Implementation of Basel Core Principles for Effective Banking Supervision in the

context of Bangladesh

Presented by:

Sarder Azizur Rahman

Student ID-112286Student ID-112286

Examination Committee:

Mr.Weerakoon Wijewardena (Chairperson)Dr. Winai Wongsurawat (Co-chair)Dr. Sundar Venkatesh (Member)

Agenda of the Presentation:1. Objective of the study

2. Research Methodology

3. Brief introduction about Bangladesh Bank

4. Basel Principles4. Basel Principles

5. Why Basel Accord is needed

6. Findings in Bangladesh Perspective

7. Recommendation and Conclusion

Objective of the research�To explore an overview of the BASEL Accords and

Basel core principles for effective Banking supervision

�To assess the compliance status of the BASEL coreprinciples of banking supervision in Bangladesh.principles of banking supervision in Bangladesh.

�To review the need of Basel II in place of Basel IAccord and make a comparison between them.

�To study the implications and impact of Basel Coreprinciples in Banking Supervision in Bangladesh.

Research Methodology

� Exhaustive study

Analysis� Analysis

� Inference

Brief introduction about Bangladesh Bank

� Central Bank of Bangladesh

� Formed under presidential order 1972 ,127(A)

� Follows The Bank Company Act 1991� Follows The Bank Company Act 1991

� Started to implement Basel Core Principles since 2002

under the FSAP carried out by IMF and World Bank

� Basel Core Principles for Effective BankingSupervision is conducted by ‘Basel II implementationcell of BRPD. Officially kicked off from 2010.

What is BaselThe Basel Accords refer to the banking supervision AccordsBasel I, Basel II and Basel III issued by the Basel Committeeon Banking Supervision (BCBS). They are called the BaselAccords as the BCBS maintains its secretariat at the Bank forInternational Settlements in Basel, Switzerland.

Basel I

�1988 with a set of minimum capital requirements forbanks.

or

�Basel I credit risk. Assets of banks were classified and�Basel I credit risk. Assets of banks were classified andgrouped in five categories according to credit risk.Risk weights of zero (for example homecountry sovereign, debt), ten, twenty, fifty, and up toone hundred percent. Banks with internationalpresence are required to hold capital equal to 8 % ofthe risk-weighted assets.

Few shortcomings of Basel I

�Basel I framework does not make adequate differentiation of creditrisk, although the risk is different as the recovery of the twoinstruments would be different.

�There is no recognition of the term structure of credit risk.

�The current rules do not recognize the portfolio diversification effectsfor credit risk while at the same time recognizing it for market riskunder the internal VAR models of banks. As a result the current rulesfor credit risk while at the same time recognizing it for market riskunder the internal VAR models of banks. As a result the current rulescan represent a false picture of the riskiness of an institution.

�The current Accord does not give due recognition to the credit riskmitigation techniques and does not recognize the role collateral canplay in reducing the losses on account of credit risk.

�The 1988 accord does not levy any capital charge for operational riskalthough that is a very important source of risk and can be moredevastating than credit risk.

Basel II� Basel II, initially published in June 2004.

� For creating international standard for banking regulators tocontrol how much capital banks need to put aside to guardagainst the types of financial and operational risks banks face.

� To maintain sufficient consistency of regulations so that thisdoes not become a source of competitive inequality amongstdoes not become a source of competitive inequality amongstinternationally active banks.

� In theory, Basel II attempted to accomplish this by setting uprisk and capital management requirements designed to ensurethat a bank has adequate capital for the risk the bank exposesitself to through its lending and investment practices. In generalthe greater risk to which the bank is exposed, the greater theamount of capital the bank needs to hold to safeguardits solvency and overall economic stability

Basel II (Cont..)

Basel II consists of three pillars:Basel II consists of three pillars:� Minimum capital requirements for credit risk, market risk and

operational risk—expanding the 1988 Accord (Pillar I)

� Supervisory review of an institution’s capital adequacy and internal assessment process (Pillar II)

� Effective use of market discipline as a lever to strengthen disclosure and encourage safe and sound banking practices (Pillar III)

Principles�Principle 1 Preconditions for effective banking supervision

�Principles 2 – 5 Licensing and structure

�Principles 6 -15 Prudential regulations and requirements �Principles 6 -15 Prudential regulations and requirements

�Principles 16-20 Methods of ongoing banking supervision

�Principles 21 Information requirements

�Principles 22 Formal powers of supervisors

�Principles 23- 25 Cross-border banking

Basel Implementation in Bangladesh.docx

Analysis

Preconditions for effective banking supervision and

Licensing

� Assessment:

� Section 44 of the Bank Companies Act, 1991 vests powersin Bangladesh Bank for inspection of books of any bankingcompany at any time.

� A suitable legal framework is in place for the BB totake action as needed against banks, and the BBtake action as needed against banks, and the BBappears to use these powers as needed. In the light ofqualitative judgment and BB by law has access to bankrecords.

Compliance Level: Largely Compliant.

Capital Adequacy

Assessments

According to BB circular No. 01, 08-01-1996, Capitaladequacy takes account of different degrees of credit riskand covers both on balance sheet and off balance sheettransactions.transactions.

Minimum Capital Standard:

Each bank will maintain a ratio of capital to risk weightedassets of 400 Crore or 10% of risk weighted assets whichone is higher.

Compliance Level: Largely Compliant.

Assessment of the risk factors

Country and Transfer Risk1. Bangladeshi banks in overseas operations need to follow the internalguidelines on country risk management and fix based on risk rating ofthe country. Limits should also be fixed for a group of countries in aparticular risk category subject to a maximum ceiling fixed byBangladesh Bank.2. For investment in abroad by banks, permission of Bangladesh Bank is necessary according to BRPD circular no. 1/96.necessary according to BRPD circular no. 1/96.

Market risk1. Under section 49 of the Banking Company Act, 1991 to imposespecific limit and/or specific charge on market risk exposures.2. The capital charge for some of the market risks already exists. Marketrisks in the investment Portfolio are controlled through quantitativerestrictions, (BRPD circular no. 2/95).

Compliance Level: Compliant

Other risk management (e.g. Liquidity risk, Interest

Rate risk, Currency risk)Already issued guidelines for banks to set up effective Asset- Liability management (ALM)

System.

� Liquidity risk management:All banks are required to maintain Cash Reserve Ratio (CRR) and statutory Liquidity Ratio (SLR) as persection 36(1) of Bangladesh Bank order, 1972 and section 24(2a) of the Banking Company Act, 1991respectively.

� Interest Rate Risk Management:The banks are expected to measure interest rate risk through traditional gap analysis supplemented bysophisticated techniques wherever possible.

� Currency Risk Management:The banks are to assign 100% risk weight to their open position limit in foreign exchange. Besides, they arerequired to fix aggregate and individual limits for each currency with the approval of Bangladesh Bank. Theyare required to adopt value at risk associated with forward exposures. The Bangladesh Bank monitorscurrency risk through a monthly return on maturity and positions for both on and of balance sheet items inforeign exchange.

Compliance Level: Largely Compliant

crd_risk01.pdf

Internal control and know your Customer

� Examination and evaluation of the adequacy and effectiveness of theinternal Control System in the banks form one of the important aspectsduring on-site inspection by the Bangladesh Bank periodically.

� In Bangladesh, ‘Know your Customer’ Rules are in place right formthe beginning. There are specific directions for obtaining properintroduction while opening Deposit “Accounts. Requirement ofintroduction while opening Deposit “Accounts. Requirement ofobtaining photographs of account holders before opening accounts hasbeen prescribed. Numbered accounts are not permitted in Bangladesh.

� Anti-Money Laundering Act 2002 has been enacted in 2003 in this regard.

Compliance Level: Largely Compliant

Methods of Ongoing Banking Supervision

(a) The main instrument of supervision in Bangladesh is theperiodical on-site inspection of banks that is supplementedby off-site monitoring and supervision. Since 1995, on-siteinspections are based on CAMEL Rating. The domesticbanks were rated on CAMEL model.

(b)Two separate departments were established in BangladeshBank for the supervision and examination purposes:

� Department of Off-site Supervision (DOS); and

� Department of Banking Inspection (DBI).

� Compliance Level: Largely Compliant

Recommendation & conclusion:� Supervision function of Bangladesh Bank should be strengthened for effective

supervision. Supervisor must be careful so that nothing happens like thecollapse of the Oriental Bank Limited in recent past.

� Supervisors of Bangladesh Bank must have to understand the nature ofinvestment that bank are incurring. In the same time they have to ensure therisks taken by the banks are being sufficiently managed.

� It is essential for the supervisors to ensure that the banks have appropriate� It is essential for the supervisors to ensure that the banks have appropriateresources to undertake risks, having sufficient capital, strong management,effective control systems and all sorts of accounting records.

� It is important and essential for the national legislators that they could giveurgent thought to the changes important to make sure that principles can beapplied in all material compliments.

� A serious effort is needed to bring the Bangladesh Bank supervisory standardsup to the level indicated in the core principles.

Recommendation (Cont..)

� Bangladesh Bank’s autonomy and ability to act on ownership changesneeds to be further strengthened through legislation and practices.

� Bangladesh Bank should issue guidelines to set “Ethical Standards” forthe commercial banks.

� Deposit insurance system should be made more effective.

� Since the new Accord is complex, and may affect different banksvarying degrees, careful and compatible strategy need to bedeveloped.

� This deserves infusion of market participants in the decision makingprocess.

Thank youThank you