Pillar 3-Market Discipline: CAIIB Paper 2 (Module D), Unit 5

19/05/2021

Pillar 3-Market Discipline: CAIIB Paper 2 (Module D), Unit 5

Dear Bankers,
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CAIIB exams are conducted twice in a year. Candidates should have completed JAIIB before appearing for CAIIB Exam. Here, we will provide detailed notes of every unit of the CAIIB Exam on the latest pattern of IIBF.
So, here we are providing “Unit 5: Pillar 3-Market Discipline” of “Module D: Balance Sheet Management” from “Paper 2: Bank Financial Management (BFM)”

Purpose of Pillar 3

The purpose of Market Discipline is to complement the minimum capital requirements (Pillar 1) and the supervisory review process (Pillar 2). Pillar 3 provides disclosure requirements for banks using Basel framework. The aim is to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on the scope of application, capital, risk exposures, risk assessment processes and hence, the capital adequacy of the institution.

In short, these disclosures would enable the market participants to assess key information about the banks and thereby make them to take ‘informed’ decision on the banks. In principle, banks’ disclosures should be consistent with how senior management and the Board of directors assess and manage the risks of the bank. Under Pillar 1, banks use specified approaches/methodologies for measuring the various risks they face and the resulting capital requirements.

Pillar 3 – Market Discipline

Guiding Principles For Banks’ Pillar 3 Disclosures

The Basel Committee on Banking Supervision has agreed upon the following five guiding principles on Pillar 3 disclosures:

Principle 1: Disclosures should be clear.
Principle 2: Disclosures should be comprehensive.
Principle 3: Disclosures should be meaningful to users.
Principle 4: Disclosures should be consistent over time.
Principle 5: Disclosures should be comparable across banks.

Scope and Frequency of Disclosures

Pillar 3 applies at the top on consolidated level of the banking group to which the Capital Adequacy Framework applies. Disclosures related to individual banks within the groups would not generally be required to be made by the parent bank. An exception to this arises in the disclosure of capital ratios by the top consolidated entity where an analysis of significant bank subsidiaries within the group is appropriate, in order to recognise the need for these subsidiaries to comply with the Framework and other applicable limitations on the transfer of funds or capital within the group. Pillar 3 disclosures will be required to be made by the individual banks on a stand-alone basis when they are not the top consolidated entity in the banking group.

Banks are required to make Pillar 3 disclosures at least on a half yearly basis, irrespective of whether financial statements are audited, with the exception of following disclosures:

Capital Adequacy;
Credit Risk: General Disclosures for All Banks; and
Credit Risk: Disclosures for Portfolios Subject to the Standardised Approach.

Validation

The disclosures should be subjected to adequate validation. Since information in the annual financial statements would generally be audited, the additional material published with such statements must be consistent with the audited statements. In addition, supplementary material (such as Management’s Discussion and Analysis) that is published should also be subjected to sufficient scrutiny (e.g., internal control assessments, etc.) to satisfy the validation issue. Presently, Pillar 3 disclosures will not be required to be audited by an external auditor, unless specified.

Materiality

A bank should decide which disclosures are relevant for it based on the materiality concept. Information would be regarded as material if its omission or misstatement could change or influence the assessment or decision of a user relying on that information for the purpose of making economic decisions.

Proprietary and Confidential Information

Proprietary information encompasses information (for example on products or systems), that if shared with competitors would render a bank’s investment in these products/systems less valuable, and hence would undermine its competitive position. Information about customers is often confidential, in that it is provided under the terms of a legal agreement or counterparty relationship.

General Disclosure Principle

Banks should have a formal disclosure policy approved by the Board of Directors that addresses the banks’ approach for determining what disclosures they will make, the internal controls over the disclosure process and the process for assessing the appropriateness of disclosures including validation and frequency.

Presentation of the disclosure requirements

The disclosure requirements are presented either in the form of templates or of tables. Templates must be completed with quantitative data in accordance with the definitions provided. Tables generally relate to qualitative requirements, but quantitative information is also required in some instances. Banks may choose the format they prefer when presenting the information requested in tables. The Master Circular on Basel III Regulations issued by Reserve Bank of India has prescribed the following disclosure tables;

Table DF-1: Scope of Application

Name of the head of the banking group to which the framework applies __________

Name of the entity/ Country of incorporation

Whether the entity is included under accounting scope of consolidation (yes/no)

Explain the method of consolidation

Whether the entity is included under regulatory scope of consolidation 225 (yes/no)

Explain the method of consolidation

Explain the reasons for difference in the method of consolidation

Explain the reasons if consolidated under only one of the scopes of consolidation 226

(i) Qualitative Disclosures:

List of group entities considered for consolidation
List of group entities not considered for consolidation both under the accounting and regulatory scope of consolidation

Name of the entity/country of incorporation

Principle activity of the entity

Total balance sheet equity(as stated in the accounting balance sheet of the legal entity)

% of bank’s holding in the total equity

Regulatory treatment of bank’s investments in the capital instruments of the entity

Total balance sheet assets(as stated in the accounting balance sheet of the legal entity)

(ii) Quantitative Disclosures:

List of group entities considered for consolidation

Name of the entity/country of incorporation (as indicated in (i) a. above)

Principle activity of the entity

Total balance sheet equity (as stated in the accounting balance sheet of the legal entity)

Total balance sheet assets (as stated in the accounting balance sheet of the legal entity)

The aggregate amount of capital deficiencies 227 in all subsidiaries which are not included in the regulatory scope of consolidation i.e. that are deducted:

Name of the subsidiaries/ country of incorporation

Principle activity of the entity

Total balance sheet equity (as stated in the accounting balance sheet of the legal entity)

% of bank’s holding in the total equity

Capital deficiencies

The aggregate amounts (e.g. current book value) of the bank’s total interests in insurance entities, which are risk-weighted:

Name of the insurance entities/ country of incorporation	Principle activity of the entity	Total balance sheet equity (as stated in the accounting balance sheet of the legal entity)	% of bank’s holding in the total equity/proportion of voting power	Quantitative impact on regulatory capital of using risk weighting method versus using the full deduction method

Any restrictions or impediments on transfer of funds or regulatory capital within the banking group:

Table DF-2: Capital Adequacy

Qualitative disclosures

(a) A summary discussion of the bank’s approach to assessing the adequacy of its capital to support current and future activities

Quantitative disclosures

(b) Capital requirements for credit risk:

Portfolios subject to standardised approach
Securitisation exposures

Standardised duration approach;
Interest rate risk
Foreign exchange risk (including gold)
Equity risk

(d) Capital requirements for operational risk:

Basic Indicator Approach
The Standardised Approach (if applicable)

(e) Common Equity Tier 1, Tier 1and Total Capital ratios:

For the top consolidated group; and
For significant bank subsidiaries (stand alone or sub-consolidated depending on how the Framework is applied)

Table DF-3: Credit Risk: General Disclosures for All Banks

Qualitative Disclosures

(a) The general qualitative disclosure requirement with respect to credit risk, including:

Definitions of past due and impaired (for accounting purposes);
Discussion of the bank’s credit risk management policy.

Quantitative Disclosures

(b) Total gross credit risk exposures²²⁸, Fund based and Non-fund based separately.

Overseas
Domestic

(d) Industry²³⁰ type distribution of exposures, fund based and non-fund based separately

(e) Residual contractual maturity breakdown of assets,²³¹

(f) Amount of NPAs (Gross)

Substandard
Doubtful 1
Doubtful 2
Doubtful 3
Loss

(g) Net NPAs

(h) NPA Ratios

Gross NPAs to gross advances
Net NPAs to net advances

(i) Movement of NPAs (Gross)

Opening balance
Additions
Reductions
Closing balance

(j) Movement of provisions (Separate disclosure shall be made for specific provisions and general provisions held by the bank with a description of each type of provisions held)

Opening balance

Provisions made during the period
Write-off
Write-back of excess provisions
Any other adjustments, including transfers between provisions
Closing balance

In addition, write-offs and recoveries that have been booked directly to the income statement should be disclosed separately.

(k) Amount of Non-Performing Investments

(l) Amount of provisions held for non-performing investments

(m) Movement of provisions for depreciation on investments

Opening balance
Provisions made during the period
Write-off
Write-back of excess provisions
Closing balance

(n) By major industry or counterparty type:

Amount of NPAs and if available, past due loans, provided separately;
Specific and general provisions; and
Specific provisions and write-offs during the current period.

In addition, banks are encouraged also to provide an analysis of the ageing of past-due loans.

(o) Amount of NPAs and, if available, past due loans provided separately broken down by significant geographic areas including, if practical, the amounts of specific and general provisions related to each geographical area. The portion of general provisions that is not allocated to a geographical area should be disclosed separately.

Table DF-4: Credit Risk: Disclosures for Portfolios Subject to the Standardised Approach

Qualitative Disclosures

(a) For portfolios under the standardised approach:

Names of credit rating agencies used, plus reasons for any changes;
Types of exposure for which each agency is used; and
A description of the process used to transfer public issue ratings onto comparable assets in the banking book.

Quantitative Disclosures

(b) For exposure²³² amounts after risk mitigation subject to the standardised approach, amount of a bank’s outstandings (rated and unrated) in the following three major risk buckets as well as those that are deducted:

Below 100 % risk weight
100 % risk weight
More than 100 % risk weight
Deducted

Table DF-5: Credit Risk Mitigation: Disclosures for Standardised Approaches

Qualitative Disclosures

(a) The general qualitative disclosure requirement with respect to credit risk mitigation including: a) Policies and processes for, and an indication of the extent to which the bank makes use of on- and off-balance, sheet netting;

policies and processes for collateral valuation and management;
a description of the main types of collateral taken by the bank;
the main types of guarantor counterparty and their credit worthiness; and
information about (market or credit) risk concentrations within the mitigation taken

Quantitative Disclosures

(b) For each separately disclosed credit risk portfolio the total exposure (after, where applicable, on- or off-balance sheet netting) that is covered by eligible financial collateral after the application of haircuts.

(c) For each separately disclosed portfolio the total exposure (after, where applicable, on- or off-balance sheet netting) that is covered by guarantees/credit derivatives (whenever specifically permitted by RBI)

Table DF-6: Securitisation Exposures: Disclosure for Standardised Approach

Qualitative Disclosures

(a) The general qualitative disclosure requirement with respect to securitisation including a discussion of:

the bank’s objectives in relation to securitisation activity, including the extent to which these activities transfer credit risk of the underlying securitised exposures away from the bank to other entities.
the nature of other risks (e.g. liquidity risk) inherent in securitised assets.
the various roles played by the bank in the securitisation process (For example: originator, investor, servicer, provider of credit enhancement, liquidity provider, swap provider@, protection provider#) and an indication of the extent of the bank’s involvement in each of them.
a description of the processes in place to monitor changes in the credit and market risk of securitisation exposures (for example, how the behaviour of the underlying assets impacts securitisation exposures as defined in paragraph 5.16.1 of Basel III Capital Regulations).
a description of the bank’s policy governing the use of credit risk mitigation to mitigate the risks retained through securitisation exposures;
A bank may have provided support to a securitisation structure in the form of an interest rate swap or currency swap to mitigate the interest rate/currency risk of the underlying assets, if permitted as per regulatory rules.
A bank may provide credit protection to a securitisation transaction through guarantees, credit derivatives or any other similar product, if permitted as per regulatory rules.

(b) Summary of the bank’s accounting policies for securitisation activities, including:

whether the transactions are treated as sales or financings;
methods and key assumptions (including inputs) applied in valuing positions retained or purchased
changes in methods and key assumptions from the previous period and impact of the changes;
policies for recognising liabilities on the balance sheet for arrangements that could require the bank to provide financial support for securitised assets.

(c) In the banking book, the names of ECAls used for securitisations and the types of securitisation exposure for which each agency is used.

Quantitative disclosures: Banking Book

(d) The total amount of exposures securitised by the bank.

(e) For exposures securitised losses recognised by the bank during the current period broken by the exposure type (e.g. Credit cards, housing loans, auto loans etc. detailed by underlying security).

(f) Amount of assets intended to be securitised within a year.

(g) Of (f) amount of assets originated within a year before securitisation.

(h) The total amount of exposures securitised (by exposure type) and unrecognised gain or losses on sale by exposure type.

(i) Aggregate amount of:

on-balance sheet securitisation exposures retained or purchased broken down by exposure type and
off-balance sheet securitisation exposures broken down by exposure type

(j) (i) Aggregate amount of securitisation exposures retained or purchased and the associated capital charges, broken down between exposures and further broken down into different risk weight bands for each regulatory capital approach

(ii) Exposures that have been deducted entirely from Tier 1 capital, credit enhancing I/Os deducted from total capital, and other exposures deducted from total capital (by exposure type).

Quantitative Disclosures: Trading book

(k) Aggregate amount of exposures securitised by the bank for which the bank has retained some exposures and which is subject to the market risk approach, by exposure type.

(l) Aggregate amount of:

on-balance sheet securitisation exposures retained or purchased broken down by exposure type; and
off-balance sheet securitisation exposures broken down by exposure type.

(m) Aggregate amount of securitisation exposures retained or purchased separately for:

securitisation exposures retained or purchased subject to Comprehensive Risk Measure for specific risk; and
securitisation exposures subject to the securitisation framework for specific risk broken down into different risk weight bands.

(n) Aggregate amount of:

the capital requirements for the securitisation exposures, subject to the securitisation framework broken down into different risk weight bands.
securitisation exposures that are deducted entirely from Tier 1 capital, credit enhancing I/Os deducted from total capital, and other exposures deducted from total capital (by exposure type).

Table DF-7: Market Risk in Trading Book

Qualitative disclosures

(a) The general qualitative disclosure requirement for market risk including the portfolios covered by the standardised approach.

Quantitative disclosures

(b) The capital requirements for:

interest rate risk;
equity position risk; and
foreign exchange risk.

Table DF-8: Operational Risk

Qualitative disclosures

In addition to the general qualitative disclosure requirement, the approach(es) for operational risk capital assessment for which the bank qualifies.

Table DF-9: Interest Rate Risk in the Banking Book (IRRBB)

Qualitative Disclosures

(a) The general qualitative disclosure requirement including the nature of IRRBB and key assumptions, including assumptions regarding loan prepayments and behaviour of non-maturity deposits, and frequency of IRRBB measurement.

Quantitative Disclosures

(b) The increase (decline) in earnings and economic value (or relevant measure used by management) for upward and downward rate shocks according to management’s method for measuring IRRBB, broken down by currency (where the turnover is more than 5% of the total turnover).

Table DF-10: General Disclosure for Exposures Related to counterparty Credit Risk

Qualitative Disclosures

(a) The general qualitative disclosure requirement with respect to derivatives and CCR, including:

Discussion of methodology used to assign economic capital and credit limits for counterparty credit exposures;
Discussion of policies for securing collateral and establishing credit reserves;
Discussion of policies with respect to wrong-way risk exposures;
Discussion of the impact of the amount of collateral the bank would have to provide given a credit rating downgrade.

Quantitative Disclosures

(b) Gross positive fair value of contracts, netting benefits²³⁴, netted current credit exposure, collateral held (including type, e.g. cash, government securities, etc.), and net derivatives credit exposure²³⁵. Also report measures for exposure at default, or exposure amount, under CEM. The notional value of credit derivative hedges, and the distribution of current credit exposure by types of credit exposure²³⁶

(c) Credit derivative transactions that create exposures to CCR (notional value), segregated between use for the institution’s own credit portfolio, as well as in its intermediation activities, including the distribution of the credit derivatives products used²³⁷, broken down further by protection bought and sold within each product group

The Master Circular issued by Reserve Bank of India also contains other details required to be disclosed by the Banks. It may be noted that beyond disclosure requirements as set forth in these guidelines, banks are responsible for conveying their actual risk profile to market participants. The information banks disclose must be adequate to fulfill this objective. In addition to the specific disclosure requirements as set out in the guidelines, banks operating in India should also make additional disclosures in the following areas:

Securitisation exposures in the trading book;
Sponsorship of off-balance sheet vehicles;
Valuation with regard to securitisation exposures; and
Pipeline and warehousing risks with regard to securitisation exposures.

Other Disclosure Requirements

In addition to the above disclosure requirements, banks are required to make the following disclosure in respect of the composition of capital:

Full Terms and Conditions: banks are required to make available on their websites the full terms and conditions of all instruments included in regulatory capital. The requirement for banks to make available the full terms and conditions of instruments on their websites will allow supervisors and market participants to investigate the specific features of individual capital instruments.
Banks are required to keep the terms and conditions of all capital instruments up-to-date in the prescribed form. Whenever there is a change in the terms and conditions of a capital instrument, banks should update them promptly and make publicly available such updated disclosure.

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Pillar 3-Market Discipline: CAIIB Paper 2 (Module D), Unit 5