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LEBANON’S PREPARATIONS AND RELATED ISSUES FROM BASEL II

LEBANON’S PREPARATIONS AND RELATED ISSUES FROM BASEL II. Assessing Progress & Roadmap. Dr Amine Awad, Board Member, Banking Control Commission Member of the Higher Banking Council

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LEBANON’S PREPARATIONS AND RELATED ISSUES FROM BASEL II

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  1. LEBANON’S PREPARATIONS AND RELATED ISSUES FROM BASEL II Assessing Progress & Roadmap Dr Amine Awad, Board Member, Banking Control Commission Member of the Higher Banking Council Washington D.C. May 17, 2004

  2. Before starting the draw up of Lebanon’s preparation to implement Basel II, it is useful to show the role of the various authorities involved in this subject. Description of the Central Bank and The Regulatory Body 1.Banque du Liban (BDL) and the Banking Control Commission(BCC) are the two independent authorities in Lebanon that work side-by-side and coordinate their actions together.

  3. 2.B.D.L, besides its role in the monetary policy, is the authority that decides on the different aspects of the development of the banking sector; it is responsible for licensing of Banks and Financial Institutions; thus BDL issues circulars related to banking policy. 3.The BCC is the authority responsible for (a) following up the banks’ operations, (b) controlling their development and performance, (c) supervising their systems and management.

  4. Accordingly, it is the authority that issues application circulars and receives periodic reports in order to follow up the operations of banks, financial institutions and exchange houses. 4.Whenever the BCC faces the case of a "problematic" institution that it cannot remedy, it refers the institution to the "Higher Banking Council" (H.B.C):

  5. BDL and the BCC are represented in the HBC, in addition to other members who are a seasoned judge with relevant experience in financial matters, the Head of Deposit Guarantee Institution and the Director of the Ministry of Finance. The H.B.C is ajudicial authority that decides on the fate of the institution being tried, its verdicts are not subject to any type of appeal.

  6. 1st Vice Gov. Board Member Governor 2nd Vice Gov. Board Member Chairman 4th Vice Gov. Board Member Board Member 3rd Vice Gov. B.C.C. B.D.L. Board Governor (as Chairman of HBC) (+) one Vice Gov. (as Member) One Board Member (as Member) (+) B.C.C (as prosecutor) H.B.C Director, Ministry of Finance One Judge Chairman of Deposit Guaranty Institution

  7. What about Lebanon’s policy regarding The application of Basle II 1.Since the year 2002, Lebanon has been following closely the research and publications related to Basle II, basically:

  8. First Consultative Paper – CP1, in June 1999 • Second Consultative Paper – CP2, in January 2001 - Several Working Papers, Press Releases and Impact Studies during 2001. • Third Quantitative Impact Study QIS 3, carried out in Autumn 2002. • Third Consultative Paper – CP3, in April 2003 • "Draft Implementation of Basel II" document: (Practical Considerations), issued in August 2003

  9. Through the continuous participation of Members of the BCC in conferences, meetings and seminars, especially in the F.S.I. in Basle to accommodate the research about the subject and to prepare for Lebanon’s banking sector in close coordination with the BDL Board 2. Since the year 2002, Lebanon has been trying to play an active role in spreading the philosophy of Basle II and in the development of related research in the Middle East region.

  10. Lebanon hosted two regional conferences in 2002 and 2003, to which 22 Arab and Middle Eastern countries were invited to follow the work of the FSI for implementing Basel II; With major instructors from the FSI, IMF, World Bank, FSA and the BCC. 3. Several big banks in Lebanon besides Lebanon’s Bankers Association contributed to the consultative Papers of the Basel Committee, thus helping developing and enriching the research.

  11. 4. Lebanon was one of the few countries in the world whose supervisory authority was underwent an initial IMF assessment in 1998, then a follow up assessment in March 2001 which covered the progress Lebanon achieved with regards to the "Core Principles for Effective Banking Supervision". The result of the assessment of the supervisory process in Lebanon was highly graded.

  12. In addition, Lebanon was among the countries chosen by the FSI to contribute to the amendment of The Core Principles for Effective Banking Supervision issued by the Basle Committee to accommodate the requirements of Basle II. 5. After Lebanon was classified by the FATF (GAFI) among the non-cooperating countries with regards to money laundering because of its Banking Secrecy Law,

  13. the Lebanese Government and Parliament enacted Law 318 in April 2001 in order to put in place a global framework for combating money laundering. Since then, BDL and the Special Investigation Commission (SIC) issued a number of circulars, the last of which was BDL Circular No. 35 dated September 17, 2003, regarding the same issue; this led to the removal of Lebanon from the list of non-cooperating countries.

  14. 6. Finally, Lebanon participated in the Survey which was prepared by the F.S.I. and the Secretariat of the Basel Committee on Banking supervision and which was designed to identify the international current plans regarding implementing Basel II and corresponding capacity building needs.

  15. Even if the official position of Lebanon concerning the potential scope of implementation of Basel II New Capital Accord is "undecided" yet, however the answer of the Lebanese monetary and supervisory authorities on the question if “our jurisdiction intend to adopt Basel II” was YES. The major topics on which the regulatory authority in Lebanon is now working on, are as follows:

  16. Mechanics of IRB approach • Validation of internal estimates • Supervisory and own – estimated haircuts Pillar 1: Capital Requirements Standardized Approach (Incl.Simplified Standardized Approach) • Credit risk mitigation techniques • Treatment of securitization exposures Credit Risk IRB Approach Operational Risk Basic Indicator or (Alternative) Standardized Approaches _ AMAs • Calculation of capital requirements using internal assessment techniques Pillar 2: Supervisory Review • Determining bank’s internal assessment process • Assessment of incremental capital requirement Pillar 3: Market Discipline • Disclosure methodologies. • Verification of achievement of disclosure requirements • Identification of the changes in reporting & information systems to produce the required disclosures.

  17. Steps Taken in preparation for The Application of Basle II The monetary and supervisory authorities in Lebanon have been continuously and actively working since two years on the preparation of the financial sector readiness for the progressive application of Basle II. Thisis being done in two parallel directions as follows:

  18. 1. Preparing empirical studies and field surveys on the banking and financial sector in Lebanon to determine what has to be amended regarding capitalization, placement policies and other issues. 2. Spreading progressively, the culture of Basle II inside the banking sector when it comes to “Internal Audit”, “Corporate Governance”, “Risk Management” and other areas.

  19. 1. With regards to the statistical surveys: These are being prepared by the BCC and discussed with a joint Committee, appointed by the Governor of BDL since March 26, 2003, whose role is to prepare for the application of Basel II. This Committee is composed of the First Vice-Governor, two Board Members of the BCC and two representatives of the Lebanon’s Bankers’ Association. It may have recourse to experts on the subject when deemed necessary.

  20. The joint committee has conducted various simulations assessing the impact of the application of Basel II on the capital adequacy ratios of banks operating in Lebanon. The scenarios were based on the current banks’ financial statements adopting the following approaches: • Standardized approach with respect to Credit and Market Risks • Basic Indicator Approach with respect to the Operational Risk

  21. Then, the committee identified the banks whose capital adequacy ratios will fall below the minimum capital requirements and it is currently developing an action plan to deal with these banks on a case by case basis.

  22. In the draft document called:" Implementation of Basel II: Practical Considerations", issued in August 2003, The Basel Committee said: A key objective of Basel II is to encourage improved risk management through the use of three mutually reinforcing Pillars. While banks have primary responsibility for appropriately measuring material risks and maintaining adequate capitalization, (cont.)

  23. (cont.) the Basel II proposals recognize that Pillar 1 minimum capital requirements cannot be the sole answer to adequate capitalization and risk management in banks or safety and soundness in a banking system. Strong risk – based supervisory review with early intervention and market discipline under Pillars 2 and 3, respectively, complement minimum capital requirements.

  24. BASEL IIFinal Implementation date Dec.31st 2006 We will summarize each pillar as follows:

  25. I- First Pillar Banks should maintain sufficient capital funds to cover: A. Credit Risk: Minimum capital requirements are based on one of the following approaches: * Standardized approach * Internal ratings-based approach * Credit Risk modeling

  26. B)Operational Risk To develop a capital charge that covers the risk of deficiencies in information systems or internal controls of which will result unexpected losses ;This is based on one of the following approaches: * Basic Indicator * Standardized Method * Advanced Method (AMA) C)Market Risk To develop a capital charge that covers interest rate and exchange rate risks in banks’ books.

  27. II- Second Pillar Is intended to achieve a level of capital commensurate with a bank’s overall risk profile and to encourage banks to develop better risk management techniques in monitoring and managing their risks. Supervisors are expected to evaluate how well banks are assessing their capital needs relative to their risks and to intervene where appropriate.

  28. III- Third Pillar Banks have to strengthen the transparency with their stakeholders ( i.e. customers, employees, shareholders, supervisors and public authorities), by: * Adopting full disclosure through reliable and timely accounts. * Adopting policies that control all types of risk. * Avoiding lack of confidence.

  29. Supervisors – including those who choose to retain the current Accord - are encouraged to move towards a system of risk – based supervision. Specifically, supervisors, to the extent possible, should shift their emphasis towards the quality of a bank’s risk management process and ability to assess risk exposures properly.

  30. What B.D.L and B.C.C. do to cope with Basel II implementation • During August 2000, the B.C.C. issued its circular No. 222, which was implemented in three phases, ending in March 31, 2002. This circular sets an action plan for banks to improve their IT security. This circular was the first action taken by the B.C.C. and aiming at reducing one of the most important operational risk in banks (Pillar I).

  31. 2. The BDL issued the circular No. 77(dated 15/12/2000),on Internal Control in Banks and Financial Institutions. Banks and F.I. should establish internal systems to measure, monitor and control their risks. (Pillars I & II)

  32. 3. The BDL issued the circular No. 81 (dated 21/02/2001). This circular concerns Corporate Governance in Banks. B.O.D. should participate actively in designing the strategy of the bank and is fully responsible of the results. (Pillar II)

  33. 4. The B.C.C. mandated the application of the International Accounting Standards (I.A.S.), through the issuance of several circulars aiming at implementing market discipline in the banking industry, by asking for timely and more transparent banks’ accounts (Namely Circular No. 227, dated February 2001) (Pillar III) 5. The B.C.C. issued a comprehensive circular No. 238, dated 23/10/2002, on “ Analyzing, managing, and processing Credit Risk in banks and financial institutions (Pillar I)

  34. 6. The BDL issued the circular No. 41 ( dated 17/11/2003), aiming at designing a general framework to solve N.P.L. in banks; this circular was designed in preparation of implementing Basel II requirements, by reducing N.P.L. and consequently improving Credit Risk in banks (Pillar I)

  35. 7. The B.C.C. issued the Memo No. 1/2004 in January 26, 2004, asking Banks and F.I.’s to communicate to the B.C.C the list of their "Specialists in Risk Management". This memo has the following objectives: • To draw the attention of Banks and F.I.’s on the importance of the Risk Management Function in their organization. • To determine the lack of specialized persons in Risk Management in the financial sector. • To determine the necessary trainings. • To know the qualified persons to deal with the B.C.C. and with the specialists in Lebanon and abroad.

  36. 8. The B.D.L. issued its circular No 49 dated April 3, 2004 on definition of TIER I & TIER II capital, in accordance with the press release issued by the Basel Committee on October 27, 1998. An amendment to this circular is due to be issued by next week, putting limits on Preferred Shares and other Financial Instruments eligible for inclusion in Tier I Capital.

  37. 9. In addition to the above, the B.C.C. is in the process of issuing a serie of very important circulars, to help the lebanese banking and financial sector implementing the New Capital Accord: 9.1.Circular on Risk Management (end of May 2004) (Pillar I). 9.2.Circular on how to monitor Market Risk (June 2004) (Pillar I). 9.3.Circular on how to define and measure Operational Risk (November 2004) (Pillar I).

  38. 10. Finally the B.D.L. will issue during the current month (May, 2004) a new circular fixing limits for « Overdrafts » and encouraging banks to grant « Term Loans »

  39. The End

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