Basel II Update

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Basel II Update

• Dubrovnik, 27-28 May 2004

Charles Freeland Deputy Secretary General
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Future schedule
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Parallel running and floors
The floor is expressed as a percentage of the
bank's capital requirement under Basel I There is
a possibility that further testing (QIS) will
result in the need for recalibration or a scaling
factor
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IRB issues resolved this month

• 1. Securitisation simplified
• Same treatment for originating and investing
  banks
• Internal Assessment Approaches permitted
• 2. Credit cards resolved
• One single default correlation factor
• Treatment of securitised credit card receivables
• 3. Stress LGDs to be consulted on further
• One single calculation required

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The Madrid "breakthrough"

• The BCBS had previously decided to calibrate IRB
  against expected plus unexpected losses (EL
  UL)
• The reason was essentially a lack of uniformity
  in national provisioning rules and accounting
  rules
• In Madrid, the BCBS decided to respond to
  industry requests to calibrate IRB to UL only
• In addition, a calculation of EL will be made by
  each IRB bank and the numerator of the ratio will
  be adjusted accordingly

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Adjustment to the numerator

• General provisions will be removed from the
  numerator for IRB banks
• EL will be compared with the sum of general plus
  specific provisions for the portfolios in
  question
• If provisions lt EL, the deficiency will be
  deducted 50 from Tier 1 and 50 from Tier 2
• If provisions gt EL, the excess will be added to
  Tier 2 (to a limit of 0-6 of risk-weighted
  assets at national discretion)

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Why did we correct EL/UL?

• It is how the banks calibrate their IRB
• The new proposal
• Is conceptually purer
• Simplifies the framework
• Recognises different provisioning practices in
  different jurisdictions
• Accountants continue to insist on "incurred
  losses but they acknowledge "experienced credit
  judgement"

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Position of non-BCBS/EU member countries

• Australia, Hong Kong, Singapore and South Africa
  will be ready by 2006
• Brazil, Chile, Malaysia, Mexico may be a bit
  slower
• China and India have NOT rejected Basel II (their
  opinions are public)
• China have already introduced Pillars 2 and 3 but
  will wait for an appropriate time to adopt Pillar
  1
• India is now introducing market risk and intends
  to adopt Basel II subject to some local
  adjustments

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Simple standardised approach (Annex 9)

• Establish sovereign risk weights - assuming no
  external ratings, export credit agency scores
  established by the OECD are a sound alternative
• Banks and regulated securities firms get one risk
  weight worse than the sovereign (i.e. 50 if
  sovereign is 20)
• New risk buckets for mortgages (35) and retail
  (75)
• 150 weighting band for past due loans
• Conversion factor for undrawn commitments up to
  one year raised to 20 of principal (from zero)
• Operational risk charge (15 of gross income)

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OECD Export Credit classifications (April 2004)
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Assistance for countries proposing to implement
Basel II

• BCBS has established an Accord Implementation
  Group
• AIG has already conducted extensive fact-finding/
  information-sharing
• FSI is planning intensive training programmes
  (e-learning project)
• IMF/WB technical assistance programmes
• Private sector consultants

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"Practical considerations" circulated to
supervisors (August 2003)

• Basel II should not take precedence over other
  supervisory priorities such as the implementation
  of the Basel Core Principles
• Countries need to decide soon what banks or set
  of banks should move to Basel II and when
• Commence national legislative/regulatory
  processes
• Strengthen supervisory resources and training

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High-level Principles for crossborder
implementation (August 2003)

• Legal responsibilities of supervisors will not
  change
• The home supervisor of a banking group is
  responsible for oversight of implementation on a
  consolidated basis
• Host supervisors, particularly of subsidiaries,
  have requirements that need to be understood and
  recognised
• There will need to be enhanced cooperation
  between supervisors, led by the home supervisor
• Where possible, supervisors should avoid
  performing uncoordinated approval and validation
  work
• Supervisors should communicate the rules of home
  and host supervisors to banking groups operating
  in multiple jurisdictions

About 20 case studies now in train - if you have
questions, contact the home supervisor not the
bank
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The level playing field!
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Pillar 1
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Pillar 1

• Key changes
• Wider spectrum of credit risk weights
• Greater recognition of collateral
• More refined treatment of securitisation
• Charge for operational risk introduced
• Undrawn commitments weighted at 20 of principal

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Standardised Approach Risk Weights
1 Risk weighting based on risk weights of
sovereign in which the bank is incorporated, but
one category less favourable. 2 Risk weighting
based on the assessment of the individual
bank. 3 Claims on banks of an original maturity
of less than three months generally receive a
weighting that is one category more favourable
than the usual risk weight on the banks claim.
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Standardised ApproachRisk weights for
individuals and corporates
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Historical Default Rates

• Main reason for using ECAIs increases the risk
  sensitivity
• High correlation between ratings and default rates

SPs PD over 5-year horizon
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Capital Charge under SA versus other measures
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Operational risk
Op risk is growing, both from unexpected external
events and internal problems (ie friendly
fire) Choice of three approaches proposed

• Basic indicator (15 of average gross income over
  3 years)
• Standardised approach (based on separate scaling
  factors for gross income from defined business
  lines) between 12 and 18 of gross income
• A range of advanced methods based on loss
  experience, subject to addition risk control
  criteria

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Pillars 2 and 3

• Critical to the balance of the proposal
• Pillar 2 (Supervisory review) includes attention
  to risk management generally, including
• Concentration risk
• Interest rate risk
• Collateral management risk
• Pillar 3 (disclosure) is designed to enforce
  market discipline

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The challenge for banks and supervisors

• Initial phase
• Determine approach to be used
• Revise legislation/administrative guidance (e.g.
  EU Directives)
• Draw up reporting forms/guidance notes
• Train staff for implementation
• Ongoing
• Activate Pillar 2
• Review standards for IRB banks

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What are the basic aims of Basel II?

• To deliver a prudent amount of capital in
  relation to the risk that is run
• To provide the right incentives for sound risk
  management
• Basel II is not intended to be neutral between
  different banks/different exposures
• However, there is a desire not to change the
  overall amount of capital in the system

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Keep an eye on BCBS website www.bis.org/BCBS