Basel III will be finalized
before November 2010, and will be implemented by the
end of 2012. We have the first
regulatory arbitrage conflicts and challenges
Welcome to the June 2010 edition of the
Basel ii Compliance Professionals Association (BCPA)
newsletter
Dear
Members,
Today we will discuss two of the most
important questions we have in our mind:
What is next? What
should we expect?
At the end of the newsletter, you can find our
offer (valid until July 1st, 2010 - 45% discount ($535
discount) for all 4 certification programs (CBiiPro,
CP2E, CP3E, CSTE).
$ 653 - Final cost for the 4
programs (all inclusive). 4 Courses, 4 Professional
Certificates.
What is next? What should we expect?
The G20 has agreed that Basel III should
be finalized before 2011 and implemented by the end of 2012.
We
do not have the final official paper yet.
December 2009: The Basel Committee
on Banking Supervision published two consultative documents
which have been
widely dubbed "Basel III".
The consultative
documents entitled “Strengthening the Resilience of the Banking
Sector” (many times in the press and the web it is called ‘Basel III'
- which is not correct) and
“International Framework for Liquidity Risk Measurement,
Standards and Monitoring” are a part of the Basel Committee’s
ongoing work.
These papers are NOT the Basel III
framework.
Deutsche Bank is concerned about
the regulatory arbitrage possibilities. Andrew Procter, the
bank’s head of government and regulatory affairs,
has expressed concern that the United
States may not adopt Basel III.
“The United States
continues to influence the Basel process but, in effect, treats
the guidelines as optional” .
“Deutsche Bank believes that no other
Basel committee members should move ahead with implementation
until there is a clear timetable from the U.S.” Andrew
believes
Our view is that Basel III
will be implemented in the United States.
When?
We are not sure. Perhaps, after the end of
2012. It is true that the United States delayed Basel II, and we
consider that something similar is likely ti happen under Basel III. But,
Basel III is going to be implemented in the United States.
A report from Rabobank’s Economic Research
Department argues that proposed capital and liquidity
requirements for internationally operating banks will have a
major impact on the banking sector, could
restrict the credit supply and hamper economic growth.
Under the Basel III requirements,
banks will have to hold more and higher quality liquid assets as
a buffer for the short-term. They will also have to
finance these assets with more stable and
long-term funding. The Rabobank economists claim that the
new requirements will affect the
traditional role of the banks, that is transforming customer’s
savings into loans.
G20 at the London Summit
in April 2009
DECLARATION ON STRENGTHENING THE
FINANCIAL SYSTEM – LONDON, 2 APRIL 2009
"We, the Leaders of the G20, have taken, and will
continue to take, action to strengthen regulation and
supervision in line with the commitments we made in
Washington to reform the regulation of the financial
sector."
"All G20
countries should progressively adopt the Basel II
capital framework; and the BCBS and national
authorities should develop and agree by 2010 a global
framework for promoting stronger liquidity buffers at
financial institutions, including cross-border
institutions"
G20 at the Pittsburgh Summit in
September 2009
PROGRESS REPORT ON THE ACTIONS
TO PROMOTE FINANCIAL REGULATORY REFORM ISSUED BY THE
U.S. CHAIR OF THE PITTSBURGH G-20 SUMMIT – 25
SEPTEMBER 2009
"We
are committed to take action at the national and
international level to raise standards together so
that our national authorities implement global
standards consistently in a way that ensures a level
playing field and avoids fragmentation of markets,
protectionism, and regulatory arbitrage."
"
Progress is being made in the two major international
initiatives now underway on bank resolution
frameworks, namely the Cross-Border Bank Resolution
Group (CBRG) of the Basel Committee on Banking
Supervision (BCBS) and the initiative by the IMF and
the World Bank on the legal, institutional and
regulatory framework for national bank insolvency
regimes.
In September, the CBRG published for
consultation a report, which includes recommendations
for authorities on effective crisis management and
resolution processes for large cross-border
institutions. "
" The Group of Central Bank
Governors and Heads of Supervision,
the oversight body of the BCBS,
reached agreement in September to introduce a
framework for countercyclical capital buffers above
the minimum requirement.
The framework will include capital
conservation measures such as constraints on capital
distributions.
The Basel Committee will review an appropriate set of
indicators, such as earnings and credit-based
variables, as a way to condition the build up and
release of capital buffers.
The BCBS is also
actively engaged with accounting standard setters to
promote more forward-looking provisions based on
expected losses.
The IASB is working to enhance its provisioning
standards and guidance on an accelerated basis,
including by considering a proposed impairment
standard based on an expected loss (called an
“expected cash flow”) approach to loan loss
provisioning for issuance in October 2009.
The IASB published initial proposals on its website in
June to seek input regarding the feasibility of this
expected loss approach before it issues an exposure
draft in October 2009.
Finally, the BCBS continues to
work on approaches to address any excessive
cyclicality of minimum capital requirements.
The
BCBS will issue concrete proposals on these measures
by end-2009.
It will carry out an impact
assessment at the beginning of 2010, with calibration
of the new requirements to be completed by end-2010.
Appropriate implementation standards will be developed
to ensure a phase-in of these new measures that does
not impede the recovery of the real economy. "
" We commit to developing by end-2010 internationally
agreed rules to improve both the quantity and quality
of bank capital and to discourage excessive leverage
and these rules will be phased in as financial
conditions improve and economic recovery is assured,
with the aim of implementation by end-2012.
The national
implementation of higher level and better quality
capital requirements, counter-cyclical capital
buffers, higher capital requirements for risky
products and off balance sheet activities, and as
elements of the Basel II capital framework, together
with strengthened liquidity risk requirements and
forward-looking provisioning, will reduce incentives
for banks to take excessive risks and create a
financial system better prepared to withstand adverse
shocks.
We welcome the key measures recently
agreed by the oversight body of Basel Committee on
Banking Supervision to strengthen the supervision and
regulation of the banking sector.
The
BCBS should review minimum
levels of capital and develop recommendations in 2010.
Our efforts to deal with impaired assets and to
encourage the raising of additional capital must
continue, where needed.
We commit to conduct
robust, transparent stress tests as needed.
We
call on banks to retain a greater proportion of
current profits to build capital, where needed, to
support lending. "
"The BCBS has stated that the
level of capital in the banking system, both the
minimum capital requirement and the buffers above it,
will be raised relative to pre-crisis levels to
improve resilience to future episodes of stress.
This will be done through a combination of measures
such as strengthening the risk coverage of the Basel
II capital framework,
improving the quality of capital, and raising the
overall minimum requirement.
The BCBS will carry out an
impact assessment at the beginning of 2010 and
calibrate the new requirements by end-2010.
Appropriate implementation standards will be developed
to ensure a phase-in that does not impede the recovery
of the real economy. "
Studying the
official papers
From the BIS Working
Papers No 309, Toward a global risk map, by Stephen G
Cecchetti, Ingo Fender and Patrick McGuire, Monetary
and Economic Department, May 2010 Definition of
Systemic Risk
"Systemic risk in the financial system is analogous to
pollution.
It is an
externality that an individual
institution, through its actions, imposes on others.
As commonly understood, this
externality takes two forms.
The first
is the joint failure of institutions at a particular
point in time resulting from their common exposures to
shocks from outside the financial system or from
interlinkages among intermediaries.
The
second is what has come
to be known as procyclicality.
This is the term used to describe the
phenomenon that, over time, the
dynamics of the financial system and of the real
economy reinforce each other, increasing the amplitude
of booms and busts and undermining stability in both
the financial sector and the real economy.
Each has different policy implications and
involves different challenges in terms of monitoring
and measurement.
Common exposures and
interlinkages create the risk of joint failure.
Assessing their importance means focusing on both
how risk is distributed and how the system responds to
either an institution-specific shock or to a common
shock that damages everyone.
In the first
case, we need to assess the risk of contagion through
credit or funding exposures on the one hand, and the
possibility of asset fire sales on the other. In the
second case, systemic effects would arise as a direct
consequence of similarities in the structure of
institutions’ balance sheets and funding patterns.
In the context of systemic
risk, procyclicality is about the progressive build-up
of financial fragility exacerbating booms and
increasing the risk of catastrophic collapse.
As costly experience has taught us, the
financial sector can
endogenously generate systemic risk in ways
that are often difficult to capture. New financial
products with unseen risks can be introduced.
Margins and haircuts, increasingly lax during booms
and progressively more stringent in busts, will
exacerbate price fluctuations in markets.
And institutions have a natural tendency to
become less prudent during cyclical upturns and more
prudent during downturns.
Add to this the fact that during
periods of steady, high real growth, financial market
volatilities tend to be low and risk premia
compressed.
Taking all of this together, the implication
is that traditional measures of aggregate risk tend to
look lowest precisely when risk is at its highest."
Studying the
official papers
Basel II and Revisions
to the Capital Requirements Directive, May 2010
Remarks by Stefan Walter, Secretary General, Basel
Committee on Banking Supervision, to the European
Parliament Committee on Economic and Monetary Affairs
on the BCBS's reform programme, 3 May 2010.
Introduction
The primary objective of
the Basel Committee on Banking Supervision (BCBS)
reform program is to raise the resilience of the
banking sector, thus promoting more sustainable
growth, both in the near term and over the long run.
The over-riding objective of the Committee’s
reform agenda, as endorsed by
the G20 and the FSB, is to deliver a banking and
financial system that acts as a stabilising force on
the real economy.
As we now know, this
clearly was not the case leading up to the recent
financial crisis.
The pre-crisis financial
system was characterised by the following weaknesses:
- too much leverage in the
banking and financial system and not enough high
quality capital to absorb losses;
- excessive credit growth based on
weak underwriting standards and under pricing of
liquidity and credit risk;
insufficient liquidity
buffers and overly aggressive maturity transformation,
both direct and indirect (for example, through the
shadow banking system);
- inadequate risk governance and poor
incentives to manage risks towards prudent long term
outcomes, including through poorly designed
compensation systems;
- inadequate cushions in banks to
mitigate the inherent procyclicality of financial
markets and its participants;
- too much systemic risk,
interconnectedness among financial players as well as
common exposures to similar shocks, and inadequate
oversight that should have served to mitigate the
too-big-to fail problem.
In particular, the
depth and severity of the crisis was amplified by a
financial system that entered the crisis with too much
leverage, insufficient liquidity buffers and capital
levels, and poor incentives for risk taking.
The banking sector therefore was too
vulnerable to shocks, whatever their source.
During the most severe episode of the crisis,
the market lost confidence in the solvency and
liquidity of many banking institutions. The weaknesses
in the banking sector were transmitted to the rest of
the financial system and the real economy, resulting
in a massive contraction of liquidity and credit
availability.
I feel certain that had regulatory standards
been higher, as the BCBS is now proposing, the crisis
would have been less severe and the burden on the
public sector and taxpayers would have been lower.
Key elements of the BCBS
reform programme
To
remedy these fundamental
shortcomings, the BCBS reforms promote the following
objectives, which link directly to my analysis of
pre-crisis shortcomings:
- ensure
that all material risks are adequately integrated into
and covered in computing the level of required capital
(especially those related to trading activities,
complex securitisations, and derivatives);
- assure that high quality capital
is present to absorb losses arising from all risk
exposures;
- introduce additional checks and
balances into regulatory, supervisory and risk
management frameworks. This includes strong
emphasis on the three pillars of the Basel II
framework, as well as moving over time to a credible
Pillar 1 leverage ratio that serves as a backstop to
the risk-based requirement and helps contain the
build-up of banking sector wide leverage;
- promote forward looking provisioning
and countercyclical capital buffers that raise the
ability of the banking sector to absorb shocks when
they inevitably come;
- introduce minimum global standards
for measuring and controlling liquidity risk;
- assure that regulation and
supervision of systemically important banks is strong,
forcing them to internalise the risks they create for
the public at large;
- strengthen risk governance and
management, building on the Pillar 2 supervisory
review process;
- improve market discipline by
enhancing Pillar 3 disclosure of firms’ risk profile
and capital adequacy; and
- promote practical approaches to
improve the management of cross border bank
resolutions.
The BCBS
reforms, integrating microprudential and
macroprudential elements, are designed to be
proportionate to the risks of individual banks’
business models, as well as the broader risks that
certain activities and institutions pose to the
system.
A significant proportion of the
reforms are targeted at those firms and activities
that are systemic in nature.
In particular, capital requirements have been
increased for trading book activities, counterparty
credit risk, and complex securitisations and
resecuritisations.
Thus, under the newly
proposed BCBS standards, systemically important banks
will be subject to tougher standards.
The BCBS has also put forward a set of proposals aimed
at the systemic risks posed by derivative activities.
Under these revisions, OTC derivative
exposures will be subject to higher capital
requirements based on stressed inputs and longer
margining periods that reflect the liquidity.
Moreover, derivatives exposures that are not cleared
through central counterparties that meet the revised
CPSS/IOSCO standards will be subject to higher capital
requirements, thus increasing incentives to use such
central counterparties.
Also, exposures among
major, interconnected financial institutions have a
higher degree of correlation compared to exposures to
the corporate sector and would therefore require
relatively higher capital.
Once the
risk coverage of the capital framework has been
improved to reflect different business models and
different degrees of systemic risk, all banks need to
back these exposures with higher quality capital that
can absorb losses on a going and “gone concern” basis.
In developing its proposals, the BCBS has paid
particular attention to the unique circumstances of
non-joint stock companies, including cooperatives and
savings banks.
Moreover, it is the expectation
of the Committee that all banks will build buffers
above the minimum in good times that can be used in
times of stress.
Having these countercyclical buffers will make
the system more resilient to shocks and reduce the
risk of spillover from the financial to the real
economy.
Impact
assessment, calibration, and implementation
In fashioning the reforms, the
BCBS is paying close attention
to the impact on the industry and the economy as a
whole both during the transition and in the long run.
This means putting in place a path to a safer
and stronger financial system that keeps growth on
track
– enhancing welfare in the long run, while
at the same time minimising the economic costs in the
short run.
Banks have returned to pre-crisis
levels of profitability. To a significant extent this
is due to the unprecedented public support measures
put in place during the crisis.
With this in mind, it seems reasonable to
expect that these profits will now be used to build
capital and liquidity buffers, and not feed excessive
bonuses, dividends, and leverage.
The BCBS reforms, which
the G20 has asked to be finalised by the end of this
year, will provide clarity on the new resilience
standards that banks should achieve.
Moving towards these standards will increase
confidence in the system.
As history has shown time and again, a weak,
undercapitalised banking sector cannot support sound,
long-term real economic growth.
Current
minimum regulatory requirements remain unacceptably
low and will not deter a renewed race to the bottom in
which financial institutions end up undercapitalised,
over-leveraged, and illiquid.
For example, the current effective minimum
capital requirement is just 2 percent common equity to
risk-based assets. This is
equivalent to risk-weighted leverage of at least 50:1.
However, it is based on a diluted definition of bank
capital.
If one were to use a more robust definition
based on tangible common equity – which has become
common practice among market participants – the
leverage permissible under the current minimum would
be even higher.
In addition, there is no
minimum global standard for liquidity whatsoever, even
though poor liquidity at banks was one of the key
amplifiers of the crisis.
In response, the Committee has proposed
internationally harmonised minimum liquidity standards
to help ensure that banks can withstand a one-month
period of acute stress and to promote banks’
resilience over the longer term through incentives to
support their activities with more stable sources of
funding.
The BCBS has put in place a rigorous
process to assess the overall impact of its reforms
with a view to ensuring that the new standards achieve
the objective of greater banking sector resilience
while they simultaneously promote maximum sustainable
growth. These processes include the following:
Public consultation:
The December capital and liquidity reforms have been
subject to rigorous public consultation. The Committee
is now reviewing nearly 300 comments with an eye
toward identifying any unintended consequences in
either the design or calibration of the proposals. It
is important to note that in many cases, higher
requirements are being introduced – by design – which
will affect those business lines and activities that
posed substantial risk to banks and the system. The
BCBS wants to make sure that it considers all major
consequences of its reforms and the incentives they
create.
Impact assessment:
The BCBS is conducting a comprehensive
quantitative impact study to assess the impact of the
reform package on individual banks and on the banking
industry. The impact study will inform the calibration
of the capital requirements and ensure an appropriate
set of minimum standards across banks, countries, and
business models. Similarly, the liquidity standards
will be calibrated so that they promote sound
liquidity buffers while allowing for prudently managed
business models and sustainable maturity
transformation in the banking system.
Overall calibration:
The Committee is engaging in an analysis to
determine the calibration of the overall capital and
liquidity requirements, factoring in the cumulative
impact of all the individual reform measures, as well
as what is necessary to achieve the resilience of the
banking sector while ensuring prudent long term
availability of credit.
Macroeconomic impact
assessment over the transition period:
The FSB
and the BCBS, in close collaboration with the BIS and
IMF, are assessing the impact of the reforms over
different possible transition periods to ensure that
there is no threat to the economic recovery. Moreover,
national macroeconomic models (subject to a common set
of protocols) are being used to assess the link
between higher capital standards, credit availability
and costs, and broader economic growth. This framework
therefore can accommodate differences in the role of
the banking sector in national economies, where some
are much more bank driven than others.
Based
on these four initiatives, by the end of this year
the BCBS will develop a balanced
set of reforms that promote greater banking sector
resilience and maximum sustainable economic growth.
The market and bank supervisors have
already forced banks to raise their capital and
liquidity buffers. However, when competitive pressures
reassert themselves, significantly higher minimum
requirements will help contain any return to the
unacceptably low capital and liquidity levels which
made the system so vulnerable to shocks the last time
around.
It therefore is critical that the calibration
of the new standards be based on what is necessary to
promote balanced and sustainable banking in the long
run. Appropriate implementation time lines and
transition arrangements will be used to make the
transition to the new standards in a manner that does
not jeopardise near term growth. Failure to set the
right long run levels will undermine near-term
confidence and jeopardise long-term financial
stability.
The BCBS is comprised of 27
countries and it conducts its work under the review of
its oversight body, the Group of Central Bank
Governors and Heads of Supervision of its member
jurisdictions. The work of the
Committee also is being reviewed closely by the
Financial Stability Board. In addition to monitoring
the consistency with the G20 reform mandates and the
broader economic implications of the transition to the
new standards, the FSB process will ensure that the
BCBS reforms are integrated into a coherent overall
set of reforms to strengthen global financial
regulations.
Consistent with the
G-20’s mandate, rigorous
processes have been put in place to ensure that all
countries implement the full set of international
prudential standards. Consistent and timely
implementation of standards by all jurisdictions is
critical to promoting a global level playing field.
Conclusion
The Basel Committee is on schedule to deliver
a fully calibrated package of global standards for
capital and liquidity by the end of this year. It is
conducting a wide range of analyses to ensure that the
design of the reforms is appropriate and that they
produce a more stable financial system and economy
over the long run without jeopardising growth in the
near term.
The BCBS reforms are intended to be
forward looking, making the system more resilient to
future crises, whatever their source. While certain
banks and countries may not have “caused” the current
crisis, everyone was affected. All countries and
financial institutions benefited from the public
sector interventions to stabilise the economy, the
functioning of markets, and the resilience of
counterparties.
Moreover, past crises
have emerged from all regions of the world, covering a
wide range of products, and affecting all types of
business models and asset classes (retail, commercial
real estate, sovereign lending, corporate lending,
trading activities, securitisations, and
underwriting).
While we cannot with certainty predict the
source of the next crisis, we can however lay the
groundwork to help mitigate or minimise the impact.
It is therefore critical that all banks and
countries strengthen banking sector resilience,
particularly given the global and diverse nature of
financial markets and the speed with which shocks are
transmitted across countries.
This and previous crises have shown that the
deepest and most prolonged downturns arise when the
banking sector gets into serious trouble and no longer
has the capacity to perform its core credit
intermediation function.
Dear
member,
Thank
you for reading our
newsletter.
Take advantage of the 4 distance
learning and online certification programs:
1. Certified Basel ii Professional (CBiiPro)
2. Certified Pillar
2 Expert (CP2E)
3. Certified Pillar
3 Expert (CP3E)
4.
Certified Stress
Testing Expert (CSTE))
of our
Association - at a cost that is unheard of.
You may visit:
www.basel-ii-association.com/Distance_Learning_Online_Certification.htm
Best
Regards,
George
Lekatis
President of the Basel ii Compliance
Professionals Association (BCPA)
General Manager,
Compliance LLC
1200 G Street NW Suite 800, Washington
DC 20005, USA
Tel: (202) 449-9750
Email:
lekatis@basel-ii-association.com
Web:
www.basel-ii-association.com
Join the Basel ii Compliance Professionals
Association (BCPA). Membership is Free
www.basel-ii-association.com/How_to_become_member.htm
Member
Benefits
www.basel-ii-association.com/Member_Benefits.htm
Reading Room
www.basel-ii-association.com/Reading_Room.htm
Read more about our
Certified Basel ii Professional (CBiiPro)
program:
www.basel-ii-association.com/Distance_Learning_Online_Certification.htm
Read more about our
Certified Pillar 2 Expert (CP2E) program:
www.basel-ii-association.com/Distance_Learning_Online_Certification_CP2E.htm
Read more about our
Certified Pillar 3 Expert (CP3E) program:
www.basel-ii-association.com/Distance_Learning_Online_Certification_CP3E.htm
Read more about our
Certified Stress Testing Expert (CSTE)
program:
www.basel-ii-association.com/Distance_Learning_Online_Certification_CSTE.htm
    | |
.gif){kind=small}
.gif){kind=small}
.gif){kind=small}