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 (2)

March 12, 2010

Future of Stress Testing - UK FSA and EU CEBS lead the way !

Earlier I had blogged about the pendulum shifting away from the light touch supervision mode to a much more prescriptive regulatory environment.

The new stress testing guidelines in Europe seem to be good indication of the trend. With most stress testing models failing to reflect the current crisis, many regulators are reviewing the stress testing guidelines and methodology. Typically in most markets, the stress testing is performed at 3 levels;

1.Institution level
2.Regulator stress testing of an institution
3.Industry wide Systemic level stress testing

Most of the changes focus on the first level of stress testing within institutions, but there is certainly thinking on other 2 aspects as well.

Purely going by the headlines, the Risk Managers in Europe must be quite stressed by the ongoing consultations around stress testing regulatory mandates. Let us look at CEBS & FSA in this blog;

CEBS Stress Testing guidance:

The new stress testing guidelines need to be carried out at portfolio, business and firm-wide levels, with specific focus on senior management and board-level engagement. They have to make sure the testing is sufficiently severe and in tune with overall strategy.

A key question to evaluate for the industry is whether it is realistic to expect the boards to have the expertise to oversee, challenge and approve stress tests, given the "quantitative “ aspects.

The guidance, to be used under Pillar 2 of the Capital Requirements Directive within the Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process, does potentially create duplication with the requirements proposed by national supervisors, and those within Pillar I. a good example being liquidity risk.

Another key concern is the recommended June 30th implementation deadline for complying to the more regulated stress testing methodology. Is too much prescriptive guidance good or bad? I do not know the answer. Does it start to negate the principle that every institution is best managed with their respective Risk models fine tuned to their business model ? We will have to watch and see, what the industry responses are to the consultations be end March.

FSA Reverse Stress Testing guidance:

For the first time, banks will need to implement reverse stress testing methodology that will help identify and assess the conditions and scenarios that will most likely impact its business viability and lead to its collapse.

So the banks will have to trace back from the worst case scenario possible to zero down on factors that led to the expected point of collapse. As a result banks are expected to be able to identify the highest risk factors and exposures of their current business models.

The FSA stress testing guidance is also revised to make it much more integral part of risk management accountability at sr. levels. And banks are expected to build/enhance a robust stress testing and scenario analysis infrastructure to assess capital needs in a crisis environment.

So Risk Managers, get busy refreshing your 101 training material for stress testing courses for your Board.

Posted by spachava at 06:26 AM | Comments (0)

January 08, 2010

Risk 2010 - Trends to keep in view

Happy 2010 to readers. Many in Risk Mgmt profession welcome 2010 with a sigh of relief, considering the financial markets turmoil and the resulting broader economic impact in 2009. So what can we in the Risk Mgmt profession look forward to in 2010?

As a passionate follower and student of global Risk mgmt practices, I see the following trends based on hands-on projects as well as close observation of how different firms are approaching risk mgmt posrt 2008-2009;

1. Risk Mgmt has become much more people centric. The dependence on quant models will obviously continue but no more blind faith in black box models, without knowing its internals.

2. Focus on organization wide employee buy-in for Risk mgmt practices at all levels i.e. Risk is really everybody's job.

3. Cross company collaboration as a key pillar of how companies manage enterprise wide Risk

4. Percentage of firms taking a more strategic and longer term view of Risk Mgmt practices will rise.

5. Emergence of more IT savy self serve Risk Mgmt power users who will be grow even more adept at sourcing and conducting their own analytics rather than rely on IT deptt. to spoon feed.

6. Liquidity risk and Asset Liability Mgmt back in focus

7. Risk computing via cloud becomes real

8. Closer link between pricing and clearing in Credit derivatives and move towards use of clearing houses for CDS & OTCs.

9. More regulators/supervisors will shift to the heavy handed approach to Risk exposures vis-a-vis the light touch.

10. Goldman Sachs Risk professionals will be in even more high demand!

Posted by spachava at 04:52 PM | Comments (2)

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 (3)

July 14, 2009

Risk Career Series - 7 Traits & Habits for a Risk Management Career - Part 1

I am starting this blog series in response to many requests for career advice and guidance that we all keep getting from time to time from young bright aspirants! Also when i started my blog i listed the below 10 Risk mgmt frontiers ideas, so next few blogs are going to be adressing the ideas not addressed so far.

1. Risk Visualization
2. Next Generation Risk & Compliance Architectures
3. Risk Pricing Clusters
4. Risk & Compliance Taxonomy
5. Pan Regional Risk Data Grids
6. Digital Assets Mgmt
7. Cross Industry Risk mgmt practices
8. Incubating Centers of Risk Mgmt Excellence & practices
9. Risk Management Career Options
10. Embedding Risk Mgmt & Compliance in an organisational DNA

My thanks and sincere apologies to all of you who took time to write to me. To some I have responded already and I really wish I could respond to all of you individually on your interest to work in the Risk Mgmt area, but a more efficient way to respond would be via this PRMIA blog.

Let me start by saying to all the young & old, inquisitive, brilliant minds out there, we need more of you in this dynamic and exciting profession. So please do keep flocking to the Risk profession.

This is not a one off blog. I will keep posting regularly on this topic regularly. I also hope that this blog topic will evolve into a Risk Mgmt Career thread with lot of questions, and inputs from the more seasoned Risk mgmt gurus and experts from the industry, so we all get a much wider perspective on entry in the Risk mgmt profession. Perhaps we can evolve into an annual PRMIA Global Risk Mgmt Career webcast.

Being involved in the selection process of the PRM candidate of the year for the last 2 years and looking at the caliber of candidates, it seems a logical extension of developing the Risk mgmt profession.

Note: Certainly do not consider my thoughts as absolute truth as they are colored by my limited personal experiences. Do take them with a pinch of salt and beware of the extra mix of continental and asian spices thrown in.

Having been fortunate enough to have lived and worked in 6 countries so far and delivered Risk projects in more than 10 countries, I see that young aspirants to Risk Mgmt industry have the same issues and questions world over. Let me try to answer some of them from a financial services industry perspective first. And will color them with examples from other industry sectors that I know of;

Q1: What does it take to be in Risk Management field ?

Response: There are 7 traits and habits that I see that consistently define a Risk Mgmt professional. This may be embodied in many other similar profession but I find these specially enhanced in top notch Risk professionals. These is just a listing of a few characteristics. It’s brilliant to have all these qualities, but one does need to have a combination of at least 4-5 skills.

1. Intellectual curiousity & Rigor of thought - Risk Management is about being intellectually curious (or being a busy body as they say in South East Asia) about what, where, when, how and who.
2. Constant and Dynamic Changes - Be able to deal with a dynamically changing environment that one works in
3. Good grounding in at least two or more disciplines - Math, Finance, Stats, Financial Engineering, Quant Finance, IT
4. Constantly Learning- If one does not believe in continuous learning, this area is not for him/her as one will find it hard to keep up with the pace of change
5. Detail oriented - At more junior level, have interest to drill down into details when required. Risk management is about details; As one goes sr. the details evolve into bigger picture but still need to detailed oriented many times.
6. Tech savy - Be it Microsoft Excel, Visual C++, Visual Basic, Microsoft ACCESS, and be able to learn different Risk applications and technology.
7. Being able to break down complex concepts into simple terms, communicate and explain clearly

Having listed the above, I must also highlight the fact that Risk Mgmt being a very vast discipline, the above skills are by no means exhaustive.

Let me stop here and continue on in my next blog. Pls. do write in your comments, questions directly on this blog, instead of individual emails. Happy Risk mgmt job hunting.

Posted by spachava at 08:33 PM | Comments (2)

June 18, 2009

7 pillars of US Financial Regulatory reform & the European Systemic Risk Council - The new blueprint

Risk & Compliance Managers, Private Equity(PE) firms, Hedge Funds, Credits firms and Consumers, in the USA and global financial markets are going to remember this week for a long time to come due to the epic changes in the financial regulation and supervision. I had blogged earlier about move to regulation from the light touch supervision. The latest US proposal on financial regulatory reform does skew towards tighter regulation.

In the EU summit starting today, a tighter financial market regulation is being discussed with 2 extra mandates for EBC - a European Systemic Risk Council and a body to set standards for closer supervision of banks, insurers and other firms. The European Systemic Risk Council, is proposed to be chaired by the European Central Bank president but will include central banks and the EU Commission representation to look at broader interlinked systemic risk issues.

The proposal is still evolving and subject to congress approval, but a quick summary of the 7 key areas and the possible impact on Regulatory Risk Management and compliance functions:

1. Consumer Protection Regulator - The UK FSA took a lead with having TCF (Treating Customer Fairly) approach but US has gone one step ahead with this new proposed agency with oversight over mortgages, credit cards, savings accounts and annuities.
Impact: World of retail financial services would have new tighter regulatory requirements.

2.Executive Pay:Investors to have a greater say in executive pay
Impact: Link of executive pay to risk management

3. Private Equity and Hedge Funds Regulation: Under Federal regulation.
Impact: Demand for Risk Management & Regulatory compliance professionals in Hedge Funds and PE firms.

4. Mortgages & Asset backed securities: Firms need to hold a portion of the loans they package and sell. E.g. 5% for ABS firms. This contrasts with the 20% proposal in EU.

Impact: Huge change in business models of many firms that are essentially in mortgage origination business to move to portfolio risk management business. ALso big impact for the underwriters of asset backed securities as they need to retain a 5% stake to improve asset quality.

5. OTC Derivatives business model: All standardized contracts derivatives contracts to be traded on regulated and transparent venues such as exchanges or electronic marketplaces and cleared centrally to reduce risk.

Impact: Deeper integration of Derivatives business with exchanges;
Greater emphasis on Risk management at exchanges; Emergence of Clearing houses as a critical Risk management institution.

6. Insurance Supervision - Possible Single Federal Regulator instead of a distributed regional state regulators networks.
Impact: Streamlined and efficient regulatory reporting

7. Financial Services Oversight Council - A consolidated group comprising all regulators to oversee systemic risk.
Impact: Less confusion on who does what

There is much more to share about the European proposal but that is a blog by itself. so watch out for next blog.

Exciting times ahead for all of us, as i do believe a lot of risk management, and regulatory compliance roles should open up in all these bodies. Happy hunting !

Posted by spachava at 03:14 PM | Comments (3)

June 10, 2009

How does one manage Risk in Bad banks ?

Recently we keep hearing new terms such as good bank, bad bank , toxic assets. Interesting times, as a bank and financial institution to me always denoted rock solid trustworthy entity.With many countries exploring bad banks concept in one way or the other, I wonder on the role that risk managers play in bad banks. Is it any different than the traditional role ?

There was talk about creating a bad bank in the US as well that seems to have gone quiet now, given that TARP money is being given back by some firms. Last week a German draft legislation was introduced that allows the country’s state run banks, Landesbanks to move illiquid assets into bad banks. This sounds slightly familiar - I remember 2 govt. entities in Malaysia - Danamodal and Danharta that were created with asset restructuring charter to take on the troubled assets of the country’s financial firms battered by the 1997 Asian currency crisis. In my humble opinion, these 2 institutions actually did quite well in terms of stabilizing the financial system.

Given the scale and enormity of the systemic risk today, the questions that comes to a simple mind like me are - what do Risk managers in these bad banks do ? Is their approach and function any different from a good bank ? Are they starting from a different baseline and different benchmark ? What kind of MTM, pricing and valuation curve would they use ? Would there be a different counterparty risk criteria? Also would risk managment be more short term view as in terms of an interim caretaker or a liquidator mode? Questions, Questions and more questions. Still seeking answers but does make me think that the future Risk courses need to include some learnings on managing risk in bad banks,if that terms continues to survive post crisis.

Posted by spachava at 06:39 PM | Comments (0)

June 03, 2009

SEC tweets on twitter too - Digital Assets Risk Managment- Has its time come?

Digital Assets Risk Mgmt as a key management priority? US President's 10-point Cybersecurity Action plan

Blogs, Wikis, Twitter, Facebook, Linkedin, Secondlife - all start to become key component of the millenial generations activities at workplace and lifestyle. Its but natural that even regulatory bodies such as SEC and stock exchanges start to embrace twitter to boost their transparency and and outreach to the net savy investors.

In a development that will have a wide reaching impact across the world, US president Obama last week released his 10-point plan to secure and protect digital infrastructure. I see this as a part of a broader recognition of the need for Risk mitigation practices in the increasingly digital world with almost 1.5 billion people being online or logging in. This plan calls for an enhanced coordination between public and private sector.

To me this explicit recognition of the information and underlying digital infrastructure as strategic assets, could be a quantum leap forward in accelerating the slow paradigm shift of how digital information risk is perceived and managed today at senior executive levels. I believe many other countries and industry sectors will follow suit.

Many questions come to the mind. Just as this plan calls for an updated national strategy to secure the information and communication infrastructure, will many corporates follow suit in terms of Designating digital assets risk management as a key management priority; awareness around digital assets; global digital assets management policy framework etc ?

Does this mean that companies will start to have a specific Digital Assets Risk Management plan, that includes Reputation Risk management, Online Assets compliance and a digital identity plan that combines the customer secuirity and privacy aspects of customers in the new online business model ?

What do you think ?

Posted by spachava at 10:24 PM | Comments (0)

May 19, 2009

Should IT be the second line of defense for Operational Risk function?

As companies gear up to handle the ever increasing risk management and regulatory enviroment, a key aspect in recent times has been emergence of the Operational Risk and the role of IT in the implementation of the op risk initiatives.

With operational Risk broadly defined as risk of losses arising from faliure of systems, processes and people, I often wonder if this is an area that CIO office has a much bigger and strategic role to play especially in organisations whose business model derives its competitive advantage from IT.

Although i guess the CIO office hardly has any bandwidth to pick up this key area. but I see this as a naturall convergence in future given the role of IT in Risk and compliance execution and effective implementation.

In various discussions I have had with leading companies, many proactive CIO's and their directs seem to have a much better handle on the operational risk aspects, actually even better than the business lines themselves. This could be as CIO really has to step back and take a big picture view of the business and priorities. As the focus in Operational risk discipline is really towards making the front line operational staff in the business the first line of defense, IT processes start to become key.

I always made the distinction between IT compliance and business complince but i am beginning to come around to the concept that perhaps the second or 3rd line of defense should be the IT deptt. as well. Which means that IT starts to become a strategic partner in managing operational risk along with the traditional technology risk they have always managed. I will share more on this going forward but welcome any thoughts around this.

Posted by spachava at 04:53 PM | Comments (2)

April 08, 2009

Liquidity Management - The future blueprint

With Liquidity management emerging as a key area of focus in the financial sector crisis, this article summarizes some of the key trends as to where the liquidity management practices are headed.
It summarizes regulatory and industry thinking i.e. BIS, CEBS and UK's FSA around liquidity management both pre and post systemic risk context.UK is probably going to be the first country off the block to implement significant changes to the new liquidty requirements with their aggressive timelines of Oct 2009.

I believe these will be epic changes in the one of the key pillars of risk management.

Let us look at the summary of the broad thinking on liquidity management based on different papers available.

I. Latest is the Dec 2008 UK FSA consultative paper on liquidity. The industry feedback closed early this month 9th March 2009 and we should see the response soon.

This was FSA quick response to drive a fundamental refresh of the liquidity management approach and requirements. The FSA’s consultative paper focus is to suggest measures that would take liquidity risk management to the next level, influencing future business models and improvements to its own ability to monitor and supervise industry wide liquidity management oversight.

Future blueprint of liquidity Management: Broadly the key tenets of the changes being proposed by FSA are:
• A new, quantitative framework for liquidity risk management which places greater emphasis on firms’ ability to assess liquidity risks and develop policies to tackle them
• a strengthened qualitative framework for liquidity risk management, with an increased focus on firms’ stress testing and contingency funding plans;
• new liquidity reporting requirements;
• a new approach to firms operating in the UK which are part of a wider UK or international group
• Cost benefit analysis (CBA) that clearly articulates the long-term impact of a strong liquidity framework
• Combination of an individual liquidity adequacy assessment (ILAA) and a supervisory liquidity review process (SLRP) conducted by FSA
• Most importantly also calls out that this would have impact on the business models going forward, so its not business as usual

Going into more specifics, some of the key pillars around this new requirements are:

A. Adequate liquidity and self sufficiency – 2 high-level principles. 1. All FSA-regulated entities must have adequate liquidity 2. No dependence on other divisions of their group to survive liquidity stresses, unless permitted to do so by the FSA.

B. Systems and controls framework- A new systems and controls framework based on the recent work of the Basel Committee on Banking Supervision (BCBS) and the Committee of European Banking Supervisors (CEBS).

C. Individual Liquidity Adequacy Standards (ILAS) – A new domestic quantitative framework for liquidity management for many of the firms that we supervise. This framework is based on firms being able to survive liquidity stresses of varying magnitude and duration.

D. Group-wide and crossborder management of liquidity - New framework for allowing firms, through waivers and modifications, to deviate from self sufficiency where this is appropriate and would not result in undue risk to consumers and other stakeholders whom the rules in question are intended to protect.

E. Reporting - A new reporting framework for liquidity, which will enable us to collect granular, standardised liquidity data at an appropriate frequency so that we can form firm-specific, sector- and market-wide views on liquidity risk exposures.

Some of the reporting frequency being suggsted:
- Enhanced Mismatch Report, incl. daily flows out to three months - Weekly, with the ability to report daily
(switches to daily in crisis times or if firm deviates from ILG)

- Pricing Data Daily pricing, Submitted weekly
- Marketable Assets Report Monthly
- Funding Concentration Report Monthly
- Retail Funding Report Quarterly
- Off-Balance Sheet Report Monthly

- Clearing & Settlement Banks Only - Intra-day Liquidity Report Daily

- Systems and Controls Questionnaire Quarterly

Expected Impact:
- Enhanced liquidity risk management capabilities, including greater use of stress testing and improvements to contingency funding plans (CFPs);
- less reliance on short-term wholesale funding, including on wholesale funding from foreign counterparties
- greater incentives for firms to attract a higher proportion of retail time deposits
- a higher amount and quality of stocks of liquid assets, including a greater proportion of those assets held in the form of government debt; and
- a check on unsustainable expansion of bank lending during favourable economic times

Interestingly the paper also calls out some of FSA own internal improvements initiatives listed below. So there is inherent recognition of need to step up its own expertise, skills and in terms of committing to set the bar higher for itself as well as the industry. I know of some regulators and supervisors that are ahead of the game and actively seek and acquire top class talent, but it would be good to see more countries take the pro-active approach.

1.Upgrade systems, embed new procedures into existing supervisory processes and help their staff deliver the high expectations that we require of firms

2. Upgrade of internal systems so FSA is capable of delivering and managing its proposed new reporting framework. Includes advanced business intelligence BI) capabilities, automated analysis and early warning indicators. FSA’s ARROW6 technology infrastructure is also being upgraded to allow for liquidity risk assessments and returns data to feed directly into FSA’s risk architecture, allowing for
aggregated liquidity risk monitoring.

3. Investing in further specialist liquidity resource, including retaining and developing liquidity risk experts.

4.Investing to help ensure that all its supervisors are competent in
liquidity issues. Every supervisor will receive training on liquidity, its liquidity policy and its internal policies and procedures for ensuring the implementation and maintenance of high liquidity standards at firms.

5. Regular self assesment of competence in liquidity area regularly

II. Early 2007 & Sept 2008 - Committee of European Banking Supervisors CEBS): Key principles:
• an agreed framework for host supervisors delegating liquidity supervision of branches of EEA credit institutions to the European consolidated supervisor;
• exploratory work on internal models and methodologies for liquidity risk management;
• supervisory guidance on the use of transfer pricing mechanisms
• development of common reporting for liquidity throughout the EEA (European Economic area)

III. Sept 2008 - Basel Committee of Banking Supervision issued its guideline on Principles for sound liquidity management:• consistent global implementation of the recently agreed Principles for Sound Liquidity Risk Management and Supervision
• agreed global standards for supervisors on the appropriateness of cross-border management of liquidity
• developing cross-border resilience benchmarking exercises on internationally active groups
• further moves torward consistency on the definition of liquid asset buffers
• exploratory work on internal models and methodologies for liquidity risk management
• further work to understand and mitigate intra-day liquidity risks run by firms.

Sources:
http://www.fsa.gov.uk/pubs/cp/cp08_22.pdf
www.bis.org/publ/bcbs138.pdf
www.c-ebs.org/formupload/f8/f8c4ac3d-ca0a-4e86-8aae-d5c6f97f6192.pdf

Posted by spachava at 11:11 PM | Comments (3)

January 17, 2009

GRM- Global Risk Mgmt and Governments Risk Mgmt with a $5 trillion plus kitty

Wishing everyone a happy and safe new year!

2008 was a humbling and disruptive year for the Financial sector, specially the bulge bracket Investment Banks as well as Risk Management profession on the whole. Many epitaphs will be written for legendary institutions that disappeared overnight and will be spoken about for decades to come in terms of the crunching global impact and the associated learnings. About $650bn of sub-prime bonds outstanding in March 2008, about 75% of them being rated triple A at issuance, and banks raised around $600 billion in 2008 worldwide to survive. This blog sets the context to a global development with wider and long term implications for the Risk Management role and function of the Governments and Sovereign Wealth funds.

GRM - Global Risk Management or Governments Risk Management
With FDIC chair floating the Aggregator bank idea this morning, there is a fascinating convergence of free markets and role of Governments as Risk Managers of last resort. There is an ongoing global risk management effort that although coordinated in some parts (e.g. G7, EU) and disparate in other parts of the world, does show signs of an orchestrated and coordinated effort. The different measures listed below really being the tactical components of a broader and longer term Governments Risk Management effort to rescue firms and economies -
1.Unprecedented direct intervention by Govt. bodies and regulators like FDIC in overnight in takeover/shotgun sales of financial institutions
2.Unprecedented but time bound Governments pledge to guarantee all loans and deposits
3.Bailouts plans such as US TARP
4.Stimulus packages
5.Benchmark rates cut
6.Assumption of toxic securities
7.Equity stake and nationalization in extreme cases
8.Interbank and debt guarantees
9.Recapitalization
10.Asset Restructuring body/Aggregator bank

Today, it is very rare to hear debates on the role of direct government intervention even in the strongest bastions of free market economies. In the past it had been very subtle support and interventions by Sovereign Wealth funds (SWF), but never of the current scale.

Below is a summary of the global risk management efforts of governments of some of the major developed and emerging economies around the world.

USA - $ 850bn (6% of GDP) - $ 700bn TARP; $300bn guarantees, FedReserve rate cut to 1%, $1.3 trillion bank lending, $150bn stimulus package, ($ 500bn planned by new govt)

China - $586bn (16% of GDP) – 2 yr stimulus comprising rural infrastructure, social services, railroads, airports, health, education, housing & more

UK - $ 450bn (21% of GDP) - $311bn to exchange illiquid securities for govt. debt, $116bn to recapitalize, $389bn guaranteed new bank debt, $23bn tax breaks

Russia -$ 209bn (12% of GDP) - $ $50bn credit line for Corp debt refinance, $88bn bank loans,$19bn stock market support

Germany -$ 151b( 7% of GDP) - $101bn in new capital, $25bn bad loans cover, $504bn interbank guarantees,$25bn tax breaks

South Korea - $ 80bn (9% of GDP) - $25bn stimulus, $55bn forex loans for exporters, $100bn guarantees for banks forex liquidity

Japan - $ 68bn (1%of GDP) -2 stimulus packages incl. tax cuts, tax breaks, credit guarantees,$322bn loan guarantees for small & midsize businesses

France - $ 50bn (2% of GDP) - $13bn to recapitalize($37bn more pledged), $403bn interbank guarantees

India -$ 41b(5% of GDP) - $ $4bn loans to mutual funds, $37bn in bank loans due to reserves rate cuts

Summary: The GRM program around the world is committing to around $5 trillion plus with amounts committed being anywhere from 1% of GDP to a high of 21% of GDP in UK. Many countries GRM initiative includes nationalizing failed financial institutions as well. So the GRM is a facet of Risk Management that will remain in forefront for years to come and CRO’s

Takeaways –

1.An additional dimension for CRO to deal with, if their institution is subject to GRM activities

2.Lessons learnt from GRM will feed into a heavier touch for Regulators in industry Risk mgmt

3.The lessons learnt by governments around the world in rescuing” Too big to fail” firms will have an impact on the future viability and ambitions of the “financial supermarts” around the world.

4.This GRM effort will have far reaching impact on the Risk Management role of governments and implicitly the role of Risk Management in society.

Sources: Dow Jones Financial News, Issue 635,A year in numbers; Business Week Dec 1 2008(Peter Coy, Enough Shock treatment)

Posted by spachava at 05:26 PM | 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)

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)

December 25, 2007

New frontiers in the Insurance supervision world

Wishing everyone merry Christmas, happy holidays and a very happy new year too !

Whilst reading up on the convergence of supervision practices for financial conglomerates operating across Banking, Capital Markets and Insurance, I came across some interesting developments in the Insurance supervision world led by International Association of Insurance Supervisors (IAIS). There is a BIS Joint Forum comprising IAIS, Basel II, IOSCO to deal with issues common to the banking, securities and insurance sectors, including the regulation of financial conglomerates.

Supervisors undoubtedly being key influencers of Risk mgmt practices globally. This article focuses on the developments in the supervision world and its impact on Risk mgmt in the Insurance industry.

Background: Established in 1994, the IAIS represents insurance supervisors from 190 jurisdictions in nearly 140 countries constituting 97% of the world's insurance premiums. The IAIS issues global insurance principles, standards and guidance papers, provides training and support on issues related to insurance supervision, and organizes meetings and seminars for insurance supervisors.
Website: http://www.iaisweb.org/

A global climate for change: The Future of Insurance Regulation - IAIS forum, 2007
In Oct 2007, the 14th annual IAIS forum was held in in Florida with the above theme. It was attended by over 600 senior level Insurance regulators (e.g. FFSA, FSA, NAIC, OSFI, CIRC, IRDA) and Insurance executives globally. I am sure some of our own PRMIA C-suite members would have attended too.

Insurance being one of the fastest growing sectors specially in the BRIC economies. Insurance supervisors face the challenge of improving supervisory expertise to cope with pace of emerging regulatory initiatives and the increasing complexity of risk assessment.

One of the key challenges identified being the need for a paradigm shift both within regulatory authorities and insurance entities to cope with the rapidly evolving financial landscape, including the move towards principles-based requirements and in the area of cross-border mutual recognition of supervisory regimes.

Some interesting top line discussion points at IAIS forum being:
(Source: Summarized from IAIS newsletter)

Regulatory challenges - striking the right balance and the need to change mindsets
The need for insurance regulators to strike the right balance from a number of perspectives, including: differing interests of key stakeholders; potentially conflicting regulatory objectives; and rules-based versus principles-based supervision.

Convergence in supervisory regimes to cope with globalization -
Insurance regulators need to enhance cross-border supervisory efforts as insurance markets and operations become more inter-dependent and transcend geographical boundaries.

Supporting the development of emerging markets -
Establish international supervisory standards for the rapidly emerging Microinsurance sector. Microinsurance provides low income populations in emerging markets with access to insurance. The development of supervisory standards is expected to contribute to greater financial inclusion in developing economies.

The above becomes critical with the BRIC nations emerging as the growth engines for the Insurers. Many global players are already engaged or in advanced stages of entry plans into these markets. The local players are also readying themselves for the ensuing competition as well as strategic tie-ups. The scale of these markets may seem intimidating to those players that are accustomed to more sedate growth rates and market aggressiveness.

For e.g., the Indian insurance sector had a CAGR of 175% over the last few years. Both life and no-life sector in India alone are forecasted to grow by over 200% and private insurers by 140% in the coming 3-4 years. In most BRIC countries, largely state owned insurance firms are now losing market share to private insurers. With the private insurers aggressively offering higher rate of return to its policy holders against state owned firms, the nature of insurance business is dramatically changing and this poses a big challenge to the supervisors.

Whilst admittedly achieving global regulatory convergence and creating a common structure on insurer solvency still have a long way to go, my top 8 KIV (Keep in view) list for its Risk mgmt impact would be as follows:

1. Stress Testing: Focus on enhanced use of stress-testing to demonstrate value of cross border operations. Jurisdiction boundaries are an issue for the companies & regulators. So in addition to internal models, would use of stress testing be one way to for firms to reassure local regulators, that in face of a major catastrophe, which potentially could wipe out many balance sheets of insurers around the world, the required capital sitting in each country will not be enough and cross border operations would become critical for capital to be tapped.

2. Sophistication of Actuarial Models and Risk Analytics – Increased demand for more sophisticated computational actuarial and risk analytics-related computing capacity.

3. A global Minimum Capital Requirement (MCR)- Is this possible & more importantly result in equitable treatment for all players in the market?

4. Solvency based Supervision to Principle based supervision -
The debate around solvency-based supervision being not nimble enough to keep pace vis-à-vis the contrarian view that the principle-based supervision may involve more financial investment to comply with, which could impact smaller firms. But largely, most supervisors are slowly but surely moving towards a principle-based supervision.

5. Mutual Recognition Agreements (MRA) for global firms to avoid duplication - To avoid duplication of regulations, effective use of mutual recognition agreements (MRA) as a possible way to streamline regulation.

6. Business Records Retention compliance: Insurance being a documentation-intensive industry, increased regulatory focus on retention and retrieval of business records, for legal discovery process as a key internal control and operational risk requirement.

7. Reinsurance being an important risk mitigation tool for insurers, improvements in supervisory
approaches to facilitate global diversification of reinsurance risk.

8. Focus on Improved supervisory expertise to cope with emerging regulatory initiatives and
the increasing complexity of risk assessment. Specially to cope with the expertise required to
effectively monitor principles-based practices and assess internal models.

Source: Research based on IAIS website, IAIS newsletter, Business Standard & PTI articles.

Posted by spachava at 12:31 PM | Comments (1)

November 06, 2007

Fed Reserve's creative FedVille !

Risk Mgmt and Compliance is generally all serious business, albeit I am sure we all do come across some colorful characters, incidents that provide the much needed breaks, extra spice and humor to the profession. Occasionally I try to seek out expressions of creativity, innovation and humor in the financial markets.

Whilst researching on creativity and innovation in markets, I came across a creative offering around financial literacy from Fed Reserve and found it fascinating enough to blog on this, even though other bodies too have done this e.g. Stock exchange simulations, FX markets games etc.

Probably much before we started to rave about banks having a secondlife.com presence, Federal Reserve Bank of San Francisco, FRBS created its own little virtual town - FedVille.

FedVille is a friendly virtual town built just for kids by Fed Reserve San Francisco. At every corner of FedVille there is something interesting to learn and experience around financial sector literacy be it at the FedVille Deli, FedVille firehouse, FedVille Movies, FedVille General Store and even a Federal Reserve Bank to tour !

http://www.frbsf.org/education/fedville/

FedVille teaches kids about pocket money, bank savings account opening, track growth in money, watch movies on money, bust counterfeit notes and take on tellers jobs in an easy and engaging way.

Other online resources being:
- Fed 101 – The life of a dollar bill, The life of a cheque, Where’s the Money, Examiner for a day, Fed president interviews, Games – Fed clue etc.

- Great economists treasure hunt

My favorite:
- Fed Chairman Game - Allows one to decide rates, policies for every 3 months period and follow its impact across a tenure of 4 years.

This game allowed me to emulate the role played by the legendary Alan Greenspan for a few minutes, albeit I am sure that my former b-school finance professor who now serves as a State Secretary of Budget and Fiscal Management would shudder at even this thought.

http://www.frbsf.org/education/activities/chairman/

Jokes aside, the above innovation learning concept adopted by Fed Reserve made me think hard on how any kind of next generation Risk Mgmt & Compliance architecture needs to help enable such innovative Risk mgmt learnings tools given that the future of learning is linked to more interactive modes of videos, podcasts, wikis and blogs.

Also we do need a healthy dose of creativity and innovation to make Risk Mgmt & Compliance concepts simpler and easier to be understood by everyone, and more importantly make the Risk learning interactive and fun experience !

Posted by spachava at 05:55 AM | Comments (3)

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)

June 25, 2007

New Risk Frontiers - Managing Risk in the Virtual World of Avtars !

Managing Risk in the virtual world - Who's responsibility is it anyway!

Key Point - As more & more financial institutions get creative about reaching out to the youth market by establishing presence in 3D online worlds, it is going to be interesting as to how the traditional Risk management practices will evolve to keep up with this new online presence and associated risks. Will this be managed by the Technology Risk experts or would it fall under Retail Banking Channels Op Risk honchos ?

Background:
Internet & Web as a financial services channel continues to shake up some of the traditional business models in a flat world. The consumer demographics is shifting from the baby boomers in the US & EU towards the generation X and generation Y - specially in BRIC countries & emerging markets such as Brazil, China, India, South East Asia - where a significant proportion of population is below age of 30 and ripe for financial products.

Banks tap social networks to target youth market -
As some of us know the amount of time spent by generation X & generation Y online is taking a quantum leap every single day. As a result some of the more creative financial institutions are preparing to reach out to the future customers by establishing presence in 3D online worlds. These includes pretigious names such as ABN AMRO, ING, Germany's Wirecard Bank, with a virtual branch in 3D online universe Second Life.com Another science fiction game Entropia Universe, has completed an auction of five virtual banking licences that allow firms to set up real world banking systems in the universe. Other examples being the Belgian financial services group Fortis has launched a MySpace-style social network for European entrepreneurs. The UK's Yorkshire Building Society (YBS) has introduced a virtual assistant to its Web site to answer online queries from mortgage customers. Dutch bank ING Direct, also has launched a viral video marketing campaign that promotes its new 'orange mortgage' to renters and potential first time home buyers.

All of these have their own unique Risk exposures - possibly the most sigificant being the customer data protection as well as reputation risk and the most importantly who one is dealing with as most assume online Avtars !

Posted by spachava at 05:19 PM | Comments (0)