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					              Workshop on
   Risk Management in Commercial Banks
                             September 3-7, 2007

                   Shanghai National Accounting Institute



                          DELEGATION LIST


OFFICIAL DELEGATES



AUSTRALIA
1. Bernie Egan
   Program Director
   Basel II-Policy Research and Statistics
   Australian Prudential Regulation Authority
   Tel: 612-9210-3584
   Fax: 612-9210-3021
   E-mail: Bernie.egan@apra.gov.au


BRUNEI DARUSSALAM
2. Rajali Abu Bakar
   Spacial Duties Officer, Grade I
   Financial Institution Division
   Ministry of Finance
   Tel: 673-238-4251
   Fax: 673-238-2215
   E-mail: rajali.abubakar@mof.gov.bn


CHINA
3. Hu Xuehao
   Deputy Director-General
   Fiance Department

                                                            1
   Ministry of Finance

4. Zhang Ruohan
   Deputy Director
   Finance Department
   Ministry of Finance

5. Xing Yingying
   Financial Market Department
   People’s Bank of China
   Tel: 86-10-6619-5819
   Fax: 86-10-6601-6647

6. Zhang Lixing
   Director
   International Department
   China Banking Regulatory Commission

7. Cui Yuanjian
   Deputy Director
   Financial Institution Division II
   Shanghai Municipal Office of Finance Service
   Tel: 86-21-2311-6320
   Fax: 86-21-2311-6384
   E-mail: foresight168@hotmail.com

8. Chen Yan
   Section Chief
   Foreign Trade Division
   Tianjin Municipal Finance Bureau
   Tel: 86-2223303740 ext. 2621
   Fax: 86-22-3311489
   E-mail: chenyantj621@163.com

9. Gao Jie
   Section Chief
   Tianjin Municipal Finance Bureau
   Tel: 86-22-23321287 ext. 230
   Fax: 86-22-23321287

10. Hu Jingru
    Section Chief
    Kunming Municipal Finance Bureau



                                                  2
11. Yang Jianjun
    Kunming Minicipal Finance Bureau


INDONESIA
12. S.Y. Dewi Irmawan
    Bank Supervisor
    Bank Supervision Directorate
    Bank Indonesia
    Tel: 62-21-230108 ext 4722 / 62-8189-43933
    Fax: 62-21-2311353
    E-mail: srl_yanlta@bl.go.ld

13. Edi Setijawan
    Bank researcher
    Islamic Bank Directorate
    Bank Indonesia
    Tel: 62-21-3818451 / 62-8111-40211
    Fax: 62-21-350 1989
    E-mail: e_setijawan@bl.go.ld


KOREA
14. Yoo, Jae Soo
    Director
    Banking System Division of Financial Policy Bureau
    Ministry of Finance and Economy


MALAYSIA
15. Aida Kasumawati Mohd Yatim
    Senior Executive
    Financial Conglomerates Supervision
    Bank Negara Malaysia
    Tel: 603-22635000 ext: 8256
    Fax: 603-2693-4051
    E-mail: kasuma@bnm.gov.my


PHILIPPINES
16. Charissa Panlilio Hipolito
    Director III
    Corporate Affairs Group
    Department of Finance

                                                         3
   Tel: 632-5257-427
   Fax: 632-5251-313
   E-mail: chipolito@dof.gov.ph

17. Restituto Cruz
    Deputy Director
    Bangko Sentral ng Pilipinas
    Tel: 632-306-13-52/632-536-74-35
    Fax: 632-306-14-15


RUSSIA
18. Yulia Grigorovich
    Head of Subdivision
    Banking Regulation and Supervision Department
    Central Bank of Russian Federation
    Tel: 7 -495- 957-84-10
    Fax: 7-495- 957-84-16
    E-mail: gjb@cbr.ru

19. Larisa Moskovkina
    Advisor
    Department of International Economic and Fiancial Relation
    Central Bank of Russian Federation
    Tel: 7-495-771-91-22
    Fax: 7-495-771-91-32
    E-mail: mla2@cbr.ru


THAILAND
20. Aroonsri Methisariyapong
    Economist
    Bureau of Financial System
    Ministry of Finance
    Tel: 662-273-9020 ext 3415
    Fax: 662-618-3374
    E-mail: aroonsri@mof.go.th

21. Pongrapeeporn Abhakorn
    Economist
    Fiscal Policy Office
    Ministry of Finance
    Tel: 6651234466
    Fax: 6626183374

                                                                 4
   E-mail: pongrapeeporn.a@mof.go.th


VIET NAM
22. Minh Pham Hong
    Expert
    International Cooperation Department
    Ministry of Finance
    Tel: 84-4-220 2828 ext. 7040
    Fax: 84-4-2208109
    E-mail: phamhongminh@mof.gov.vn

23. Hoa Bui Thi Phuong
    Department of Banking and Financial Institution
    Ministry of Finance
    Tel: 84-4-220-2828 ext. 7094
    Fax: 84-4-220-8020
    E-mail: buiphuonghoa@mof.gov.vn



INTERNATIONAL ORGANIZATION


WORLD BANK
24. Arvind Gupta
    Lead Specialist
    Finance and Private Sector Development in East Asia and the Pacific


APEC BUSINESS ADVISORING COMMITTEE
25. Ken Waller
    Chair
    Financial Advisory Board
    Australian APEC Study Centre


BIS
26. Alicia Garcia-Herrero
    Regional Office for Asia and the Pacific


PRIVATE SECTOR


                                                                          5
27. Chris Mouat
    Director
    China Partnerships
    Australia and New Zealand Banking Group Limited

28. Patrick Zhu
    Head of Retail Risk
    China Partnerships
    Australia and New Zealand Banking Group Limited

29. David Millar
    Chief Operating Officer
    Professional Risk Managers’ International Association

30. Guo Jun
    Secretary General
    Professional Risk Managers’ International Association China
    Tel: 86-10-6236-7872/13120278568
    Fax: 86-10-6236-6907
    E-mail: guojun@gtrm.cn/Beijing@prmia.org

31. Chen Hua
    Credit Risk Management Department
    China Development Bank
    Tel: 86-10-8830-8910
    Fax: 86-10-6833-7127
    E-mail: chenhua@CDB.com.cn

32. Liu Ruixia
    Deputy General Manager
    Risk Management Department
    Industrial and Commcial Bank of China
    Tel: 86-10-6610-6026
    Fax: 86-10-6610-6501

33. Sun Chongwei
    Regional Manager
    International Department
    Industrial and Commcial Bank of China
    Tel: 86-10-66106015
    Fax: 86-10-66106501
    E-mail: chongwei.sun@icbc.com.cn

34. Ji Hou

                                                                  6
   Director
   Auditing Center (East)
   Everbright Bank of China
   Tel: 86-21-6252-1276
   Fax: 86-21-6213-0938
   E-mail: jih@cebbank.com

35. Ren Guoqiang
    Auditing Center (East)
    Everbright Bank of China
    Tel: 86-21-6252-0306
    Fax: 86-21-6212-0938
    E-mail: rengq@cebbank.com

36. Song Xiaoping
    President
    Jinqiao Subbranch, China Merchants Bank
    Tel: 86-21-50753779
    Fax: 86-21-50753795
    E-mail: songxiaoping@cmbchina.com

37. Liu Hongfeng
    Manager
    China Merchants Bank
    Fax: 86-755-83195059
    E-mail: liuhf@cmbchina.com

38. Yin Li
    General Manager
    Risk Management Department
    Shanghai Branch, Bank of China
    Fax: 86-21-50372059
    E-mail: yinli@bank-of-china.com

39. Chen Qiqi
    Senior Manager Assistant
    Shanghai Branch, Bank of China
    Tel: 86-21-38824588 ext. 21410
    Fax: 86-21-50372059
    E-mail: chenqiqi@hotmail.com

40. Wang Shufang
    President
    Pudong Branch, Bank of Shanghai

                                              7
   Fax: 86-21-5070-1959
   E-mail: huanghq@bankofshanghai.com

41. Huang Haiqing
    Administration Assistant
    Pudong Branch, Bank of Shanghai
    Fax: 86-21-5830-5623
    E-mail: huanghq@bankofshanghai.com

42. Zhang Qingxian
    Manager
    Risk Management Department
    Pudong Branch, Bank of Shanghai
    Tel: 86-21-5830-5232
    Fax: 86-21-5830-5473
    E-mail: huanghq@bankofshanghai.com

43. Miao Jun
    Manager
    Risk Management Department
    Pudong Branch, Bank of Shanghai
    Fax: 86-21-5830-5473
    E-mail: huanghq@bankofshanghai.com

44. YE Qingyu
    Senior Risk Manager
    Shanghai Branch, Bank of Communications
    Tel: 86-21-63111000 ext. 3426
    Fax: 86-21-53856683
    E-mail: yeqy@bankcomm.com

45. Wang Zhuanhong
    Senior Credit Extension Manager
    Shanghai Branch, Bank of Communications
    Fax: 86-21-53856005

46. Huang Wen
    Manager
    Risk Management Department
    Pudong Branch, Shanghai Rural Commercial Bank
    Tel: 86-21-50588286
    Fax: 86-21-50588287

47. Liu Xiangdong

                                                    8
   President
   Chia Tai International Finance Co., Ltd.

48. Jiang Yiling
    Deputy General Manager
    Chia Tai International Finance Co., Ltd.
    Tel: 86-21-63352788
    Fax: 86-21-63351986
    E-mail: jiangyiling@ctif.com.cn

49. Bao Xiaofei
    General Manager
    Risk Management Department
    Daiwa SMBC-SSC Securities Co., Ltd.
    Tel: 86-21-6859-8000
    Fax: 86-21-6859-8030
    E-mail: Baoxiaofei@dssc2004.com

50. Tan Yonghong
    Senior Manager
    Risk Management Department
    Daiwa SMBC-SSC Securities Co., Ltd.
    Tel: 86-21-6859-8000
    Fax: 86-21-6859-8030
    E-mail: TanYongHong@dssc2004.com

51. Windiartono
    Senior Manager
    PT. Bank Rakyat Indonesia
    Tel: 62-21-5713-114 / 62-8151-854335
    Fax: 62-21-5713121
    E-mail: windiartono@bri.co.id

52. Wibowo Sulistianto
    AVP
    Risk Management Department
    PT. Bank Negara Indonesia
    Tel: 62-21-5728-039
    Fax: 62-21-2511-148
    E-mail: Wibowo.sulistianto@bni.co.id

53. Promod Dass
    Head
    Financial Institution Ratings

                                               9
   RAM Rating Services Berhad
   Tel: 6-03-7628-1790 / 60-1626-30901
   Fax: 6-03-7620 8251
   E-mail: promod@ram.com.my

54. Yin Ching Wong
    Manager
    Financial Institution Rating
    RAM Rating Services Berhad
    Tel: 6-03-7628-1717
    Fax: 6-03-7620-8251
    E-mail: yinching@ram.com.my

55. Chu Thị Minh Hà
    Deputy Director
    Credit Management Department
    The Bank of Investment and Development

56. Phùng Nguyệt Minh
    Specialist
    Capital Planning Department
    The Bank of Investment and Development

57. Nguyễn Kim Trang
    Specialist
    Capital Planning Department
    The Bank of Investment and Development

58. Phạm Quốc Trung
    Director
    Customs Service Development Department
    The joint stock bank - VP Bank

59. Đặng Tuấn Tú
    Deputy Director
    Customs Service Development Department
    The joint stock bank - VP Bank

60. Đỗ Thị Bình Giang
    Deputy Director
    ATM Center
    The joint stock bank - VP Bank

61. Phạm Thị Lan Ngọc

                                             10
   Specialist
   ATM Center
   The joint stock bank - VP Bank

62. Phan Thị Phương Thúy
    Specialist
    ATM Center
    The joint stock bank - VP Bank

63. Nguyễn Thị Bịch Lộc
    Manager
    Human Resourse and Training Department
    The joint stock bank - VP Bank

64. Nguyễn Xuân Hùng
    Specialist
    Internal Audit Department
    Vietnam Bank for Ariculture and Rural Development

65. Bùi Thị Nhung
    Deputy Director
    Department of Preventing and Management Risks
    Vietnam Bank for Ariculture and Rural Development

66. Vũ Thị Thu Huyền
    Specialist
    Board of Management Department
    Vietnam Bank for Ariculture and Rural Development

67. Cao Xuân Đông
    Deputy Director
    Credit Management Department
    Vietnam Bank for Ariculture and Rural Development - Bac Ha Branch

68. Trần Thanh Hà
    Deputy Director
    International Currency Department

69. Võ Thị Khánh Vân
    An Binh Joint Stock Bank - Hanoi Branch

70. Ngô Thị Mỹ Hương
    An Binh Joint Stock Bank - Hanoi Branch



                                                                        11
71. Trương Minh Đức
    An Binh Joint Stock Bank - Hanoi Branch

72. Nguyễn Hoàng Sơn
    An Binh Joint Stock Bank - Hanoi Branch

73. Nguyễn Băng Tâm
    VTC




                                              12
     Workshop on Risk Management in Commercial Banks

                              September 3-7, 2007
                Shanghai National Accounting Institute, P.R. China

                   Co-sponsors:
                         Ministry of Finance, P.R.China
                         Australia Treasury
                         Ministry of Finance and Economics, Korea

                   Co-organizers:
                         Asia-Pacific Finance and Development Center
                         World Bank Institute


                                PROGRAM

Monday, September 3, 2007

8:30-9:00        Registration
                 Venue: 3rd Floor, Lecture Building III
9:00-9:10        Session 1 Opening Speech
                 Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
9:10-9:30        Group PhotoTaking
9:30-10:40       Session 2 Overview of Risk Management in Banking Sector
                 Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                 Speaker: Arvind Gupta, Lead Specialist for Finance and Private
                 Sector Development in East Asia and the Pacific, the World Bank
10:40-10:50      Coffee Break
10:50-12:00      Session 3 The Present Situation and Ahead of Banking Risk
                 Management in China
                 Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                 Speaker: Zhang Lixing, Director, International Department, China
                 Banking Regulatory Commission
12:00-13:30      Lunch
                 Venue: 2nd Floor, Dinning Hall II




                                        1
13:30-15:00       Session 4 The Present Situation and Ahead of Banking Risk
                  Management in India
                  Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                  Speaker: Arvind Gupta, Lead Specialist for Finance and Private
                  Sector Development in East Asia and the Pacific, the World Bank
15:00-15:30       Coffee Break
15:30-17:00       Session 5 Implementing Risk Management – people, process and
                  systems considerations
                  Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                  Speaker: David Millar, Chief Operating Officer, PRMIA

Tuesday, September 4, 2007

9:00-10:20        Session 6 Strategies to Enhance Risk Management and Corporate
                  Governance in Commercial Banks
                  Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                  Speaker: Ken Waller, Chair of the Australian APEC Study Centre's
                  Financial Advisory Board
10:20-10:40       Coffee Break
10:40-12:00       Session 7 Building A Healthy Regulatory Framework for Risk
                  Management in Commercial Banks: Commercial bank’s perspective
                  Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                  Speakers: Chris Mouat, Director, China Partnerships, ANZ ;Patrick
                  Zhu, Head of Retail Risk, China Partnerships, ANZ
12:00-13:30       Lunch
                  Venue: 2nd Floor, Dinning Hall II
13:30-15:00       Session 8 Building A Healthy Regulatory Framework for Risk
                  Management in Commercial Banks: Regulator’s perspective
                  Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                  Speaker: Bernie Egan, Program Director, Basel II – Policy Research
                  and Statistics Australian Prudential Regulation Authority, Australia
15:00-15:30       Coffee Break
15:30-17:00       Session 9 Building A Healthy Regulatory Framework for Risk
                  Management in Commercial Banks: Rating agency’s perspective
                  Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                  Speakers: Promod Dass, Financial Institutions Rating Department,
                  Rating Agency Malaysia Bhd.; Wong Yin Ching, Manager, Financial
                  Institutions Ratings, Rating Agency Malaysia Bhd.




                                         2
Wednesday, September 5, 2007

9:00-10:30         Session 10 Building A Healthy Regulatory Framework for Risk
                   Management in Commercial Banks: Regulator’s perspective
                   Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                   Speaker: Yoo, Jae Soo, Director, Banking System Division, Financial
                   Policy Bureau, Ministry of Finance and Economy, Korea
                   Q&A
10:30-10:50        Coffee Break
10:50-12:00        Session 11 Building A Healthy Regulatory Framework for Risk
                   Management in Commercial Banks: Commercial bank’s perspective
                   Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                   Speaker: Liu Ruixia, Deputy General Manager, Risk Management
                   Department, Industrial and Commercial Bank of China
                   Q&A
12:00-13:30        Lunch
                   Venue: 2nd Floor, Dinning Hall II
13:30-15:00        Session 12 Cross-border Banking and Supervisory Cooperation under
                   Basel II
                   Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                   Speaker: Alicia Garcia-Herrero, BIS Regional Office for Asia and
                   the Pacific
                   Q&A
15:00-15:30        Coffee Break
15:30-17:00        Session 12 Break-out Small Group Discussion
                   Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III
                   The participants will be divided into small groups to review and
                   discuss the presentations during the three days and the
                   implications/applicability in their own current financial environment.
17:00-18:00        Session 13 Group Report &Conclusion
                   Venue: U-Shaped Classroom IV, 3rd Floor, Lecture Building III

Thursday, September 6, 2007

8:30-18:00         Site Visit-Shanghai Downtown

Friday, September 7, 2007

8:30-18:00         Site Visit-Suzhou




                                           3
Workshop on Risk Management in
      Commercial Banks

                Overview of Workshop



September 3, 2007
Shanghai National Accounting Institute, P.R. China
Asia-Pacific Finance and Development Center          1
Why a Program on Risk Management

Banking systems
 – Mobilize savings (economies of scale)
 – Allocate and monitor the use of society’s savings
 – Facilitate risk amelioration and trading
Well-Functioning Banking systems
 – Improve capital allocation and economic growth.
 – Reduce income inequality
 – Lower poverty & Inequality
Consequences of Banking Failures
 – Economic growth suffers --- output declines, entrepreneurship
   gets thwarted.
 – Fiscal burden diverts resources from essential public goods
   and public investments

                                                                   2
             Asia has been very successful in
                   mobilizing resources




Source: East Asia Finance, The Road to Robust Markets, World Bank, 2006


                                                                          3
       Progress has been made in the banking
                      sector




Source: East Asia Finance, The Road to Robust Markets, World Bank, 2006


                                                                          4
            Capital Markets Are Growing




Source: East Asia Finance, The Road to Robust Markets, World Bank, 2006


                                                                          5
        Banking Sector Agenda Remains




                                                                          6
Source: East Asia Finance, The Road to Robust Markets, World Bank, 2006
Why Risk Management? Banking Instability




                                           7
Framework for Banking Stability




                                  8
          Why Risk Management?

Banks often have
 –   Liquidity problems
 –   Large open currency positions of private banks
 –   Significant holdings of government debt
 –   Low asset quality
 –   Risk assessment and management systems weak
 –   Lack of good corporate governance
 –   Major macroeconomic instability
 –   High public sector deficit
 –   Systemic distortions created by weak banks
 –   Weak financial disclosure rules and oversight
     arrangements
                                                      9
          Why Risk Management?

Increase in bankruptcy in most economies as markets become
more competitive --- globalization and domestic liberalization
“Winner’s Curse”. More creditworthy firms have direct access to
debt markets. Banks make more loans to borrowers without access
to credit markets average loan quality has deteriorated.
Volatile Values of Collateral
More competitive financial markets ---Interest margins have
declined
The growth of derivatives : all have credit exposures

Thus worsening of the risk-return tradeoff
BIS Risk-Based Capital Requirements: Links capital charges to
external credit ratings or internal model of credit risk.


                                                                10
Why Risk Management: Economic Rationale




                                          11
                       Why Risk Management?
Macro-financial Rationale
   Procyclicality of bank lending is a widespread phenomenon and not confined to
   specific episodes
   Shocks to capital result in a reduction of bank loan supply (both in and outside
   crises and independent of structure)
   The effect of initial capital is stronger in crisis times
   Loan losses have the potential to exacerbate macroeconomic fluctuations, that
   is, financial instability may have real effects (even outside of crises and absent
   bank defaults).
   Financial and monetary stability are not disjoint.
   Monetary policy can have powerful effects in exacerbating or alleviating
   financial instability. Banks’ balance sheet characteristics affect their lending
   activity: banks with higher provisions tend to extend less credit than their
   stronger competitors
   The impact of provisions on bank loan supply is stronger for banks that are
   poorly capitalized.
   Bank capital ‘matters’ more in times of low economic growth


Source: Bank weakness and bank loan supply , Erlend Nier and Lea Zicchino, 2004, Bank of England
                                                                                                   12
Why Risk Management? Corporate Rationale

 Risks arising from provision of financial services such as
  –   Market risk
  –   Credit risk
  –   Operational risk
  –   Cross border risk
 To set performance incentives that are not perverse and better
 align growth and stability
 Measure economic capital
 Allocate resources more efficiently
 Apply risk based pricing
 Customer selection and product development
 Active management of portfolio risk
 Establish an integrated risk management system to ensure
 consistent risk measurements / policies for each type of risk, across
 all businesses.

                                                                    13
    Traditional Approaches to Credit
            Risk Management

Character – reputation, repayment history
Capital – equity contribution, leverage.
Profitability – earnings volatility.
Collateral – Seniority, market value &
volatility of market value of collateral.
Economic cycle and market conditions.

Problems of consistency and subjectivity

                                           14
New Approaches to Risk Management

Role of Credit Risk Models
 – Support tactical credit risk management
 – Support decision making at the strategic level
 – Understand better lending implications
Credit Risk Modeling Framework
 –   Definition of default
 –   Aggregation of credit risk
 –   Recovery
 –   Exposure
Types of Models (Econometric, Equity Based,
Actuarial)

                                                    15
               Measuring Risks

All measurements of risk incorporate not only
quantitative but also qualitative elements.
 – Even with good data and tools, uncertainty exists
 – Estimation error always exists, often difficult to quantify
 – Need to combine with qualitative tools and judgment
Use of sensitivity analysis, stress testing, and scenario
analysis
 – For analyzing potential effects not captured by static
   quantitative tools
 – To inform use of baseline measure
 – When data are scarce or tools are lacking, baseline measure should
   use more sensitivity analysis and qualitative factors
 – Should cover the major risk types (credit, market, operational)



                                                                        16
INTEGRATED RISK MANAGEMENT

THREE RELATED ASPECTS
– Integrated risk management as having consistent
  policies and methods of measurement of risk
  through-out the firm.
– Integrated risk management as the integration of risk
  measurements, particularly economic capital, as a
  component, into all aspects of business decisions.
– Integrated risk management as the process of
  centralizing certain key risk architecture functions, to
  ensure consistency in measurement and reporting of
  risk.
                                                        17
         Risk Management System

   Risk Management           Risk Architecture
        Functions               Functions
Approve and monitor risk        Build and maintain risk
limits.                         infrastructure of firm:
Approve limit exceptions.       Develop methods to
Approve new forms of            measure and analyze
transactions                    risks, including economic
Function as eyes and ears       capital.
of senior management            Develop risk policies.
with regard to risk taking      Develop comprehensive
of business.                    risk reports.
                                Develop IT based risk
                                systems

                                                       18
            Risk Management

Risk Models for Individual Assets
 – Regression model and using simulation model
Portfolio Risk Models for Economic Capital
 – The Conceptual Framework: Economic Capital
 – Types of Portfolio models
 – Assessing economic capital
Basel II Capital
 – Basel’s Capital Rules
 – Assessing Basel capital
Basel II implementation process in banks
                                                 19
Basics Tasks in Credit Risk Management

Professional Risk Manager’s International
   Association
  Review strategic credit positions:
   – Any changes to largest exposures (net of collateral)?
   – How about changes to counterparty ratings?
   – Any significant credits to be approved by chief credit officer or board?
  Credit limits and provisions:
   – Any limit excesses?
   – Limits to be reviewed?
   – Provisions still up to date?
   – All concentrations within limits?
  Credit exposure:
   – All exposures covered and correctly mapped?
   – Any Wrong way position?


                                                                                20
 Basic Tasks in Credit Risk Management
                (Cont’d)

Credit reporting:
 – All significant risks covered in credit report?
 – Report distributed to all relevant parties?
 – Any significant credits that must be discussed at top management/board level?
Stress and scenario analysis:
 – Any surprises from stress and scenario analysis at portfolio or global level?
 – Anything not covered by current set of scenarios?
Provisions:
 – Any past or anticipated changes in general loss provisions?
 – Any changes to specific provisions?
Documentation:
 – Full documentation in place for all transactions?
 – Break clauses and rating triggers fully recognized?
Credit protection:
 – Credit protection utilized and understood?
 – Any further possibility to exploit credit protection?


                                                                                   21
 RISK METHODS AND ANALYTICS FUNCTIONS



                                                     Risk Methods and Analytics




Operational Risk Analytics   Credit Risk Analytics   Counterparty Risk Analytics   Market Risk Analytics   Model Validation




         Source: Evan Picoult, Citigroup October, 2006
                                                                                                                              22
     Definition of Economic Capital

Capital is held to ensure that a bank is likely to remain
solvent, even if it suffers unusually large losses
 – Available economic capital:
 – The amount by which the value of all assets currently exceeds
   the value of all liabilities
Required economic capital:
 – The amount by which the value of all assets should exceed the
   value of all liabilities to ensure that there is a very high
   probability that the assets will still exceed the liabilities in one
   year’s time
Typically, banks aim to have a high (e.g., 99.9%)
probability of remaining solvent


                                                                     23
                  Economic Capital

EC is the amount of capital to be held to protect against
low probability losses
The building blocks of EC
 – PD, LGD, EAD, correlation, (M)
The key parameters describing the Credit Loss PDF
 – EL and UL
 – Capital as percentile of PDF
Basel Capital is a stylized version of EC
 –   A single correlation is assumed
 –   A single systematic risk factor
 –   “Infinite granularity”, no large loans or concentrations
 –   No uncertainty in LGD

                                                                24
  Thinking about Economic Capital

Given the random amount of losses we suffer each
year, how much could we lose if we are unlucky?
 – Capital as an unexpected loss percentile
 – Capital = percentile of PDF

How much could we expect to lose in a recession?
 – Capital as expected loss conditional on “severe" draw of
   systematic risk factor
 – Uncertainty in LGD and EAD assumed to be idiosyncratic, so
 – Conditional EAD and conditional LGD are equal to their
   expected values, respectively
 – Capital = conditional default probability x LGD x EAD


                                                                25
 Use of Economic Capital & RAROC

Capital decisions
 – General provisions, reserves, capital allocation
Portfolio allocation decisions
 – Identification of opportunities and problems
Pricing and profitability decisions
 – RAROC: Risk-Adjusted Return On Capital
Boosting high RAROC business lines
Loan pricing
 – Margin = EL + H x Capital + OpRisk + OpCost

                                                      26
Risk Adjusted Return on Capital




                                  27
               Stress Testing

What is Stress Test? Techniques used by
financial firms to gauge their vulnerability to
exceptional, but plausible, events.
How do you identify a plausible, stressful
scenario?
 – Use a historical scenario
 – Develop a hypothetical scenario
What is likely to be stressed?
 – The earnings, reserves, and capital adequacy of the
   individual banks
 – Stress test should cover loans and other parts of the
   balance sheet as well as the income statement
                                                       28
          Principles vs. Rules based Standards for
                         Governance
Rules-based: detailed, rigid with little discretion, but intention can
be circumvented
Principles-based: broad principles with little structure to guide,
flexible and responsive to changes, as judgment is guided by
spirit/intention
Objectives-based: principles+ where objectives are clearly defined,
sufficient detail and structure is given so that standard can be
operationalized and applied on consistent basis

Economies can adopt standards to reorganize bureaucracy for
transparent and effective delivery of services, with accountability.
These operational standards ensure that processes minimizes self-
serving behaviour, turf fights and silo mindsets, and promote
collaboration and unity of purpose in delivery of public services

Hence, institutional reform involves not only performance and
conformance, but also transformance into a socially accountable
                                                              29
growth
                        Basel II

Much more complex and risk sensitive
First Pillar – Minimum capital
Second Pillar – Supervisory review
Third Pillar – Market discipline

Treats exposures very unequally depending on exposure
characteristics
Treats banks very unequally depending on sophistication of
risk management systems

            Will profoundly alter bank behavior


                                                       30
               Basel II Scope of Application

Applied on consolidated basis to           Insurance entities
internationally active banks                    Generally, deduct bank’s equity and
All banking and other financial activities      other capital investments in insurance
(whether or not regulated) captured             subsidiaries
through consolidation                           However, some G10 countries will
Financial activities do not include             retain current risk weighting treatment
insurance                                       (100% for standardized banks) for
     Majority-owned subsidiaries not            competitiveness reasons
     consolidated: deduct equity and            Supervisors may permit recognition by
     capital investments                        bank of excess capital invested in
     Significant minority investments           insurance subsidiary over required
     without control: deduct equity and         amount
     capital investments                   Commercial entities generally deducted
     Deduction of investments 50% from significant investments in commercial
     tier 1 and 50% from tier 2 capital    entities above materiality thresholds
                                                Significant investments in commercial
                                                entities below materiality thresholds
                                                risk weighted 100%
                                                                                   31
                Basel II – Three Pillars

                  Minimum Capital Charges: Minimum capital
 First Pillar
                  requirements based on market, credit and operational
                  risk to (a) reduce risk of failure by cushioning against
                  losses and (b) provide continuing access to financial
                  markets to meet liquidity needs, and (c) provide
                  incentives for prudent risk management.
                  Supervisory Review: Qualitative supervision by
Second Pillar     regulators of internal bank risk control and capital
                  assessment process, including supervisory power to
                  require banks to hold more capital than required
                  under the First Pillar

                  Market Discipline: New public disclosure
 Third Pillar     requirements to compel improved bank risk
                  management


                                                                             32
       Basel II – Capital Components

Credit risk charges
 –   Revised
 –   To ensure capital charges are more sensitive to risks of exposures in banking book
 –   Enhancements to counterparty risk charges also applicable to trading book exposures

Operational risk charges
 – New
 – To require capital for operating risks (fraud, legal, documentation, etc.)
Market risk charges
 – Initially unchanged, but Basel/IOSCO review has proposed changes to specific
   risk calculations and Second Pillar stress testing
 – To require capital for exposures in trading book
 – Rules in Market Risk Amendment (1996)



                                                                                           33
                 Basel II – Types of Banks
                     • Measure credit risk pursuant to fixed risk weights
 Standardized        based on external credit assessments (ratings)
                     • Least sophisticated capital calculations; generally
                     highest capital burdens

                     • Measure credit risk using sophisticated formulas
                     using internally determined inputs of probability of
Foundation IRB       default (PD) and inputs fixed by regulators of loss
                     given default (LGD), exposure at default (EAD)
                     and maturity (M).
                     •More risk sensitive capital requirements
                     •Measure   credit risk using sophisticated formulas
                     and internally determined inputs of PD, LGD, EAD
Advanced IRB
                     •Most risk-sensitive (although not always lowest)
                     capital requirements
                     •Transition to Advanced IRB status only with
                     robust internal risk management systems and data
                                                                             34
   Summary of Main Changes in the BCP

More emphasis placed on governance, transparency and accountability of
supervisory agencies, and reaffirming supervisory independence and
adequacy of resources and legal protections.
Bank governance given more attention to ensure that there is effective
control over a bank’s entire business. More details are provided on board
and senior management responsibilities, set clear strategies and
accountabilities.
Strengthened guidance on risk management practices. While some areas
were already covered in the former BCP, these have now been brought
under “standalone” CPs including (i) an integrated approach to risk
management, (ii) liquidity risk (iii) operational risk and (iv) interest rate risk
in the banking book.
The importance of greater disclosure to enable market discipline to
supplement official supervision is reinforced. New criteria have been added
specifying that the supervisor “require” disclosure and not just “promote” it,
as formulated earlier.
The “know-your-customer” (KYC) principle expanded to better capture
issues pertaining to the abuse of financial services firms by criminal
elements as reflected in the revised FATF standards as far as relevant for
bank supervisors.

                                                                               35
         Credit Rating Agencies

Role of Credit Rating Agencies (CRAs) is vital
 – CRAs assess the credit risk of banks
 – CRAs attempt to make sense of the vast amount of
   information available regarding a bank, its market
   and its economic circumstances
 – They give investors, lenders to banks, and to
   regulators a better understanding of banking system
   and banking institution risks.
 – A credit rating, typically, is a CRA’s opinion of how
   likely a bank will mange its financial obligation and
   operations in a timely and efficient manner.
 – Under Basel II they have a special role.
                                                       36
   Role of Credit Rating Agencies

What Credit Rating Agencies Do for Banks?
What is the Rating Process?
What are the Rating Methodologies?
How transparent is the ratings process
public dissemination of ratings and market
timing?
How do they manage Conflicts of Interest?




                                         37
Perspectives on Supervision and Regulation


 Objectives of regulation and supervision
  –   Systemic Stability
  –   Safety and Soundness
  –   Consumer Protection
  –   Consumer Confidence
 Universal functions
  –   Prudential regulation
  –   Prudential supervision
  –   Systemic Stability
  –   Conduct of Business: Regulation and Supervision

                                                        38
Perspectives on Supervision and Regulation

 – Safety Net Arrangements
 – Liquidity Assistance
 – Insolvent institutions
 – Crisis Resolution
 – Market Integrity
Institutional Structure of Financial Regulation
 – Fragmented or Integrated




                                              39
  Why Cross-Border Supervision?

Waves of large intra-nation bank mergers over
the past decade have created banks of
unprecedented size
 – Japan credit quality problems have resulted in
   consolidation partially the result of government
   policy
 – US – Drive to have truly national banks ---merger
   wave among larger regional banks
 – Europe – Intra- market mergers created “national
   champions” – often with government encouragement

                                                  40
  Risk Based Approach In Regulatory
    Institutions Issues and Actions

Involvement of Senior Staff
Improve communication with banks
– Clearer Guidances
– Clearer explanation of assessments
Training and Guidance for Supervisors
Use of IT



                                        41
       Why Cross-Border Supervision?
Implications of Banking Industry Globalization

  Global banks may be key players in
  markets that are not key to the bank
  National borders provide tax/regulatory
  arbitrage opportunities but provide little
  other benefit to the bank
  Reputation/political risk may be as
  important as potential financial impact of
  adverse outcomes in the host country

                                               42
Cross- Border Banking Supervision

Basel II attempts to better promote international
harmonization of regulatory environment. Goals include:
 – Improve soundness and stability of the international banking
   system
 – Insure capital is not a source of competitive inequality
 – Encourage stronger risk management
Home-Host Coordination
Better Knowledge of Subsidiary Activities
Home-Host Supervisory Challenges
Better Knowledge of Subsidiary Activities
Home-Host Supervisory Challenges: Objectives,
Implementation and Expectations, Incentives
Capabilities

                                                                  43
Thank You




            44
Banking Reform and Risk
 Management in China

                Zhang Lixing
  Director of International Affairs Division
          International Department
   China Banking Regulatory Commission
         3 September 2007, Shanghai
                                               1
Contents


An Overview of China’s Banking System

Evolution of Banking Reform and Risk Management

Challenges to Risk Management & Our Response

Basel Implementation



                                               2
3
Questions Frequently Asked ???

      Ten year ago: Could China avoid a banking crisis that
                     befell others in Asia?

          Seven years ago: Could China afford banking
                            Reform?

         Four years ago: Could China kick-start banking
                            reform?


       Three years ago: Could China avoid a hard landing?


       Two years ago: Could China start listing its banks above
                            book value?                           4
In history (Prior to 2003)

        Banks discharged with policy and social duties during the
        transformation from planned economy to market economy


          NPLs surging as a result of weak corporate governance
          and risk management, and systemic risks loomed large


    Three policy banks established in 1994, marking the separation of policy
 finance and commercial banking
    The Law on Commercial Banks enacted in 1995
    Issuance of RMB270 billion worth of special government bonds for purpose
 of Big Four recapitalization
    Off-load of RMB1.4 trillion worth of NPLs to four newly established AMCs
    The credit quota policy abolished to allow banks with more credit decision
 powers                                                                      5
A Snapshot of Major Reforming Actions
Post 2003
  A new round of banking reform starting with the CCB, the BOC, and the
  ICBC, following a roadmap of re-capitalization, restructuring and IPO
  Through partnership with foreign strategic investors, the reformed banks
  benefiting from improved corporate governance, risk management and
  internal controls
  The reform package being drafted for the ABC, the last of the Big Five,
  which will lean towards rural development and micro-financing for
  farmers
  Reforms of small and medium-sized banks rolling out steadily, featured
  by financial rehabilitation, corporate restructuring and introduction of
  foreign strategic partners
  Numerous postal savings offices across the country consolidated to form
  China Postal Savings Bank, officially opened for business on 31
  December 2006
                                                                            6
                                                   (to be continued)
Mindset Change in Corporate Governance

                    ♦ Adoption of customer-oriented development strategy
   Strategy         ♦ Development of profit-driven business plan
                    ♦ Pursuit of shareholder value maximization


                    ♦ More emphasis on risk and internal controls, risk pricing and
      Risk            business diversification
Management and
Internal Control    ♦ Adoption of IFRS, RAROC, EVA, etc. to measure credit cost
                      and performance.


                    ♦ Promoting a market-focused and performance-based
      HR and          human resources management and incentive program
IT Infrastructure   ♦ Recruiting talents both at home and from abroad
                    ♦ Accelerating IT infrastructure construction

                                                                                  7
A Snapshot of Major Reforming Actions
Post 2003
 In the rural areas inhabited by over a half of the nation’s
 population:
       The reforms of rural credit cooperatives accelerated, with some
       being merged and some transformed into rural cooperative or
       commercial banks. As a result, the number of the RCCs reduced
       from 35,540 to 19,348 between 2002 and 2006.
       At the end of 2006, the CBRC released Guidelines on Adjusting
       the Market-entry Threshold for the Banking Institutions in Rural
       Areas, which highlights two breakthroughs: (1) welcome all kinds
       of capital to the formation of new types of financial institutions in
       rural areas;(2) welcome all kinds of banking institutions to branch
       out in rural areas
       As of June-end 2007, 20 township banks commenced business in
       rural communities.


                                                                               8
Substantially Improved Capital Adequacy
 Banks in Compliance with Capital Adequacy Requirements


                                      77.4%       78.30%
                            75.1%
                                                   125

                  47.5%
                                       100



      0.6%                   53
                    30
              8

       2003        2004     2005       2006      2007Q2
          Number of Banks   % of Total Banking Assets

 Source: CBRC
                                                           9
Non-Performing Loans on the Decline
                                                In 2005, NPL ratio
                                                of major Chinese
                                                banks dropped to
                                                single digit for the
                                                first time.
             NPL Volume(US$bn)
             NPL Ratio
      275
                   254
     23.6%                       208

                  17.9%                  151             150            149

                                 13.2%

                                         8.9%
                                                        7.5%            7.0%



     2002          2003          2004    2005            2006          2007Q1


  Source: CBRC
                                                                                10
Shortfall in Loan Loss Reserves Narrowed
  (Unit: US$ Billion)


          200




                        115.9
                                72.2
                                       57.9




          2003          2004    2005   2006


 Source: CBRC                                 11
Performance of Reformed Banks (2006)
                         CCB        BOC              ICBC          BoCom
ROA                         0.94         1.04             0.72        0.94
ROE                         14.91       13.69            13.37       17.66
Large Exposure              5.88         2.38             3.24        3.24
NPL Ratio                   3.26         4.65             3.68        2.01
Provisioning Coverage
   Ratio
                            85.49       97.46            73.84       98.75

Cost/Income Ratio           36.67       35.71            35.78       35.00
Capital Adequacy Ratio      12.61       13.46            14.21       11.10
                                    RBS,             Goldman
                         BOA,       Merrill Lynch,        Sachs,
Foreign Investors/
Strategic Partners
                         Temasek    Li Ka-shing,     Allianz,        HSBC
                                    Temasek,         American
                                    UBS, ADB         Express


Source: CBRC                                                                 12
Actions to Ensure Sustainability
          Guidance on                   Regulations on risk-focused
      Corporate Governance                     supervision


     Hold bank board accountable          Covering: capital adequacy,
      for risk limits setting             large exposures, connected
     Align the incentive package with     transactions, underwriting
      risk control performance            due diligence, market risk,
                                          operational risk …
     Underpin independent risk
      control functions




                                                                        13
Challenges & Response: Macroeconomic Changes
    The close interaction between the banking and economic growth has
    shaped the banking landscape in the past, and will reshape it down the
    road.

          Annual GDP Growth of China                                       Scale of Bank loans, Bonds and
          US$ bn
                                                   2387                    Stock in China by March 2007
                                    2023
                         1719

              1504
   1370                                            11.1%        11.5%                           14%
                        10.1%      10.4%                                                                 2%
  9.1%        10.0%
                                                                2775




   2002        2003       2004       2005          2006         2007Q2         84%
                        GDP      GDP Growth rate

                                                                                            Negotiable Maket Cap.
                                                                                            Bond Depository Balance
 Total Assets of Banking Institutions                                                       Bank Loan Balance
 (Unit: US$ trillion)                                     5.9
                                            5.6

                                 4.6
                                                                         Note: Government bond and financial
                        3.8                                                 bond are excluded from bond issuance
             3.3
  2.9                                                                       and bond depository balance.
                                                                         Source: CBRC/CSRC/China Bond
                                                                                                                      14
  2002       2003       2004     2005       2006      2007Q1
Challenges & Response: Macroeconomic Changes

  Banking in China is featured with unbalanced development by region,
  product and client base.
  With homogeneous marketing strategy and product offering, banks are in
  a tough competition and often compromise lending policies to meet
  market share target
  As China’s economic cycle shows, risks in certain industries and regions,
  if not properly handled, will surely accumulate and concentrate.
  Policy adjustments for balancing economic development may lead to
  new and heightened credit risk for banks.

  Response: close watching, careful scrutiny, prompt signaling and
  warning, and encouraging banks to open eyes for new
  opportunities
                                                                        15
Challenges & Response: Market Liberalization

  The urge to conduct universal banking brings banks to face not only
  credit risk, operational risk, market risk, but also conflicts of interest,
  connected transactions, inadequate disclosure and other risks.

  The trend towards cross-sector operations is posing new challenges to
  Chinese regulatory and supervisory framework as well.

  Response:
  Carefully reviewing each and every application
  Learning the experience of other countries in legislation and
  regulation of complex financial institutions
  Actively promoting coordination and information sharing with
  other regulatory authorities
                                                                                16
Challenges & Response: Market Liberalization
  As China moves towards interest rate and foreign exchange
  liberalization, banks are more than ever exposed to market risk.
  There is considerable demand within China by the corporate sector and
  financial system to hedge their market risk through derivatives.
  With abundant liquidity, the demand for investments in new financial
  products has risen significantly.
  Absence of a reliable RMB yield curve makes hedging and investment a
  difficult task.

  Response:
  Providing guidance on market risk management
  Issuing the Notice on Establishing Reference Benchmark for
  Market Risk Measurement                                                17
Challenges & Response: Market Liberalization
     With further capital account opening, qualified Chinese banks are
     increasingly allowed to invest in overseas markets, including both fixed
     income instruments and equity.

      Number of Approved Institutions               Amount of Approved Quota


60                                         20
             QFII          QDII                           QDII         QFII
50
                                           15
40

30                                         10

20
                                           5
10

0                                          0
May-03       Sep-04    Jan-06     May-07   May-03       Sep-04     Jan-06      May-07


Source: CBRC/CSRC                                                               18
Challenges & Response: Market Liberalization
  Once investing abroad, banks will directly face all types of risk as well as
  counter-party risk in their international investments.

  Response:
  Requiring banks to improve their risk identification and
  management capability, provide sufficient training and education
  to their business and operational staff, and adequately inform
  their customers about the risks of products they offer.
  Encouraging banks to partnership with experienced international
  firms to learn from their partners m in risk diversification and
  management.
  Entering supervisory agreement with HK SFC, FSA and SEC
  down the road.
                                                                           19
20
Challenges & Response: Innovation Progress

  Innovation improves banks’ efficiency and creates new revenue streams,
  but it also brings a new array of risks, ranging from credit risk, market
  risk to operational risk.

  Response:
  Strengthening on-site examinations
  Issuing rules to address risks from specific business such as
  derivatives, ABS, on-line banking, etc.
  Requiring independent and effective audit to ensure the proper
  handling of risks


                                                                        21
Basel II Implementation
  Chinese banks with overseas presence are mandated to adopt Basel II
  starting from the end-2010. Those not ready by the prescribed deadline
  may enjoy a grace period up to end-2013. Other banks including foreign
  bank subsidiaries may choose to apply for adoption when they are ready.

  Credit Risk: banks may start with FIRB approach though they are
  encouraged to target to AIRB approach.

  Market Risk: banks are required to adopt Internal Models approach,
  while those not ready may have a waiver with the approval from the
  supervisor provided that a clear roadmap towards IM approach should
  be in place.

  Operational Risk: CBRC will work closely with the industry for a practical
  capital charge approach.


                                                                         22
Basel II Implementation

   Complete the rule-making by the end of 2008



   Launch QIS in 2009



   Accept banks’ application from the beginning of 2010


          Tremendous efforts will be made in training
          of both the supervisors and practitioners.

                                                          23
The right time to repair the roof is
while the sun is shining, not when
 the weather has already turned.
       --- John F. Kennedy




                                       24
Thank You



            25
Workshop on Risk Management in
      Commercial Banks
           Overview of Indian Situation



September 3, 2007
Shanghai National Accounting Institute, P.R. China
Asia-Pacific Finance and Development Center          1
           Indian Commercial Banks

Banks continue to play a
dominant role in
intermediation
27 government banks, 30
private banks, 33 foreign
banks
Government banks dominate
in share of assets, but ….
New private banks and
foreign banks lead in
competitiveness and quality
of earnings. Two private
banks in top ten banks



                                     2
                  Banking Landscape


Steadily improving
 – Financial Liberalization commenced in 1991-92
 – Prudential guidelines introduced for banks
 – Over USD5 billion equity infused by the government during the
   next 10 years
 – ‘New’ private banks licensed
 – Gradual tightening of prudential norms
Basel II guidelines from March 2007
 – Standardised Approach under credit risk
 – Basic Indicator Approach under operational risk
 – IRB aimed for 2010
The better performing private banks listed on the
NYSE or LSE; dual reporting of financials under US
GAAP
                                                                   3
     Prudential Norms Strengthened

From March 2004 onwards, banks moved to the internationally accepted
90-day norm for recognition of loan impairment (from the 180-day norm in
place so far). To this end, commercial banks were to begin charging
interest at monthly, rather than quarterly, intervals and to build up
additional provisions to achieve smooth convergence.
More stringent provisioning requirement on the doubtful assets introduced
from March 2005. All assets classified doubtful for three years or more will
have to be 100% provisioned, whereas previously they were
fullyprovisioned on the unsecured portion and 50% provisioned on the
secured part of the exposure.
Non-performing government-guaranteed exposures treated in a similar
manner to any other non-performing loan (NPL) in terms of classification
and provisioning, from March 2006 onwards.
Risk weightings on exposures to public financial institutions (PFIs) will be
raised from 20% to 100%, while risk weightings on mortgage loans
increased from 50% to 75% (further increase significantly in 2006 and
2007) and consumer credit, including personal loans and credit card
receivables from 100% to 125% from March 2005.


                                                                           4
              Prudential Measures


Foreign banks operating in India and Indian banks having presence
outside India are allowed to migrate to the Standardised Approach
for credit risk and the Basic Indicator Approach for operational risk
under Basel II with effect from March 31, 2008.
All other scheduled commercial banks are to migrate to these
approaches under Basel II in alignment with them but in any case
not later than March 31, 2009.
For smooth transition to Basle II and with a view to providing banks
in India additional options for raising capital funds, banks were
advised in January 2006 that they could augment their capital funds
by issue of additional instruments such as (i) innovative perpetual
debt instruments (IPDI) eligible for inclusion as Tier I capital; (ii)
debt capital instruments eligible for inclusion as Upper preference
shares eligible for inclusion as Tier I
capital; and (iv) redeemable cumulative preference shares eligible
for inclusion as Tier II capital.
                                                                     5
 Bank Lending Increasing Rapidly




Source: RBI                        6
Rapid Credit Growth in Recent Years




                                      7
                        Asset Quality

Steadily Improving
 – increased loan loss provisions
   and write-offs using the windfall
   profits from trading in
   government securities
Slowdown in NPL accruals
Improved risk appraisal systems
and focus on d loan monitoring
NPL recovery facilitated by
changes in debt recovery laws --
The Securitization and
Reconstruction of Financial
Assets and Enforcement of
Security Interest (SRFAESI) Act.
Market discipline and
surveillance enhanced by equity
issuance to institutional and          Source: Fitch
household investors.


                                                       8
                                Asset Quality




Source: Reserve Bank of India
                                                9
          Net Interest Margin

Net Interest
Margins remain
reasonable but
will come under
pressure as
competition in
the banking
system increases
especially from
new private
banks.
                                10
Return on Average Assets




                           11
Return on Equity




                   12
Cost to Income Ratio




                       13
Capital Adequacy Ratio




                         14
   Financial Exclusion is Still High




Source: Speech by Deputy Governor RBI, June 2007
                                                   15
Access to Financial Services is Limited in
              Rural Areas

Out of 203 million households in the
country, 147 million are in rural areas – 89
million are farmer households. 51.4 per
cent of farm households have no
access to formal or informal sources
of credit while 73 per cent have no
access to formal sources of credit.
Only 49% of household savings are in
Financial Assets (CSO Estimates 2004)

                                             16
    Risk Management Improving

Government banks in the midst of
reengineering their business processes
Marketing and credit functions are being
separated in government banks
Risk evaluation function is being centralized
Risk grade models are being introduced to
accommodate different industries and
collaterals
For consumer lending scoring models are being
tested
IRB approach will not be possible before 2010
                                            17
                  Implementing Risk
                    Management

                – people, process and systems
  A Higher             considerations
Standard for
    Risk
Professionals     David Millar, COO, PRMIA

                  Workshop on Risk Management in
                        Commercial Banks,

                 Shanghai, 3rd – 7th, September, 2007

www.prmia.org
                       Presentation contents
  The dimensions & drivers of              • What is risk?
    risk                                   • What are the drivers?
  The categorisation of risk               • Impact of Basel II
                                           • Risk frameworks
  Risk and capital                         • Capital
                                           • Bank capital
                                           • Basel II and risk-based capital
                                           • But capital is not all
  Risk architectures                       • Management information
                                           • Financial risk data
                                           • Non-financial risk data
  Implementation                           • All parts of a bank are not equal
    considerations                         • Implementation issues
                                           • Governance
                                           • Risk cultures
                                           • Supervisors
A Higher Standard for Risk Professionals                          www.prmia.org
                Implementing Risk Management

                – people, process and systems considerations




  A Higher
Standard for
    Risk
Professionals
                Dimensions and Drivers of
                   Risk Management




www.prmia.org
                            What is a risk?
     1.   a situation involving exposure to danger,
     2.   the possibility that something unpleasant will happen,
     3.   an object (person or thing) that creates or exacerbates a
          risk situation.
   A scenario that can be described (qualified, if not quantified)
   and that may be damaging, in any way, to an organisation.

     •    A risk may cause a “loss event” – financial or otherwise –
          directly or indirectly
     •    A risk may not cause a loss event – it may never happen
          – but it could and needs protecting against
     •    A loss event is caused by a risk – even if the cause is out
          of the control of the institution
     •    A loss event may not cause a financial loss, it may even
          create a profitable situation - but it is still a loss event
A Higher Standard for Risk Professionals                      www.prmia.org
                             Risk in history
    Early money “Metal” money was lent – the risk was not getting paid –
    lending     or getting paid late (credit risk) – but the lenders also
                started to act as deposit takers or took shareholders.
    The age of  Money lent to fund a voyage – periods were long –
    discovery   profits, and risk, very high – loss could be total.
    1500’s      Monetary inflation (market risk) appears – companies
                with shareholders set up to fund voyages – promissory
                notes appear – paper starts to replace metal, so credit
                worthiness of paper issuer becomes key.
    18th - 19th Banking is primarily to support commercial trading:
    Centuries   other risks – operational, reputational, etc – appear.
    19th – 20th Investors and depositors at risk – liquidity and inflation
    Centuries   risk - also bankruptcies, corruption and insider dealing.
    1920+       Regulation introduced to target market failures
                (systemic risk) and regulate practices.
    1980+           Regulators target excessive risk taking, and investor
                    protection – banks must now put aside capital as first
                    line of defence against the risk of insolvency – and
                    demonstrate risk management skills.

A Higher Standard for Risk Professionals                           www.prmia.org
             Drivers of risk management
      • Regulatory drivers
              – Local
              – Regional
              – Global                             Stick
      • Business drivers
              – Increased profitability
                                                   and
              – Reduced losses
              – Improved reputation
                (customers, public and analysts)   Carrot
              – Credit agency ratings
      • With the objective of managing risk,
        not eliminating it
A Higher Standard for Risk Professionals             www.prmia.org
                          Business drivers
     Increased         More efficiency, more productivity, increased
     profitability     sales, maximised return on capital.

     Reduced           Cut out unnecessary activities and improve
     losses            inefficient ones, reduce process failures,
                       minimise non-productive overheads, avoid
                       losses through theft or fraud.

     Improved          Create a valid image of positive values, reduce
     reputation        any negative impressions, emphasise a positive
                       and secure future, attract investors and staff.

     Credit            By demonstrating the above, improve the rating
     ratings           given to the entity by the global credit rating
                       agencies (Moody’s, Standard & Poors, etc).


A Higher Standard for Risk Professionals                        www.prmia.org
        What the rating agencies say …
  • “Moody's believes that the assessment of risk is becoming
    increasingly central to the fundamental analysis of a rated
    bank. Put simply, risk management improves the quality and
    stability of earnings, thereby enhancing the competitive position
    of the bank and facilitating its long-term survival.”

  • “The ongoing integration of its subsidiary banks into a single
    network poses challenges in terms of operational, personnel,
    and systems integration. Moreover, the banks purchased by
    XXX may have hidden operational risks.” A Standard & Poor’s
    Report

  • “Fitch (Ratings) expects financial institutions, in their
    response to both regulatory and management requirements, to
    adopt a balanced approach to risk. This includes an emphasis
    on tools and techniques designed to assist the management of
    a financial institution in the prioritization of its risk budgets and
    in where to focus its efforts.”
A Higher Standard for Risk Professionals                       www.prmia.org
                         Regulatory drivers
   Local       • National corporate governance recommendations, i.e.
   regulations   Turnbull (UK), CLERP 9 (Australia), CCGC (Singapore)
                     •   Other regulations impacting component risk areas:
                             –   Money laundering
                             –   Data privacy
                             –   Health & safety
                             –   Anti-ageism, anti-racial or gender discrimination, etc

   Regional    • i.e. the EU Directives (CRD, MiFID, MAD, etc) – these
   regulations   are centrally defined and implemented via local
                         regulations – MiFID requires a “risk framework”.
   Global      • The Sarbanes-Oxley Act of 2002 (US but global
   regulations   impact) requires risk controls to be put in place
                     •   The New Basel Capital Accord (Basel II) ties risk to
                         capital requirements – for banking institutions only
                         (at present – risk-based capital for insurers?)
                     •   Also accounting (IAS), trade, health, vehicle,
                         transport regulations which impact risk considerations

A Higher Standard for Risk Professionals                                    www.prmia.org
               Cross-border implications
   • There is no international jurisdiction. Regulations
     (global or local) implemented by local courts or
     regulators.

   • International implications are enforced by:
          Agreement by local bodies that they will implement
          international regulations (i.e. Basel II but also such as
          transport regulations), sometimes with local variations
          A local regulator imposing regulations on the local branch of
          an overseas company so that the implications extend to the
          home country and other branches, i.e. money laundering
          regulations, Australia’s Foreign Trade Practices Act, etc

          An overseas company taking advantage of national facilities
          (i.e. listing on their stock exchange) which then convey
          obligations across the whole company, i.e. Sarbanes-Oxley
A Higher Standard for Risk Professionals                       www.prmia.org
                  Summary of key drivers
  For all                     Business Improvement Drivers
  commercial
  banks                       • More profit
                              • Fewer losses
                              • Better ratings

                              + local regulations

  Plus for major              Basel II for all, but Sarbanes-Oxley for US
  global                      banks and those that have listed in the US
  commercial
  banks
                                                        →
                              …. or loss of US listing (and reputation?).

A Higher Standard for Risk Professionals                          www.prmia.org
                Implementing Risk Management

                – people, process and systems considerations




  A Higher
Standard for
    Risk
Professionals
                   Categorisation of Risk




www.prmia.org
                 Can we categorise risks?
                                      Enterprise
                                        Risk


     Risk assessments, indicators, controls and loss event data


     Strategic               Financial           Procedural
                                                               Other Risks
      Risks                    Risks               Risks


  • Business             • Credit            •   Operational   •   Regulatory
    decisions            • Market Pricing    •   Disaster      •   Reputational
  • Poor direction       • Interest Rate     •   Fraud         •   Pandemic
  • Competition          • Liquidity         •   Terrorism     •   Legal
  • New                  • Asset &           •   Project       •   Environment
    technology             Liability         •   Contractual   •   Government
                         • Systemic

A Higher Standard for Risk Professionals                            www.prmia.org
                     Basel II Risk Coverage
                                      Enterprise
                                        Risk


     Risk assessments, indicators, controls and loss event data


     Strategic              Financial        Operational
                                                                 Other Risks
      Risks                   Risks             Risk


  • Business             • Credit Risk       •   Disaster        •   Regulatory
    decisions            • Market Risk –     •   Fraud           •   Reputational
  • Poor direction         Pricing,          •   Terrorism       •   Pandemic
  • Competition            Interest Rate,    •   Project         •   Environment
  • New                    Liquidity         •   Contractual /   •   Government
    technology           • Asset &               Legal
                           Liability
                         • Systemic
A Higher Standard for Risk Professionals                              www.prmia.org
                   Basel II Risk Coverage
  • Credit Risk
          – The risk of a bank not receiving payment for its
            assets.
  • Market Risk
          – The risk that a banks assets lose value due to
            market fluctuations.
  • Operational Risk
          – The risk of loss resulting from inadequate or
            failed internal processes, people and systems or
            from external events, including legal risk, but
            excluding strategic and reputational risk.



A Higher Standard for Risk Professionals            www.prmia.org
            Risk needs to be Categorised
  • Credit Risk
          – Counterparty categorisation, loan description,
            probability of default, expected loss, loss given
            default.
  • Market Risk
          – Trade details, market variables, probability
            calculations.
  • Operational Risk
          – Risk categories, event categories, probabilities,
            controls (descriptions, costs, effectiveness, etc),
            expected losses, unexpected losses, actual
            losses, indicators, responsibilities and
            authorisations, etc.
A Higher Standard for Risk Professionals              www.prmia.org
         Operational risk categorisation
          frameworks can be complex




                                  + Risk Indicators (KRIs)
A Higher Standard for Risk Professionals                     www.prmia.org
                Implementing Risk Management

                – people, process and systems considerations




  A Higher
Standard for
    Risk
Professionals
                        Risk and Capital




www.prmia.org
                           What is capital?
      The net worth of a business; i.e. the amount by which
      its assets exceed its liabilities
                                Gearing
                               Leverage

                                                       Equity
                                                       Equity
                                    Capital
                                    Capital                         Gearing
                                                                    Leverage
             Assets                                    Debt
                                                       Debt
          Investments
                                   Liabilities
                                   Liabilities
                                                        Earnings
                                                        Earnings
                                       Balance Sheet


A Higher Standard for Risk Professionals                        www.prmia.org
                      Capital covers risk …
                  Non Financial Firms – Risk Cover

                                                     Risks
                  Expected             Unexpected                        Catastrophic
     Frequency




                   Losses                Losses                            Losses
      of Loss




                                   Reserve      Equity                   Debt/Bond
                    Pricing
                                  Financing     Capital                   Holders




                                                                Severity of Loss
                                                    Source: after Marshall, Operational Risks, 2001


A Higher Standard for Risk Professionals                                        www.prmia.org
                 Banks are very different
                                           Bank capital most
    Bank assets                            exposed to asset
   are risk assets                          value changes
                                 Gearing
                                Leverage

                                                               Equity
                                                               Equity
                                    Capital
                                    Capital                                 Gearing
                                                                            Leverage
             Assets                                            Debt
                                                               Debt
          Investments
                                    Liabilities
                                    Liabilities
                                                                Earnings
                                                                Earnings
                 Bank liabilities      Balance Sheet
                  are deposits

A Higher Standard for Risk Professionals                                www.prmia.org
          A different level of risk cover …
                      Financial Firms – Risk Cover

                                                       Risks
                  Expected             Unexpected               Catastrophic
     Frequency




                   Losses                Losses                   Losses
      of Loss




                                       Economic
                    Pricing                                       Public
                                        Capital

                                                    Debt/Bond
                                                     Holders




                                                            Severity of Loss

A Higher Standard for Risk Professionals                            www.prmia.org
          The Public is at the End of the
                      Road …
   Greenspan: “… nor should we require individual banks
   to hold capital in amounts sufficient to fully protect
   against those rare systemic events which, in any event,
   may render standard probability evaluation moot. The
   management of systemic risk is properly the job of
   central banks. Individual banks should not be required
   to hold capital against the possibility of overall
   financial breakdown. Indeed central banks, by their
   existence, appropriately offer a form of catastrophe
   insurance to banks against such events …”
                                           Source: Alan Greenspan, FRBNY, 1996




A Higher Standard for Risk Professionals                            www.prmia.org
                            Bank Capital …
     •   … differs from a non financial firm’s capital: it protects
         against future, unidentified risks and losses while
         enabling the bank to operate at the same level.

     •   … strengthens the stability and soundness of the
         (international) banking system and, if applied universally,
         the competitive inequality among banks is diminished.

     •   So banks simply need to cover themselves against the
         risk of insolvency due to losses exceeding allocated
         capital.

     •   Banks manage risks; regulators decided on an arbitrary
         capital to risk asset ratio: there is no correct answer.
     •   “Capital adequacy” for banks was conceived in 1988 (the Cooke
         Committee, to become the Basel Committee on Banking Regulations
         and Supervisory Practices).


A Higher Standard for Risk Professionals                           www.prmia.org
  The BIS created standards on capital
   • Basel Capital Accord (Basel I),
           – In 1988 the Basel Committee on Banking Supervision
             recommended a risk-weighted capital ratio for
             internationally active banks,
           – This set minimum standards of capital adequacy,
   • A “New Capital Accord” (Basel II) proposed in
     1999,
           – Extended to cover regulatory (Pillar 2) and disclosure
             (Pillar 3) requirements, (Pillar 1 = approaches as how to
             calculate regulatory capital)
           – Final (reviewed) version released November 2005 (over
             100 countries to implement – still some questions
             regarding the US implementation
           – Complete Accord will take effect from 2007 (earliest
             participants) onwards to 2012
A Higher Standard for Risk Professionals                     www.prmia.org
                    … and decided that …
    • Risk-weighted assets would be basis for capital
      requirements

                                                  Risk-
     Minimum Capital
                            =     8% of         weighted
      Requirements
                                                 Assets

                                 Credit          Market         Operational
                                  Risk-     +     Risk-     +      Risk-
                                weighting       weighting        weighting


                              Now variable Introduced            New in B2
                                & more     1997, small          and variable
                             complex in B2 changes in             (also 3
                            (3 approaches)      B2              approaches)

A Higher Standard for Risk Professionals                              www.prmia.org
                       8% is the minimum




A Higher Standard for Risk Professionals   www.prmia.org
                Citigroup’s Capital ratios                                               (2003)
   Tier 1 capital                                                        $M
     Common stockholders’ equity                                              $ 96,889
     Qualifying perpetual preferred stock                                        1,125
     Qualifying mandatorily redeemable securities of subsidiary trusts           6,257
     Minority interest                                                           1,158
   Less: Net unrealized gains on securities available-for-sale                 (2,908)
                                                                                            Tier 1 Capital
     Accumulated net gains on cash flow hedges, net of tax                       (751)
                                                                                            Ratio =
     Intangible assets:
                                                                                            8.91%
        Goodwill                                                              (27,581)
        Other disallowed intangible assets                                     (6,725)
                                                                                            Total Capital
                                                                                            Ratio =
        50% investment in certain subsidiaries                                    (45)
                                                                                            12.04%
        Other                                                                    (548)
   Total Tier 1 capital                                                       $ 66,871      Minimum
   Tier 2 capital
                                                                                            Regulatory
                                                                                            Capital =
     Allowance for credit losses                                                 9,545
                                                                                            $60,023
     Qualifying debt                                                            13,573
     Unrealized marketable equity securities gains                                399
     Less: 50% investment in certain subsidiaries                                 (45)
   Total Tier 2 capital                                                       $ 23,472
   Total capital (Tier 1 and Tier 2)                                          $ 90,343
   Risk-weighted assets                                                   $ 750,293
A Higher Standard for Risk Professionals                                                    www.prmia.org
   But Basel Capital Adequacy is not all
     •    Commercial banks, which comply with Basel II,
          can decide (or their regulator can decide) which
          approaches to calculating regulatory capital
          they adopt, but …
     •    … regardless of capital approaches all Basel II
          compliant organisations must develop:
              –   an appropriate risk management environment,
              –   risk identification, assessment, monitoring and
                  mitigation/control,
              –   regular independent evaluation of policies, procedures
                  and practices,
              –   and make sufficient public disclosure to allow the market
                  to assess their approach to operational risk management.




A Higher Standard for Risk Professionals                          www.prmia.org
           Regardless of Pillar 1 approach
  • Even if the bank goes for the simplest
    approach to Risk-weighted Capital:-
    – A risk assessment culture must be
      created,
    – Credit and operational risks must be
      monitored,
    – Risk must be tracked,
    – A risk trend history must be created,
    – Risk actions must be disclosed.
   “… additional capital would not be the only answer as capital is not a substitute for
   appropriate risk assessment practices or adequate internal control processes.”
   Nicholas Le Pan, Chairman of the Basel Committee’s Accord Implementation Group, March 2004.



A Higher Standard for Risk Professionals                                                         www.prmia.org
                Implementing Risk Management

                – people, process and systems considerations




  A Higher
Standard for
    Risk
Professionals
                      Risk Architectures




www.prmia.org
                   Many interlocking parts
                                                                            MIS and
                                            Transaction                  Internal Audit –
                                            Compliance –                strategic direction and
                                                                        control, disclosure, etc
                                            transparency, best
                                            execution, Conduct
                                             Of Business, etc.




                    Transaction                                       Risk
                    Processing –                                   Management
                     quote, buy/sell,                              – capital adequacy,
                   clear, settle, report,                           risk management,
                            etc.                                     event repair, etc.



                                              Business
                                              Controls –
  A similar model could                       trading limits,
                                               management
  be created for the retail                   processes and
  financial business                        authorisations, etc.




A Higher Standard for Risk Professionals                                                      www.prmia.org
                                       A risk MIS view
                                                    Board/Senior
                                                    Management




                                                  Risk MIS
                                                                                                  Risk indicators
                                                                    Days                                                          Parts
                                                                   debtors                        Net sales
                                                                                                                                returned

    ALM /             Limits
                       and        Capital
    ALCO             positions   allocation                                     % leavers                            Response                        Oil
                                                                                                                       time                       reserves




                                                                                  HR management


                                                                                                     Sales systems




                                                                                                                                  Manufacturing
       Liquidity Risk System




                                                                     Accounts
     Market Risk System
                                          Operational Risk




                                                                                                                       CRM
                                              System




                                                                                                                                                     etc.
   Credit Risk System


                Transaction or event data



A Higher Standard for Risk Professionals                                                                                            www.prmia.org
                               An enterprise risk MIS view
                                                  Board/Senior
                                                  Management



  Enterprise Risk MIS                                                                          Strategic Risk System                                       Corporate Goals


                                                                            Risk indicators
                                                                Days                            Net sales
                                                                                                                                Parts                        Risk Appetite
                                                               debtors                                                        returned




   ALM /            Limits
                     and        Capital
   ALCO                        allocation
                   positions                                                % leavers                              Response
                                                                                                                     time
                                                                                                                                                   Oil
                                                                                                                                                reserves       External
                                                                                                                                                              Information
                                                                                                                                                           • Competitor reports
                                                                               HR management


                                                                                                   Sales systems




                                                                                                                                Manufacturing
     Liquidity Risk System                                                                                                                                 • Demographics
                                                                 Accounts




   Market Risk System
                                                                                                                      CRM

                                                                                                                                                           • Weather trends

                                                                                                                                                   etc.
                                            Operational Risk
                                                System
       Credit Risk                                                                                                                                         • Financial trends
        System
                                                                                                                                                           • Gartner, etc
                                                                                                                                                           • New technologies
              Transaction or event data
                                                                                                                                                           • Political moves
                                                                                                                                                           • Etc.




A Higher Standard for Risk Professionals                                                                                                                                  www.prmia.org
                                               A corporate MIS view
                                                                                                Board/Senior
                                                                                                Management




                                                                 Corporate MIS
                                                                                                                                                         Corporate
      Enterprise Risk MIS                                                            Strategic Risk System                                                Goals

                                                                                                                                                       Risk Appetite
                                                                              Risk indicators                                                          External
                                                                                                                                                        Information
                                                                  Days
                                                                 debtors                    Net sales
                                                                                                                            Parts
                                                                                                                          returned
                                                                                                                                                       • Competitor
                                                                                                                                                         reports
                                                                                                                                                       • Demographics
                                                                                                                                                                             Regular
      ALM /         Limits and    Capital
                                                                                                                                                       • Weather trends
                                                                                                                                                       • Financial
                                                                                                                                                         trends
                                                                                                                                                                            corporate
                                                                                                                                                                           performance
      ALCO          positions    allocation                                                                    Response                        Oil     • Gartner, etc
                                                                              % leavers
                                                                                                                 time                       reserves   • New
                                                                                                                                                         technologies
                                                                                                                                                       • Political moves
                                                                                                                                                       • Etc.
                                                                                                                                                                               data
                                                                                                                            Manufacturing
                                                                                               Sales systems
                                                                               management




         Liquidity Risk System
                                                                   Accounts




                                                                                                                 CRM




       Market Risk System
                                                                                                                                               etc.
                                                                                   HR




                                              Operational Risk
          Credit Risk                             System
           System



           Transaction and event data




A Higher Standard for Risk Professionals                                                                                                                                         www.prmia.org
              Financial risk management
                     environment
    High-tech, fast throughput,                                 Internal
    transaction processing                                    ratings, etc




                                                                 Capital
                        Daily
    Core               trans-
                                                              calculations,
 processing            action
                                               5 years        risk metrics,
  systems               data               transaction data     ALM, etc




A Higher Standard for Risk Professionals                           www.prmia.org
            Operational risk management
                    environment
 Getting risk data from the …
 … bottom (the point of incident)
 … to the top (for analysis) … is key.

                                    ASSESSMENT
            MITIGATION


                         FEEDBACK




                                                 … through layers of
                                                 management …




                                                                                EVENTS
    RISKS




A Higher Standard for Risk Professionals                               www.prmia.org
            Risk management environment
                                         Risk Management
                     Risk Data Base Management
                                           Regulatory and




                                                                                        Disaster Recovery
                        Support Centre
                                            Supervisory




                                                                                          and Continuity
                                                                          Security
                                             Watching




                                                             Hosting
    Users




                                            Risk issues
                                              support




                                                                       Infrastructure
                                                                          Support
                                          Software updates
                                          and maintenance
                                               notes


                                Service Management
                     Risk Maintenance Facility

A Higher Standard for Risk Professionals                                                   www.prmia.org
                         …. comprising ….
 Help desks          Provides support to users on issues surrounding Risk,
                     e.g. new financial products, new selling processes,
                     changes in “approved persons”, company structure
                     changes - a ‘valued opinion’ on operational risk issues.


 Regulatory          Reports on requirements of new regulations and
 “watchers”          developing regulatory and supervisory issues and latest
                     thinking from regulators and supervisors.

 Risk database Maintains the risk framework and ensures that it reflects
 management changes in company structure, responsible for the impact
                     of regulatory and supervisory changes on organisation
                     and risk categorisation, performance checks the data
                     collection and risk event completion activities, verifies
                     the completeness of the risk recording function.

 Service             Provides technical support for all risk management
 Management          systems – software upgrades, access security, new
                     users, hardware changes, communications links, etc

A Higher Standard for Risk Professionals                              www.prmia.org
                    Technical implications
  Financial (credit, market,               Non-financial (operational)
   liquidity, etc) risk                     risk
  •Real-time                               •Once a day for input, once
  •High availability                        a month for reporting
  •High performance                        •Low performance
   requirements                             requirements
  •Automated input, few                    •Manual input, many users
   users
                                           •Relatively small amounts
  •Very large amounts of
                                            of fairly complex data
   relatively simple data
  •Kept for a long time (5                 •Kept for a very long time
   years)                                   (at least five years)
  •Data comes from existing                •New data collection
   core systems                             systems need to be
                                            developed
A Higher Standard for Risk Professionals                       www.prmia.org
                Implementing Risk Management

                – people, process and systems considerations




  A Higher
Standard for
    Risk                Implementation
Professionals           considerations




www.prmia.org
                Banks are not homogeneous
        – with respect to risk management implementation

                        Front office       Middle office   Back office

 Corporate           Speed
                     Impact
                     Regulated
                     “Rule-aware”
 Retail              Speed
                     Impact
                     Regulated
                     “Rule-aware”
 Investment          Speed
                     Impact
                     Regulated
                     “Rule-aware”
         … but a bank needs a view of risk which combines different
                           departmental profiles
A Higher Standard for Risk Professionals                      www.prmia.org
                           Implementation
               Risk theories and regulations

  Processes, tools
    and capital
     allocation
                                   Rollout
                                considerations
                                                     Ongoing
                                                 maintenance and
                                                  improvement



                               A risk culture
A Higher Standard for Risk Professionals                 www.prmia.org
            From financials to processes
  • Credit/market risk relatively mature                     (liquidity
     risk still causing concerns!)
        – But still needs data and model validation,
          corrections, backdating of parameters, etc
  • Operational risk still immature
        – Specifying it
             What is it? How to recognise and classify it?
        – Setting it up
             Involving the users, gaining commitment, regulatory
             approval, etc
        – Rolling it out and maintaining it
             Collecting accurate data - feedback – validation -
             correcting errors – changing classifications – renewing
             systems, etc
A Higher Standard for Risk Professionals                        www.prmia.org
                            The Pillar II Maze
                     Risk theories and regulations
       capital allocation
       Processes, tools,



                                                     Updating the
        and disclosure


                                                       system          User
                            Create the risk
                                                Regulatory          acceptance
                              framework
                                                 approval
                                                             How much
                                              Feedback        data to
                             Cleaning                         collect
                             old data               Risk
                                                   Culture      Ensuring
                                        User                   clean data
                                    involvement


                               An risk culture
A Higher Standard for Risk Professionals                             www.prmia.org
            Some implementation issues
   Processes, systems and capital allocations are easy
   – the problems are the “people issues”:
   1. Build the governance processes
   2. Creating the framework – consensus on risk categorisation
   3. Getting user involvement – from the right people
   4. Achieving user acceptance – “why am I doing this? I have
       better things to do!”
   5. Deciding on how much data to collect – too little = poor
       statistics, too much = inaccurate data
   6. Ensuring clean data – cleaning old data, ensuring new data
       is completing correctly
   7. Gaining regulatory approval – different
       interpretations/numerics in different jurisdictions
   8. Building a risk culture – everyone knows what risk is
   9. Integrating feedback and statistics – to improve the system
   10. How to update the systems – validating and changing
       processes, risk categories (framework) and systems upgrades
A Higher Standard for Risk Professionals                 www.prmia.org
                 Why a governance process?

         Basel II (and Sarbanes-Oxley and others)
         requires that the Board takes overall
         responsibility for risk management – and
         is aware of risk developments

         It requires that all senior management
         takes responsibility for the risk processing
         and management within their areas, and

         It mandates a “risk culture” with in the
         organisation.


A Higher Standard for Risk Professionals       www.prmia.org
                    Risk objective setting
   Strategic       •   High level goals      i.e. the mission statement, the
   objectives      •   Support               strategic objectives and the
                       mission/vision        strategies to achieve them.
                   •   Strategic choices
   Related         •   Operations            i.e. the lower level targets for
   objectives      •   Compliance            this programme
                   •   Reporting
   Selected        •   Align and support     Conformation of high profile
   business        •   Management decision   objectives and verification that
   objectives                                they match the high level goals
                                             and mission
   Risk            •   Costs                 How the strategic choices
   appetite        •   Time                  impact the variables against
                   •   Resource allocation   which success is measured

   Risk            •   Acceptable variance   i.e. the unit variations that the
   tolerance       •   Unit and measure of   organisation will tolerate in
                       objective             order to achieve a specific
                                             programme
                                                         Source: COSO ERM Framework

A Higher Standard for Risk Professionals                             www.prmia.org
                              Commitment
  • Commitment on risk management is needed
    from:
          – Owners/shareholders
          – The Board
          – Senior management
          – Departmental managers
          – Audit, asset and liability management and
            compliance
          – Human resources
          – Staff
          – Geographies

A Higher Standard for Risk Professionals           www.prmia.org
                    Building a risk culture
   An internal risk culture is the sum of the individual and
   corporate values, attitudes, competencies and behaviour that
   determine commitment to and style of risk management.
    • It includes both an enterprise-wide risk and an internal
      control culture
    • It requires clear lines of responsibility, segregation of
      duties and effective internal reporting
    • It requires high standards of ethical behaviour at all levels
    • Although a framework of formal, written policies and
      procedures is critical, it needs to be reinforced through a
      strong control culture
    • It is the responsibility of both the board and senior
      management


A Higher Standard for Risk Professionals                  www.prmia.org
           Examples of staff risk culture
    • All staff know:
            What a risk control or risk event is
            Why they exist
            What their risk responsibilities are
            Prime and alternative reporting routes
            What happens to their reports
            What was the result of “their” event’s mitigation
            What the institution’s risk status is (overall and
             their part)
            How it is improving (or getting worse)
            What their risk training plan is
A Higher Standard for Risk Professionals               www.prmia.org
Examples of management risk culture
   • All Board and senior management know:
           What the institution’s risk policy is
           What their risk appetite is
           What their own risk responsibilities are
           What major risk controls have been infringed or
            what risk events have taken place
           What cumulative risk situation have
            accumulated
           What the institution’s risk status is
           How it is improving (or getting worse)
           What the business impacts are
A Higher Standard for Risk Professionals              www.prmia.org
      Why are Risk Cultures important?
  • Risks are managed by people
  • People can apply standards with greater or lesser
    degrees of efficiency – or they can make mistakes
  • People must apply the appropriate risk
    management standards to the best of their ability
  • Regulators appreciate that the best standards and
    guidelines are only effective if implemented
    correctly – and with diligence and enthusiasm.
  • Regulators will therefore test an organisations’ risk
    culture along with its risk standards, best practices,
    capital robustness and disclosure procedures.



A Higher Standard for Risk Professionals          www.prmia.org
        Attributes of a risk management
                     culture
  1. Attention is paid to quantifiable and unquantifiable risks.
  2. All risks are identified, reported and quantified.
  3. Awareness of risk through performance measurement, risk-
     adjusted pricing, pay structures and forecasting.
  4. Risk management is accepted as everyone’s responsibility.
  5. Risk managers have teeth.
  6. The enterprise avoids what it doesn’t understand.
  7. Uncertainty is accepted.
  8. Risk managers are monitored.
  9. Risk management is not to stop people from taking risks but to
     create value, by enhancing the chances of success.
  10.The risk culture is defined, the risk appetite is understood.
                                  Source: Operational Risk Management, PWC, November 2003 (abbreviated)
A Higher Standard for Risk Professionals                                              www.prmia.org
                                … and finally
  • Talk to the supervisors
          – Regulations are interpreted and implemented by
            regulators, central banks and supervisors
          – They will have national interpretations – and
            local preferences and good practices
          – They are responsible for cross-border
            cooperation and interpretation
          – They will set implementation practices – rule
            and regulation based – or risk and principle
            based
          – Because commitment to the regulations is their
            primary function, whereas, for the bank it is a
            secondary activity

A Higher Standard for Risk Professionals           www.prmia.org
     Ten questions for risk management
 1. Have you identified the potential business risks to the                                               Y/N
    organisation?
 2. Have you assessed the likelihood and consequence of the                                               Y/N
    significant risk being realised?
 3. Have you assessed those risks that could:                                                             Y/N
       –   Damage your reputation?
       –   Affect your market position?
       –   Result in prosecution?
 4. Have you established controls to manage significant business                                          Y/N
    risks?
 5. Have you established a positive culture for controlling the risks?                                    Y/N
 6. Have you established a contingency plan to mitigate disaster?                                         Y/N
 7. Have you established continuity management control                                                    Y/N
    arrangements?
 8. Do you regularly audit compliance with control arrangements?     Y/N
 9. Do you regularly review these arrangements with respect to their Y/N
   adequacy and effectiveness?
 10. Do you report annually on your risk and control measures?                                            Y/N
  From the “Turnbull Guidance” on Internal Control in the Combined Code of the Committee on Corporate Governance

A Higher Standard for Risk Professionals                                                         www.prmia.org
                PRMIA – The Global Organisation
                 The Professional Risk Managers’ International
                 Association (PRMIA) is the world’s leading risk
                 professional’s association.
                 43,000+ risk professionals from all segments of
                 the financial services industry in 179+ countries
  A Higher       (both free and paid membership)
Standard for     Members from 4,000+ organisations, 200+
    Risk         members meetings annually in 60+ chapters
Professionals    A quarterly journal and a monthly newsletter
                 The Professional Risk Manager’s Handbook
                 The PRM exam – the world’s most comprehensive
                 risk manager’s exam
                 Member-led (400+ volunteers), grass-roots
                 organisation with its own Code of Risk Ethics
                 A “not for profit” organisation governed and
www.prmia.org    owned by its members
                      Thank you




  A Higher
Standard for
    Risk
Professionals




                      David Millar
                Chief Operating Officer
                david.millar@prmia.org
www.prmia.org
CHINA AUSTRALIA GOVERNANCE PROGRAM
                Melbourne, July 2007


              POST-PROGRAM REVIEW


             Presentation to AFDC
Workshop on Risk Management in Commercial Banks
          3-7 September 2007, Shanghai

                  By Ken Waller
    Director, Melbourne APEC Finance Centre
Background
 Collaboration between the Asia Pacific
 Finance and Development Centre,
 Shanghai and the Melbourne APEC
 Finance Centre
 Aim – to improve risk management and
 governance in China’s banking system


                                          2
Background (cont…)
 Intensive dialogue between Chinese and
 Australian regulators, bankers, officials,
 and regional and international agencies
 Site visits by the Chinese delegation to
 major Australian financial, policy and
 regulatory institutions


                                              3
Objectives of the Program
 To build durable relations between
 Australian and Chinese institutions
 To identify capacity building needs
 To develop a five-year capacity building
 program



                                            4
Key Outcomes of the Dialogue
 A deeper understanding of issues
 involved in improving governance and
 risk management in China
 A sharing of experiences of successes
 and challenges in implementing Basel II
 A deepening of relations between the
 Australian and Chinese institutions
                                           5
Key Outcomes (cont…)
 A solid review of banks’ market, credit
 and operational management and
 challenges
 Strategic options that could be pursued
 in building capacities




                                           6
Findings and Recommendations
The following are some of the identified priorities:
  RISK MANAGEMENT:
  Some of these will be discussed in further detail in the second presentation

        Organisational structures for risk management
        An appropriate risk management culture
        Data Gathering and cleansing issues
        Retaining skilled risk-management staff
        Measuring and reporting risk management
        IT systems and the collection of relevant data
        Calculation and allocation of economic capital                           7
Findings (cont…)
 CORPORATE GOVERNANCE:
   Roles and responsibilities of the Board of
   Directors
   Directors relationships with Senior Management
   The role of Supervisory Boards in China
   Appointment of Directors; qualifications; training
   and evaluation of performance


                                                        8
Findings (cont…)
 CAPACITY BUILDING:
   Capacity building should be ongoing, principles-
   based and should draw on issues and key lessons
   The sharing of mutual experiences
   The focus is to build a good corporate governance
   culture and developing policy in line with best
   practice



                                                       9
Summary of the Site Visits
 Visits to: 11 banks, a policy department
 and 2 regulatory agencies
 The key discussions were about:
   Financial / regulatory policies and structures
   Australia–China relations
   The history and development of Australia’s banks
   Privatisation and deregulation
   Specific risk & operational management
   frameworks
   Transition from Basel I to Basel II                10
Major Discussion Points
 Deregulation
 Competition
 Good practices in risk management and
 corporate governance
 Impacts of implementing Basel II
 China’s financial reform
 Challenges for China’s banks posed by
 Basel II
                                         11
Conclusions
 Sound risk management and corporate
 governance practices are preconditions for a
 healthy finance system
 Banking is about managing risk soundly and
 profitably
 Governance arrangements are integral for
 effective risk management
 Characteristics are reflected in Basel II
                                                12
Conclusions (cont…)
 Capacity building is vital
 Well skilled and motivated people are
 critical
 Developing good governance and risk
 management capacities is a journey that is
 different for each bank and for different
 countries

                                              13
The Future
 A report to the Australian and Chinese
 governments
 The AFDC and the MAFC will conclude
 an agreement to intensify their
 cooperation
 The agreement will identify a number of
 joint projects, subject to appropriate
 funding sources                           14
Future Joint Projects
 High level dialogues
 Risk management and/or governance
 training programs
 Joint research on key issues of common
 interest to support training in the banking
 sectors of both China and Australia
 Building an alumni network to promote
 exchanges                                     15
  ~~~~~~~
THANK YOU
  ~~~~~~~

            16
RISK MANAGEMENT ISSUES
       IN BANKING
         SYSTEMS

             Presentation to AFDC
Workshop on Risk Management in Commercial Banks
          3-7 September 2007, Shanghai

                  By Ken Waller
    Director, Melbourne APEC Finance Centre
Agenda for this presentation
  To discuss specific issues of risk management
  arising from:
    I. The recent China-Australia Governance
    Program that was held in Melbourne

    II. Australia’s banking system – from a public
    policy perspective


                                                     2
I. Risk management issues for banks
  Three main issues emerged from the recent
  China-Australia Governance Program held
  in conjunction with MAFC and the AFDC:
    a. Organisational structures
    b. Culture
    c. Measuring and reporting risk management
    – the key issues for smaller banks

                                                 3
I.a. Organisational structures
  An integrated approach – fundamental Basel II
  Comprehensive across the whole business –
  including business units
  governance is integral
  more urgency to integration –
  conglomeration/cross-border activities/risk
  diffusion

                                             4
I.b. Culture
  Culture starts at the top (the Board level)
    It is increasingly important as banks shift from
    rules-based to risk-based supervision
  Requires greater participation / transparency /
  communication within banks
  Generation of comprehensible and reliable
  data
  Business Units shift from passive compliance
  to proactive disclosure and self-assessment          5
I.c. Measuring and reporting
  Credit risk
    data often inadequate                      Issues for
    heavy costs/inadequate expertise           smaller
    balance model results/ expert judgment     banks

  Operational risk
    requires management / Business Unit support
    business continuity
    stress testing – disaster recovery plans
  Cultural change – biggest challenge
    requires devising sound strategic approaches            6
II. Australia’s banking system
   Risk management in Australia’s banking –
   the four main issues from a public policy
   perspective:
     a. Banks’ risk management policies
     b. Banks’ performance
     c. Assessment of banking system stability
     d. Handling current threats


                                                 7
II.a. Banks’ risk management policies
  Integrated risk management
  Strategic in concept and in application
  Independently reviewed – and policies totally
  integrated with system of governance and
  with culture
  Approved and monitored by board
  Critically assessed and disciplined by
  regulator, rating agencies, business analysts
  and ultimately by markets
                                                  8
II.b. Banks’ performance – 2006
  Strong profitability / asset growth / housing
  and business
  Falling cost-to-income ratio
  NPL’s – 0.4% of on-balance sheet assets; low
  arrears
  Write-offs - 0.20% of outstanding loans
  Overseas exposure – 29% of total assets
  Regulatory capital ratio 10.4%
  VaR – of unhedged positions / 0.04% of          9

  shareholder funds
II.c. Banking system stability
  More reliance on funding from wholesale
  markets – offshore
  Banks’ foreign liabilities 28% of total
  liabilities – mainly $US and hedged
  Liquidity risk well managed – securitisation
  S&P upgraded 4 largest banks to AA+
  Over recent period strong growth in share
  prices
                                                 10
II.d. Handling current threats
  FSAP IMF review
  Crisis management arrangements – quasi
  deposit insurance
  Stress testing
  Central bank response to current tightening of
  credit and liquidity – money market operations
  to maintain official cash rate

                                              11
  ~~~~~~~
THANK YOU
  ~~~~~~~
            12
Workshop on Risk Management in Commercial Banks
          Chris Mouat, Director China Partnerships ANZ
             Patrick Zhu, Head of Retail Risk China ANZ
                                                             Sep 2007

                        Australia and New Zealand Banking Group Limited




                                                                          0
Some background on ANZ….

 Established in 1835
 One of the 5 largest and most successful companies in
 Australia
 The leading bank and the largest company in New
 Zealand
 The leading bank in the South Pacific
 Australia’s leading bank in Asia
 31,000 employees
 Over 6 million customers, across 28 countries
 Strong performance
  −   Top quartile global performance
  −   Cost/Income ratio 45.6%
  −   2006 NPAT $3.688 billion
  −   Return on equity 20.7%
  −   252,000 shareholders
 Rated AA



                                                         1
        ANZ’s Asia Network operates in 12 markets, supporting
        corporate customers who invest and trade across the region

                   MAINLAND CHINA                                                                                              SINGAPORE          (ASIA HQ)
               since 1986           •   Shanghai                                                                               since 1974          •   Singapore
                 77 people          •   Beijing                               Asia Network                                      127 people
             A$3.1B Assets                                                                                                   A$9.1B Assets



                   HONG KONG                                                                                                                           JAPAN
               since 1970           •   Central, HK Is.                                                                        since 1969          •   Tokyo
                 33 people                                                                                                       56 people         •   Osaka
             A$5.6B Assets                                                                                                  A$10.5B Assets


                   TAIWAN                                                                                                                        VIETNAM
               since 1980           •   Taipei                                                                                 since 1993          •   Hanoi
                 40 people                                                                                                      113 people         •   Ho Chi Minh
             A$1.7B Assets                                                                                                   A$0.6B Assets         •   Can Tho (Rep)



                   SOUTH KOREA                                                                                                                 INDONESIA1
               since 1978           •   Seoul                                                                                  since 1973          •   Jakarta
                 21 people                                                          ANZ in Asia
                                                                                                                                 71 people
             A$2.3B Assets                                                                                                   A$1.6B Assets


                   THE PHILIPPINES                                         INDIA                                                    Malaysia & Thailand
               since 1990           •   Manila                       since    19842         •   Mumbai                   1971       Representative Offices            1985
                 41 people                                               5 people                                        3 people                                  2 people
             A$1.0B Assets                                         Non-Bank FinCo                                        • Kuala Lumpur                        •   Bangkok

1. 85% ANZ owned, trading as ANZ Panin Bank. Excludes ANZ Panin cards business which reports as part of Asian Partnerships
2. ANZ formerly owned ANZ Grindlays which operated throughout South Asia/Middle East. In 2000, ANZ sold Grindlays to Standard Chartered Bank                                  2
    ANZ has a strong history across Greater China
    ANZ China


                                                                          •             Mainland China (Shanghai & Beijing)
                                                                          •   Correspondent bank for Bank of China (1948)

                                                                          •   Beijing Rep. Office (1986)

                                                                          •   Branches in Shanghai (1993) & Beijing (1997)

                                                                          •   Sole Australian bank with full range of services

                                                                          •   License to provide RMB & FX business

                                                                          •   ~60 employees




•             Taipei                                                      •             Hong Kong

•   Branch established 1980                                               •   Branch commenced operations in 1970

•   Full commercial banking services                                      •   Leading Australian/NZ bank

•   Client base largely global Multi-national companies based in Taiwan   •   Commercial banking services focusing on Trade Finance &

•   35 employees                                                              regional/global MNCs

                                                                          •   40 employees




                                                                                                                                        3
ANZ’s Asia Strategy has two components: Servicing global relationship customers through ANZ
network and local markets through local partners


                                                                           Pacific Network                                            Asia Network
                                                                                    ANZ Branches                                            ANZ Branches

                                                                                                                          •   12 markets
                                                                                                                          •   Larger customers investing and trading
                                                                                                                              across Asia
                                                                 •   11 countries
                                                                                                                          •   Trade Finance, Project Finance, FX, Capital
                                                                 •   Market shares upwards of 30%
                                                                                                                              Markets
                                                                 •   Expanding into French and US territories
                                                                                                                          •   606 employees
                                                                 •   1,520 employees




                                                                                                                                  Asia Partnerships
                                                                                                                          •   6 countries, 7 banking partnerships
       Asia Partnerships
                                                                                                                          •   Equity and value-add
                                                                                                                          •   New markets for ANZ capability
                                                                                                                          •   Retail and small business focus
                                                                                                                          •   96 ANZ employees




 ASIA: Mainland China, Hong Kong, Taiwan, South Korea, The Philippines, Singapore (+HQ), Japan, Vietnam, Indonesia, Cambodia, Malaysia (Rep), Thailand (Rep)
 PACIFIC: Papua New Guinea, Timor Leste, Solomon Islands, Vanuatu, New Caledonia (Rep), Fiji, Tonga, Cook Islands, Samoa, American Samoa, Kiribati
                                                                                                                                                                            4
Partnership provides benefits to both partners through
effective combination of strengths

Partnership Model

                 “home team advantage”                                             “world class skills”
 Local Partner




                 • Customer franchise                                             • World-class products
                                                        Working




                                                                                                           ANZ
                 • Strong distribution                                            • Risk Mgmt expertise
                                                        together
                 • Local experience                                        • Sales Mgmt and training
                 • Government relationships                                        • Leading technology



Practical Approach to Partnerships


             Agreed outcomes             • Agreed business strategy
                                         • ANZ expertise available
                                         • Active development of local staff


             Practical governance        • Investment and trust in relationship
                                         • Agreed Board and management positions
                                         • Agreed participation in governance


             Sharing the upside          • Alignment of decisions and consequences
                                         • Target medium term 30-49% equity position

                                                                                                                 5
ANZ Journey

        Engage the      •Financial sector deregulation
        competition
                        •Speculative property exposures, with significant
                        concentrations
        (1986 – 92)
                        •1989 – interest rates at 18%


        Ride out the    • Economy in recession
           crunch       • Decline in property prices accelerated
                        • 1992 NPLs - 6% across the industry
        (1992 – 98)
                        • ANZ close to insolvency- no government bailout



        Refocus on      •Specialisation strategy - develop capability in
           profit &     targeted segments
       virtuous cycle
                        •Be Lean – eliminate road blocks and cost

       (1998 - Now)     •Exploit optimum risk return customers and segments

                        •Risk management restructure & alignment with
                        business                                              6
Today’s Risk Governance Structure


                                                ANZ Board



                                                                                              Board Audit
                                              Risk Committee                                  Committee

                                 • Oversees policy, strategy / processes
                                 • Authorises Group’s Limits framework
                                 • Authorises limit approvals of the CTC




                                    Executive Management Committees
        Credit & Trading           Group Asset &                  Operational Risk            Project & Initiative
        Risk Committee           Liability Committee            Executive Committee           Review Committee
             (CTC)                     (GALCO)                        (OREC)                        (PIRC)
    • Policy                                                                                  • Project risk
                                 • Balance Sheet Risk
                                                                • Compliance
    • Major Lending Decision                                                                  • Project governance
                                                                • Payments/operational risk
    • Asset Writing Strategies                                                                • Project priorities
                                                                • Security
    • Portfolio
    • Traded Risk




                                                                                                                     7
Independence and Segregation of Risk – Risk Functional
Structure
Key   Risk Functional Features:
•     Clearly defined accountabilities and authorities
•     Functional experts
•     Collaboration with regions and business units
•     Independent reporting


                                                                     CEO/
                                                                   President



                                Risk                        • Clear checks and balances             Business
                                                          • Effective working relationships


                                                                      Transaction
                                                  Risk Grade                        Problem
              Policy &    Reporting &   Portfolio                     Structuring
                                                  Modelling &                        Credit
            Framework      Analysis   Management                        & Credit
                                                   Validation                     Management
                                                                       Approval
                                                   Credit Risk
                                                                                               • Assess risk of
        •   Set framework, assure framework                                                      transactions within
        •   Approve transactions                                                                 framework set by Risk
        •   Provide risk reporting and analysis
        •   Specify risk measurement tools (eg. statistical risk grade models)                 • Document and
        •   Manage problem loans (workout strategies, collections)                               manage loans
                                                                                                 according to Risk
                       Other Risk Area (eg. Market Risk, Operational Risk)                       policy


                                                                                                                         8
The risk policy architecture enables clearly defined
responsibility and authority


                                                              Policy Levels                                         Scope
Each policy level is subordinate to
 the ‘umbrella’ of the level above




                                                                   Level 1 – Risk Principles




                                                                                                                      GLOBAL
                                                                                                                      GLOBAL
                                      Key control policies
                                                                               Level 2 – Group Risk policies


                                      Specification of core
                                      products & businesses
                                                                              Level 3 – Product/Business policies




                                                                                                                      LOCAL
                                                                                                                      LOCAL
                                      Detailed description of how to
                                      undertake a business activity and the        Level 4 – Operating procedures
                                      aspects of credit risk management to
                                      consider




                                                                                                                               9
      When and what to centralise and automate?

       CENTRALISED CREDIT                  Increase scale & efficiency                             Ensure consistency & manage
       ASSESSMENT                                                                                   complexity of transactions
                                                                ANZ Small
                                      ANZ Personal
                                                                 Business                                     ANZ Large
       Headquarters                   (Automated* &
                                                              (Automated* &                               Corporates (Manual
                                        Centralised
                                                                Centralised)                                and Centralised)



                                                                               Smaller scale & mid-level
                                         As a pre-condition to deliver            loan complexities
                                          an automated & centralised
          Regional branches               process, a Line of Business               ANZ Medium
                                             platform that enables                    Business
                                          consistent sales proposition             Banking (Manual
                                                   is required                      & Centralised)




       2nd level branches
                                                                                                              ANZ before
                                                                                                               (Manual &
                                                                                                             Decentralised)
       DECENTRALISED
       CREDIT
       ASSESSMENT


                                                                                                               Complexity of risk*

                                  AUTOMATED PROCESS                                                             MANUAL PROCESS

* Automated processes do not imply 100% automation. There is a % of transactions that are referred out for manual assessment for various reasons.
                                                                                                                                               10
Retail Credit Process – Automated and Centralised

   PROCESS          WHO                                     WHAT
    Collect
    Collect                      • Sales: Collect customer information
   Customer
   Customer          Sales
                                 • Centralised: Definition of information required
     Info
     Info
   Enter Info        Sales       • Sales: Real-time input of information into system
   Enter Info

  Info Storage
  Info Storage    Centralised    • Centralised: Information shared by authorised staff

                                 • Credit system or credit manager: Analyse transaction
                 80% Scorecard
  Analyse Info
  Analyse Info                   • Credit system (scorecards) monitored closely by the
                   20% Credit
                                   centralised Modelling Decision Validation team

                                 • Credit system or credit manager: Recommends a decision
  Recommend
  Recommend      80% Scorecard
                                 • Internal Quality Assurance randomly review recommended
   Decision
    Decision       20% Credit
                                   decisions
                                 • Centralised: Opening of accounts, printing Letter Of Offers
    Process
    Process      Centralised &     and loan draw downs
     Loan
     Loan           Sales        • Sales: Post loan checking and all other functions (eg. loan
                                   settlement)
                                 • Centralised:
    Account
    Account       Centralised         o Periodic review
     Mgmt
     Mgmt           Credit            o Maturity of loan
                                      o Make pay or no-pay decisions for NSF

                                                                                                 11
Retail Credit Process – Automated and Centralised

     Applicants
                                        Offer Accepted

                                        Offer to applicants


                     front end input

                              Automated
                                                                          Accepted
                             Decision Model
                                                  Approve                Application
                                Verification                    Offer      Loaded
       Back Office
         Input                    Bureau         Referred for      Approve
                                                   manual
                               Scoring Model     assessment             Decline
                                Policy Rules
                                                 Re-Submit
  Fax, Email
  & Intranet                  Decline
                                                                             Decline



                                                                                       12
Business Banking Credit Process – Manual and Centralised

   PROCESS          WHO                                        WHAT
    Collect
    Collect                     • Sales: Collect customer information
   Customer
   Customer         Sales
                                • Centralised: Definition of information required
     Info
     Info                       • Sales: Send information to centralised team
   Enter Info    Centralised    • Centralised: Receive, check and enter information into shared
   Enter Info                     computer system


  Info Storage   Centralised    • Centralised: Information shared by authorised staff
  Info Storage
                                • Credit manager: Analyse transaction
                 Centralised         o Use scorecard
  Analyse Info
  Analyse Info     Credit            o Apply policy rules
                                     o Cross-check with credit bureau


  Recommend
  Recommend      Centralised    • Credit manager: Recommends a decision
                   Credit       • Internal Quality Assurance randomly review recommended decisions
   Decision
    Decision

                  Centralised   • Centralised: Opening of accounts, printing Letter Of Offers and loan
    Process
    Process      Operations &     draw downs
     Loan
     Loan           Sales       • Sales: Post loan checking and all other functions (eg. loan settlement)

                                • Sales:
    Account
    Account                          o Periodic review
                    Sales            o Maturity of loan
     Mgmt
     Mgmt                            o Make pay or no-pay decisions for NSF

                                                                                                            13
Business Banking Credit Process – Manual and Centralised

     Applicants
                            Offer Accepted

                             Offer to applicants




                                                                Accepted
                                                               Application
                      Verification                 Offer         Loaded
       Back Office      Bureau
         Input                                        Approve
                      Policy Rules     Manual
                                     assessment
                     Scoring Model

  Fax, Email
  & Intranet                                         Decline
                                                                Decline



                                                                             14
Corporate process – manual and centralised

                      Business Unit                                   Group Risk


                            Relationship               Credit             Independent
         Sales
                               Credit                 Decision            Risk Function

         Has                 Prepares
    responsibility            credit                Dual Approval
                                                                            Separate from
    for customer           submissions                                    relationship team
     relationship
                          Financial analysis                             Remuneration not
                                                                         linked to deal flow
    Customer pricing,       Credit scoring
        taking into                                                         Experienced
                           Rating agencies
       account risk,                                                        practitioners
    capital allocation,         KMV
    relationship costs                                                      Largest deals
                          Sound judgement                                 approved by CTC
                                                                            & Board RMC
        Industry          Deal structuring &
        expertise         security/covenants

     Single Customer                    Portfolio           Credit            Portfolio
   Concentration Limits                   Caps             Training           Modelling
                                                                                               15
Segmentation of Sales and Credit – Example: ANZ
Institutional Banking

     Institutional Financial Services                 Group Risk
                     Business         Relationship
   Utilities &
                  Services, Health       Credit      Credit Executive
 Infrastructure
                    & Education
                                                                        CAD below CRO
                                         Group
                                      Relationship                      Discretion excludes:
 Telco, Media &   Retail, Transport
                                         Credit      Credit Executive
 Entertainment     & Distribution                                       • Country & Bank Limits
                                         Group
                      Natural         Relationship                      • Intra ANZ Exposures
                     Resources           Credit      Credit Executive
                       Group             Group
                                                                        • Investment & Trading
                                      Relationship                        Limits
Manufacturing                            Credit      Credit Executive
                                         Group
                                                                        • Private Equity Funding
                                      Relationship
                  Food, Beverages
                                         Credit      Credit Executive   • Underwriting Transactions
                  & Agribusiness
                                         Group

                     Property &       Relationship                      • Breaching SCCL Levels
                                                       Real Estate
                    Construction         Credit
                      Finance
                                                       Credit Unit
                                         Group
   Financial
 Institutions &
  Government                          Relationship
                                                     Bank & Country
                                         Credit
    Trade &                                               Risk
                                         Group
  Transaction
   Services

                                                                                                      16
Credit Governance and Lending Discretion Structure

                 Sales / Asset Writing            Dual Approval                   Credit
                                                                                                        High




                                                                                                       discretion
                                                                                                        Lending
                                                                                                       Low
                                                                                                       High




                                                                                                          en d
                                                                                                             ce
                                                                                                        ri an
                                                                                                      pe ill
                                                                                              Low




                                                                                                    ex Sk
                                                                 Low                   High
   Requirements for mandatory escalation of lending
                                                                     Risk in transaction
         decisions provides quality assurance
                                                                   (incl. size and quality)




     Separation of        Clear Delegation        Assurance of         Alignment of            Recognition of
     credit & sales           of Credit            Quality in             Skills &              Credit Risk
                            Authority to             Credit            Capabilities              Variation
   • Asset Writing           Individuals          Assessment
   • Credit                                                                                   • Size
     Assessment                                 • Upward flow                                 • Complexity


                                                                                                                    17
Benefits for the Bank

    Independence and segregation of risk has proven to be beneficial to the
          sales and credit teams, as well as the greater organisation

                 Sales                                          Credit Risk

                                                               Specialist risk
         Greater focus on sales
                                                             assessment skills
         = Higher commission
                                                          = Improve loan quality




                                                                     ss
                    H




                                                                   Lo
                     ig
                        h




                                                                &
                        er




                                                               t
                                                             os
                            R
                             ev




                                                            C
                               en




                                                           er
                                                       w
                               u
                                e




                                                     Lo
                                         Bank
                               Sustainable asset growth
                                      Lower NPL
                                 Increased efficiency
                                    = Higher profit

                                                                                   18
The Aim of Financial Market Risk Controls:-

To monitor and control market risk exposures to ensure that management are
not surprised by losses resulting from changes in market risk factors.

Market risk factors include:

        FX rates,

        Interest rates,

        Equity prices,

        Credit spreads and

        the volatilities of these prices


Operational Risk is also implicit within all Business Units with a key element of
Operational Risk being the integrity of the data contained within the system.


                                                                                    19
Applicability of Market Risk to Chinese Commercial Banks

1. Financial Market assets constitute a material percentage of assets
2. Financial Market assets generate a material percentage of bank income
3. Financial Market assets represent the banks’ liquidity portfolio
4. The financial markets environment in China is relatively benign (eg PBoC
   interest rate controls limit volatility and this provides an ideal opportunity
   to introduce more sophisticated financial market risk controls as their
   introduction will not require a major change to current treasury practices
   and/or operations
5. This will then enable all relevant areas (Treasury, Finance, Risk, Audit etc)
   to become familiar with these controls in a “less stressed” environment.
6. This contrasts with having to introduce controls at a time of stress (eg
   sharp deregulation, unforeseen circumstances, liquidity problems)
7. This also enables gradual increased sophistication of existing market risk
   controls, as market conditions become more deregulated, thus ensuring
   that the business develops in concert with the controls and not in possible
   opposition to them.

                                                                                    20
     Operational Risk Management

The risks arising from day to day operating activities which may result in direct or
indirect loss. These losses may result from failure to comply with policies,
procedures, laws and regulations, from fraud or forgery, from a breakdown in the
availability or integrity of services, systems and information, or damage to the
bank’s reputation:

Applicability to Market Risk:

1.      Dealers undertake transactions which are outside limits or controls

2.      Transactions are not settled correctly resulting in loss (late settlement fees,
        payments to incorrect counterparty, receipt of incorrect securities etc)

3.      Transactions are processed incorrectly (eg wrong coupon rate recorded resulting in
accrual of income that may be too low/high and thus P&L suffers sharp movement when
corrected)

                                 Possible Mitigants:
1.      Segregation of duties               2.    Transaction authorisation
3.      Financial & managerial reporting    4.    Monitoring
                                                                                         21
    Balance Sheet Risk – Interest Rate Risk:

•   Balance sheet interest rate risk management involves minimising fluctuations in net
    interest income and market value that may occur over time as a result of changes in
    market interest rates.
•   Much of this risk arises when the repricing characteristics of the assets and liabilities
    making up the balance sheet are not matched. The greater the extent of such
    mismatching, the greater will be the potential for volatility in future net interest income
    and market value.
•   3 key risk measures:
     • Value at Risk (VAR): Quantifies the risk to market value of an overnight
       movement in rates. The size of the shift is calculated from the most recent 500
       days of actual rate movements (using a 97.5% level of confidence).
     • Earnings at Risk (EAR): Quantifies the risk to mismatch income over the next
       12 months from an overnight, parallel shift in the yield curve. The size of the shift
       is based on a statistical analysis of movements in the 1 month point on the yield
       curve.
     • Market value limits: Limits absolute and relative falls in market value due to
       market price movements over a set period.




                                                                                                  22
Value at Risk

Value-at-risk is the estimated total loss that may be sustained on a financial instrument (or
portfolio of instruments) from an adverse market movement, estimated for a given level of
confidence over a specified holding period
Function of 4 factors:
1.    Market Price
2.    Standard deviation in market value
3.    Confidence interval
4.    Holding Period
Example:
•Bank might report that its portfolio has a 1-day VaR of $5 million at the 95% confidence
level.
•This implies that provided usual conditions will prevail over the 1 day the bank can expect
that, with a probability of 95%, the value of its portfolio will fall by 5 million or less during 1
day,
•or in other words: it can expect that with a probability of 5% (i. e. 100%-          95%) the
value of its portfolio will fall by more than 5 million during 1 day.
•Stated yet differently, the bank can expect that the value of its portfolio will decrease by 5
million or less on 95 out of 100 usual trading days
                                                                                                 23
    EAR (example: assumed balance sheet and assumed numbers):
                                                                                                EAR Impact -
Assets                                                                                        next 12 month NII
                                                                                  Amount
                                                                        M onths   (Million)     -1.00%     1.00%
Loans                  Floating Rate      avg   term   to   repricing      2         1,300        -10.8      10.8
                       Fixed Rate         avg   term   to   repricing     12         2,400          0.0       0.0
Bonds                  Floating Coupon    avg   term   to   repricing      4         1,800        -12.0      12.0
                       Fixed Coupon       avg   term   to   maturity      19            900         5.3      -5.3
Buy/Sell Repo *        Floating Coupon    avg   term   to   repricing      3            870        -6.5       6.5

Total Assets                              avg term to mat/repricing       8.0        7,270       -24.1      24.1


Liabilities
                                                                                  Amount
                                                                        M onths   (Million)
Customer Deposits      Floating Rate      avg   term   to   repricing     0.5        2,900        27.8     -27.8
                       Fixed Rate         avg   term   to   repricing     2.5        1,450        11.5     -11.5
Other FI Deposits      Floating Rate      avg   term   to   repricing     0.5           950        9.1      -9.1
Sell/Buy Repos         Floating Coupon    avg   term   to   repricing     1.2        1,100         9.9      -9.9

Total Liabilities                         avg term to mat/repricing       1.1        6,400        58.3     -58.3

Net Assets / Equity                                                                    870        34.2     -34.2


NII Impact of 1% fall in interest rates   Higher NII over next 12 months of 34.2m

NII Impact of 1% rise in interest rates   Lower NII over next 12 months of 34.2m
   * Reverse repo
                                                                                                                   24
Balance Sheet Risk – Liquidity Risk



•   The primary aim of liquidity management is to ensure that the Bank can in all
    circumstances meet its commitments to customers as they fall due.


•   This includes a desire to avoid being forced to liquidate assets in a distressed
    market (thus suffering large losses) in order to meet commitments (eg current US
    sub-prime crisis).


•   Several factors contribute to the overall level of liquidity risk, these include:


    The level of mismatching between projected cash inflows and outflows.
    The diversity (eg, by type, customer, currency, geography) of the balance sheet's
    funding base.
    The capacity to raise funds in the wholesale market.
    The volume and quality of liquid assets.

                                                                                        25
Standard Treasury Processes:



   Balance
   Sheet Mgt              RMB Trading              FCy Trading         New Products



     Liquidity               Profit                      Profit           Profit



                                       Banks                       Customer           Not at
            At Risk                   Own Profit                  Margin Income        Risk


                                Treasury Support Unit(s)

    Operations / Branch                                           Mgt / ALCO / Risk
                                        Finance (P&L)
        (Payment)                                                       (Limits)

                                                                                           26
APEC Workshop on Risk Management in Commercial
Banks
                             27 April 2005

Building a Healthy Regulatory Framework for Risk Management
in Commercial Banks: Regulator’s Perspective


September 2007

Bernie Egan
Program Director, Basel II
APRA



                                                         1
Summary




To introduce the regulatory framework, practices and main challenges under Basel II
   in Australia and the role of the Government

(There is some duplication with the presentation given in July in Australia)




                                                                                      2
Australian Prudential Regulation Authority (APRA)




Australia has a ‘deregulated’ banking system – a government decision

APRA is a risk-based integrated prudential regulator

Institutions supervised by APRA are subject to APRA’s ‘rules’, known as prudential
    standards, which are legislative instruments and subject to Parliamentary
    disallowance. (Note the difference to other jurisdictions where the legislature
    ‘makes’ the rules)




                                                                                      3
Governance and risk management and capital



Governance provides incentives for boards and management to pursue objectives that
are in the interests of banks and their shareholders

To prudential supervisors, governance is an essential element in the safe and sound
functioning of a bank

“… risk management process (including Board and senior management oversight) to
identify, evaluate, monitor and control or mitigate all material risks and to assess
their overall capital adequacy in relation to their risk profile. These processes should
be commensurate with the size and complexity of the institution” (Core Principles for Effective
Banking Supervision October 2006)


      Note: the important concept of proportionality and the ‘link’ to capital rather
      than Basel II specifically

This also reflects Australia’s approach



                                                                                            4
Capital regulation




Banks are in the business of taking risks

Banks want to hold capital
    as protection against unexpected loss (and expected losses where provisions are
       insufficient)
    to provide them with financial flexibility
    as a sign of strength to their customers

But there is also a need for regulatory capital
    for systemic reasons
    statutory obligations eg depositor insurance or in Australia’s case the Australian
       Banking Act states “It is the duty of APRA to exercise its powers and
       functions ….. for the protection of depositors …..”



                                                                                         5
 Different perspectives on capital



Regulatory Capital
     Depositor protection and system stability

Economic Capital
     Maximisation of stockholders wealth - the maximum amount of unexpected
     losses potentially arising from all sources that could be absorbed while a bank
     remains solvent, with a given level of confidence over a given time horizon.

Rating agency capital

     The minimum level of capital the credit ratings agencies require a bank to hold
     in order for the bank to maintain its desired credit rating.




                                                                                       6
Sharing Basel II experiences



Each jurisdiction must make its own Basel II implementation decisions

With the benefit of hindsight would APRA implement Basel II differently?

Are there lessons (for China) from Australia’s experiences?

(Common) challenges following the introduction of Basel II

But: each banking supervisor has its own legal responsibilities




                                                                           7
Basel II implementation considerations



Timing

Staggered or simultaneous implementation of all (the various) Basel II approaches

Tailoring Basel II

    Greatest scope for purely domestic banks adopting the standardised approaches

    Limited scope for internationally active banks adopting the advanced approaches

Process for approving advanced approaches




                                                                                    8
Basel II supervisor and bank relationships



Form and basis of the existing relationships – prescriptive?

                                              - risk-based?

Especially for banks adopting the advanced Basel II approaches, supervisors must
develop a better understanding of how banks govern themselves and how they
measure and manage their risks

“…. move towards a system of risk-based supervision, developing skills in assessing the
quality of a bank’s risk management and its ability to assess risk exposure.” Jaime Caruana
June 2004

Issues of consolidated (domestic and cross-border) supervision of international banking
groups through home/host supervisory arrangements




                                                                                        9
Basel II governance and risk management



Bank supervisors have long pushed banks to improve governance and risk management

Basel II strengthens the link between regulatory capital and risk management

Especially for banks adopting the advanced Basel II approaches under which banks use
their own risk estimates (and some models), ‘best practice’ governance and risk
management becomes even more critical




                                                                                 10
The Australian Basel II timeline




All Basel II approaches will be made available in Australia from January 2008

All Australian banks and other authorised deposit-takers will adopt the Basel II
    standardised approaches unless accredited by APRA to adopt the Basel II
    advanced approaches

Basel II is a journey, not a destination




                                                                                   11
 Three pillars of Basel II


                                                          Standardised        Advanced

• B 1
 Pillar    Minimum capital requirements for credit,       Credit risk:        Credit risk – use of own
     a     market and operational risk                    greater             risk estimates –
     s                                                    granularity +       probability of default,
     e
     l                                                    ratings (where      exposure at default,
                                                          applicable)         loss from default
   I
   I
                                                          Operational risk:   Operational risk – use
    c
    o                                                     ‘crude’ and         of own risk estimates
    n                                                     ‘mechanistic’       and models
    s
Pillar 2
    i      Supervisory review: banks demonstrate they     a ‘cruder’          Internal capital
    s      have capital targets consistent with their     approach than       adequacy assessment
    t
    s      overall risk profile and current operating     that expected of    process + supervisory
           environment, with supervisors ensuring that    the advanced        ‘review’
   o
   f       banks have sound internal processes in place   ADIs
           to assess the adequacy of their capital
    t
    h
Pillar 3   Market discipline                              Easily provided     Detailed qualitative
    r
    e                                                     capital and         and quantitative
    e                                                     credit quality      disclosures on capital
   m                                                      information         and risk estimates
   u                                                                                             12
   t
   u
Basel II implementation challenges


Basis of application for approval to adopt the advanced Basel II approaches

Supervisory approval process

Use and experience

Dealing with the varying state of Basel II readiness of applicant banks – qualitative,
quantitative, data, documentation – ‘supervisory challenge’

Basel II reporting

Estimating/dealing with potential changes in the level of regulatory capital

Implementing Pillars 2 and 3

Home/host issues




                                                                                     13
IRB/AMA accreditation issues



Level of robustness

Lag in documentation for model development and validation

Senior management information

Low default portfolios

Greater risk sensitivity is being achieved

Definition of default issues

Operational risk

         Emerging discipline

         Measure capital + manage risk



                                                            14
Some thoughts on Pillar 3




For the banks adopting the advanced Basel II approaches there will be detailed
disclosure of risk estimates. That will highlight

    Differences in risk estimates between banks

    Differences in supervisory approaches

The Basel Committee and its working groups are committed to assisting with
‘educating’ the market




                                                                                 15
 The implementation of Basel II in Australia


APRA’s prudential standards
    Drafts have been released (mostly two drafts of each standard)

    Little change expected in final standards

No approval required for ADIs adopting the standardised approaches

Advanced approaches challenging and require APRA approval – limited scope for
   transitional arrangements

Some interim arrangements

    Margin lending

    Advanced approaches - downturn LGDs on residential mortgage loans

Reporting – draft forms to be released shortly



                                                                                16
 Risk management


(As previously discussed) banking is about risk-taking

Basel II requires that risks be understood and managed and capital held
   commensurate with the risks

Australian examples of Basel II leading to better risk management

     Standardised approaches – residential mortgage lending ‘grid’

     Advanced approaches – risk estimates that are more robust and reflective of the
       risks

Pillar 2

     Capital to be held against all risks

     APRA to add transparency and structure to its existing process of supervisory
       review

     ADIs adopting the advanced approaches are working cooperatively to improve
       their understanding and management of risks
                                                                                     17
 Governance


Basel II requires an ADI’s Board of directors to provide oversight of its capital
   adequacy

For ADIs adopting the advanced approaches, the Board should also provide oversight
   of material aspects of the risk estimation process

APRA requires board sign-off on applications to adopt the advanced approaches

The strength of the Board structure and how expertise is brought to the Board

APRA ‘rules’ on governance “… ensure that regulated entities are managed in a sound
   and prudent manner by a competent board of directors …”

APRA ‘rules’ on fit and proper “Persons who are responsible for the management and
   oversight of an authorised ADI need to have appropriate skills, experience and
   knowledge …”

Boards (and senior management) are able to bring a holistic approach to risk oversight


                                                                                     18
 Bringing it all together


Benefits to banks from the improved risk management and corporate governance
   arising out of the Basel II Framework

        Identifying risk

        Pricing risk

        Managing risk

        Holding adequate capital against risk

        Transparency of the risk process




                                                                               19
1
2
           Rating Process

            CORPORATE                                RAM RATINGS


 Request for a Credit Profile Rating


        Provides information            Team of analysts studies the information


                                            Analysts conduct site visit and
                                                management meeting



                                           Analysts prepare rating report for
                                              Internal Rating Committee
      Corporate accepts rating
                 or
      Corporate rejects rating
                 or                     Rating is assigned and corporate notified
Corporate appeals for reconsideration

                                        Corporate may choose to make the rating
                                             public or remain confidential



                                            Rating is kept under surveillance
                                                                                    3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
     Benefits of Basle II?

Brought Risk Management and International Best Practices to
the forefront


Forced banks to clean-up and organise the databases


“Cost-of-risk” on capital assessed up-front


Has allowed domestic banks to narrow the gap with foreign
banks with respect to risk management


Foundation for risk-based pricing


                                                              26
27
     Evolving Market Dynamics

New types of banking entities / products – the market is
moving faster than risk management ideas!


Risk Management is as good as “2020-Hindsight”


Risk based pricing not easily applied in the market place


Non-bank financial institutions entering the market




                                                            28
29
30
31
32
33
34
35
36
37
     Thank you



No 19-G, The Boulevard, Mid Valley City,
         Lingkaran Syed Putra,
    59200 Kuala Lumpur, Malaysia
        Tel : (603) 7628 1000
        Fax : (603) 7628 1700
   Website: http://www.ram.com.my
Building A Healthy Regulatory Framework
   for Risk Management in the Korean
            Commercial Bank



                    Jae-soo Yoo

              Director of Banking Division
       Ministry of Finance and Economy, KOREA
Table of Contents
Table of Contents




         I. Korean Banks: Where do they stand ?

         II. Macro Economic Risk Management System

         III. New Basel II : Challenges & tasks




                              1
I. Korean Banks: Where do they stand? (1)
I. Korean Banks: Where do they stand? (1)


     After the Financial Crisis in 1997, the landscape of the Korean banking industry
     has been dramatically changed: High Profitability, Low NPL

                            Major Indices of Korean Banks                     (As of March 31. 2007)
                                                                                                                   (100mil KRW. %)
                                                                                        Substandard and
                                                   Shareholder’s Equity
                                                                                Net          bellow
   Bank      Total Asset    Loans      Deposits                                                           BIS       ROA     ROE
                                                                   Paid-in    Income
                                                                                                   %
                                                                   capital

  Shinhan      1,852,913   1,030,417   1,052,913      99,439         75,281     8,278      9,037   0.74   12.01*     2.04   33.86

   Woori       1,883,635   1,101,728   1,059,082     112,745         31,798     8,066     10,893   0.86   11.60*     1.94   28.67

  SC-cheil      607,860      324,637     334,359      27,658         12,366     1,128      5,423   1.44   10.86*     0.76   16.92

   Hana        1,265,018     709,189     835,021      71,013          9,872     4,555      7,547   0.89   11.34*     1.69   26.13

    KEB         822,419      381,390     461,584      59,229         32,245     2,384      3,175   0.64   12.45*     1.36   15.53

    Citi        559,564      240,646     280,702      33,826         13,099     1,385      2,046   0.70   14.02*     1.06   16.50

  Kook min     2,138,502   1,345,147   1,384,229     145,188         16,819    11,825     15,590   1.00   14.17*     2.39   32.08

   Total      9,129,911    5,133,154   5,407,889    549,098        191,479     37,622    53,711    0.89   12.41      1.84   27.40




                                                               2
I. Korean Banks: Where do they stand?(2)
I. Korean Banks: Where do they stand?(2)


 Profitability (1)
                                               Trend of Net Income                                                        (100 billion KRW)
                           97          98              99           00       01       02       03       04        05        06      07.3
   Domestic Banks           -           -             -5.4         -4.1      4.6      5.0      1.8      8.8      13.6      13.6      6.5
   - Commercial Banks     -3.9       -12.5            -5.9         -2.8      3.5      3.4      0.8      6.4      9.2       9.1       4.0
   - Special Banks          -           -              0.5         -1.3      1.1      1.6      1.0      2.4       4.4       4.5      2.5


                                                       Trend of ROA                                                                     (%)
                                   97           98           99        00       01       02       03       04       05        06      07.3
  Domestic Banks                    -            -         -14.4     -11.0     12.8     10.9     4.0      15.2     18.4      14.9     26.9
  - Commercial Banks             -14.2        -52.5        -23.1     -11.9     15.9     11.7     3.2      18.0     20.3      16.1     27.0
  - Special Banks                   -            -           4.2      -9.5      7.8      9.6      5.6     10.7     15.4      13.0     26.7
  U.S. Commercial Banks          14.7         13.9          15.3      14.0     13.1     14.5     15.3     14.4     12.9

                                                       Trend of ROE                                                                     (%)

                           97            98           99           00        01       02        03       04        05        06      07.3
  Domestic Banks            -            -        -14.4        -11.0         12.8     10.9     4.0      15.2      18.4     14.91     26.90
  - Commercial Banks      -14.2      -52.5        -23.1        -11.9         15.9     11.7     3.2      18.0      20.3     16.08     27.01
  - Special Banks           -            -            4.2          -9.5      7.8      9.6      5.6      10.7      15.4     13.01     26.73
  U.S. Commercial Banks   14.7       13.9         15.3             14.0      13.1     14.5     15.3     14.4      12.9




                                                                    3
I. Korean Banks: Where do they stand?(3)
I. Korean Banks: Where do they stand?(3)


 Profitability (2)
                                Trend of NIM* (Net Interest Margin)
                                                                                                            (%)

                                 99       00       01          02     03       04       05     06     07.3
     Domestic Banks             2.5      2.4       2.6         2.7   2.6       2.6      2.8    2.64   2.47
     - Commercial Banks         2.9      2.7       3.0         2.9   2.8       2.8      3.1    2.90   2.74
     - Special Banks            1.6      1.7       1.9         2.2   2.1       2.1      2.2    2.04   1.85
     U.S. Commercial Banks      4.0      3.9       3.9         4.0   3.8       3.7      3.6
     * NIM = Net Interest profit (interest revenue – interest cost)/interest bearing assets


                        Trend of Interest Spread** (Won denominated)
                                                                                                            (%)

                              99         00        01          02     03        04       05     06    07.3
    Domestic Banks            3.3       3.1       3.4       3.5      3.3       3.5       3.7   3.5    3.3
    (Loan)                   10.6       9.7       9.0       7.7      7.0       6.8       6.7   6.8    6.8
    (Deposit)                 7.3       6.6       5.6       4.2      3.7       3.3       3.0   3.3    3.5
     - Commercial Banks       3.6       3.3       3.7       3.5      3.4       3.6       3.9   3.7    3.4
     - Special Banks          2.8       2.6       2.8       3.4      3.2       3.0       3.0   3.0    2.9

     ** Interest Spread = average interest rate of loans – average interest rate of deposits




                                                           4
I. Korean Banks: Where do they stand?(4)
I. Korean Banks: Where do they stand?(4)


 Soundness                      Trend of ‘Substandard and bellow’
                                                                                                                         (%)
                          97      98      99      00        01     02       03      04          05          06     07.3
    Domestic Banks         -       -     12.9     8.0       3.4    2.3      2.6     1.9         1.2         0.8     0.9
    (Corporate)            -       -       -       -         -     2.7      2.6     1.9         1.3         0.9     1.0
    (Retail)               -       -       -       -         -     1.1      1.7     1.5         1.0         0.7     0.8
    (Credit Card)          -       -       -       -         -     6.3     10.0     5.1         2.4         1.3     1.3
     - Commercial Banks   6.0     7.4    13.6     8.8       3.3    2.4     2.7      1.9         1.3         0.9     0.9
     - Special Banks       -       -     11.2     6.1       3.6    2.1     2.3      1.7         1.1         0.7     0.8

                                          Trend of NPL Ratio                                                             (%)

                                99      00      01          02       03       04          05          06          07.3
     Domestic Banks              -       -      2.8         1.9      2.0      1.6         1.0         0.7          0.7
     - Commercial Banks         8.3     6.6     2.8         1.9      2.2      1.7         1.1         0.8          0.7
     - Special Banks             -       -      2.7         1.7      1.6      1.2         0.8         0.6          0.7
     U.S. Commercial Banks       -       -       -          1.4      1.1      0.9         0.8

                                      Trend of Delinquency Ratio                                                         (%)
                          97      98    99      00      01         02       03      04          05          06     07.3
    Total                  -       -    5.1     2.8     2.1        2.0      2.0     1.7         1.2         0.8     1.0
    (Corporate)            -       -    4.3     2.9     1.9        1.8      1.9     1.8         1.3         1.0     1.0
     -conglomerate         -       -     -       -      1.8        1.2      0.6     0.2         0.1         0.5     0.6
     -SME                  -       -     -       -      1.9        1.9      2.1     2.1         1.6         1.1     1.2
    (retail)               -       -    3.7     2.5     1.3        1.5      1.8     1.7         1.1         0.7     0.8
    (Credit card)          -       -    7.8     7.5     7.3       11.9     10.5     5.5         3.2         1.6     1.7
     - Commercial Banks   6.7     8.7   4.8     3.3     2.1       2.0      2.1      1.9         1.3         0.9     0.9
     - Special Banks       -       -    5.7     1.6     2.2       1.7      1.6      1.3         1.0         0.7     0.9

                                                        5
I. Korean Banks: Where do they stand?(5)
I. Korean Banks: Where do they stand?(5)


 Capital Adequacy
                                               Trend of BIS                                                      (%)
                                 97     98      99       00       01        02      03       04.        05       06
     Domestic Banks               -      -     11.7     10.6     11.7      11.3    11.2    12.09       13.00    12.75
     - Commercial Banks          7.0    8.2    10.8     10.5     10.8      10.5    10.5    11.29       12.43    12.31
     - Special Banks              -      -     13.9     10.7     13.6      13.2    12.8    13.73       14.09    13.60
     U.S. Commercial Banks        -      -       -      12.1     12.7      12.7    12.7     12.6       12.33      -


                             Trend of ‘Tier 1’ and ‘Tier 2’ ratio                                                (%)
                                        97     98     99       00    01          02     03       04       05       06
              Domestic Banks             -      -      -       6.7   7.7        7.2    7.0      8.0      9.3      9.2
              - Commercial Banks        3.9    4.9    6.8      6.3   6.7        6.3    6.2      7.1      8.7      8.5
     Tier 1
              - Special Banks            -      -      -       7.8   9.8         9.3    8.7      9.8     10.4     10.4
              U.S. Commercial Banks      -      -      -       9.4   9.9        10.0   10.0     10.0     9.9        -
              Domestic Banks             -      -      -       3.9   4.0         4.1    4.2      4.1      3.7      3.6
              - Commercial Banks        3.1    3.3    4.0      4.2   4.1        4.2    4.3      4.2      3.7      3.8
     Tier 2
              - Special Banks            -      -      -       2.7   3.8         3.9    4.1      4.0      3.7      3.2
              U.S. Commercial Banks      -      -      -       2.7   2.8         2.7    2.6      2.6      2.4       -

                                     Trend of Coverage Ratio                                                     (%)
                               99        00       01          02          03         04        05       06        07.3
     Domestic Banks           44.1      59.5     76.1        89.6        84.0      104.5      131.3    173.9     171.7
     - Commercial Banks       44.1      61.1     74.0        83.2        82.1       96.4      119.3    159.0     160.0
     - Special Banks          43.9      54.3     80.3       108.4        89.2      125.7      162.1    216.6     200.8
     U.S. Commercial Banks   178.0     149.2    131.0       127.1       145.7      174.6      170.5      -


                                                        6
II. Macro Economic Risk Management System (1)
II. Macro Economic Risk Management System (1)



     What’s Early Warning System ?

    1. An Expansion the EWS on external factors developed in 1999 to cover
      overall economic areas :
      Financial market, Raw materials, Property market, labor


    2. A comprehensive and systemic risk management system for early
      detection and resolution of economic crisis(2004.9)


     Participation : relevant institutions (MOFE, FSC, BOK)

     - Working group in charge of financial sector are setting up to exchange
       information, detect warning signals and come up with policy measures



                                      7
II. Macro Economic Risk Management System (2)
II. Macro Economic Risk Management System (2)



     When Risks are detected, level of alert will be triggered

    Types of risk: unstable financial (stock) market, disruption of financial
      intermediation functions, contagion effect from overseas market

     Five triggers of different level of alert




     Financial Policy Council : Coordinate policy among MOFE, FSC
     and BOK

      MOFE: in charge of the general crisis management plan such as
        monitoring market trend, identifying cause/route of crisis, stabilizing
        investor sentiment ete

                                       8
   III. Basel II Challenges and tasks
   1. Implementation process of New BIS Accord


 Overview
           2002                         2003                               2004                                            2005
       ∧                                                 ∧
「New Basel Accord                                  Launch「New BIS
 Implementation                                      Accord T/F」
  plan」(March)                                         (January)
                                                                   ∧
                                                             launch「New BIS
                                                                 Office」
                                                                  (April)
                                               ∧                                   ∧
                                          Prepare  1st                       Issue domestic
                                             draft                            guidelines and
                                          (October)                         workshop(October)
                                                         ∧                                    ∧                            ∧
                                                                                      Decide timeline and
                                                Issue 1st draft                                                  Detailed AMA guidelines
                                                                                      method for New BIS
                                                and workshop                            implementation               (1st draft)(May)
                                                  (December)                              (December)
                                                                                                            ∧                         ∧
                                                                                                   Formulate credit risk       Detailed guideline on
                                                                                                  control structure and               capital
                                                                                                  public hearing(March)        adequacy(draft)(July)

                                                                                                 ∧                                         ∧
                                                                               IRB approval process · formulate pre-run
                                                                                                                                       Detailed IRB
                                                                                requirements and request submission of
                                                                                                                                  Guideline(draft)(August)
                                                                                     implementation plan (January)


         1st T/F           2nd T/F                                                                  3rdT/F
       (Apr~July)         (Oct~Feb)                                                                (Jan~ )

         : Organization               : Guideline
                                                                  : Adoption                  : T/F in place
         building                     documentation



                                                                       9
 III. Basel II Challenges and tasks
 2.「New BIS Ratio Calculation Guideline(draft)」

■ National guideline on New BIS Accord
     ㅇ The Basel Committee announced New BIS Accord in late June, 2004.
          A need for domestic guideline to assure smooth domestic implementation of New BIS Accord
          A need for domestic guideline to assure smooth domestic implementation of New BIS Accord

      ㅇ The regulator and banks form joint T/F to collect market feedback.
         Full utilization of national discretion granted to national supervisors to reflect the domestic financial market
         Full utilization of national discretion granted to national supervisors to reflect the domestic financial market



■ Use of national discretion
    ㅇ A decision was made on applicability of 67 items out of 75 national discretion items in total
              8 pending items will be addressed through empirical analysis and in-depth research.
              8 pending items will be addressed through empirical analysis and in-depth research.

      ㅇ Example of national discretion
           1. Expanded scope of SMEs
           1. Expanded scope of SMEs

             Under IRB, total asset as well as total sales(60
             Under IRB, total asset as well as total sales(60                       Expanded scope of SMEs in light
                                                                                    Expanded scope of SMEs in light
             bil.) can be used to classify SMEs.
             bil.) can be used to classify SMEs.                                      of the nature of the industry
                                                                                      of the nature of the industry

           2. <Option 1> applicable for bank exposure
           2. <Option 1> applicable for bank exposure

                    to retain stability of the banking system and avoid a radical increase in risk weights of banks
                    to retain stability of the banking system and avoid a radical increase in risk weights of banks



                                                         10
 III. Basel II Challenges and tasks
 3. Implementation timeline
■ Implementation timeline
    – FSS decides timeline and method for New BIS implementation in the national market
        in December, 2007.
    – As our nation is not a member country of the committee, global trend and domestic
        financial · economic conditions are considered in decision making process.
■ Timeline for domestic implementation
    – An impact of New BIS implementation on the financial sector · economy, readiness of
        domestic banks and overseas trend are considered.
    – Global trends are accommodated, and domestic banks are given time.
    – Potential issues due to phased adoption of risk measurement approaches are avoided.

    collective implementation in early 2008 irrespective of risk measurement approach
    collective implementation in early 2008 irrespective of risk measurement approach
■ Scope of application for banks
    – Risk management skills and competitiveness are enhanced across the banking
       industry.
    – Banks are treated fairly in competition.
       applied to all banks operating in the domestic market
       applied to all banks operating in the domestic market
■ Imposition of risk measurement approach
    – Banks are granted a right to choose their risk measurement approach (considering
       risk characteristics and management ability)
    – Global trends are accommodated.
       autonomous choice of banks
       autonomous choice of banks
                                           11
 III. Basel II Challenges and tasks
 3. Implementation timeline (con'd)


■ Scope of application of New BIS Accord in the national market



                              Diversified Financial
                              Diversified Financial
                                     Group
                                      Group
                                                                           (1) ~ (4) :: consolidated accounting
                                                                           (1) ~ (4) consolidated accounting
                                                                           for all banks operating in the national market
                                                                           for all banks operating in the national market
                                  Holding Company
                                  Holding Company
          (1)

                             Internationally Active
                              Internationally Active
        (2)                           Bank
                                       Bank                       (3)
                                                                                    Not applicable to a holding company
                                                                                    Not applicable to a holding company

        Internationally Active
         Internationally Active                  Internationally Active
                                                  Internationally Active
                 Bank
                  Bank                                    Bank
                                                           Bank
(4)


      Domestic
      Domestic         Securities
                       Securities
        Bank
        Bank             Firm
                         Firm




                                                        12
III. Basel II Challenges and tasks
4. IRB approval process · use-test requirements

■ IRB and AMA approval process
                                  2005                     2006                              2007                            2008
                                                                               Late March     Late June
                                    Preliminary discussion and preview
                                    Preliminary discussion and preview                  Application
                                                                                        Application
     Common
     Common                                                                                 Review and decision
                                                                                            Review and decision
                                                                                                                            New BIS
                                                                                                                            New BIS
                                                                                                                        implementation
                                                                                                                         implementation
                                                       Pre-run of a rating system
                                                        Pre-run of a rating system
Retail and F-IRB
Retail and F-IRB                                    (for 2 years before application)
                                                     (for 2 years before application)
                                                          Pre-run of a rating system
                                                          Pre-run of a rating system
      A-IRB
      A-IRB                                         (for 3 years before implementation)
                                                     (for 3 years before implementation)


       AMA
       AMA                                               Pilot of a rating system(2 years before implementation)
                                                         Pilot of a rating system(2 years before implementation)


■ Use-test requirements
Rating system construction      Construction of a rating system in line with New BIS standards and estimation of risk components such
 and validation in line with    as Probability of Default, Loss Given Default
     New BIS standard           Validation of a rating system and risk components
                                A rating system should be used not only for calculation of regulatory capital but also for other banking
Utilization of rating systems   activities.
                                Examples of key application areas such as loan approval, pricing and provisioning
                                Board and management approval required for key decisions on credit rating and risk components
Management understanding
     and reporting              The management should fully understand design and operation of a rating system, and continuously
                                ensure that the system is running properly.


                                                               13
III. Basel II Challenges and tasks
5. Credit risk control structure

■ Credit risk control structure principles
 - The following principles are designed to maintain check and balance of credit risk functions
   in order to ensure adequacy of a rating system.

             Independence of rating assignment
              Independence of rating assignment

             Review by an independent 3rd party
             Review by an independent 3rd party

             Independence of credit risk control function
              Independence of credit risk control function

             Bigger role of the board and the management
             Bigger role of the board and the management


■ Credit risk control structure overview

                                                  Board and management
                                          reporting                              reporting
               Exposure originationg
                 (risk generated)       Risk management
                                                                        Review function
                                             function


                     Marketing                        Credit risk control function




                                             14
III. Basel II Challenges and tasks
5. Credit risk control structure (con'd)

■ Independence of rating assignment and review by an independent 3rd party

                        Sales
                        Sales                  Independent function
                                                Independent function                   Review by an independent 3rd party
                                                                                       Review by an independent 3rd party

                                                   Grade assigned
                                                   Grade assigned
                                                                                       Is the same grade is granted
                                                                                        Is the same grade is granted
               Grade recommended
               Grade recommended                    Final decision
                                                    Final decision                     according to the documented
                                                                                        according to the documented
                                                                                            procedures? **
                                                                                            procedures? **
                 Grade assigned **
                 Grade assigned                         Review
                                                        Review


                                Compare performance
      * Exceptions considering size and materiality(i.e. loan approved by the delegated authority of the branch
      ** Sampling to review consistency and timeliness of ratings for management reporting


■ Independence of credit risk control function
     – Credit risk control function is responsible for design, implementation and performance
       of a rating system.
     – Credit risk control function is independent from sales function that has a direct stake in
       loan increase.

■ Bigger role of the board and the management
    – The board (including relevant committees) and the management should approve key
       decisions on a rating system and risk components.
    – The management is responsible for understanding and continuous review of a rating
       system.
                                                            15
III. Basel II Challenges and tasks
6. Quantitative impact study (QIS) (con'd)

■ Key items for Quantitative impact study

         Risk weights of unrated exposures (standard approach)
         Risk weights of unrated exposures (standard approach)
         CCF of unused committed credit line (F-IRB)
         CCF of unused committed credit line (F-IRB)
         Adjustment of effective maturity(F-IRB)
         Adjustment of effective maturity(F-IRB)
         Risk weights of equity exposures(IRB)
         Risk weights of equity exposures(IRB)
         Risk weights of unrated securitisation exposures
         Risk weights of unrated securitisation exposures


   Risk weights of unrated exposures
   Risk weights of unrated exposures                                                        Risk weights of equity exposures
                                                                                            Risk weights of equity exposures
      A big impact on BIS ratio under
       A big impact on BIS ratio under                                                       An increasing burden of equity capital
                                                                                             An increasing burden of equity capital
      standard approach
       standard approach                                                                     against equity exposures under IRB
                                                                                             against equity exposures under IRB
      Adjustment of risk weights within 100
       Adjustment of risk weights within 100                                                 approach
                                                                                             approach
      ~ 150% range
       ~ 150% range                                                                          Compare impact of standard approach
                                                                                             Compare impact of standard approach
      (existing :: 100%)
       (existing 100%)                                                                       and IRB approach on BIS ratio
                                                                                             and IRB approach on BIS ratio
                                                             BIS ratio
                                                             BIS ratio                           Risk weights of unrated securitisation
                                                                                                 Risk weights of unrated securitisation
 CCF of unused committed credit line
 CCF of unused committed credit line                                                                              exposures
                                                                                                                  exposures
  An increasing burden of equity
  An increasing burden of equity                                                                   An impact of deducting unrated
                                                                                                    An impact of deducting unrated
  capital expected due to application
  capital expected due to application                                                              securitisation exposures from
                                                                                                    securitisation exposures from
  of a high CCF
  of a high CCF                                                                                    regulatory capital
                                                                                                    regulatory capital
  Credit lines are divided into four,
  Credit lines are divided into four,                                                              Compare deduction approach and
                                                                                                    Compare deduction approach and
  and assigned different CCF.
  and assigned different CCF.                  Adjustment of effective maturity
                                               Adjustment of effective maturity                    investor grade
                                                                                                    investor grade
                                                 All exposures are assigned a maturity of
                                                 All exposures are assigned a maturity of
                                                 2.5 years under F-IRB.
                                                 2.5 years under F-IRB.
                                                 Compare a maturity of 2.5 years and
                                                 Compare a maturity of 2.5 years and
                                                 nominal matyrity
                                                 nominal matyrity



                                                               16
III. Basel II Challenges and tasks
7. Current Status of Korean Banks in implementing Basel II



■ Korean Banks launched Task Force Team and set up detailed road map
  for Basel II implementation
   ㅇ (commercial banks and some policy banks) collect long-term default/loss data
      for risk estimation and develop Credit Rating System
   ㅇ (regional banks and others) targeting the standardized Approach , which doesn’t
    require FSS approval, examine on the adequacy of current collateral
    & guarantee system for New BIS Accord.

■ For those tasks that an individual bank is not able to deal with, inter-bank
  cooperation is under way.
   ㅇ running “Korea Operational riskdata Exchange Committee (KOREC) ” in order
      to solve the shortage of operational risk loss data




                                          17
III. Basel II Challenges and tasks
8. Difficulties in implementing Basel II



■ Insufficiency in preparation

ㅇ Lack of credibility and validation on risk components such as PD(probability of Default),
  LGD(Loss Given Default), EAD(Exposure at Default)
ㅇ Short on pre-running of Risk Rating System
   -adequate rating system
ㅇ Insufficient corporate governance and oversight
  - Lack of independence in validation of risk rating system
   *U.S. is also running across the problem, and decided to reschedule the timeline of
    implementation (Jan 2008 -> Jan 2009)



■ Possibility of high volatility in BIS CAR after New Basel Accord
ㅇ Applying strictly the New Basel Accords would lower the BIS CAR mainly due to
   strict application of credit conversion factor on unused committed line as well as
   autonomous estimates on LGD in the A-IRB




                                             18
III. Basel II Challenges and tasks
9. Reaction of Financial Regulators (FSS)


■ Adjustment of timeline for Basel II implementation
  ㅇ For the A-IRB, defer implementation date by one year(early 2008->early 2009)
  ㅇ For the F-IRB, alleviate requirements for data during transition periods(3 years)

■ Mitigating shock of implementation
  ㅇ Exercising national discretion according to the New Basel Accords in order to alleviate
     burdens of banks.
     * For equity exposure in IRB, applying the standardized approach
       For the F-IRB, replacing effective maturity of 2.5 years with measured effective maturity
  ㅇ Reducing Credit Conversion Factor for unused committed line in F-IRB during grace periods
     75% -> 20~50%(the standardized Approach)

■ Facilitating inter-bank cooperation

  ㅇ In order to produce credible LGD estimates, collecting loss data across banks and
    analyzing them
  ㅇ Running “Korea Operational riskdata Exchange Committee (KOREC) ” in an effort to
    solve the lack of operational risk data




                                            19
III. Basel II Challenges and tasks
10. Current Status of Korean Banks in implementing Basel II



 ■ To implement Basel II in 2008 early, banks must submit application for IRB approval
   by July 2007.
   *submission of application should be made six months before the implementation date

   ㅇ (application for the theIRB) Four banks(KB, KEB, KDB, IBK) submitted applications
     for approval
     - The IRB would be in effect as of January 1, 2008 if an application is approved
   ㅇ (Application of the standardized Approach)
     other commercial banks and NACF(originally targeted for the IRB) and regional banks,
     NFFS, KEXIM(initially targeted for standard method) are planning for the standardized
     Approach

 ■ The final approval for those four applicants to the the IRB would be processed
    during the second half of the year based on scrutinized review on insufficiency
    and improvement matters




                                           20
III. Basel II Challenges and tasks
10. Potential Concerns under Basel II in Korea


 ■ Impacts of the New Basel Accord on SME lending in Korea

   ㅇ The impact of Basel II on capital requirements for SMEs is not substantial (Korea
    Development Institute, 2007)

 ■ Impacts of the New Basel Accord on Housing Finance Market in Korea.

 ㅇ Under the new Basel II, loans secured by residential properties are treated more
   favorably and thus the loan-to-value ratio for housing loans is likely to increase. The
   Korean government carefully watch the trend of housing loan and its size. If needed,
   policy measure will be taken place immediately.


 ■ Implementing the External Credit Assessment Institution of the Basel II Accord in
    Korea.

 ㅇ Korean Credit rating agencies has short history and lacks available resources.
 ㅇ The new combined Act for Capital markets (will be enforced by 2008) will help to develop
    Korean Credit rating agencies.

 ■ Procyclicality problem.



                                            21
 End of
Documents

    22
The Basel II implementation in ICBC




                                      1
1.The preparation work to implement Basel II

(1)set up the Enterprise-wide risk management
  system 。 It is represented on the four aspects of
  risk policy and system building, risk measurement,
  information system, data consolidation.




                                                2
3
 (2)set up the risk measurement
system covering all kinds of
customers and realized the
scientific measurement on credit
risk, market risk, liquidity risk and
operational risk.




                                    4
  Establish the IRB methodology and system.
Referring to has developed a series of rating
models covering corporate business, inter-
bank business, retail business and sovereign
exposures. The data indicates that the
corporate rating model has the good
performance with AR 0.55 which has entered
into the international standard (0.5-0.7).


                                                5
(3)Build up the IT system for IRB project.
 ICBC has developed the obligor rating
 system which is embedded with the rating
 methodology and rating models and realized
 the whole process IT management from
 obligor rating, credit line approval to post-
 disbursement management. ICBC also
 developed the financial report checking
 system, the collateral appraisal management
 IT systems to supply the data basis for facility
 rating and the industrial analysis system to
 supply the technology support for regional
 and industrial risk rating and portfolio
 analysis.                                        6
7
(4) Build up the IRB data foundation.
In 2002, ICBC conducted data consolidation project which
  enables centralized and real-time processing of credit risk
  management and to further enhance customer rating, credit
  limit, 12-grade loan classification, middle and long-term
  facility rating functions.
 In 2003, ICBC developed the CIIS, PCM2003 systems which
  improved the credit risk management efficiency and
  accumulated the data for credit risk quantification. Until now
  ICBC has accumulated six-year loan information covering all
  kinds of customers including the basic information, financial
  information, trading and rating information, which satisfied
  the 5-year data accumulation requirements of the F-IRB.


                                                                   8
(5)Set up the policy basis of the IRB
  implementation and train the internal rating
  staff.




                                                 9
  2.The main developments and advances of
               Basel II project.
             ICBC Risk Management Projects List
                  Project Name                      Time

ICBC EWRM Project                                   2004

ICBC Capital Management Project                     2005

ICBC Interest Rate Risk Management Project          2005

ICBC Non-retail Credit Risk IRB Project           2005-2006

ICBC Market Risk Management Project                 2006

ICBC Internal Audit Project                         2006

ICBC Retail Credit Risk IRB Project                 2007
                                                              10
3、The problems and the challenge

The existing problems
  A. The loss data cannot meet the 7-year data
  requirement.
  B. The obligor rating and facility rating models
  need to be validated and calibrated.
  C. Need to develop the retail-business approval
  and performance monitoring risk quantification
  models.
  D. Need to enhance the application of IRB results
  on portfolio management.



                                                  11
4、The work plan of next step
 A. Expedite the application of the IRB
 results on the whole process of risk
 management.
 B. Advance the retail IRB project to
 improve ICBC retail risk management.
 C. Expedite the data warehouse
 establishment and improve the facility
 rating system to lay the foundation for A-
 IRB.
 D. Enhance the establishment of risk
 culture.

                                              12
Cross-border banking and Supervisory
     Cooperation under Basel II

          Alicia Garcia Herrero
     Bank of International Settlements

                AFDC 2007
         Shanghai September 5, 2007
 Overview
1. History of cross-border supervision until
   Basel I
2. Some basics of Basel II and home-host
   issues
3. High-level principles for the cross-border
   implementation of Basel II
4. The Asian case
5. Concluding remarks
1. The history of cross-border supervision until Basel I

 From the Basel Concordat – 1975

     No foreign banking establishment should escape supervision
     Supervision of foreign banking establishments calls for contact
     and co-operation between host and parent supervisory authorities
     Supervisory authorities should seek to remove restraints on
     transfers of information
Revisions followed …

   Revised Basel Concordat – 1983
      Established principle of consolidated supervision
      Host authorities responsible for subsidiaries
   Recognition of differences in
      Supervisory methodologies and resources
      Characteristics of local banking systems
      Supervisory cultures (eg mutual reliance)
Leading to Basel Minimum Standards – 1992

   International banks should be supervised by a home country that
   performs consolidated supervision
   Creation of cross-border bank should receive the prior consent of
   both host and home country authorities
   Home country authorities should have the right to gather
   information from their cross-border banking establishments
   Host country responsible for determining the compliance with
   these three standards
         It could impose restrictive measures or prohibit the
         establishment of banking offices
The Core Principles
Core Principle 25 – home-host relationships
   Cross-border       consolidated  supervision    requires
   cooperation and information exchange* between home
   supervisors and the various other supervisors involved,
   primarily host banking supervisors. Banking supervisors
   must require the local operations of foreign banks to be
   conducted to the same standards as those required of
   domestic institutions.




   * Information exchange is covered in more detail in CP 1(6), which underpins the standards set
   out in CP 25.
Core Principle 25 – essential criteria

    Information exchanged should be adequate for both home and
    host
    Identify relevant supervisors for material cross-border operations
    and establish informal/formal arrangements for information
    sharing
    Home to host:
          Supervisory approach for overall group
          Group-wide context for host operations
          Group-level problems likely to impact host
          Significance of sub to group
Core Principle 25 – essential criteria (2)

    Host to home:
         Non-compliance with host requirements
         Adverse developments in local operations
         Adverse assessments of risk management, controls
         Significance of sub to host financial sector
    Foreign subs subject to similar rules as domestic
    Host consults home before licensing
    Home allowed access to group’s operations in host
2. The basics of Basel II
 Basel Committee created as a forum for supervisors to address
 issues related to cross-border supervision
     Members are G-10 bank supervisors
 Build trust and supervisory network, encourage others (eg regional
 groups of supervisors) to do so as well Three major agreements in
 history
     1988 Basel Accord
     1996 Market Risk Amendment
     2004 Basel II (updated in Nov 2005)
 Basel II sets International convergence of capital measurement and
 capital standards
     Scope of application: all levels of ownership structure of
     internationally active banks
     Three mutually reinforcing pillars
The pillars
    Pillar 1: Minimum capital requirements
        Three risks: credit, operational and market
        Five asset classes for credit risk: corporate,
        sovereign, bank, retail and equity
        Two approaches to credit risk: standardised and
        internal ratings-based (IRB)
    Pillar 2: Supervisory review
        Four principles
        Specific issues: interest rate risk, stress tests,
        concentration risk, counterparty risk
    Pillar 3: Market discipline
        Disclosure requirements
Pillar 1: Assessing capital for credit risk
Basic principle of Pillar 1: capital should cover
unexpected loss (UL) with high probability
With perfectly diversified loan portfolio and correct
estimates of probability of default (PD), loss given
default (LGD) and exposure at default (EAD):
    UL will be zero
    Expected loss (EL) should be covered by provisions
In uncertain world, actual losses may be higher than
expected
    UL will be positive and should be covered by capital
    EL should be covered by provisions
    Capital (K) + (Provisions – EL) ≥ UL with 99.9% prob
How the two approaches apply the UL principle

    Standardised approach relies on support of external
    credit assessment (ECA):
     Asset → ECA → risk weights (UL) → K
    Internal ratings-based (IRB) approach relies on
    parameter estimates
     Asset → { PD, LGD and EAD } → UL → K
       Foundations IRB: bank estimates PD, supervisor
       provides LGD and EAD
       Advanced IRB: bank estimates PD, LGD and EAD
       For retail loans, only advanced IRB allowed and UL
       smaller than for corporate loans
Pillar 2: The four principles

P1. Overall capital: Banks should have process for
assessing overall capital adequacy
P2. Supervisory response: Supervisors should
evaluate banks’ internal capital adequacy
assessments
P3. Excess capital: Supervisors should expect banks
to operate above the minimum regulatory capital ratios
P4. Early intervention: Supervisors should intervene
at early stage to prevent capital from falling below
minimum
Basel II and home-host – issues

 … under Basel II, home-host issues have received more attention
 than they had in the past
 Options introduced for credit, op risk calculations
    No real change from Basel I re standardised approach (credit),
    other than issues associated with ECAIs
    But for more advanced approaches – significant variation in
    banks’ approaches is likely across jurisdictions
 For advanced approaches, bank-wide information requirements are
 substantial
Basel II and home-host – issues (2)

   Supervisory review process under Pillar 2 – initial and ongoing
   supervisory approvals, validation
      Supervisory reliance: Host prepared to accept home’s
      review/approval processes at the group level? Home prepared to
      rely on host’s review of significant subs?
      Supervisors expect separate ICAAPs at parent and sub levels?
   Models and processes require scale to function and be cost-
   effective
      Further scope/demand for supervisory cooperation
Basel II and home-host – issues (3)

  No international standards exist for ‘other’ Pillar 2 risks
     Interest rate risk in the banking book, liquidity risk, reputational
     and strategic risk, credit risk concentration
  Supervisors’ attitudes toward treatment of diversification benefits
  (across risk types, business lines, legal entities) likely to vary across
  jurisdictions
 Basel II and home-host – issues (4)

Different implementation timing in different jurisdictions
   Many combinations possible:
       Home implements advanced Basel II – host Basel I
       Home implements advanced Basel II – host standardised
       Basel II
       Home remains on Basel I – host Basel II
Overall approach to Pillar 2 likely to vary across jurisdictions
   Some supervisors focusing on capital requirements for
   individual risk components, others placing more emphasis on
   totality of Pillar 2 assessments
    Basel II and home-host – an example



                           Internationally
                             active bank

                            Head office
                                                          Consolidated
                            Country X
                            FIRB/AMA                        reporting
Reporting
              Branch        Subsidiary       Subsidiary   Reporting to
 to home     Country A      Country B        Country C
regulator                                                 host regulator
            Only simpler    Only AIRB
                                              Basel I
            approaches      And AMA
Basel II and home-host – a work in progress

   Pillar 2 currently major focus of Accord Implementation Group
   (AIG)
       Case studies key aspect of that work
       Information-sharing helps identify key issues/challenges and
       promotes discussion about resolution
   Supervisory colleges are an effective forum for addressing Pillar 2
   issues on a bank-by-bank basis
       Not a panacea, as not all hosts are involved
       Information-sharing, not decision-making
       Bilateral relationships are important complement to colleges
Basel II and home-host – a work in progress (2)

 Each jurisdiction must decide how best to deal with differences, based
 on
    Significance/proportionality
    Impact on regulatory capital
    Banks’ motivation – gaming?
    Legislative constraints
    Pragmatism (eg hosts allowing subs to rely on data and systems
    from the parent, provided it is adapted to local circumstances)
 Pillar 2 having positive impact on supervisory practices
    Significant in some jurisdictions (eg increased transparency of
    processes), refinement in others
3. High-level principles for cross-border
implementation of Basel II
  Facilitate practical cooperation and information exchange
  Intended to strengthen the quality of banking supervision
  across countries
  Existing cross-border responsibilities will generally continue to
  apply
  Enhanced cooperation for supervision of internationally active
  banking groups will be necessary under Basel II
Legal responsibilities

                                 Principle 1
Basel II will not change the legal responsibilities of national supervisors for
   the regulation of their domestic institutions or the arrangements for
consolidated supervision already put in place by the Basel Committee on
                            Banking Supervision


    Basel Concordat continues to apply
    Home supervisor = consolidated supervision
    Host supervisor = sub-consolidated supervision
    Build on existing arrangements without imposing undue burden
Home supervisor

                             Principle 2
  The home country supervisor is responsible for the oversight of the
implementation of Basel II for a banking group on a consolidated basis



 Home supervisor makes final determinations, including Pillar 2, on a
 consolidated basis
 Home supervisor may seek input from host supervisors, especially for
 material subsidiaries
 Banks need to communicate their implementation plans internally
Host supervisors

                              Principle 3
Host country supervisors, particularly where banks operate in subsidiary
 form, have requirements that need to be understood and recognised



 Banks must satisfy legal requirements in host jurisdictions
 Beneficial if host supervisors accept methods and approval processes
 used at the consolidated level
 There may be legitimate reasons, however, not to recognise
 approaches used at the group level
Practical cooperation

                             Principle 4
  There will need to be enhanced and pragmatic cooperation among
  supervisors with legitimate interests. The home country supervisor
                  should lead this coordination effort


 Look for ways to enhance cooperation and information exchange
 Host country information requests should be reasonable
 Work plans should be coordinated as much as possible
 Communication between home and host, home and bank, hosts and
 subsidiaries
 Arrangements can be formal or informal
   Reduction of burden

                                  Principle 5
    Whenever possible, supervisors should avoid performing redundant and
uncoordinated approval and validation work in order to reduce the implementation
           burden on the banks, and conserve supervisory resources


     Cooperation especially important where different techniques used in
     different jurisdictions
     Ideally, supervisory work will reflect the organisation and management
     structure of the bank
     Home country will need sufficient information to conduct consolidated
     supervision
   Communication with banks

                                   Principle 6
In implementing Basel II, supervisors should communicate the respective roles of
   home country and host country supervisors as clearly as possible to banking
groups with significant cross-border operations in multiple jurisdictions. The home
country supervisor would lead this coordination effort in cooperation with the host
                               country supervisors.


      Home supervisor should develop an implementation plan (in
      cooperation with host supervisors) and communicate the plan to the
      bank
      Clarify that supervisory legal responsibilities remain unchanged
      Plan should be flexible and tailored to the bank
4. The Asian case

           Implementing Pillar 1 of Basel II in Asia
              Transitional burden on foreign banks
              The race for data
              Home-host issues with internal ratings-
              based approaches
           Dealing with systemic risk and regional
           contagion
              Incentives for banks under Pillar 2
              Supervisory assertiveness
              Home-host issues and Pillar 3
Foreign banks in Asia have a small presence although growing
Cross-border banking in emerging Asia
     Asian crisis in 1997 a defining event
          Value of total cross-border bank credit to non-banks in
          region contracted by more than 10% in 1997
          Foreign bank presence has remained low: foreign bank
          credit < 10% of total
          Retrenchment by Japanese banks; dominant foreign
          banks now Citibank, HSBC, Standard Chartered,
          Deutsche and ABN Amro
     Still foreign banks have made their presence felt
          In certain market segments, foreign banks are
          aggressive, including in credit cards
          In Philippines, Indonesia, Thailand, credit cards,
          mortgages up
             Asia and Basel II

Basel II as measure to bolster reforms after Asian
crisis
Move from collateral-based lending to “risk
management”
Timetables for implementation are ambitious
   The quick: Indonesia to implement AIRB in 2010
   Quicker: Malaysia, Philippines, Thailand in 2009
   Quickest: Australia, Hong Kong, New Zealand,
   Singapore in 2007-08
   Even China: Basel 1 ½ by 2007 -- Basel 1 plus
   Pillars 1 and 2 of Basel II
Pillar 1 and home cost issues in Asia


  During transition, foreign banks need to calculate capital
  twice, imposing regulatory burden
  Possible advantage of advanced IRB for mortgage and
  consumer loans leads to race for data
  Complexity of Basel 2 puts premium on home-host
  cooperation on information, including validation
  Over 100 discretionary items in Pillar 1 call for regional
  harmonization
  Required amount of information sharing may be
  burdensome to home and host supervisors
Contagion and systemic risk in Asia

  Lessons of 1997 crisis
     Alba et al (1998): Pro-cyclical capital flows and
     macro policy led to Asian crisis
     Correlated collateral leads to regional contagion
  Acharya and Yorulmazer (2002): Banks have incentive
  to ignore systemic risk
  Inadequacy of Pillar 1
     It focuses on individual assets of individual banks
     Borio, Furfine and Lowe (2001): It underestimates
     risk in booms and overestimates risk in busts
Pillar 2 to the rescue?
Under Pillar 2, banks internally assess overall risks
and capital – but may have little incentive to assess
systemic risk
Powerful supervisors may just tell banks what to do
But weak supervisors reluctant to evaluate bank
assessments
   Banks may belong to powerful families or major
   industrial groups
   Stress tests for systemic risk heavy on discretion
   and judgment
   Research may give supervisors ammunition
        Home-host issues:
    Hong Kong and New Zealand
Hong Kong is big as both home and host supervisor
   Regional hub for large UK, Chinese banks
   Coordinate on entry criteria, cooperate on validation
   Apply simpler approach to operational risk but use
   Pillar 2 to offset burden of double calculation
New Zealand is ultimate host
   Australians own 85% of New Zealand’s banks
   Require big banks to incorporate locally
   Harmonize Basel II with APRA in move to “seamless”
   regulation
    Cross-border supervisory
 cooperation in dealing with crisis
Supervisors may have different mandates – one to
protect depositors, the other to maintain soundness
of financial system
In times of stress, two supervisors may differ on
whether the problems are systemic
Foreign bank may be systemically important in host
country but not at home
For lenders of last resort, if support is required,
who provides it?
Dilemmas in resolving crisis cooperation
issues
     Trade-off between ring fencing and cross-border
     supervisory cooperation
     What information to share? Easy to underestimate
     amount of information needed to be shared by home
     and host supervisors
     How to resolve lender-of-last-resort issues without
     undermining Pillar 3 – need to give up transparency?
5. Concluding remarks

 Effective supervision of international banking groups depends
 on effective supervision at both the local and consolidated
 level
 Effective cooperation and coordination between home and
 host supervisors will be key to success of Basel II
 Basel II offers an opportunity to develop pragmatic
 arrangements for enhanced collaboration and information
 sharing
5. Concluding remarks (cont’)

 More effective and efficient cooperation and information flow
 combined with supervisory mutual trust and confidence in
 their respective assessment processes will
      Enhance the supervisory process
      Help to conserve scarce supervisory resources
      Help to reduce overall regulatory burden on banks
      Promote a comprehensive and sound implementation of
      Basel II
 Beyond principles and formal arrangements, at the end of the
 day what matters is having the right person at the end of the
 line
5. Conclusions (cont’)
 For the Asia case:
    Transition between standardized and advanced IRB
    imposes burden on foreign banks
    Possible advantage of advanced IRB leads to race for
    data
    Complexity of Basel II multiplies home-host issues
 Dealing with regional contagion
    Under Pillar 2, banks may have little incentive to
    assess systemic risk
    Can supervisors be assertive enough to evaluate
    overall capital adequacy?
    Can home and host supervisors reconcile approaches
    to dealing with crisis?
      Appendix: Useful References

Principles for home-host supervisory cooperation and
allocation mechanisms in the context of Advanced
Measurement Approaches (AMA) – consultative paper (Feb
2007)
Core principles for effective banking supervision / Core
principles methodology (October 2006)
Home-host information sharing for effective Basel II
implementation (June 2006)
Principles for the home-host recognition of AMA operational
risk capital (Jan 2004)

				
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