External capital requirement
Internal capital requirement: economic capital
The new accord on capital adequacy -'Basel II'- came into force for Rabobank Group on
1 January 2008. This accord represents an integrated framework for the supervision of banks
and is based on three pillars. The first pillar sets a number of methods to determine the
minimum capital requirements for credit risk, market risk in the trading books and operational
risk. The second pillar focuses on the qualitative assessment of risk management, risk models
and their application in the organisation. The third pillar concerns the publication of the risk
profile and the risk management techniques used.
The Dutch Central Bank (DNB) has authorised Rabobank Group to determine the capital
requirements under Basel II according to the most advanced approaches. Therefore,
Rabobank Group has developed its own risk models during the past years. Regarding credit
risk and operational risk, Rabobank Group has opted for the Advanced Internal Ratings Based
approach (AIRB) and the Advanced Measurement Approach (AMA), respectively. For market
risk in the trading books, also a self-developed and DNB-approved risk model is used.
The introduction of Basel II will have a beneficial effect on Rabobank Group's capital
requirement. Total capital requirement at 31 December 2007 will be almost 27% lower, from
EUR 21.3 billion under the Basel I regulations to EUR 15.5 billion under Basel II. For 2008 and
2009, the Basel II requirements are subject to a minimum of 90% and 80%, respectively,
of the Basel I capital requirement. The greater part of the Basel II capital requirement relates
to credit risk (EUR 13.7 billion). There are also requirements for operational risk (EUR 1.4
billion) and market risk (EUR 0.4 billion). The reduction from Basel I is mainly due to the
relatively low risk profile of Rabobank's large mortgage portfolio. In addition, Basel II takes
into account collateral, which will lead to a substantial reduction of the capital requirement
in both corporate lending and leasing.
At 31 December 2007, the available Tier I capital amounted to EUR 28.5 billion, leading to a
Tier I ratio under Basel I of 10.7%. Based on the Basel II requirements, this ratio would be 14.7%.
The second pillar of Basel II prescribes that banks should have an internal capital assessment
process that, apart from the risk types to which the external capital requirement applies, also
calculates an internal capital requirement for the other material risk types. Within Rabobank
Group, this internal capital assessment process has been realised by the introduction of an
economic capital framework. Besides credit risk, operational risk and market risk in the
trading books, Rabobank Group also calculates economic capital for business risk, interest rate
risk, residual value risk, real estate risk, transfer risk, insurance risk and the risk related to the
remaining assets. Apart from considering more risk types, the level of confidence used is
another important difference between internal economic capital and the external capital
requirement. The supervisory authorities apply a level of confidence of 99.9% for the
external capital requirement, i.e. a chance of 1 in 1,000 that insufficient capital is available
to absorb losses in any one year. For the determination of the internal economic capital,
Rabobank Group has opted for the much higher level of confidence of 99.99%. This means
that Rabobank Group has set its internal capital requirement such that this chance is only
1 in 10,000. This coincides with Rabobank Group's Triple A rating ambition and results in a
significantly more conservative capital requirement than set by the supervisory authorities.
Rabobank Group has developed advanced models for the calculation of economic capital
for all material risk types.
At 31 December 2007, the economic capital amounted to EUR 20.5 (16.9) billion.
Relating the profit achieved on a certain activity to the economic capital required for that
activity produces the RAROC (Risk Adjusted Return On Capital). In 2007, RAROC for
Rabobank Group was 13.0% (13.8%).
The increase in economic capital compared to 2006 is due to the growth Rabobank Group
saw in 2007. Also, a number of risk models have been improved and more risk types have
been included in the economic capital framework. For each risk type and each business entity,
economic capital is calculated and reported on a monthly basis.
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Rabobank Group Annual Report 2007
