Basel Capital Adequacy Framework. Eric Falkenstein Vice President ICM Credit Risk Management for Asian Financial Institutions June 28, 2000 [email protected] 212.553.7231. Topics. The current capital regulations The current Basel dialogue Next Steps. What is Bank Capital?.
Bank Capital is:Bank Capital is not:
- Common Equity - Customer Deposits
- Preferred Equity - Short-term Debt
- Subordinated Debt - Other Liabilities
- Loan Loss Reserve - Goodwill
A) Tier I or Core Capital Ratio
B) Total Capital Ratio
Tier 1 or Core Capital 4% 6%
Tier 1 + Tier 2 or Total Capital 8% 10%
1) Provide summary of best practices of credit models
2) Assess the potential applications and limitations of credit risk models for supervisory and regulatory purposes
3) Solicit feedback
download at www. bis.org
Current credit management methods potentially rational direction for future refinements, yet there are limitations:
1) Lack of Data.
2) Validation (see #1).
“Regulators would have to be confident that models were used to actively manage risk, and that conceptually sound, empirically validated, and produce capital assessments comparable across financial institutions.”
“Significant hurdles, principally concerning data availability and model validation, still need to be cleared before these objectives can be met, and the Committee sees difficulties in overcoming these hurdles in the timescale envisaged for amending the capital Accord."
3 pillars to the revised capital framework
1) minimums (most of the focus)
2) supervisory review (probably more important!)
3) market discipline (good idea, but need broad liquid debt markets)
An example of the new refinements put forth by Basel:
Subject: Loss Given Default
comment: US and European data is all that's really available
Subject: Shape of the density function of losses
comment: Unknown (lognormal? Normal?), but not considered a major limitation
Subject: Conditional upon the economy
comment: Need sound linkage
Subject: Conceptual Approaches
Comments: Credit Value-at-Risk and/or Scenario
Subject: Default mode and Mark-to-Market Mode
Comments: Mark-to-market superior perhaps
Comments: Not a big issue, 1 year likely
Subject: Parameter Specifications
US corporate bond rating information good
Use conservative assumptions when missing data
Start collecting data as soon as possible
Panel data set compiled from regulatory bodies
Subject: Supervision and Regulatory Application
Portfolio by portfolio
Link evaluation of credit models to how models are actually used
Simple models not necessarily bad
Don't use US data to parameterize models
Best Case Scenario:
Basel will make preliminary proposal by February 2001.
Phase-in will start in January 2003.
Probable Scenario: year or two later...