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
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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
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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
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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
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