ADVISORY

Internal Capital Adequacy

Assessment Process
FINANCIAL SERVICES
HazemHassan
Public Accountants & Consultants
Contacts
KPMG Hazem Hassan
Pyramids Heights Office Park
Km 22 Cairo / Alexandria Desert Road
12556 Al Ahram
P.O.Box 48 Al Ahram
Giza - Cairo Egypt
Aziz Maher
Partner Financial Services
Tel: (202) 35 36 2200/11 Ext.1519
Fax: (202)35 36 2305/03
E-mail: azizmaher@kpmg.com
Dr. Lionel Khalil
Director Financial Risk Management
Tel: (202) 35 36 2200/11 Ext.3714
Fax: (202)35 36 2305/03
E-mail: lkhalil@kpmg.com
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Content
- Pillar 2 : Internal Capital Adequacy Assessment Process (ICAAP)
- Integrated Risk, Return, Capital, and Value Management
- Benefit from a well-defined Basel II Evolution Program
1 1
2 2
4 4
Pillar 2 : Internal Capital Adequacy
Assessment Process (ICAAP)
Banks take on risks in order to earn a return, therefore management
system to identify and take on well priced risks becomes ever more
important in todays competitive banking market
1
Benefit from a well-defined
Basel II Evolution Program
Basel II compliance
KPMGs FRM Services provide Basel II
regulatory and compliance advisory
services to assist various types of
financial institutions in meeting their
regulatory obligations effectively and
efficiently and keep up with Basel II
issues:
Proactively setup an organization
ready to comply with regulatory
requirements,
Mitigate regulatory impact on
processes and methods,
Effectively improve and monitor
systems and data, and
Ultimately obtain competitive
advantage through cost-effective
compliance.
KPMG Differentiators
KPMG's Basel II Methodology is a
structured approach to help clients
assess:
Their actual status concerning the
Basel II Accord readiness,
Existing gaps and shortcomings,
Activities to be undertaken to fill
gaps and reach desired end state.
The objectives of KPMG's Basel II
Methodology are to:
Define a standard, modular
approach to performing Basel II
programs in 4 Phases,
Provide practical guidance based
on Basel II leading practices, and
Provide risk management guidance.
Phase 1 Phase 2 Phase 3 Phase 4
B A S E L I I P R O J E C T M A N A G E M E N T
ASSESS AND PLAN DESIGN AND IMPLEMENT
USE TEST
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APPROVAL
MONITOR
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CONTROL
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Corporate Governance/
Risk Management
Credit Risk
Operational Risk
Market and Other Risks
Capital Planning
Disclosure
(including linkage to IFRS)
Supervisory Review Process
ORGANISATION
PROCESSES
METHODS
SYSTEMS
DATA
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Internal Capital Adequacy
Assessment Process (ICAAP)
Basel II, Pillar 2 demands banks to put a
internal capital adequacy assessment
process (ICAAP) in place. Like in any
business enterprise that involves the
commercial provision of products or
services to meet a particular need,
owners of banks require to be
compensated for the resources that they
invest to generate such services. This
compensation needs to be explicitly
linked to the entrepreneurial risk
undertaken by them.
Economic Capital
The Basel Committee defines economic
capital as the methods or practices that
allow banks to attribute capital to cover
the economic effects of risk-taking
activities. It is a measure of risk rather
than capital held, and is distinct from the
Pillar 1regulatory capital measures. It
provides banks with a common
currency for measuring, monitoring,
and controlling different risk types and
the risks of different business units.
The risk types typically covered
include: credit risk, market risk,
operational risk, business/strategic risk,
counterparty credit risk, insurance risk,
real estate risk and model risk... They
can be measured at various levels,
from firm-wide to an individual
portfolio.
KPMG Services: a single view
of Risk and Return
Economic Capital Management is the
central notion of integrating the risk
and the return perspective of an
institution or bank to support the
maximization of its value subject to
the restriction of remaining solvent.
KPMG proposes a value-oriented
review of risk and return processes:
Alignment of risk and return
management process with
business model
Better decision making through
risk and return oriented review of
business opportunities
Transparency regarding
implications of business decisions
along entire value chain
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Board level
Operational
level
Risk
management
activities
Risk
categories
Bottom-up risk management
Top-down risk management
Credit
risk
Op.
risk
Market
risk
Liq
risk
Reputat.
risk
Other
risks
Action plan
Risk framework and strategy
Risk appetite
Risk-return measure and hurdle rates
Capital allocation
Communication to stakeholders
Incentive scheme
Regular update of objectives
Risk identification and measurement
Risk mitigation
Measuring diversification benefits
Risk aggregation
Monitoring of overall risk profile
Al location of diversification benefits
Performance Measurement
Preparation of reports
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Internal Capital Adequacy Assessment Process Internal Capital Adequacy Assessment Process
Aggregationof the ECAP
Internal Capital Adequacy Assessment Process
3 2
Events ThatCause Changes inCapital DemandandSupply
Integrated Risk, Return, Capital, and
Value Management
A going-concern
perspective takes
into account for
economic capital
only capital
components that
can be consumed
without creating a
potential
disturbance in the
normal banking
operations.
The Internal Capital Adequacy
Assessment Process (ICAAP) focuses
on Capital management, which ensures
the capital adequacy of the bank, and is
carried out on the bank level in a
dedicated, centralized unit.
The capital management function has
to consider first the regulatory view of
Basel II: the balance-sheet capital (Tier
1, Tier 2, and Tier 3) constitutes the
capital supply side while regulatory
capital for credit risk, market risk, and
operational risk accounts for the capital
demand. Second, the capital
management function should consider
the view of rating agencies, which base
their valuation mostly on Tier 1 capital
on the capital supply side.
Third the capital management function
has to consider simultaneously the
economic view of matching the capital
supply (risk-taking capacity) with the
capital demand (economic capital).
Capital supply is mainly influenced by
planned capital transactions and
expected profits. Capital demand is
mainly driven by business plans and by
risk-profile forecasts in combination
with macro-economic scenarios.
Since the requirements for both
regulatory and economic capital have to
be fulfilled, the bank has to define
possible solutions in case of conflicting
requirements for regulatory and
economic capital. Major differences in
capital supply can occur due to hidden
reserves, goodwill, other intangible
assets, deferred tax assets or liabilities,
provisions
The ICAAP is structured according to
the following:
Board and senior management
oversight
It is the responsibility of the board
and senior management to
oversee the ICAAP by setting well
defined risk management
strategies and guidelines.
Comprehensive risk assessment
A prerequisite for the ICAAP is the
comprehensive assessment of material
risks by measuring economic capital. The
measurement of economic capital
comprises collection of all necessary data
and implementation of appropriate models.
Determination of risk-taking capacity
The basis for capital adequacy is to
compare economic capital with its risk-
taking capacity. Risk-taking capacity is
derived from accounting items after
considering economic adjustments. In
doing so, the bank can differentiate
between creditor-protection and going-
concern perspectives.
Capital adequacy maintenance.
Risk-taking capacity should cover
economic capital at all times. To serve this
purpose, capital adequacy has to be
monitored on a continuous basis. The
capital strategy for the coming years
should be aligned with business planning.
Possible measures to maintain capital
adequacy can affect either capital demand
or capital supply.
Controlling and reporting.
Monitoring the capital planning process
and reporting to the board on its
effectiveness help to ensure that risk
management efforts are implemented
appropriately. A robust controlling and
reporting framework enables a continuous
evaluation of relevant issues and provides
access to the necessary reports for parties
involved in monitoring capital adequacy.
Internal control review
Internal controls provide a foundation for
sound corporate governance. A bank has
to make sure that its risk management
methods, processes, and systems are
adequate in relation to its size and risk
profile. To this end, senior management
must regularly review the capital
framework, ensuring that any
methodological changes, process redesign,
or reprogramming are tested and verified
by a third party, such as the internal or
external auditor.
Principle of ICAAP
Internal Capital Adequacy Assessment Process