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Implications of Basel II for Central Bank Policies

This document discusses the implications of Basel II for central bank policies in relation to financial stability. It covers topics such as the duties of central banks, tensions between financial stability and other objectives, the pillars of Basel II, and the effects of Basel II on Turkey's banking system. The conclusion provides suggestions for implementing Basel II in Turkey.

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Implications of Basel II for Central Bank Policies

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  1. IMPLICATIONS OF BASEL II FOR CENTRAL BANK POLICIES Erdem Başçı Vice Governor Central Bank of the Republic of Turkey Erdem.Basci@tcmb.gov.tr Conference on Financial Stability and Implications of Basel II May 2005, İstanbul

  2. CONTENTS Central Banks and Financial Stability Financial Stability and Basel II Basel II and Turkey Conclusion and Suggestions 1

  3. 1) CENTRAL BANKS AND FINANCIAL STABILITY

  4. CENTRAL BANKS AND FINANCIAL STABILITY Definition: Financial Stability • Lack of financial crises • Sustained success of financial contracts 2

  5. CENTRAL BANKS AND FINANCIAL STABILITY Duties of Central Banks • Price stability • Employment and growth • Payment systems • Financial stability 3

  6. CENTRAL BANKS AND FINANCIAL STABILITY Tensions • Financial stability versus price stability • Financial stability versus financial development 4

  7. CENTRAL BANKS AND FINANCIAL STABILITY • Maintenance of financial stability is much more difficult and complex compared to price stability • There is no straightforward instrument that a central bank can use for financial stability • Financial stability reportsare useful communication tools 5

  8. 2) FINANCIAL STABILITY AND BASEL II

  9. FINANCIAL STABILITY AND BASEL II Better risk management Financial Stability Effective supervision International standards 6

  10. BASEL II PILLAR* 1 PILLAR* 2 PILLAR* 3 FINANCIAL STABILITY AND BASEL II I. Adequate Capital II. Supervisory Review III. Market Discipline All three pillars of Basel II have direct implications for financial stability. 7

  11. FINANCIAL STABILITY AND BASEL II Pillar 1: Minimum Capital Requirements Capital allocation that is more sensitive to risks Alignment of regulatory and economic capital Encouragement of better risk management techniques FINANCIAL STABILITY Banks with adequate capital is the most important level of defensefor a central bank. 8

  12. FINANCIAL STABILITY AND BASEL II Pillar 2: Supervisory Review Process Urges banks to • maintain adequate capital in relation to their risks • monitor, measure and manage their risks by developing betterrisk management techniques • take into consideration risks that are not defined under Pillar 1such as, market risk(capital charges for price and FX risk,) liquidity risk(no capital charge, additional arrangements) 9

  13. FINANCIAL STABILITY AND BASEL II Pillar 3: Market Discipline • Better information disclosure • Enhanced efficiency of financial markets 10

  14. 3) BASEL II AND TURKEY

  15. BASEL II AND TURKEY Basel II preparations • Basel I, Capital Adequacy: 1988 (TR: 1989) • Basel I, Market Risk: 1996 (TR: 2002) • QIS 3: 2003 • QIS-TR: 2004 11

  16. BASEL II AND TURKEY Reduced Fiscal Dominance • Public debt to GDP ratio • Deposit to GDP ratio • Loans to GDP ratio 12

  17. BASEL II AND TURKEY Reverse Currency Substitution • Asset Side Share of household FX deposits Share of commercial FX deposits • Liability Side Share of household FX denominated loans is 0 Share of Treasury’s FX liabilities 13

  18. BASEL II AND TURKEY Effects on Bank Balance Sheets • TL denominated government securities may receive “0” lower risk weight (national discretion). • FX denominated government securitieswill receive 100 percent risk weight under the current BB- rating for Turkey. FX denominated sovereign risk weights 14

  19. BASEL II AND TURKEY Effects on Bank Balance Sheets (Standard Approach) • Basel II assigns toRisk Weight • consumer loans 75 % • small and medium sized enterprises 75 % • mortgages (owner occupied) 35 % • Additional capital requirement against operational risk 15

  20. 4) CONCLUSION AND SUGGESTIONS

  21. CONCLUSION AND SUGGESTIONS • For implementing of Basel II Turkey needs to improve: • risk culture and awareness • supervisory capacity • rating agencies • disclosure practices • use of international standards • credit registry • coordination betweensupervisors and banks 16

  22. CONCLUSION AND SUGGESTIONS • Basel II is very good news for central banks as far as financial stability objective is concerned • Macro-prudential analysisthat covers banks as well as non-bank sectors is also essential. • Financial Stability Report of the CBRT will focus mainly on macro-prudential analysis. 17

  23. IMPLICATIONS OF BASEL II FOR CENTRAL BANK POLICIES Erdem Başçı Vice Governor Central Bank of the Republic of Turkey Erdem.Basci@tcmb.gov.tr Conference on Financial Stability and Implications of Basel II May 2005, İstanbul

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