Basel II : The New Capital Accord

1
Basel II The New Capital Accord

• Implications for Bank Supervisors in our Client
  Countries and the World Banks Agenda

2
BASEL I

• Basel I was aimed at international active banks
  in developed countries
• Originally G-10 countries intended to raise the
  minimum capital levels of their large banking
  organizations and establishing a level playing
  field
• Became the international standard worldwide

3
Capital Requirements under Basel I

• Slotting of assets (off- and on balance sheet
  items) into four categories
• Applying 8 to the sum of risk weighted assets
• A x 0 a (A government bonds, etc)
• B x 20 b (B interbank lending)
• C x 50 c (C mortgages, etc.)
• D x 100 d (D other loans, etc)
• Capital requirement (abcd) x 8
• 3) A specific capital charge against market risks
  could be added for
• banks incurring such risks
• - Weightings (0,20,50,00) were meant to reflect
  riskiness of
• underlying banking operations
• - Value of loans was supposed to fully reflect
  loans impairment

4
Basel I overly simplistic ?

• Not sufficiently risk sensitive
• One size fits all framework
• Capital ratio a misleading indicator where
  other elements are lacking (adequate loan
  classification, etc.)

5
Basel II a major change in approach

• Regulatory capital (vs. economic capital) might
  not be adequate
• Capital should be calculated based on actual
  estimates of unexpected losses rather than on
  arbitrary risk weights
• Process oriented framework (multi-options system
  to account for diversity and complexity of
  banking operations)
• Supervisory review (capital could be adjusted
  upward based on qualitative, supervisory
  judgment)
• Public disclosure (necessary element as the
  suggested framework offers a menu of options)
• Much more than just a technique for computing
  capital requirements touches upon banks risk
  management system

6
Is Basel II overly complex for our clients ?

• The Basel Committees core target population
  remains large complex banking organizations
• The use of external ratings is very limited in
  non G-10 countries
• The IRB approach is out of reach for most banks

7
Possible Implications

• Bank A
• Risk weighted assets X
• Universal bank
• Network
• Good internal control
• Adequate corporate governance
• Similar capital requirement for Bank A and B
  under Basel I

• Bank B
• Risk weighted assets X
• Specialized bank
• No branch
• Deficient internal control
• Deficient corporate governance
• Bank Bs capital requirement likely to be higher
  than Bank As under Basel II

8
Basel Committees response

• As recognized international rule setter for
  banking supervision related issues, BC has become
  more sensitive to the need to broaden its
  audience
• Non G-10 countries concerns are expressed under
  the auspices of the Core Principle Liaison Group
  (CPLG)
• World Bank and IMF participate in CPLG meetings
  The Bank represents the views of developing
  countries and we played a role in (i) advocating
  a framework of universal application and (ii) the
  implementation of Pillar 2 and Pillar 3

9
CPLGs view on Basel II

• Basel Committee is recognized as the
  international rule setter
• Applying Basel II to G-10 and Basel I to non G-10
  is not acceptable
• Basel II should offer more options to fit non G10
  countries needs

10
The simplified approach suggested by a sub
group of the CPLG (Brazil, China, India, Russia,
Saudi Arabia)

• Basel II Basel I Pillar 2 Pillar 3
• - Current risk weighted system (possibly with
  several changes including a capital charge to
  account for operational risk)
• - Supervisory review (possibility for supervisors
  to impose capital add-ons)
• - Disclosure (current extent of disclosure by
  banks on capital, loan classification, etc. is
  unsatisfactory )

11
Bank Supervisors will confront challenges in
implementing Pillar 2

• Pillar 2 s building blocks (principles)
• - Assessment of the adequacy of capital needs
  by the banks themselves, i.e capital is to be
  adjusted to the overall risk profile of a bank
• - A banks assessment is to be reviewed by bank
  supervisors
• - Supervisors should be entitled to require
  capital in excess of minimum, if need be
• - Supervisors should have adequate tools at
  their disposal to intervene at an early stage
  before capital is depleted

12
Looking ahead

• Basel II will become the standard
• Most foreign banks in developing and emerging
  economies will strive to adopt the IRB approach
  (level playing field)
• Non G-10 supervisors must provide incentive for
  banks to adopt the IRB approach in the medium term

13
The Banks role going forward

• Most, if not all, IMF/WB lending operations in
  the financial sector have imposed/ recommended
  compliance with Basel guidelines on capital
• WB future work will refer to and encourage the
  adoption of Basel II like frameworks
• As a knowledge institution the Bank has no
  option but to disseminate international
  standards and best practices in our client
  countries
• As part of the FSAP, the Bank will continue
  assessing compliance with Basel guidelines,
  including Basel II
• The Bank staff needs to have the necessary skills
  in anticipation of TA requests

14
The Banks role going forward (contd)

• In light of its experience, the Bank along with
  the Fund, should actively participate in the
  revision of Core Principles (2003?)
• The Bank must continue being active in the CPLG
  where non G-10 specific issues are addressed
• The Accord Implementation Group (AIG) will be
  instrumental in raising issues that non G-10
  countries will confront going forward (Banks
  view is likely to be requested as we can provide
  useful input)
• Staff need to be prepared to work with our client
  countries on implementation issues

15
Conclusion

• Basel II will have far reaching implications over
  the long run (Mc Donough ratio likely to be as
  famous as the Cooke ratio)
• As part of its work in the financial sector, the
  Bank must be prepared to continue to provide
  support to our countries to meet best practices,
  including those regarding Basel II
• The Bank must invest in training for financial
  sector specialists to understand Basel II