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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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
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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
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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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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
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