Capital Adequacy Norms Primary Dealers: War with VaR
Article Details
Pub. Date
:
June, 2002
Product Name
:
The Analyst
Product Type
:
Perspective
Product Code
:
ANPE10206
Author Name
:
E Kalyan Babu, Team Analyst
Availability
:
YES
Subject/Domain
:
Finance
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Description
The new guidelines for primary dealers are definitely a step in the right direction. Usage of Value-at-Risk models to set aside capital will reduce the risk exposure taken up by primary dealers and lead to the development of an efficient bond market in India.
The Reserve Bank of India recently issued new guidelines to banks and primary dealers for making adequate provision to cover their potential for losses in their portfolio of government securities in case of an increase in interest rates. These guidelines are based upon the Market Risk Amendment to the Basel Accord on Capital Standards (January 1996), which stressed the need to set up capital charges for covering the market risk of banks' open positions in traded debt, forex as well as equity. This additional capital charge is over and above the capital set aside for credit risk.
The RBI guidelines decree that the capital charge for Primary Dealers (PDs) be based on Value-at-Risk (VaR) of their portfolios. VaR is the indicator of the maximum loss that a portfolio can suffer within a given time horizon at a pre-specified confidence level. According to the regulation, each PD is required to provide for capital to the tune of 3.3 times the 60-day average of the 99 percent VaR over a 30-day horizon, as measured by models developed internally. RBI's move is a progressive deviation from the past as the regulator specified the exact valuation as well as risk measurement norms for the market as a whole for the first time.
The essence of internal rating models is that market participants must understand and manage their risks on their own rather than looking for help from the regulators. With additional capital being set aside, market players will have a cushion to fall back on in case of sudden adverse changes in market prices and thereby making the financial system more stable.
Keywords
Capital Adequacy Norms Primary Dealers: War with VaR, capital, market, portfolio, Amendment, dealers, prices, regulator, ValueatRisk, development, financial, government, interest, manage, decree, Reserve, traded.
