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BASEL II - WHERE TO NOW? - PowerPoint PPT Presentation

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BASEL II - WHERE TO NOW?. Andrew Jennings January 2009 . Disclaimer. Opinions expressed in this presentation are those of the speaker and do not necessarily reflect the views of Citigroup Inc or its affiliates. BASEL II – Where we are now?. 10 years in its creation

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Andrew Jennings January 2009

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  • Opinions expressed in this presentation are those of the speaker and do not necessarily reflect the views of Citigroup Inc or its affiliates

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BASEL II – Where we are now?

  • 10 years in its creation

  • Banks have spent about £10bn - £20bn on its implementation

  • Many banks have started to report under Basel II

  • Significant improvement over Basel I

  • BUT …. Still needs improvement

  • Greater importance of Pillar 2

  • Basel Committee due to release a paper shortly

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Basel II - Enhancements

  • Trading book risk – inclusion of “Event Risk”

  • Greater emphasis on Stress Testing

  • Review of Off-Balance Sheet exposures

  • Treatment of securitisations

  • Counterparty risk – reducing credit default swap risk

  • Liquidity

  • External Audit Quality

  • Fair value accounting

  • Improved disclosure

  • Others??

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Tier 1 Capital and Stress Testing

  • Increased attention to Tier 1 ratios

  • Need to have sufficient Tier 1 capital after a severe stress event.

  • Increased attention to severe stress results

  • Raises pro-cyclicality of Basel II

  • Consideration of provisioning policies

  • More emphasis on building up capital in ‘good times’

  • Implications for banking returns

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  • Increased importance

  • Reverse stress test proposed

  • Regulators setting stress testing assumptions

  • Regulators set Basel II parameters if data is lacking

  • Cover all risks

  • Informs forward planning, capital requirements and risk appetite.

  • Contingency capital plans.

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  • Severe but plausible stress test across whole bank.

  • Identify concentrations:

    • Single large exposures

    • Large losses as a result of large moves of a specific factor (eg house prices)

    • Consider secondary effects and changes in historic correlations.

  • Identify portfolios with ‘Fat Tails’ e.g.

    • Secondary mortgages and some sub-prime mortgages

    • Leveraged or Bridge Loans

    • Originate to distribute portfolios awaiting sale

    • Basis risk of ‘well hedged’ positions.

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  • Good quality risk data vital to optimise Basel II capital requirement.

  • Poor quality leads to conservative capital estimates and potentially excessive capital usage.

  • Credit and finance data need to be, as near as possible, the same.

    • Settlements outstanding,

    • Deferred fees

    • Impaired counterparties

    • Correct mark to market

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DATA QULAITY (continued)

  • Include non finance data

    • Legal netting where available

    • Full collateral data

    • Risk ratings assigned

    • Counterparty identified

    • Comprehensive netting

    • Legal vehicle used

    • Identify defaults and recoveries promptly and comprehensively

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Accurate Data for models

  • Exposure at Default:

    • Volume of data limited so changes can have a disproportionate effect.

    • Particularly noticeable for credit cards and un-drawn wholesale commitments.

    • High quality risk management of use of un-drawn commitments will have a significant benefit in Basel II capital requirements.

  • Loss Given Default

    • Evidence of downturn LGD and its variation across cycle.

    • Management of defaults and recoveries.

    • Sectoral and geographic analysis.

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  • Operational Risk model – very different distribution of operational risk.

  • Expected Positive Exposure (‘EPE’) for OTC derivatives.

  • Model ALPHA (below defined regulatory level x1.4)

  • VaR or EPE for Secured Finance Transactions (SFTs).

  • VaR for all aspects of Market Risk, but will include event risk.

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  • More difficult than Basel I

  • Explore those that make sense for your bank – e.g. in Retail:

    • Potential to sell defaulted credits which are difficult to collect

    • Reduce undrawn commitments

  • Explore those that make sense for your bank – e.g. in Wholesale:

    • Cancel swaps

    • Reduced intra group exposure

    • CDS hedging of higher risk exposures

    • Banking book/trading book split

    • Undrawn commitments – especially if under 1 year.

    • Collateralised or covered by parent guarantee.

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  • Given previous comments there is considerable pressure on banks’ balance sheets

  • Most significant ratio to many banks is the Tier 1 regulatory ratio.

  • Need to optimise return on Tier 1 capital

  • Reduce assets utilisation

  • Risk has a vital role in helping identify opportunities.

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Oh Man, I got the

BASEL II Blues !