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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October 14, 2007
Convergence of Risk Capital, Disclosures in the PE, Hedge Funds, M&A era !
Hola from Barcelona, Spain.
In preparation for a Risk mgmt and Excel bootcamp here in Barcelona, I was studying the European Risk mgmt practices related to transparency and risk controls specially in context of Private equity, Hedge funds and much publicized M&A deals. At a broad level, these are about more transparency for investors based on EU instituted guidelines for streamlining M&A regulations last year as well as related to Hedge Funds operations. These are expected to have wide ranging implications for the markets guidelines in the US and the rest of the world too.
I am discussing two developments - one in Germany, the other in UK.
Germany Modernization of the Conditions for Risk Capital - Germany’s Cabinet has issued a draft law to regulate the country's private equity industry. This proposed law has 2 goals in mind - 1. Protect domestic companies from corporate raiders 2 . Make M&A more transparent for investors. The govt. will vote on this new risk management law. This will require investors to publicize minority holdings owned through options, identify the actual owners of individual holdings and, when acquiring more than a 10% stake, announce their intentions.
The German securities regulator BaFin will have greater power and flexibility to decide if minority investors such as hedge funds "acted in concert" to influence the corporate strategy. If its proved that shareholders did join forces, the new law would compel them to bid for the company. The new law would require companies to announce their positions regardless of how they acquired or would acquire the stakes, while current legislation allows investors to hold off reporting an investment when it's held through options. Germany's new law would enable the country's securities regulator to prohibit a company from exercising voting rights tied to a stake if it decides the investor violated any new regulations.
Switzerland - Companies are now required to announce any stake of more than 3%, regardless of how it's held.
UK - Last week, a group of 14 of London’s biggest hedge funds under a Hedge Fund Working Group drew up a voluntary industry code of conduct. Under the plan the London group, which manages approx. $180 bn of assets or about 10 per cent of the global industry total, Hedge funds would have to “comply or explain”, agreeing to meet the standards or tell people why they were not meeting them.
The plan focuses on 3 main standards to protect investors.
1. Disclosure of holdings of complex hard-to-value securities, and the methods used to value them
2. Clear risk management plans, including plans to address liquidity risk
3. Clear policies on dealing with the conflicts between investors and managers
US - It will be interesting to see the resulting developments in our own market in the US. This growing push by foreign markets to improve global oversight and transparency of financial markets, including hedge funds and complex financial products is bound to influence U.S. oversight practices as well especially given the subprime-lending exposures.
The markets supervisors too are certainly nudging hedge-fund managers and investors to develop voluntary guidelines to help improve disclosure and mitigate the systemic risks.
In a related development the President's Working Group on Financial Markets is creating two advisory groups to develop "best practices" for investors of hedge funds and the managers who run the investment vehicles.
The first group comprising hedge-fund managers will develop guidelines such as valuation and enhanced disclosures to investors.
A second group, comprised of investors, will develop guidelines on the type of "due diligence" necessary for hedge funds investors, as well as the information investors should receive. The timeline for expected recommendations is by the end of the year.
In summary, in my humble opinion, self regulation and tighter Risk controls for Hedge funds, PE firms and M&A deals are pretty much on cards in the near horizon.
Posted by spachava at 04:21 AM
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September 01, 2007
Financial Services for the Poor - Risks & Defaults !
Desiring a break from following the subprime lending woes & the associated default risks in the US market, I jumped on a chance to work on a Research paper on Micro ventures financing.
This blog is about some interesting facts about risks and defaults in the world of microfinance, micropayments, peer to peer lending and financial inclusion initiatives.
In early days of Microcredit and when the concept of Financial services to the poor was in its infancy, the segment of poor people was considered to be potentially high risk in terms of defaults.
The perception was strong enough to influence even the most local of the financial institutions to be not too enthusiastic on lending to this market segment. It was so bad that finally a form of credit was made mandatory under “ priority sector lending” schemes by many Central banks in most poor and developing countries to provide some basic level of liquidity for this segment.
Despite pockets of success for Microcredit initiatives in early 70’s& 80’s, the failure of too many aggressive Microcredit ventures in mid 80’s to early 90’s was again a proof to many naysayers about the repayment viability of this segment.
However ever since late 1990’s, the consistent success of microcredit business model around the world have slowly started to change this old paradigm.
Today there are numerous data points to support the contrarian hypothesis that the segment of poor actually can have an overall better credit rating & higher repayment rates as compared to people in the more richer countries.
It is estimated that an estimated 2.5 to 3 billion people live on less than 2-4 US dollars per day. Around 2.0 billion people have never used a bank. This has led to many governments actively pushing a financial inclusion agenda to have more equitable society in future.
With the Risks & defaults picture across the microcredit sector looking positive, the business viability of financial services to the poor is looking extremely attractive. Many global and local financial institutions are now reviewing their business models to be able to serve this underbanked segment across the world & recalibrating their traditional risks and defaults paradigms associated with the poor !
Once the new disruptive business model of Peer to Peer Lending networks becomes mainstream and start to look at this segment, there may be a potential trigger for another big paradigm shift on looking at risks,defaults,collateral from a portfolio to an individual peer to individual peer level. But then that’s a topic for another blog !
Posted by spachava at 03:51 AM
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April 12, 2007
10 Risk Frontiers ideas seeking thought leadership !
Risk Mgmt & Compliance developments and practices continue to evolve so dramatically each day!
Sleepless in Seattle, I start this blog to share, discuss and most importantly learn about the new Frontiers in Risk & Compliance - both current & futuristic trends with signficant impact on the Risk Mgmt & Compliance practices & profession.
My future observations would focus on the following 10 Risk frontiers:
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
Posted by spachava at 07:49 PM
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