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Basel II: Light at the end of the tunnel? . Chris Matten [email protected] PWC. Agenda. The final Framework What next?. The final Framework is finally here!. Agreed by Central Bank Governors and Heads of Banking Supervision for all G10 countries Intended for broader use

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Presentation Transcript
  • The final Framework
  • What next?
the final framework is finally here
The final Framework is finally here!
  • Agreed by Central Bank Governors and Heads of Banking Supervision for all G10 countries
  • Intended for broader use
  • EU to proceed with Risk-Based Capital Directive
    • PwC/NIESR Impact Study completed and published in April 04
changes to cp3 1
Changes to CP3 (1)
  • New transitional arrangements, with A-IRB/AMA delayed by one year
  • Banks must address any shortfall in the floor by increasing stated RWAs under Basel II
  • Intended to assist US banks and others in meeting the deadlines
  • Flagged 11 May 04
changes to cp3 2
Changes to CP3 (2)
  • Scaling factor introduced
  • Initially set at 1.06
  • I.e. whatever the resulting calculation under Basel II, result must be multiplied by 1.06
  • Intended to maintain same level of aggregate capital in the banking system
  • Flagged 11 May 04
changes to cp3 3
Changes to CP3 (3)
  • Segregation of EL from UL under IRB risk-weights
  • Different, simpler RW function for defaulted assets
    • To reflect potential adverse move in LGDs and EAD
  • Provisions under IRB to be held equal to EL
    • Any shortfall to be deducted equally from Tier 1 and Tier 2
    • Any surplus may be allowed in Tier 2, up to 0.6% of RWAs
  • Intended to address criticism of double-counting of EL
  • BUT raises problems with IFRS (IAS 39)
  • Covered in 30 Jan 04 press release



changes to cp3 4
Changes to CP3 (4)
  • Reduction in RW factors for QRRE
  • Fixed correlation factor (0.04) rather than a function of PD
  • Intended to reduce RW esp. for credit cards
  • Flagged 11 May 04
changes to cp3 5
Changes to CP3 (5)
  • Default RW for other assets is 100%
  • Intended to fix a ‘hole’ in CP3 which did not specify a RW for other assets
  • BUT does not seem right
    • Standardised approach defaults to Basel 1988 where RW not specified
    • Under IRB, cash would appear to take 100% RW! (vs 0% under standarised approach)
  • Awaiting clarification from BCBS
  • Local supervisors expected to be pragmatic in interpretation
  • New provision not previously announced
changes to cp3 6
Changes to CP3 (6)
  • LGDs to be based on economic downturn, not average
  • Need to calculate (a) default-weighted average over full observation period (ideally covering at least one cycle), and (b) potential LGD ‘which reflects economic downturn conditions’.
  • LGD to be used is higher of (a) and (b)
  • Intention is for single LGD, but in practice?
  • Flagged 11 May 04
changes to cp3 7
Changes to CP3 (7)
  • Provisions for securitised assets under IRB have been completely revised
  • Internal Assessment Approach (IAA) introduced for ABCP
  • No differentiation under RBA for issuers and investors
  • Intended to address industry criticisms
  • Flagged 30 Jan 04

RBA - ratings based approach; SF – Supervisory Formula; IAA – Internal Assessment Approach

changes to cp3 8
Changes to CP3 (8)
  • Some diversification benefit for banks using AMA
  • Overseas subsidiaries which are not ‘significant’ can have allocated portion of group-wide diversified AMA
  • ‘Significant’ means in the context of the banking group, not the country of operation
  • BUT “banking subs whose host supervisors determine that must calculate stand-alone capital requirements may not incorporate group-wide diversification benefits…”
  • Intended to provide relief from multiple AMA calculations in large banking groups
  • Covered in 30 Jan 04 press release
importance of pillar 2
Importance of Pillar 2
  • Principle 1: “ Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels”
  • Board and senior management oversight
  • Sound capital assessment
    • Policies and procedures.. to measure.. all material risks
    • Process to relate capital to level of risk
  • Comprehensive assessment of all risks
  • Monitoring and reporting
  • Internal control review
2 views on pillar 2
2 views on Pillar 2
  • Pillar 2 as a holistic view of capital, with Pillar 1 as a sub-set

Pillar 2

Pillar 1

Pillar 2

  • Pillar 2 as an “add-on” to Pillar 1

Pillar 1

does principle 1 require an ec model
Does Principle 1 require an EC model?
  • Adoption of an EC model is consistent with Principle 1
  • BUT other approaches may also qualify:
    • Stress tests
    • DFA
    • Scenario analysis
  • Adoption of an EC model should be driven primarily by business demands; Pillar 2 compliance is then an added requirement
  • The final Framework
  • What next?
the final framework is finally here or is it
The final Framework is finally here!… or is it?
  • Need to leave door open for US lawmakers and supervisors
    • Framework is a ‘statement of the Committee agreed by all its members’
    • Adoption procedures ..’will include additional impact assessments…as well as further opportunities to comment’
  • National supervisors may set higher levels for Pillar 1 and/or specific requirements in Pillar 2
    • Eg APRA – IRR capital in Pillar 1 for sophisticated banks
    • Eg EBK – ‘Swiss finish’ higher risk weights
bcbs work in progress 1
BCBS work-in-progress (1)
  • “Double-default”issues
    • Recognition of double-default effects necessary
    • BUT need to work through the issues
    • Aim to produce a solution prior to Basel II implementation
  • Trading book issues
    • Potential future exposure (EADs)
    • Counterparty risk
    • Joint working group with IOSCO due to report back in 2005
  • Re-calibration of scaling factor
  • Definition of ‘eligible capital’
    • Treatment of provisions (EL) tends to depress Tier 1 relative to total CAR
    • Uniform standards on hybrid Tier 1 required
    • No changes expected prior to implementation of Basel II.
bcbs work in progress 2
BCBS work-in-progress (2)
  • Encouragement of ‘Economic Capital’ re-introduced
    • Does Pillar 2 require an EC model?
    • Can other methods (DFA, stress testing, scenario analysis etc) apply?
  • Use of full credit risk models an option for the future
    • “IRB..represents a point on the continuum between purely regulatory measures….and internal credit risk models”
  • Future clarification of suitable AMA approaches for operational risk
    • BCBS waiting for an industry standard to emerge.
  • Co-ordination with IAS
implementation in eu
Implementation in EU
  • Risk-Based Capital Directive in preparation
  • 4 options for implementation:

1. Full implementation from 31 Dec 06

2. Any option allowed during 2007, including old Accord and Basel II, with

full adoption of Basel II from 31/12/07

3. Same as 2, but A-IRB/AMA only allowed from 31/12/07

4. Delay implementation until 31/12/07

  • This is a political issue as much as a technical one
  • Parity with US banks as well as within EU a critical factor
implementation in singapore
Implementation in Singapore
  • Locally-incorporated full banks to comply by 31/12/06
  • Choice of methodologies: no compulsion, no prohibition
  • Branches to follow home country supervisor requirements
  • Restricted licence banks: currently net worth and other criteria, but Basel II a possible future option
  • Finance companies: remain on Basel 1988 (as amended)