LEBANONS PREPARATIONS AND RELATED ISSUES FROM BASEL II

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LEBANONS PREPARATIONS AND RELATED ISSUES FROM
BASEL II

• Assessing Progress Roadmap

Dr Amine Awad, Board Member, Banking Control
Commission Member
of the Higher Banking Council

Washington D.C. May
17, 2004
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• Before starting the draw up of Lebanons
  preparation to implement Basel II, it is useful
  to show the role of the various authorities
  involved in this subject.
• Description of the Central Bank and
• The Regulatory Body
• 1.Banque du Liban (BDL) and the Banking
• Control Commission(BCC) are the two
• independent authorities in Lebanon that work
• side-by-side and coordinate their actions
  together.

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• 2.B.D.L, besides its role in the monetary policy,
  is the authority that decides on the different
  aspects of the development of the banking sector
  it is responsible for licensing of Banks and
  Financial Institutions thus BDL issues circulars
  related to banking policy.
• 3.The BCC is the authority responsible for (a)
  following up the banks operations, (b)
  controlling their development and performance,
  (c) supervising their systems and management.

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• Accordingly, it is the authority that issues
  application circulars and receives periodic
  reports in order to follow up the operations of
  banks, financial institutions and exchange
  houses.
• 4.Whenever the BCC faces the case of a
  "problematic" institution that it cannot remedy,
  it refers the institution to the "Higher Banking
  Council" (H.B.C)

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• BDL and the BCC are represented in the HBC, in
  addition to other members who are a seasoned
  judge with relevant experience in financial
  matters, the Head of Deposit Guarantee
  Institution and the Director of the Ministry of
  Finance. The H.B.C is a judicial authority that
  decides on the fate of the institution being
  tried, its verdicts are not subject to any type
  of appeal.

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• What about Lebanons policy regarding
• The application of Basle II
• 1.Since the year 2002, Lebanon has been
  following closely the research and publications
  related to Basle II, basically

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• First Consultative Paper CP1, in June 1999
• Second Consultative Paper CP2, in January 2001
• - Several Working Papers, Press Releases and
  Impact Studies during 2001.
• Third Quantitative Impact Study QIS 3, carried
  out in Autumn 2002.
• Third Consultative Paper CP3, in April 2003
• "Draft Implementation of Basel II" document
  (Practical Considerations), issued in August 2003

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• Through the continuous participation of
  Members of the BCC in conferences, meetings and
  seminars, especially in the F.S.I. in Basle to
  accommodate the research about the subject and to
  prepare for Lebanons banking sector in close
  coordination with the BDL Board
• 2. Since the year 2002, Lebanon has been trying
  to play an active role in spreading the
  philosophy of Basle II and in the development of
  related research in the Middle East region.

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• Lebanon hosted two regional conferences in
  2002 and 2003, to which 22 Arab and Middle
  Eastern countries were invited to follow the work
  of the FSI for implementing Basel II With major
  instructors from the FSI, IMF, World Bank, FSA
  and the BCC.
• 3. Several big banks in Lebanon besides
  Lebanons Bankers Association contributed to the
  consultative Papers of the Basel Committee, thus
  helping developing and enriching the research.

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• 4. Lebanon was one of the few countries in the
  world whose supervisory authority was underwent
  an initial IMF assessment in 1998, then a follow
  up assessment in March 2001 which covered the
  progress Lebanon achieved with regards to the
  "Core Principles for Effective Banking
  Supervision".
• The result of the assessment of the
  supervisory process in Lebanon was highly graded.

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• In addition, Lebanon was among the
  countries chosen by the FSI to contribute to the
  amendment of The Core Principles for Effective
  Banking Supervision issued by the Basle Committee
  to accommodate the requirements of Basle II.
• 5. After Lebanon was classified by the FATF
  (GAFI) among the non-cooperating countries with
  regards to money laundering because of its
  Banking Secrecy Law,

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• the Lebanese Government and Parliament enacted
  Law 318 in April 2001 in order to put in place a
  global framework for combating money laundering.
  Since then, BDL and the Special Investigation
  Commission (SIC) issued a number of circulars,
  the last of which was BDL Circular No. 35 dated
  September 17, 2003, regarding the same issue
  this led to the removal of Lebanon from the list
  of non-cooperating countries.

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• 6. Finally, Lebanon participated in the Survey
  which was prepared by the F.S.I. and the
  Secretariat of the Basel Committee on Banking
  supervision and which was designed to identify
  the international current plans regarding
  implementing Basel II and corresponding capacity
  building needs.

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• Even if the official position of Lebanon
  concerning the potential scope of implementation
  of Basel II New Capital Accord is "undecided"
  yet, however the answer of the Lebanese monetary
  and supervisory authorities on the question if
  our jurisdiction intend to adopt Basel II was
  YES.
• The major topics on which the regulatory
  authority in Lebanon is now working on, are as
  follows

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• Steps Taken in preparation for
• The Application of Basle II
• The monetary and supervisory authorities in
  Lebanon have been continuously and actively
  working since two years on the preparation of the
  financial sector readiness for the progressive
  application of Basle II. This is being done in
  two parallel directions as follows

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• 1. Preparing empirical studies and field
  surveys on the banking and financial sector in
  Lebanon to determine what has to be amended
  regarding capitalization, placement policies and
  other issues.
• 2. Spreading progressively, the culture of
  Basle II inside the banking sector when it comes
  to Internal Audit, Corporate Governance,
  Risk Management and other areas.

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• 1. With regards to the statistical surveys
• These are being prepared by the BCC and discussed
  with a joint Committee, appointed by the Governor
  of BDL since March 26, 2003, whose role is to
  prepare for the application of Basel II. This
  Committee is composed of the First
  Vice-Governor, two Board Members of the BCC and
  two representatives of the Lebanons Bankers
  Association. It may have recourse to experts on
  the subject when deemed necessary.

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• The joint committee has conducted various
  simulations assessing the impact of the
  application of Basel II on the capital adequacy
  ratios of banks operating in Lebanon. The
  scenarios were based on the current banks
  financial statements adopting the following
  approaches
• Standardized approach with respect to Credit
• and Market Risks
• Basic Indicator Approach with respect to the
• Operational Risk

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• Then, the committee identified the banks whose
  capital adequacy ratios will fall below the
  minimum capital requirements and it is currently
  developing an action plan to deal with these
  banks on a case by case basis.

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• In the draft document called" Implementation of
  Basel II Practical Considerations", issued in
  August 2003, The Basel Committee said
• A key objective of Basel II is to encourage
  improved risk management through the use of three
  mutually reinforcing Pillars.
• While banks have primary responsibility
  for appropriately measuring material risks and
  maintaining adequate capitalization,
• 
  (cont.)

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• (cont.)
• the Basel II proposals recognize that Pillar 1
  minimum capital requirements cannot be the sole
  answer to adequate capitalization and risk
  management in banks or safety and soundness in a
  banking system. Strong risk based supervisory
  review with early intervention and market
  discipline under Pillars 2 and 3, respectively,
  complement minimum capital requirements.

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BASEL IIFinal Implementation date Dec.31st 2006
We will summarize each pillar as follows
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• I- First Pillar
• Banks should maintain sufficient
• capital funds to cover
• A. Credit Risk
• Minimum capital requirements are based
• on one of the following approaches
• Standardized approach
• Internal ratings-based approach
• Credit Risk modeling

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• B) Operational Risk
• To develop a capital charge that covers the risk
  of deficiencies in information systems or
  internal controls of which will result unexpected
  losses This is based on one of the following
  approaches
• Basic Indicator
• Standardized Method
• Advanced Method (AMA)

C) Market Risk To develop a capital charge that
covers interest rate and exchange rate risks in
banks books.
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II- Second Pillar Is intended to achieve a level
of capital commensurate with a banks overall
risk profile and to encourage banks to develop
better risk management techniques in monitoring
and managing their risks. Supervisors are
expected to evaluate how well banks are assessing
their capital needs relative to their risks and
to intervene where appropriate.
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III- Third Pillar Banks have to strengthen the
transparency with their stakeholders ( i.e.
customers, employees, shareholders, supervisors
and public authorities), by
Adopting full disclosure through reliable and
timely accounts.
Adopting policies that control all types of
risk.
Avoiding lack of confidence.
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• Supervisors including those who choose to
  retain the current Accord - are encouraged to
  move towards a system of risk based
  supervision. Specifically, supervisors, to the
  extent possible, should shift their emphasis
  towards the quality of a banks risk management
  process and ability to assess risk exposures
  properly.

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What B.D.L and B.C.C. do to cope with Basel II
implementation

• During August 2000, the B.C.C. issued its
  circular No. 222, which was implemented in three
  phases, ending in March 31, 2002.
• This circular sets an action plan for banks
  to improve their IT security.
• This circular was the first action taken by
  the B.C.C. and aiming at reducing one of the most
  important operational risk in banks (Pillar I).

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• 2. The BDL issued the circular No. 77(dated
  15/12/2000),on Internal Control in Banks and
  Financial Institutions.

Banks and F.I. should establish internal systems
to measure, monitor and control their
risks. (Pillars I II)
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• 3. The BDL issued the circular No. 81 (dated
  21/02/2001).
• This circular concerns Corporate Governance in
  Banks.

B.O.D. should participate actively in designing
the strategy of the bank and is fully
responsible of the results.
(Pillar II)
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4. The B.C.C. mandated the application of the
International Accounting Standards
(I.A.S.), through the issuance of several
circulars aiming at implementing market
discipline in the banking industry, by asking for
timely and more transparent banks accounts
(Namely Circular No. 227, dated February 2001)
(Pillar III)

• 5. The B.C.C. issued a comprehensive circular No.
  238, dated 23/10/2002, on  Analyzing, managing,
  and processing Credit Risk in banks and financial
  institutions (Pillar I)

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• 6. The BDL issued the circular No. 41 ( dated
  17/11/2003), aiming at designing a general
  framework to solve N.P.L. in banks this circular
  was designed in preparation of implementing Basel
  II requirements, by reducing N.P.L. and
  consequently improving Credit Risk in banks
  (Pillar I)

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• 7. The B.C.C. issued the Memo No. 1/2004 in
  January 26, 2004, asking Banks and F.I.s to
  communicate to the B.C.C the list of their
  "Specialists in Risk Management".
• This memo has the following objectives
• To draw the attention of Banks and F.I.s on the
  importance of the Risk Management Function in
  their organization.
• To determine the lack of specialized persons in
  Risk Management in the financial sector.
• To determine the necessary trainings.
• To know the qualified persons to deal with the
  B.C.C. and with the specialists in Lebanon and
  abroad.

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• 8. The B.D.L. issued its circular No 49 dated
  April 3, 2004 on definition of TIER I TIER II
  capital, in accordance with the press release
  issued by the Basel Committee on October 27,
  1998.
• An amendment to this circular is due to be
  issued by next week, putting limits on Preferred
  Shares and other Financial Instruments eligible
  for inclusion in Tier I Capital.

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• 9. In addition to the above, the B.C.C. is in the
  process of issuing a serie of very important
  circulars, to help the lebanese banking and
  financial sector implementing the New Capital
  Accord
• 9.1.Circular on Risk Management (end of May 2004)
  
• (Pillar I).
• 9.2.Circular on how to monitor Market Risk (June
  2004) (Pillar I).
• 9.3.Circular on how to define and measure
  Operational Risk (November 2004) (Pillar I).

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• 10. Finally the B.D.L. will issue during the
  current month (May, 2004) a new circular fixing
  limits for  Overdrafts  and encouraging banks
  to grant  Term Loans 

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The End