Basel II : From Risk to Opportunity

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Basel II From Risk to Opportunity ?
Overview of implementation status across european
banks
Jean Christophe BORIES
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AGENDA

• Introduction
• Basel II objectives reminder
• Where we stand today in the world?
• Key Benefits
• Major concerns
• Technical implementation issues
• Case studies
• Link to ERM framework -gtinternal control
• Conclusion. To a Basel III Framework

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Basel II comittee requirements and
objectivesReminder

• Promote a strong capital foundation at banks
• Strengthen supervision and risk management
  practices in the face of rapid financial
  innovation
• Promote understanding of the links between risk
  management, disclosure and accounting practices
• strengthen outreach to non-member countries,
  industry participants and other constituents.

The new framework has three mutually reinforcing
pillars 1. The minimum capital requirement, 2.
The supervisory review and 3. Market discipline.
Pillar 1 is about setting the minimum capital
requirement for credit, market and operational
risks. Pillars 2 and 3 relate closely to the
Basel Committees Core Principles for
Effective Banking Supervision (BCP), but in this
new context in which new risk management systems
are encouraged for adoption, emphasis is put
on supervising the quality of banks new systems
for risk assessment (Pillar 2), and on disclosure
of information on risk management practices and
on different types of risk exposures, along with
disclosure of other types of information, such
as banks financial performance and financial
position (Pillar 3 Basel, 2004).
Three Pillar Of Basel II
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• Basel II where we stand now?

• The most part of the projects was launched in
  2003 2004 with a pre-study before offical text
  was published by local regulators
• Some components were put into production for the
  first time in 2006.
• Pilar 1 report was almost completed, but Pilar 2
  3 had not been tackled yet, just in pre-study
  phase for Pilar 2 ICAAP process is not widely
  implemented , we report some early adopters
  initiatives
• Most of the retails banks have chosen to go for a
  standard approach or IRBF . Projects are
  starting to move from IRBF to IRBA
• ROI on Operationnel Risk is not sufficient .

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• Basel II where we stand now ?

• The majority of our clients take benefits of it
  throughout the progression of construction works.
• QIS5 results involve priority change of the
  projects due to the specificities of realized
  works.
• Europeans Supervisors Banking Commission Basel II
  visits started in 2006 2007.
• According to BCBS 85 of European financial
  organizations finished Basel II implementation in
  late 2007

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Basel II where we stand now ?
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And in Russia
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Basel II 5 main concerns

• 1. First concern is at a very broad level,
  looking at whether regulating capital is the best
  way
• to ensure systematic banking stability . ?
  Northern Rock
• 2. Second is whether Basel II will reduce bank
  credit levels to developing
• economies both internationally and nationally
  this effect could be worse for poorer
• countries and those with low perceived
  creditworthiness. There is evidence that this
• could reduce investment,
• demand and future growth.

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Basel II 5 main concerns (2)

• 3. Third concern is whether Basel II would
  increase pro-cyclicality of bank lending,
• both domestically and from international banks.
  This would increase volatility of
• growth and investment, as well as increase
  systemic risk in the banking system.
• 4. The fourth area of concern is whether the
  introduction of Basel II could discourage
• particularly lending to SMEs and to other sectors
  or modalities crucial for growth,
• employment and investment.
• 5. A fifth concern is whether the introduction of
  Basel II could give important competitive
• advantages to foreign banks. This could not just
  have negative consequences for
• lending to SMEs, especially since there is
  growing evidence that foreign banks cherry pick
• and lend more to creditworthy large firms. It
  could also mean that greater
• concentration of the banking system due to a
  larger role for foreign banks weakens
• the ability and power of national regulators to
  properly regulate them, which could
• again pose serious problems for banking stability.

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Objective report on BASEL II works progression
from technical point of view

• Components impacted by process
• Impact review
• Infrastructure and architecture synthesis
  Before/After.

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Components impacted by Basel II

• Components
• impacted
• by
• Process (1)

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Components impacted by Basel II

• Components
• impacted
• by
• Process (2)

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• Internal modeling impact

• Acquisition of modeling tools (_at_risk, SAS, )
• Structuring of decision support bases related to
  the models study Datamart models or study bases
• Development of modern tools for scoring or
  outsourcing of score (score agencies)
• Training for Risk and Marketing Management
  personnel
• Facilities management in models study
• Historic database problems

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• RWA (Risk weighted assets) Calculation

• Calculation engine acquisition (Fermat,
  Algorithmics,)
• Technical specifications of the supply have been
  created and the majority of them implemented at
  test phase.
• Problems related to the identification of data
  sources and associated management rules.
• History monitoring problems.
• RWA validation problems according to the modern
  priorities
• Issues in diversified and international
  organizations

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• Pooling and segmentation

• Design realization of pooling motors on
  Datamart risks
• Pooling technical specifications have been
  already set and are at test phase
• Data quality problems
• Problems related to the segments identification
  with Marketing Management
• Strong need for flexibility

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Case study pooling and segmentation

• Un pool regroupe toutes les créances dun couple
  Type de produit marché avec la capacité
• de distinguer en ligne à ligne les créances gt
  0,2 de lencours du pool ou bien supérieure à 1
  M.
• A chaque pool est associé un taux de pondération
  qui dépend de la réglementation
• permettant ainsi le calcul du RWA

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• Default Management

• Detection of default in the credit chains, often
  heavy adaptations. Some companies took advantage
  of theses factors in order to change tools.
• Default adaptation to the Basel format have been
  already realized and it is actually at test
  phase.
• Data quality problems because of the management
  rules change
• History problems because of the rules change
• Necessary training at all the organizational
  levels
• Problems in Contagion Risk Management

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• Operational Risks

• Incidents evaluation and typology
• Decision of basic indicators due to the lack of
  Operational Risks culture, incitation is
  relatively weak.
• Installation of incident detection tools (often
  intranet).
• Transmission and evaluation of incidents in the
  datawarehouse.
• Necessary training at all the organizational
  levels
• Connection with internal control tools and Risk
  assessment processes
• Emerging Anti Money Laundering (AML) and Anti
  Terrorism financing (FIRCOSOFT)

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• Market Risks

• Existing pricers updates or additional
  developments
• Existing applications are often brought back
• Installation of interfaces in order to transmit
  RWA evaluation in the datawarehouse
• Relatively weak impact, because the recommended
  Basel II methods are already implemented
• Weak Change Management
• VaR uniformely used on markets risks with
  limitations

Moyenne trimestrielle trading Var, 1 jour, 99 ù
(en M Eur)
Taux
Actions
Change Matières premières
Effet de compensation
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Market Risks VaR became a standard
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Basel II Impact on organization

• New Risk Management Governance
• CRO as a member of the board
• Link of Risk director with CFO, IT Manager and
  General Management
• Tight link between risk management activities and
  business processes activities
• Risk Training to be performed at lowest level
  (even in the oultlet)
• Risk Comittee
• Internal Control
• Organizational link to supervisor (Central Bank)
  need a permanent fonction
• Compliance officer to proactively manage in the
  Risk Management Domain
• Learning curve of Basel regulation
• Human capacity to absorb such new techniques
• Set as a program divided into handable projects
• Need to have a strong interaction with various
  dept

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• Synthesis

• Construction processes have been launched but
  many problems remain and they will be more urgent
  in the Pilars 2 3
• Data quality
• Default and guarantees management
• Accounting consistency
• Everything is related to the IS quality that
  should be oriented on the risks integration as an
  essential priority
• A new datum in relationship Project owner/Main
  contractor
• Incitative developments of risk hedging in
  particular Business Continuity Plan/Disaster
  Recovery Plan
• New risk management organization

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• Perimeter and activities included
• in the Risk oriented Information System

Modeling Simulation Evaluation
Risk reduction
ERP
Risk financement
Cartography
IS Bank Management
Reporting/ supervision Assignement
IS Risk Management
Defaults incidents
Financial IS
Monitoring
Etudes Audit
Environment (other banks,stock echange place
systems, insurance, brokers, financial
information databases, clients scoring,)

• A full set of niche players
• Lack of integration with Back Office tools
• Not much TCO like approach
• Internal development warning
• Excel dangers
• Standard of risk reporting to Central Bank (COREP
  and XBRL norm)

State of the Art
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Evolution to integrated Risk Management
platform
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Basel II IT players and costs
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• Evolution of trend architecture
• Generic scheme (BII)

Decision support system for assignement
Modeling Simulation
Credit chain
Credit Management
Accounting referential
Defaults
Accounting Management
Accounting chain
User Departments
Regulatory reporting
Audit Management
Client referential
Bank Supervision
DW
DMT Risks
Risk Management
risk reporting
Risk assessment
RWA
Market referential
Market Management
M/O reporting Market risks
FO/BO markets
Operational Incidents
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Basel II Pilar 2 and 3 Coming Developments

• Economic capital calculation tool implementation
• Economic capital assignment and monitoring by
  business line (ICAAP process)
• Integration of IT tools in a target RM
  architecture
• Pilar 2 Stress Testing and impact on pricing of
  credit
• Pilar 3 Communication standard
• Data Quality Management Projects

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• Conclusion from Basel II to Basel III

• Basel II stepstone
• Has been an opportunity to setup a standard RM
  framework for supervisors and banks.
• Early adopters have enhance their risk management
  by a large investment on the RM tools and
  processes
• On the other hand some concerns from a financial
  stability standpoint and lack of guidelines
  making implementation quite complex
• Training needs and Change management

• Basel III is in the air
• A complete Audit on banking system asked by the
  end of 2008 by the EC Ecofin
• From Rating models validated on a common base by
  the supervisors to a Risk model validated
  internally or by agreed third parties
• More emphasis on BCP, Internal Control of Risk,
  External Risk Audits, Operational risk
  measurement
• A text expected by 2010, implementation by 2011
  and 2012
• Integration of Solvency II for diversified banks
  (Bankinsurance)

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