RBI/2007-2008/266
DBOD.No.BP.BC
66 / 21.06.001 / 2007-08
March 26, 2008
The Chairman/
Chief Executive Officer
All Commercial banks
(Excluding Local Area Banks
and Regional Rural banks)
Dear Sir,
Supervisory Review Process
under the New Capital Adequacy Framework –Guidelines for Pillar 2
The
New Capital Adequacy Framework (NCAF), based on the Basel II Framework evolved
by the Basel Committee on Banking Supervision, has been adapted for India vide
our Circular
DBOD.No.BP.BC 90/ 20.06.001/ 2006-07 dated April 27, 2007. In this regard,
a reference is also invited to paragraph 2.4 (iii)(c) of the Annex to the aforesaid
circular in terms of which the banks are required to have a Board-approved policy
on ICAAP and to assess the capital requirement as per ICAAP. We presume that the
banks would have formulated the policy and also undertaken the capital adequacy
assessment accordingly. These guidelines are being issued by way of further guidance
to the banks.
2. The Basel II Framework has three components
or three Pillars. The Pillar 1 is the Minimum Capital Ratio while the Pillar 2
and Pillar 3 are the Supervisory Review Process (SRP) and Market Discipline, respectively.
While the guidelines on the Pillar 1 and Pillar 3 have already been issued by
the RBI vide the aforesaid circular, the guidelines in regard to the SRP and the
Internal Capital Adequacy Assessment Process (ICAAP) are furnished at Annex
- I. An illustrative outline of the format of the ICAAP document is furnished
at Annex –
II.
3. 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. This in turn would require a well-defined
internal assessment process within the banks through which they assure the RBI
that adequate capital is indeed held towards the various risks to which they are
exposed. The process of assurance could also involve an active dialogue between
the bank and the RBI so that, when warranted, appropriate intervention could be
made to either reduce the risk exposure of the bank or augment / restore its capital.
Thus, ICAAP is an important component of the SRP.
4. The
main aspects to be addressed under the SRP, and therefore, under the ICAAP, would
include:
(a) the risks that are not fully captured by
the minimum capital ratio prescribed under Pillar 1;
(b) the risks that
are not at all taken into account by the Pillar 1; and
(c) the factors
external to the bank.
Since the capital adequacy ratio prescribed
by the RBI under the Pillar 1 of the Framework is only the regulatory minimum
level, addressing only the three specified risks (viz., credit, market and operational
risks), holding additional capital might be necessary for the banks, on account
of both – the possibility of some under-estimation of risks under the Pillar 1
and the actual risk exposure of a bank vis-à-vis the quality of its risk
management architecture. Illustratively, some of the risks that the banks
are generally exposed to but which are not captured or not fully captured in the
regulatory CRAR would include:
(a) Interest rate risk
in the banking book;
(b) Credit concentration risk;
(c) Liquidity
risk;
(d) Settlement risk;
(e) Reputational risk;
(f) Strategic
risk;
(g) Risk of under-estimation of credit risk under the Standardised
approach;
(h) "Model risk" i.e., the risk of under-estimation
of credit risk under the IRB approaches;
(i) Risk of weakness in the credit-risk
mitigants;
(j) Residual risk of securitisation, etc.
It
is, therefore, only appropriate that the banks make their own assessment of their
various risk exposures, through a well-defined internal process, and maintain
an adequate capital cushion for such risks.
5. It is recognised
that there is no one single approach for conducting the ICAAP and the market consensus
in regard to the best practice for undertaking ICAAP is yet to emerge. The methodologies
and techniques are still evolving particularly in regard to measurement of non-quantifiable
risks, such as reputational and strategic risks. These guidelines, therefore,
seek to provide only broad principles to be followed by the banks in developing
their ICAAP.
6. The banks are advised to develop and put
in place, with the approval of their Boards, an ICAAP commensurate with their
size, level of complexity, risk profile and scope of operations. The ICAAP would
be in addition to a bank’s calculation of regulatory capital requirements under
Pillar 1 and must be operationalised with effect from March 31, 2008 by the foreign
banks and the Indian banks with operational presence outside India, and from March
31, 2009 by all other commercial banks, excluding the Local Area Banks and Regional
Rural banks.
7. The banks are advised to transmit to the
RBI (i.e., to the CGM-in-Charge, Department of Banking Supervision, Reserve Bank
of India, Central Office, Centre I, World Trade Centre, Cuffe Parade, Colaba,
Mumbai – 400 005) a copy of their Board-approved ICAAP document. The document
should, inter alia, include the capital adequacy assessment and projections
of capital requirement for the ensuing year, along with the plans and strategies
for meeting the capital requirement. An illustrative outline of a format of the
ICAAP document is furnished at Annex
– II, for guidance of the banks though the ICAAP documents of the banks
could vary in length and format, in tune with their size, level of complexity,
risk profile and scope of operations. The first ICAAP document should reach the
RBI not later than June 30, 2008 or March 31, 2009, as applicable, and thereafter,
before the end of March every year, covering the capital assessment and projections
for the following financial year.
Yours faithfully,
(Prashant
Saran)
Chief General Manager-in-Charge