Risk Management, PRMIA

August 10, 2010

Top 6 Basel III Design Elements

Regulatory Blueprint - Top 6 Basel III Design Elements !
Let us start learning LR, LCR, NSFR, Capital Surcharge,Gone Concern! A mouthful isn't it?

Well, Basel III is coming our way sooner than expected ! The much awaited (do I hear a groan!) Basel III regulation is getting its final touches.

The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, met on 26 July 2010 to review the Basel Committee's capital and liquidity reform package. The BIS with G20 consultation is driving the Basel III release by November 2010 with an implementation start by end 2012.
The deadline for final institution level Basel III conformance though is expected to be around 2018.

Their focus is on
- quality, quantity, and international consistency of capital
- to strengthen liquidity standards
- to discourage excessive leverage and risk taking
- and reduce procyclicality

In general banks will need to hold more capital and manage liquidity better to withstand economic and market events. The global regulators are reviewing a new bank's Tier 1 capital requirement from its current 4% level.

Another key decision awaited is the timeline for banks to exclude lower quality capital from their capital calculations.

Whilst the regulation is still evolving, some of the design elements of Basel III at high level are:

1. Definition of Capital - Tighter definition of top quality capital with a capital buffer range with capital distribution constraints around it
2. Treatment of Counterparty credit risk-Capital buffers
3. Leverage Ratio - Cap on debt via Leverage ratio; Definition and Transition; 2011start; Parallel run Jan 2013-Jan 2017; Disclosure starts Jan 2015; Migration Jan 2018
4. Regulatory Buffers, Provisions, and Cyclicality of the Minimum
5. Systemic banks, contingent capital and a capital surcharge
6. Global liquidity standard-Liquidity Coverage Ratio(LCR), Net Stable Funding ratio (NSFR)- Measure of long term liquidity but with diluted initial pilot of 1 year Horizon liquidity buffer

Some of the industry concerns are already addressed in Basel III. For e.g. less stringent treatment of deferred tax assets and affiliates for calculating capital, longer phase in for new liquidity rules and cap on debt. These specially help many banks gain time to raise vast amounts of funds and a more considered roadmap for their minority stakes.

Basel III originally proposed a ban on banks counting capital held in affiliates as part of their own holdings.This did trigger concerns of a freeze in acquisition of minority stakes or sell-offs to avoid the need for extra capital. Banks will now be able to include capital from minority-held companies up to a certain threshold. Basel III has included top rated corporate debt in short term liquidity buffer. The industry and regional concerns about including only government bonds being considered. For. e.g. many countries such as Australia with strong public finances do not have enough government debt for local banks to buy.

For those of you wanting to dig deeper, you can download the document from http://bis.org/press/p100726/annex.pdf
Look forward to your thoughts and comments.

Source; BIS, Reuters, Bloomberg

Posted by spachava at 05:59 PM | Comments (4)

September 10, 2009

The Spanish approach to Risk management !

As a major European economy Spains banking sector has relatively fared well in the international financial crisis. Both Banco Bilbao Vizcaya Argentaria (BBVA) and Banco Santander (BS), amongst the largest banks in the world have done relatively well compared to their peers. Very few banks have needed capital infusion and government hand holding. Spanish banks have done quite well in past years fueled by a real estate boom. Of course as the real estate declines over the past two years and the economy is in recession, many banks do have heavy exposures to the real estate sector and are saddled with a rising rate of bad loans. The government is stepping up with a fund of up to euro90 billion (US$125.46 billion) to help banks restructure and cope with the effects of recession.

However the relatively better performance of Spanish banks is still commendable and can be attributed to below key factors.
1.Strict financial regulation environment enforced by the Bank of Spain (Banco de Espana)
2. More prudent Trading and risk management practices
3. Dynamic Capital Provisioning-Banks forced to set aside provisions during an economic boom fueled by construction and consumer spending.
4. Loan Loss Provisioning-Spanish banks have higher loan-loss provisions than many of their foreign counterparts because of the way Banco de Espana set reserve requirements.
5. Traditional banking focus-Most banks focus on traditional retail banking business and are less enamored by exotic business lines and products.
6. Spanish approach to Securitization-More for funding purpose than the most common risk transfer mechanism.
7. Strict treatment of Off Balance Sheet items-All instruments need to be reflected in balance sheets and i.e. no structured products that treated as off balance sheet items.
8. Strong on-site supervision
9. Different capital requirement for mortgage loans depending on their loan-to-value ratios.

In many countries across the world, banks are required to increase reserves as losses increase and allowed to decrease reserves as profits rise. This setup increases bank lending during economic boom periods and decreases lending activity during downturns, a cyclical tendency.

Banco de Espana sets reserves based on an weighted average of a banks assets, with the weights determined by past default frequencies for different asset classes. The hypothesis is that historical default frequencies will accurately reflect reserves going forward. This presumes that the historical record provides a good indication for distinguishing between cyclical and more permanent components of loan performance.

We already see many countries starting to look at dynamic provisioning as a best practice. Of course the issue with dynamic provisioning is that its compatibility with IFRS needs to be handled.
Here again Bank of Spain has led the way to find common ground with accounting standards.

So hats off to Spain for showing the way for prudent banking via solid commonsense risk management.

Sources & Acknowledgements: BBVA Economic Research Working Paper,Feb 2009-Dynamic Provisioning and other tools, Banco De Espana, Financial Times, Financial Week.

Posted by spachava at 10:25 PM | Comments (0)

August 08, 2009

Risk Management & Regulatory frameworks - The Canadian Loonie Way

I often refer to FSA, Fed Reserve, APRA, ECB, MAS in my blogs. During my ongoing research on next generation regulatory and supervision frameworks, I start to identify some of the leading economies where financial institutions managed their risks comparatively better. Canada, worlds second largest country by area is on the top of my list. In this blog I cover off some of the Risk management practices & the supervisory framework in Canada. A free spirited multi cultural country, C$1 and C$2 coins are referred fondly by its citizens as the loonie and twoonie respectively. The one dollar coin has a image of a Canadian Loon; the two dollar coin has an image of a polar bear.(thanks to Greg Keeling from BMO, Canada for his insights on the terms loonie & twoonie).

OSFI (Office of the Superintendent of Financial Institution) or BSIF(Bureau du surintendent des institutions financieres Canada) supervises all the Canadian financial institutions. Some of the differentiating factors and broader learnings and best practices from Canada being:
1. OSFIs razor sharp mandate & focus on Solvency vis-a-vis competitiveness of the financial sector
2. Gross Leverage ratio
3. Quality of Tier 1 capital
4. Treatment of High Loan to Value ratio
5. On-site supervision
6. Through the Cycle estimates under Pillar 2

1. OSFIs razor sharp mandate & focus on Solvency vis-à-vis competitiveness of the financial sector-OSFIs single point focus is on Solvency of its financial institutions. It is relatively less saddled with the financial sector competitiveness that other supervisors routinely are required to balance for their respective financial centres.

2. Gross Leverage ratio to limit Leverage- Many countries have woken up to the need for constraining bank leverages and the promise of a gross leverage ratio for banks to do this. Canada for a long time already has this in place through its maximum assets-to-capital multiple. OSFI has been using a leverage ratio, on top of risk based capital to ensure solvency even when risks are not measured with 100% accuracy.

3. Quality of Tier 1 capital-75% of Tier 1 capital has to be in common shares and targets of 7% Tier 1 and 10% total capital.

4. Treatment of High Loan to Value ratio-All high Loan to Value ratio loans need to be insured either by a government agency or agency with a government guarantee.

5. On-site supervision-High reliance on the robustness and rigor of the On-site supervision. Still regulatory mode and not light touch supervision as in other firms.

6. Inspirit adoption of Basel II by 2007 and special attention to Through the cycle PD estimates-Canadian banks were Basel II ready by 2007 and encouraged to adopt Basel II in spirit and not as a tick mark exercise. The local banks were able to avoid capital requirement spikes by developing through-the-cycle estimates of probability of default and other measures. This is particularly a key learning for those banks that experience capital requirements spike due to limitations of their approach that was focused on Point in-time PD estimates. This can make system less pro-cyclical and or more counter- cyclical.

7. Some of the other areas where OSFI is taking a lead are-Loan Loss Provisioning, Compensation, Constitution of Risk experienced/aware Boards members, Macroprudential Monitoring, Macroprudential Calibration of Policy Tools, Liquidity, management, Capital rules specific to securitization and counterparty risk.

OSFIs top priorities in 2008-2011 are:

A. Enhanced Identification of Emerging Risks
B. Institutional and Market Resilience
C. Changes to International Financial Reporting Standards(IFRS)
D. Minimum Continuing Capital Surplus Requirement (MCCSR)
E. Financial Sector Assessment Program (FSAP)/Financial Action Task Force (FATF)Reviews
F. Basel II Capital Accord – Post- Implementation phase
G. People Identify changing human resources requirements
H. Pensions Systems and Processes

Sources: www.osfi-bsif.gc.ca; OSFI 2008-2011 Plan & Priorities; Julie Dickson, Superintendent, OSFI speech at Asian Banker 2009, Risk Magazine

Posted by spachava at 06:17 AM | Comments (2)

August 24, 2008

Basel II Cross border realties - EU's CEBS releases range of practices

As the Basel II journey continues world over, the European Banking Supervisors (CEBS) recently released a range of practices on Basel II implementation issues.

I found this paper very informative and interesting and highly recommend to anyone interested in the practical realities of Basel II implementations across borders.

This compilation is based on CEBS significant involvement over last year in collecting and analyzing the Basel II implementation issues that cross-border groups and their supervisors believe to be the most challenging from a cross-border perspective.

This report classifies Basel II implementation into 3 groups and addresses some practical issues observed.

A) Supervisory process for model validation.
B) Pillar 1 technical issues
C) Pillar 2 issues

I cover off only some of the high level aspects to pique your interest to read the entire 18 page paper. The paper handles key issues in each of the above 3 areas and provides examples from specific scenarios around them.

A) Supervisory process for model validation
A key question handled is - Has delegation/division of tasks between supervisors been applied in practice? Which are the most relevant tasks to be delegated/allocated to home and host supervisors?

Summary of the observation - This is effective where the supervisors collaborate to perform the task they are best placed to conduct. The key point being that delegation needs to work both ways i.e. Host delegating to Home and Home delegating to Host. Generally speaking, home supervisors should inform hosts of centrally performed model reviews, and hosts are responsible for the supervision of local model implementation issues.

More specifically the home supervisor being responsible for the review of the internal governance of model validation (rating process, control environment, stress testing, worldwide model implementation, internal audit etc.), including the review of a sample of centrally developed models, and the examination of the adequacy of the related IT environment.

In the case of centrally developed models that are applied across the banking group (group-wide models), the home supervisor leads the approval work. Where models applied across the banking group are developed/managed/enhanced at a subsidiary banking entity, the home and host supervisors jointly carry out the approval work. Host supervisors are responsible for the assessment of specific local requirements. Host supervisors are generally responsible for the examination/assessment of the implementation of the rating systems developed by the local subsidiary.

Where a model is applied in several countries, the host supervisors of the subsidiaries where the main developmental work has been performed are responsible in consultation with the home supervisor.

- Local and central models A key question addressed was -
- How are local and central models defined? Are differences driven by specificities and/or organizational arrangements of banking groups?

Summary - Here broadly two main approaches were seen to be prevalent on the basis of the experience gained so far.

- The first one uses geographical specificities as the driver for separation and examines whether a particular rating system requires any local aspects to be taken into account. If this is the case,
the model is defined as local; if local aspects do not have a role, the model is considered to be central.

- The second approach focuses on the division of tasks within the banking group. Models developed, tested and validated by a central unit and used on a group-wide basis are defined as central models while models developed, tested and validated locally, and used in one or more entities, are considered to be local models.

The other issues handled in this section being:

- Portfolio classification - Is it possible for banks to adopt the IRB classification for exposures subject to the Standardised approach on a temporary (roll-out) and/or permanent (permanent partial use) basis?

- Use test for new models - How can the use test requirement be applied practically for new models?

- Supervisory assessment of group-wide models - What is the role of home and host supervisors in the validation of central models?

- Language of IRB/AMA application - In which language do banks have to submit the application to use internal models to the home supervisor? Is the approach consistent across banking groups?

B) Pillar 1 technical issues. In pillar 2 key topics addressed are around default defintion and downturn LGD.

- Definition of default - Which definition of default (DoD) is applied in practice across a cross-border banking group? How is the default of individual entities related to the default of groups?

Summary - Some groups use a different DoD for the consolidated calculation, whereas others use a single DoD across all the group’s entities. However, the first approach is not perceived to be a major problem.

- Downturn LGD - What are the banks’ methodologies to estimate the “downturn LGD”, as requested by the CRD? What is the supervisory approach?

Summary - Different approaches are explianed via different real life examples. Example 1 is around UK FSA. The UK Financial Services Authority has published a paper in which the results of an empirical exercise on downturn LGD estimates are presented1; data were gathered from 12 firms. The main outcome at this early stage is that the degree of variation of the two key downturn parameters (i.e. reduction in property value and probability of possession given default) is quite large. Therefore, some “reference values” for these variables are provided (-40% and 35% respectively), which could be used by each bank for discussion with supervisors. As soon as firms improve their estimation techniques, and the available data increase, FSA expects the thinking on this topic to evolve.

Example 2 is around Spain. The Bank of Spain has published a paper2 in which the requirements for downturn LGD for residential mortgages are presented. The document defines the following concepts: realised, long-run average and downturn LGD; it also requires a minimum segmentation in the estimation process based on risk drivers; and finally, it identifies the estimation procedures accepted.

Other issues covered in this section being-

- Estimation and validation of risk parameters in “low-default-portfolios” - What are the approaches followed by banks to estimate and validate risk parameters for “low default portfolios”? What is the supervisory approach?

- Project finance - What are the banks’ methodologies for estimating risk parameters for Project Finance? What is the supervisory approach?

C) Pillar 2 issues
- Scope of application of ICAAP - What is the scope of application of ICAAP?
- Requirements imposed for ICAAP - What are the requirements that banks have to follow for ICAAP?

Acknowledgment and Source: CEBS Paper on Range of Practices on some Basel II implementation issues.

Posted by spachava at 07:34 AM | Comments (1)

June 27, 2008

FDIC approves interagency Basel II based Standardized approach Capital proposal for smaller US banks;

I had earlier blogged about the US NPR Basel II interpretation for its largest banks. Consider this as chapter 2 of the same blog.

The Board of FDIC (Federal Deposit Insurance Corp.) yesterday issued a proposal for over 8,500 US smaller banks to have the option of adopting a simpler US version of Basel II guideline.

The new proposal termed 'Basel II-Based Standardized Approach Capital Proposal' is a step forward to make the smaller US banks adopt the more simpler and easier elements of Basel II standardized approach.

This is consistent with some other large countries that opted to mandate Basel II standardized approach for Credit Risk and Basic Indicator approach for Op Risk as the first phase for its banks with an option to adopt Basel II Advanced as an optional Phase II. This also means that the often speculated upon Basel II IA or Basel I.5 option in US, whatever one may choose to call it is mostly off the table as an option.

FDIC expects this standardized approach capital framework to add greater risk sensitivity without creating excessive complexity and burden and thus, should minimize inequities between large and small banks. The key factor in favor of standardized approach is the fixed risk weights that provides supervisors with better control over fluctuations and unconstrained reductions in risk based capital. In my view this is a safe and pragmatic approach especially given the credit crisis in the US.

Some of the key aspects of this proposal are:
- adding more risk buckets to the existing rules
- expanding the use of external ratings to a broader range of exposures
- expanding the recognition of credit risk mitigants, such as collateral and guarantees
- establishing a more risk-sensitive approach for residential mortgages based largely on loan-to-value measures
- increasing the capital requirements on certain off-balance sheet exposures, including liquidity lines to asset-backed commercial paper exposures
- requiring a capital charge for operational risk using the Basic Indicator Approach under the Basel II capital framework

The Basel II standardized albeit being a lot simpler and easier to adopt, still would prove to be a challenging initiative for smaller institutions. Some banks did underestimate and underinvest in the Basel II standardized approach projects in other countries ahead in the Basel II journey. This was due to overconfidence in their readiness and the ability to implement Basel II. Due to which some did face issues with the Basel II supervisory validation process.I do hope this learning carries over to the US market.

This FDIC proposal is open for comments and feedback from the industry for 90 days. Perhaps some of the leading Basel II experts from PRMIA community could submit feedback on a collective basis. I am happy to facilitate such an effort if there is enough interest.

The burden of regulation has lately been a hot topic in the US, specially on the stock exchange listings requirements and also led to the review of some of the SOX requirements. But at same time pressure builds up for better regulation of markets after the credit crisis and bail out of Bear Sterns. There was also Deptt. of Treasury led initiative to rationalize the supervisory system in the US comprising OCC, Fed Reserve, SEC, FDIC etc. Combined with the IFRS ratification, its perhaps conveys the urgency in the way US regulators are looking to streamline its financial sector vis-à-vis other leading economies, walking the thin line between competitiveness, market friendly policies and effective oversight.

Source: www.fdic.gov

Posted by spachava at 07:59 PM | Comments (1)

March 12, 2008

Basel II 1st Jan 2008 accreditation milestone

It's time to appreciate and salute the tireless efforts of the folks driving the Basel II initiatives for the last couple of years around the world.

For many countries, 1st Jan 2008 accreditation being a big milestone for Basel II project sponsors and executives who i am sure have spent many sleepless nights during last 2-3 years on the Basel II accreditation and model validation initiatives.

Reviewing the current state of Basel II initiatives in 2008, provides some interesting insights on the journey of Basel II early adopters. The Basel II was expected to first be implemented as per the 2008 timelines in the 13 financially important countries represented on the Basel Committee on Banking Supervision (BCBS). They include Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, the UK and US. And majority of the Tier 1 financial institutions in the above economies achieved their host country Basel II accreditation on 1st Jan 2008.

There were another category of early adopters such as Australia, Singapore, South Korea & Hong Kong, driven to enhance their reputation as major financial centers even further. The above is by no means an exhaustive list and we can safely expect every developed country’s top financial institutions operating globally to have achieved Basel II accreditation in some form or the other.

Summarizing some of the key points based on recently published reports/updates in some of the countries.

Australia - Australia went live with Basel II accreditation from 1 Jan 2008 – a significant accomplishment for this medium sized economy with financial markets sophistication matching that of leading financial centres. The Australian Basel II effort was characterized by regular guidance and interaction with the industry via discussions and consultative papers. The Australian Prudential Regulation Authority (APRA) granted Basel II accreditation to a number of banks, including Commonwealth Bank of Australia Ltd (CBA), Australia & New Zealand Banking Group Ltd (ANZ) and Westpac Banking Corp Ltd effective 1st January 2008. CBA, ANZ and Westpac were granted advanced accreditation, allowing them to adopt the internal-ratings-based approach to credit risk and the advanced measurement approach to operational risk. Australia's largest investment bank, Macquarie Bank, has also gained Basel II accreditation at the foundation level. Some of the outstanding issues to be addressed in Australian market over the next year or so being:

o Prudential Capital Ratio (PCR) to be determined based on 2 key inputs – one from the supervisors assessment and the other from the bank’s own internal capital adequacy assessment.

o Deferring of banks own counterpary credit risk estimates to be included in the IRB.

o Future review of 20 per cent risk weight currently assigned to margin lending exposures Also review of internal models for interest rate risk in the banking book

United Kingdom - Following the Basel II in EU as introduced via the Capital Requirements Directive (CRD). Some of the financial institution in UK accredited for Basel II are Alliance & Leicester(IRB), Nationwide, HSBC (IRB approach), Standard Chartered Bank (IRB approach). Most UK banks chose to adopt the standardized approach as on 1st Jan 2008. Out of the 350 banking subsidiaries (not including building societies and securities firms), about 25-30 adopted IRB approach.

As per, the Financial Services Authority (FSA), the capital requirements at IRB approach institutions will change from their current levels over a two-year period, to avoid an overnight step-change in the industry’s total capital. Some of the insights being: Review the potential failings in existing regulatory capital regime. Appropriate use of Ratings being one such area. The use of ratings is a central feature of Basel II and the problems in ratings revealed by recent events is an issue that is coming to fore.

Review of the liquidity mechanisms towards a uniform and internationally agreed policy on liquidity. Given the urgency of dealing better with liquidity issues. local supervisors may initiate measures quicker than wait for an international consensus.

USA - Basel II journey in US - Notice of Proposed Rulemaking (NPR) - There are vastly different local flavors of Basel II approach variations across the globe. As many developed economies approach the final Basel II implementation milestones in their respective jurisdictions, the US banks Basel II & Basel IA initiatives have entered final stages of comment, review and adoption. A key consultation being around the Basel II NPR guidance with the formula for LGD computation. This papr understand the complexities involved as it serves as a quick summary for others wanting to know where US Basel II is headed.

The US Basel II 2009 roadmap proposes the advanced approaches for computing risk-based regulatory capital for the largest US banks numbering around 10-20, and permits the smaller and mid size domestic banks numbering around 9000 to continue to conform to flavour of Basel I. The top 10" group of core banks are mandated to operate the advanced approaches for credit and operational risk in 2009. Of course most global institutions operating in US with home Basel II accreditation also plan to conform to the Basel II. The Basel II NPR proposal includes a formula to relate LGD and the expected LGD (ELGD), in the Basel II Supervisory review of Capital Adequacy in Pillar II. Some believe that this is overly conservative limiting the capital reduction benefit for the US banks.

Learnings post Basel II accreditation : Taking some key data points from some of these Basel II initiatives so far.
Summarizing the key global observations from countries and financial institutions that have achieved Basel II accreditation in 2008:

• Most Tier 1 financial institutions have either adopted or on a roadmap to adopt Advanced approaches.

• Capital Adequacy around Basel II is not panacea solution for managing bank’s risk and capital. Banks do still need to continuously monitor and enhance their agility to react o market conditions, specially on the liquidity management aspects.

• Basel II impact on industry - Improved Risk management practices across industry with increased overall rigor and oversight on the process, workflows, models and methodology driven by the advanced Basel II approaches. Also forced banks to integrate their systems and processes better.

• Financial Institutions underestimated the amount and extent of work for accreditation from the supervisor.

• Even for those countries where Basel II accreditation is complete, the Basel II journey continues on. Banks still need to spend significant effort to make supervisors comfortable on the robustness of the quantitative estimates of risk that form the foundation for their regulatory capital calculation. In the interim, supervisors such as APRA are providing guidance in terms of sufficient regulatory capital.

• Banks also do not expect any material change in its capital management approach until the full implications of the new arrangements are finalized with the regulatory authorities. Most supervisors have introduced /looking to introduce “thresholds” or “floors” to ensure that capital requirements do fall too quickly from Basel I levels in the early years post implementation. Therefore, generally financial institutions will see a gradual rather than a dramatic reduction in minimum capital requirements post Basel II. E.g. APRA has placed a cap of 10 percent in 2008 on any reduction in capital from the Basel II changes & the cap will be retained into 2009 pending a review of the Basel II experience. (Source: APRA Basel II update, Feb 2008),

Banks already with accreditation do agree that it enhances risk measurement and management techniques and will significantly increase flexibility in decision-making and capital management.

References & Sources: Basel II NPR & Proposed Supervisory Guidance documents from US Agencies:Board (Fed Reserve System), OCC, FDIC, OTS, Treasury, APRA publication, Feb 2008, Basel II update- Katrina Squares, Thomson News Report.

Posted by spachava at 08:20 AM | Comments (2)

July 16, 2007

Pillar 3 Disclosure - Prudential Std APS 330 Consultation paper from APRA

As the Basel II saga continues, in some developed countries the implementation is slowly inching past the Pillar 2 Supervisory review & model validation phase towards the Pillar 3 disclosures. In Australia, APRA has released APS 330 - a draft prudential standard for Market disclosure.

Summary: Last month in June, APRA released the market draft prudential standard APS 330 Capital Adequacy: Market Disclosure (APS 330). This sets min. prudential disclosure requirements for locally incorporated ADI’s (Authorized Deposit taking Institutions) and a limited set of (quantitative only) disclosures for foreign owned subsidiaries.

During my Risk modeling days, I was lucky to have the opportunity to interact closely with the Supervision deptt. of a few Central banks that were refining their Risk Assessment and Outlier methodology in preparation for Basel II.

Since then, I have always been a keen follower of the consultation papers released regularly by Supervisors. I find the papers and the the industry responses, very insightful & useful to feel the local pulse, benchmark the Basel II progress & understand the local industry concerns. APS 330 is one such recent paper from the proactive APRA (Australian Prudential Regulation Authority) on Pillar 3.

In summary, the APS 330 std proposes that all ADI's make at least some basic level of disclosure of their capital adequacy and mandates Pillar 3 disclosure for all locally incorporated ADI's in Australia, with minimum requirements.For a locally incorporated and owned ADI’s that have adopted advanced Basel II approaches, the requirements involve full and detailed disclosure broadly consistent with the Pillar 3. For all other ADIs, including foreign-owned subsidiaries, a limited set of (quantitative only) disclosure requirements relating to capital structure, capital adequacy and credit risk exposure is proposed.

The proposed guidance strives for a balance between a pragmatic approach to the Pillar 3 disclosure requirements with due consideration to the market disclosure needs as well as to minimise the reporting burden on the smaller ADIs.

The APS 330 proposal for Prudential disclosure also includes the following specifics on the how to:
- Specific order/layout of disclosures to allow comparison across institutions
- Websites as one of the readily accessible medium/location of the disclosures
- In specific instances, provision for an ADI not to disclosure proprietary and confidential information

I also wonder if the Market Disclosure needs will also eventually trigger the industry adoption of 2 items from my list of 10 items in my blog on Risk mgmt frontier.

1.Standardization of commonly used Risk reporting termswhat I refer to as Risk Mgmt taxonomy.

2.Risk Visualization - Adoption of reports that are visually easy to read and interpret.
The other recent Basel II papers being:(my next blogs)
- APRA revised Basel II advanced approaches, June 13
- APRA revised Basel II securitisation standard July 11

Source: APRA APS 330 Capital Adequacy: Market Disclosure, June 2007
http://www.apra.gov.au/Media-Releases/2007-Media-Releases-Home.cfm

Posted by spachava at 12:47 PM | Comments (0)

July 04, 2007

Basel II journey in US - Notice of Proposed Rulemaking (NPR)

As a keen follower of the Basel II initiatives around the world, it is fascinating to study the local flavors of Basel II approach variations. As many developed economies approach the final Basel II implementation milestones in their respective jurisdictions, the US banks Basel II & Basel IA initiatives are entering final stages of comment and review.

A key consultation being around the Basel II NPR guidance with the formula for LGD computation. My recent relocation to the West Coast, reignited the curiosity about the USA Basel II journey. This blog entry serves as much as a summary note to myself to understand the complexities involved as it serves as a quick summary for others wanting to know where US Basel II is headed.

The US Basel II roadmap proposes the advanced approaches for computing risk-based regulatory capital for the largest US banks numbering around 20, and permits the smaller and mid size domestic banks numbering around 9000 to continue to conform to flavour of Basel I. The Basel II NPR proposal includes a formula to relate LGD and the expected LGD (ELGD), in the Basel II Supervisory review of Capital Adequacy in Pillar II. Some believe that this is overly conservative limiting the capital reduction benefit for the US banks.
Some of the specific concerns on NPR being:

- Poposed safegaurds in NPR that go beyond the BIS Basel II text,including the effect on risk sensitivity that may result from the proposed limit on declines in aggregate capital
- Proposed definition of default and treatment of downturn LGDs
- Retention of the existing leverage ratio

Also in 2006 a group of large US banks jointly requested the US regulators to allow “alternative appropriate methodologies” including standardized approach for Credit Risk and operational risk, as a possible fallback plan.

Early this year in February, the US regulatory Agencies collectively released three interagency supervisory guidance proposals as companion guides to NPR detailing how the Agencies intend to implement the Basel II NPR and sets their expectations for the credit risk and operational risk approaches under the proposed Basel II framework. These 3 proposed guidance were focused on: IRB-A for Credit Risk, AMA for Op risk and the new Pillar II Internal Capital adequacy assessment process (ICAAP). ICAAP should identify and measure material risks, set capital goals related to risks, and provide governane and controls to ensure that internal capital assessments are subject to proper oversight.

The May 29 deadline for the comments on these guidance documents has gone past and the Congress appointed Govt. Accountability Office(GAO) has also given the “Go ahead but with extreme caution” signal for planning the Basel II transition.

Albeit the final journey is yet to start, these developments set the stage for the US Basel II guidance and transition to enter the critical final phase.

Sources: Basel II NPR & Proposed Supervisory Guidance documents from US Agencies:Board (Fed Reserve System), OCC, FDIC, OTS, Treasury.

Posted by spachava at 07:20 AM | Comments (1)