syndicated Loan : • Paripassu Sharing Agreement

• Facility Agreement • Escrow Account Agreement • Creation of Paripassu Sharing charge with RJSC • Participation Letter • Subordination Agreement • Deed of Floating charge on the Balance for Escrow Account • Accepted Mandate Letter • Information Memorandum • Participant’s Commitment Letter

18. LTR : • Letter of Trust Receipt • Insurance Policy Cover note

26

C. As per Type of Security:

SL Type of Security Document 1. Corporate

Guarantee : • Corporate Guarantee of Guarantor Company on Non-Judicial

Stamp • Resolution of the Board of the Guarantor Company

(Memorandum of the Guarantor company must permit to do so.) regarding Guarantee.

2. Hypothecation of Stock/Receivables

: • Letter of Hypothecation • IGPA to sale hypothecated Stock / Receivables • Letter of disclaimer form the owner of Rented Warehouse

3. Pledge of goods in Trade

: • Letter of Pledge • IGPA to sell pledged goods • Letter of disclaimer form the owner of rented Warehouse

4. Assignment of Bill

: • Assignment of Bill by the beneficiary through IGPA • Letter of Acceptance of Assignment by the work giving

authority • Original Work Order

5. Lien on Financial Instrument like FDR etc.

: • The Instrument duly discharged on the back of it. • Letter of Lien (‘1st Party Lien’ - if the Borrower is the owner of

the Instrument, ‘3rd Party Lien’- if the Owner of the Instrument is one other than Borrower)

• Letter of Authority to encash the instrument as & when needed by the Bank

• Confirmation of Lien (Marking of Lien) from the issuing Bank. 6. Lien on Demated

Stock/Shares • NOC of the Company in case of Sponsor’s Share

• Confiscate Request Form (Form19-1) duly signed by the pledgor.

• Pledge Request form (Bye Law 11.9.3) duly signed by the holder of the share.

• Pledge setup Acknowledgement from Brokerage House • CDBL generated copy of Pledge Setup

7. Pari-Passu Security

: • Pari Passu Security Sharing Agreement among lenders. • NOC from existing lenders if the property/assets are already

under pari pasu sharing. • Certificate of RJSC on creation of charge on Fixed & floating

assets of the company. • Form XIX for modification of charge on Fixed & floating assets

with RJSC 8. Mortgage of

Landed Property : • Original Title Deed of the property

• Certified copy of Purchase Deed along with Deed - Delivery receipt duly endorsed (In absence of original Title Deed)

• Registered Partition Deed among the Co-owners (if required) • Mortgage Deed duly Registered along with Registration Receipt

duly discharged • Registered IGPA favoring Bank to sale the property • Bia Deeds of the mortgaged property • Certified Mutation Khatian alongwith DCR • Record of Rights i.e. CS, SA, RS Parcha, Mohanagar Jorip

27

parcha (if within Mohannagar Area) • B.S. Khatian • Affidavit to be sworn by the owner of the property before 1st

class Magistrate that he has valid title in the property and not encumbered otherwise

• Upto date Rent Receipt • Uptodate Municipal Tax Payment Receipt (if property within

Municipal Area) • Upto date Union Parishad Tax Payment Receipt (if property

within UP) • Approved Plan of Construction from concerned authority (if

there is any construction upon the land) • Original Lease Deed (In case of Lease hold property) • Allotment Letter favoring Lessee (in case of Leasehold

Property) • Mutation letter favoring Lessee (in case of Leasehold Property) • NOC of the competent Authority for Mortgage. • NEC along with search fee paid receipt • Board Resolution of the Mortgagor company duly supported by

the provision of Memorandum & Article of Association (when one company Mortgage for the loan of other company)

• Photograph of the Mortgaged Property • Location Map • Survey Report from professional Surveyors • Physical Visit Report by Bank Officials • Lawyer’s opinion in respect of acceptability of the property as

collateral security • Lawyer’s satisfaction certificate regarding appropriateness of

mortgage formalities

Documentation relating to Bank to Bank Loan take over process :

1. Photo copies of security documents like mortgaged property documents, Corporate

Guarantee etc.

2. Lawyers Opinion regarding acceptance of the securities

3. Liability position of the borrower from the existing bank

4. Confirmation Letter of existing bank about redemption of mortgage and handing over of

all original security deeds & documents directly after adjustment of loan through Pay

Order.

5. Undertaking of the owner of the property that they will mortgage the property after being

redeemed by existing bank.

28

ANNEXURE-4: An Illustration on Calculation of Capital Charge against Residual Risk

ABC bank has a standard corporate loan of BDT 1.00 Crore (outstanding amount) which is

unrated and partially covered by properly lien marked FDR. The value of FDR is BDT 0.40

Crore. At the time of SRP evaluation, the bank finds that the loan file lacks some documents

listed in the standard documentation checklist. So, this loan will be considered for capital

charge.

Formula for Base for Capital Charge = Outstanding Amount - Provision (General/Specific) -

Minimum Capital Requirement -Value of qualified financial collateral

Here,

Outstanding Amount = 1.00 Crore,

Provision = 1.00 Crore × 1% = 0.01 Crore

Minimum Capital Requirement (MCR) = 1.00 Crore × 125% × 10% = 0.125 Crore

Value of qualified financial collateral = 0.40 Crore

So, Base for Capital Charge = (1.00 - 0.01 - 0.125 - 0.40) Crore = 0.465 Crore

Capital Requirement against Residual Risk = Base for Capital Charge × Factor weight for

documentation error or valuation error

= 0.465 Crore × 10% = BDT 0.0465 Crore

1. ‘Standard’ loan refers to the loans defined as standard in BRPD Circular No. 14/2012

dated September 23, 2012,

Explanations:

2. As the example demonstrates a standard corporate loan, general provision will be

applied at the rate of 1% as instructed in BRPD Circular No. 14/2012 dated September 23,

2012,

3. As the loan is unrated, the risk weight is 125% and existing minimum Capital

Adequacy Ratio is 10% (Ref: Guidelines on Risk Based Capital Adequacy-December

2010, Page-12; BRPD Circular No. 10/2010 dated March 10, 2010)

29

ANNEXURE-5: Sector Classification for Credit Concentration Risk

1. RMG,

2. Textile,

3. Knitting,

4. Leather,

5. Ship Building,

6. Ship Breaking,

7. Agriculture23

8. Agro based industries,

,

9. Fuel and Power,

10. Frozen Food,

11. Pharmaceuticals,

12. ICT,

13. Banks and NBFIs,

14. Insurance,

15. NGOs and MFIs,

16. Capital Market Intermediaries,

17. Real Estate-

a. Commercial,

b. Residential.

18. Telecommunication,

19. Trading,

20. Healthcare,

21. Loans to Professional,

22. Consumer Loan,

23. Staff Loan,

24. Transportation-

a. Manufacturing,

b. Service.

25. Others

23 Agriculture includes poultry, hatchery, dairy, fishery, forestry and all primary agricultural sub industries.

30

ANNEXURE-6: Definition of Group Group of Companies: A number of companies being run under the umbrella of a

company or a group of common promoters/directors can be termed as group of companies.

Moreover, if family relation of any promoter of any company is the promoter of another

company, both of the companies will be considered in the same group.

31

ANNEXURE-7: List of Instruments

1. Deposit in Banks and NBFIs,

2. Savings Certificate,

3. Treasury Bill,

4. Treasury Bond,

5. Corporate Bond,

6. Debenture,

7. Share/Stock,

8. Others.

32

ANNEXURE-8: Sector Classification for Listed Instruments

1. Bank

2. Cement

3. Ceramics Sector

4. Corporate Bond

5. Debenture

6. Engineering

7. Financial Institutions (NBFIs)

8. Food & Allied

9. Fuel & Power

10. Insurance

11. IT Sector

12. Jute

13. Miscellaneous

14. Mutual Funds

15. Paper & Printing

16. Pharmaceuticals & Chemicals

17. Services & Real Estate

18. Tannery Industries

19. Telecommunication

20. Textile

21. Travel & Leisure

22. Treasury Bond

33

ANNEXURE-9: Indicators for Assessing Concentration Risk

1. Herfindahl Hirschman Index (HHI):

si = Share (%) of each element across the total cluster.

The Herfindahl–Hirschman Index is named after

economists Orris C. Herfindahl and Albert O. Hirschman. The formula for quantifying HHI is

as follows:

1.1.

a. HHI ≤ 0.01 indicates homogeneous concentration,

Measurement:

b. HHI > 0.01 to ≤ 0.1 indicates satisfactory concentration,

c. HHI > 0.1 to ≤ 0.18 indicates moderate concentration,

d. HHI > 0.18 indicates high concentration

2. Simpson’s Equitability Index (SEI):

Where,

Given that,

D = Diversity of elements across the cluster,

p = Proportion of the elements across the cluster,

S = Number of elements within the cluster,

Simpson’s Equitability Index (SEI) is a simple

mathematical measure that characterizes diversity of elements within a defined cluster. It is

also termed as Simpson’s Diversity Index. The formula to calculate SEI is as follows:

2.1.

a. SEI = 1 indicates equitable concentration,

Measurement:

b. SEI > 0.70 to < 1 indicates satisfactory concentration,

c. SEI > 0.30 to < 0.70 indicates moderate concentration,

d. SEI > 0 to < 0.30 indicates high concentration.

3. Shannon's Index:

Shannon's Index (SI) is another popular diversity index which is also

known as Shannon's diversity index, the Shannon-Wiener index, the Shannon-Weaver index

and the Shannon entropy. SI applies natural logarithm to assess the diversity of the elements

within a defined cluster. The formula to calculate SI is as follows:

∑=n

iisHHI 2

∑= s

iip

D2

1

SDSEI =

34

Where,

Given that,

H = Diversity of elements across the cluster,

p = Proportion of the elements across the cluster,

S = Number of elements within the cluster,

4.

3.1. Measurement:

a. SI = 1 indicates equitable concentration,

b. SI > 0.60 to < 1 indicates satisfactory concentration,

c. SI > 0.20 to < 0.60 indicates moderate concentration,

d. SI > 0 to < 0.20 indicates high concentration.

Gini Coefficient (GC):

Given that,

G = Gini Coefficient,

i = Element serial,

y = Value of element,

n = Total number of elements

The Gini coefficient (also known as the Gini index or Gini ratio)

is a measure of statistical dispersion can be used to measure the concentration among the

porfolios of a bank. GC measures the inequality among values of a data cluster. A GC of zero

expresses perfect equality, where all values are the same and a GC of one (100 on the

percentile scale) expresses maximal inequality among values. The formula to calculate GC is

as follows:

LogSHSI =

4.1. Measurement:

a. G = 0 indicates equitable concentration,

b. G > 0 to < 0 .40 indicates satisfactory concentration,

c. G> 0.40 to < 0.80 indicates moderate concentration,

d. G > 0.80 to ≤ 1indicates high concentration.

nn

n

iG n

ii

i

n

i

y

y 12

1

1 +−=

∑

∑

=

=

pi

s

ii LogpH ∑−= 2

35

ANNEXURE-10: Duration Gap Analysis Duration Gap analysis is one of the most traditional management techniques and has

been developed by banks to analyze the mismatch or re-pricing risk in the banking booki in

particular. An advantage of gap analysis is that it is a simple method, which is fairly easy to

communicate to management.

Gap analysis measures the arithmetic difference between the interest-sensitive assets

and liabilities of the banking book in absolute terms. Gap analysis shows the cash flows,

including on a cumulative basis, of a portfolio, sub portfolio or product by maturity segment

based upon the contractual maturities of financial instruments or assumptions regarding them.

Gap report shows the exposure that is released during a particular time period and the

exposure that is outstanding during a particular time period.

Using gap analysis, the earnings sensitivity of the banking book to interest rate

movements can be derived. When the value of interest-sensitive liabilities exceeds that of

interest-sensitive assets, including off-balance-sheet positions, there is a negative or liability-

sensitive gap. This means that if market interest rates rise, net interest income is adversely

affected. Conversely, a positive or asset sensitive gap means that if market interest rates fall

a. Estimate the market value of all on‐balance sheet rate sensitive assets and

liabilities of the bank/NBFI to arrive at market value of equity.

,

net interest income is adversely affected.

The vulnerability of an institution towards the adverse movements of the interest rate

can be measured by using duration GAP analysis. The banks shall follow the following steps

in carrying out the interest rate risk on net worth:

b. Calculate the durations of each class of asset and the liability of the on‐balance

sheet Portfolio.

c. Arrive at the aggregate weighted average duration of assets and liabilities

d. Calculate the duration GAP by subtracting aggregate duration of liabilities from

that of assets.

e. Estimate the changes in the economic value of equity due to change in interest

rates on on‐balance sheet positions along with the three interest rate changes.

f. Calculate surplus/ (deficit) on off‐balance sheet items under the interest rate

change.

g. Estimate the impact of the net change (both for on‐balance sheet and off‐balance

sheet) in the market value of equity on the capital adequacy ratio (CAR).

36

h. Market value of the asset or liability shall be assessed by calculating its present

value discounted at the prevailing interest rate.

i. The outstanding balances of the assets and Liabilities should be taken along with

their respective maturity or re-pricing period, whichever is earlier.

Duration is the measure of a portfolio’s price sensitivity to changes in interest rates.

Longer the duration causes larger the changes in the price for a given change in the interest

rates. Larger the coupon lower would be the duration and smaller would be the change in the

price for a given change in the interest rates.

Market Value (MVt) or

Present Value (PVt)

n = ∑ t=1

CFt

(1+YTM)t

Where - CFt = Coupon/Cash flow at time t t = remaining periods of time to maturity , YTM = the yield to maturity of the security, and n = the number of cash flows.

Yield To Maturity (YTM):

Where- CF = Coupon/Cash flow

F = Face Value

P = Purchase Price

t = Years to maturity

D =

Duration

n ∑

t=1 t×CFt

×100 =

n ∑

t=1

t×CFt

×100

(1+YTM)t (1+YTM)t

n ∑

t=1

CFt MV or PV

(1+YTM)t

Where - CFt= cash flow at time t, t = the number of periods of time until the cash flow payment, YTM = the yield to maturity of the security generating the cash flow, and n = the number of cash flows.

37

Weighted Average Duration

The duration GAP is measured by comparing the weighted average duration of assets with

the weighted average duration of liabilities (leverage‐adjusted).

DA

Weighted Average Duration of Assets(DA)

n = ∑ a=1

WaDa

Where -

Wa = value of the asset “a” divided by the Total assets

Da = duration of the asset “a”

n = total number of assets

DL

Weighted Average Duration of Liability(DL)

n = ∑ l=1

WlDl

Where -

Wl = value of the liabilities “l” divided by the Total liabilities

Dl= duration of the liabilities “l”

n = total number of liabilities “l”

Duration Gap

38

DGAP�

= DA -

�MVL� MVL�

×DL��MVA��MVA�� MVA�� MVA��

MVA��

The Changes in the

Market Value of

Equity.

Where -

Δi = The

change in the interest

rate,

y = The effective yield to maturity of Total Assets, TA = Total Assets

ANNEXURE-11: Calculation

of Capital Charge against Appraisal of

Core Risk Management Methodology

Core Risk�Rating

of Core Risk Management�Percentage�MCR�Ca

pital i t��( )

39

�60.00��ICT�1�0%��0.00��

60.00��ICT�1�0%��0.00��

�ICT�1�0%��0.00��

ICT�1�0%��0.00��

1�0%��0.00�� 0%��0.00��

�0.00�� 0.00��

40

ANNEXURE-12: Reporting Format for Submission of Statements on ICAAP under Supervisory Review Process

CONFIDENTIAL

UNDER e¨vsK †Kv¤úvbx AvBb, 1991

Statements on ICAAP under Supervisory Review Process

As on ………………………

NAME OF BANK

DATE OF SUBMISSION

Information requested in this return is required under section 13 and section 45 of Ôe¨vsK †Kv¤úvbx AvBb, 1991Õ. The return should be submitted to Bangladesh Bank within the specified date advised by Bangladesh Bank. Note. This return is to be prepared in accordance with the completion instructions issued by Bangladesh Bank. We endorse that this return is, to the best of our knowledge and belief, accurate and proper. ……………………………….. ……………………………….. Managing Director/ Chief Financial Officer Chief Executive Officer ……………………………….. ………………………………..... Name Name ……………………………….. ……………………………….. ... Chief Risk Officer Head of SRP Team ……………………………….. ………………………………...... Name Name Name and telephone number of responsible person(s) who may be contacted by Bangladesh Bank in case of any query. ……………………………….. ………………………... ………………………... Name Telephone Number E-mail:

41

(NAME OF BANK)

List of SRP Team Members

Sl. no.

Name Designation Contact No. (Direct).

e-mail adress

1 2 3 4 5 6 7 8 9 10

*** The SRP team has been formed in accordance with the board resolution no. .......... dated ......... *** Statements on ICAAP under Supervisory Review Process have been approved through the board resolution no. .......... dated.........

Sl. No. Capital Requirement(Tk. Crore)

123

0.001 0.002 0.003 0.004 0.005 0.006 0.00 0.007 0.008 0.009 0.00

0.000.00

Other material risks

Adequate Capital Requiremnt for year of -------

Residual Risk

Evaluation of Core Risk Management

Concentration Risk Liquidity Risk

A) Minimum Capital Requirement under Pillar-1

B) Additional capital required under Pillar-2 C) Total Capital Requirement (A+B) for the year 2010

Particulars of Risks

Credit Risk Market Risk Operational Risk

Reputation Risk

Settlement Risk Strategic Risk

Environmental & Climate Change Risk

Outstanding Amount of Total Loans & Advances

Outstanding Amount of Total Loans & Advances Eligible

for Capital ChargeTotal Provision (Genral &

Sepcific)

MCR against Total Loans & Advances

Total Value of Qualified Financial Collateral

Total Base for Capital Charge

Capital Requirement against Documentation Error

Capital Requirement against Valuation Error

Capital Requirement against Residual Risk

0.00

Capital Charge for Residual Risk

Sector RMG Textile Knitting Leather Ship Building Ship Breaking Agriculture Agro based Industries

Fuel and Power Frozen Food Pharmaceuticals ICT Banks and NBFIs

Insurance

AmountP2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

NGOs andMFIs

Commercial Residential Manufacturing ServiceAmount 0.00

P2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!

P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Number of Sectors 27

HHI #DIV/0!SEI #DIV/0!SI #DIV/0!

Gini Coefficient

Cluster Tk 200 crore andabove

Tk 175 crore andabove but below Tk. 200

crore


crore


crore


crore


crore


crore

Tk 50 crore andabove but below Tk.

25 crore

Tk. 25 crore and below

Total

Amount 0.00P2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Number of Clusters 9


Gini Coefficient

Sector

Credit Concentration Risk

Sector wise exposure

Group wise exposure

Loans to Professional

Consumer Loan Staff Loan Others TotalReal Estate TransportationHealthcare

Capital Charge for Concentration Risk

Capital Market Intermediaries

Telecommunication Trading

Cluster Tk 200 crore andabove


crore


crore


crore


crore


crore


crore

Tk 50 crore andabove but below Tk.

25 crore

Tk. 25 crore and below

Total

Amount 0.00P2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Number of Clusters 9


Gini Coefficient

Instrument Deposit in Banks and NBFIs

Savings Certificate Treasury Bill Treasury Bond Corporate Bond Debenture Shares Others Total

Amount 0.00P2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Number of Instruments 8


Gini Coefficient

Single borrower wise exposure

Instrument (Financial Securities) wise Investment

Market Concentration Risk

Sector Bank Cement Ceramics Sector Corporate Bond Debenture Engineering Financial Institutions (NBFIs)

Food & Allied Fuel & Power Insurance IT Sector

AmountP2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!Sector Jute Miscellaneous Mutual Funds Paper & Printing Pharmaceuticals &

Chemicals Services & Real Estate Tannery Industries Telecommunication Textile Travel & Leisure Treasury Bond Total

Amount 0.00

P2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!

P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!Number of Sectors 22


Gini Coefficient

Currency USD GBP EUR AUD JPY CAD Others TotalAmount 0.00

P2 #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!Log P #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM! #NUM!

P2 Log P #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!Number of Instruments 8


Gini Coefficient

Capital Requirement against Concentration Risk

Cluster Top 10 Borrower Top 20 Borrower Top 30 Borrower Top 40 Borrower Top 50 Borrower Other TotalAmount 0.00

Percentage #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!

Top borrower wise exposure

Sector wise Investment in Listed Instruments

Currency wise Investment of Foreign Exchange

Cash Reserve Requirement (CRR)Statutory Liquidity Requirement (SLR)Medium Term Funding Ratio (MTFR)Maximum Cumulative Outflow (MCO)Advance Deposit Ratio (ADR)Liquidity Coverage Ratio (LCR)Net Stable Funding Raito (NSFR)

Capital Requirement against Liquidity Risk

** The outputs for each of the above indicators will be the annual average.

Capital Charge for Liquidity Risk

Credit Rating of the BankCapital Charge for Credit Rating

Internal FraudNumber Total amount Unrecovred amount Capital Charge

External FraudTotal amount Unrecovred amount Capital Charge

Non-payment or delayed payment of accepted bills (foreign & domestic)Number of evidencesTotal amountCapital Charge

Capital market perceptionCategory of Listing in DSECapital Charge

Capital Charge for Quality of Customer Service

Capital Requirement against Reputation Risk

0.00

Capital Charge for Reputation Risk

CAMELS Rating of the BankCapital Charge for CAMELS Rating

Operating Expenses as % of Operating income PercentageCapital Charge

Classified loans and advancs as % of total loans and advancesPercentageCapital Charge

Classified loan recovery as % of total classified loans PercentageCapital Charge

Written-off loans as % of total classified loansPercentageCapital Charge

Interest waiver as % of total classified loansPercentageCapital Charge

Rescheduling of loans and advances more than 3 timesNumberTotal outstandingProvision (General & Specific)MCRValue of qualified financial collateralCapital Requirement against Residual RiskCapital Charge

Capital Requirement against Strategic Risk

0.00

Capital Charge for Strategic Risk

Non-receiving or delayed receiving of receivable bills (foreign & domestic)Number of evidencesTotal amountCapital Charge

Capital Requirement against Settlement Risk

0.00

Capital Charge for Settlement Risk

Core Risk Rating MCR Capital requirement

CRM 0.00ALM 0.00ICC 0.00

AML 0.00FEX 0.00ICT 0.00

0.00

Capital Charge for Evaluation of Core Risk Management

Total Capital Requirement

Outstanding Amount of Total Loans & Advances

Outstanding Amount of Total Loans & Advances Eligible

for Capital Charge

Total Provision (Genral & Sepcific)

MCR against Total Loans & Advances

Total Value of Qualified Financial Collateral

Capital Requirement against Residual Risk

Capital Requirement against Strategic Risk

Total Base for Capital Charge

Capital Requirement against Environmental & Climate

Change Risk

Capital Charge for Environmental & Climate Change Risk

Capital Charge for Other Material Risk

2013 2014 2015 2016 2017

Capital Growth Plan

General Provision (Unclassified loans + SMA + off Balance Sheet exposure)Assets Revaluation Reserves up to 50% Revaluation Reserve for Securities up to 50%Revaluation Reserve for equity instruments up to 10%

Fully Paid-up Capital/Capital lien with BB Statutory Reserve Non-repayable Share premium account General Reserve

Tier-1 (Core Capital )

Total Regulatory Capital

Other (if any item approved by Bangladesh Bank)Total Tier-2 Capital

Subordinated debt

Total Tier-1 Capital

Tier-2 (Supplementary Capital)

Retained Earnings

All other preference shares

Dividend Equalization Account Other (if any item approved by Bangladesh Bank)

Minority interest in Subsidiaries Non-Cumulative irredeemable Preferences shares

Basel-II Implementation Cell, Banking Regulation and Policy Department, Bangladesh Bank www.bb.org.bd

Revised Process Document May 2013.pdf

Documents

Transcript of Revised Process Document May 2013.pdf