Pillar 2: internal capital requirement
Rating to counterparties, for calculating the LGD (Loss
Given Default), i.e. the best estimate of the actual loss at
the time of a counterparty's defaulting, and for calculating
the EAD (Exposure at Default). PD, LGD and EAD are needed
for the calculation of both external and internal capital
requirements for credit risk.
For operational risk, Rabobank Group has chosen the
Advanced Measurement Approach, for which it has also
developed models according to the supervisory authority's
directives.
Rabobank Group's relatively low risk profile, as appears from
the outcome of Rabobank Group's preliminary calculations,
is reflected in much lower capital requirements and hence
a significantly improved solvency ratio under the Basel II-
regulation.
Current prospects are that the Basel II capital requirement
will be approximately 30% to 40% lower than the present
Basel I capital requirement. Under the new regime, the
capital requirement for credit risk will be nearly halved for
the Rabobank Group, thanks mainly to the large mortgage
portfolio. Under Basel II, the average capital requirement
for the mortgage portfolio will fall by more than three-
quarters. In addition, the solvency requirement for corporate
lending as well as for leasing will be significantly lower
because, unlike Basel I, Basel II takes the collateral obtained
into account. The requirement for these portfolios will be
reduced by more than 50%. However, Basel II has a separate
operational risk capital requirement for banks. For Rabobank
Group, the capital requirement for operational risk will be
around 10% of the total capital requirement under Basel II.
Under Basel I, the Tier I ratio at 31 December 2006 was over
10%. Using the internal calculation for the Basel II require
ment, this ratio is over 16%.
Until the start of the Basel II regime on 1 January 2008,
Rabobank Group is to report three more times to the Dutch
Central Bank on capital requirements under the present
Basel I accord and the new Basel II accord. In addition, the
official request for the use of the internal risk models for
the capital requirement calculation will be submitted in
2007. In 2008 and 2009, Rabobank Group will calculate the
solvency requirement according to both Basel I regulation
and Basel II regulation. In those years the Basel II capital
requirement is subject to a floor of respectively 90% and
80% of Basel I capital.
Rabobank Group has a robust internal process for capital
adequacy assessment. For the time being, it is based mainly
on the current Basel I risk numbers, with a minimum Tier I
ratio of 10% as an important financial target of Rabobank
Group. In order to increase the risk sensitivity of the internal
capital adequacy assessment, Rabobank Group, as one of
the key targets of its Basel II/RAROC programme, introduced
its own economic capital framework. This created an
internal capital requirement, 'economic capital, besides the
external, regulator-based capital requirement. Economic
capital is defined as the amount of capital to be held by
the bank to absorb unexpected losses, based on a one-year
period and a confidence level set by Rabobank Group.
Consistent with its triple-A ambition, Rabobank Group
applies a confidence interval of 99.99% (insufficient capital
anticipated once in every 10,000 years). It is noteworthy
that the supervisory authorities themselves use a 99.9%
confidence interval (once in every 1,000 years). Rabobank
Group uses advanced statistical methods to determine the
amount of economic capital to be held. Risk diversification
also plays an important role in the calculation of economic
capital. Better diversification means that less economic
capital is required, as the probability of unexpected losses
occurring simultaneously within different risk categories is
by definition lower. Rabobank Group will improve these
models further in the future based on gained experience.
Rabobank Group's economic capital framework will give
better insight in the interrelationship between risk and return
and will enhance its capability to take pricing decisions and
to support activities such as portfolio management.
Rabobank Group's total economic capital for 2006 has been
calculated at EUR 16.9 (14.9) billion. The increase compared
to 2005 was due to the growth in Rabobank Group's activities
and to model refinements. This includes the development
of a new model to determine economic capital for the
minority interests. Also the economic capital for the other
assets was modelled. The economic capital is well below
the available Tier I capital (core capital) of EUR 26.4 (24.9)
billion. This large capital buffer illustrates Rabobank Group's
solid financial position.
70 Rabobank Group Annual Report 2006
