August Over the months, Monetary Authority of Singapore ( MAS ) has

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1 Proposals For The Implementation Of Basel II In Singapore Phase 1 Overview... 1 The Structure Of The New Rules... 1 Part I Introduction Part II Definitions Of Terms Part III Scope Of Application Part IV Minimum Capital Adequacy Ratios... 3 Part V Transitional Arrangements... 3 Part VI Definition Of Capital... 4 Part VII Operational Risk... 4 List Of Specific Questions For Consultation... 5 Concluding Words... 5 Please feel free to contact the Knowledge & Risk Management Group at eoasis@rajahtann.com Overview In June 2004, the Basel Committee on ing Supervision ( BCBS ) issued its report on International Convergence of Capital Measurement and Capital Standards: A Revised Framework (commonly known as Basel II). We issued a client update titled Basel II: Revised Framework For The International Convergence Of Capital Measurement And Capital Standards Finally Introduced dated June 2004 on this. Over the months, Monetary Authority of Singapore ( MAS ) has been working with Singaporeincorporated banks ( Reporting s ) to implement Basel II in tandem with the G-10 countries to foster continual improvements in the risk management practices. Whilst MAS has been in regular discussion with Reporting s to set out its expectations and requirements for Basel II implementation and to hear their feedback and issues, it is now entering the process of formalising the requirements and seeking public feedback. This consultation paper has been issued by MAS and the public consultation period ends on 9 September As the standards and requirements for Basel II implementation are extensive, MAS will consult on the proposed requirements in phases over the next year. This Phase 1 consultation paper introduces the structure in which the standards and requirements will be set out, as well as the general requirements pertaining to scope of application, capital adequacy ratios, transitional arrangements and definition of capital. The paper also proposes standards for the simpler operational risk approaches under Basel II. This Update reviews the key elements of the proposed changes that MAS intends to introduce to implement Basel II into Singapore. The source for this Update is the Consultation Paper. The Structure Of The New Rules The intent is for MAS to implement Basel II by way of a new notice that will set out the capital rules applicable to Reporting s. The new notice will replace MAS Notice to s 637, which will be repealed upon implementation of Basel II. Other bank capital requirements currently set out in MAS Notices to s 627, 628 and 630 will also be migrated to the new notice to create a single comprehensive rulebook. The proposed structure of the new notice mirrors Basel II s three-pillar framework. Pillar 1 specifies minimum capital adequacy ratios for Reporting s and the methods that Reporting s must use to calculate these ratios. Pillar 2 sets out MAS expectations in respect of a Reporting s internal assessment of whether it has adequate capital to cover its exposures to all risks. Pillar 3 specifies the minimum disclosure Page 1

2 requirements for a Reporting in relation to its capital adequacy, with a view to fostering market discipline. MAS will introduce this framework in phases. The key areas set out for consultation in this phase are essentially Part 1 to 6 and Part 9 of the new notice. A brief description of each of these parts are discussed. Part I Introduction This part introduces the three-pillar framework and sets out MAS expectation that a Reporting should select the Pillar One approaches that are commensurate with the complexity and sophistication of its business and operations. A Reporting is also encouraged to move toward the risk management practices embodied in the more advanced approaches although it may not be ready to adopt them fully for the purpose of computing minimum. In addition to complying with the minimum in the new notice, a Reporting is also expected to consider whether it has adequate capital to cover its exposure to all risks. To this end, the new notice sets out the expectations of MAS in respect of the internal capital adequacy assessment of a Reporting ( Pillar 2 ) which are non-mandatory. The notice also specifies the minimum disclosure requirements for a Reporting in relation to its capital adequacy ( Pillar 3 ), with a view to fostering market discipline. Part II Definitions Of Terms This part explains the terms used in the new notice. Part III Scope Of Application MAS will continue to require capital adequacy requirements to be met on a solo and consolidated basis. The requirements are the same as those in the existing MAS Notice 637, but involve the exercise of Basel II national discretions by MAS. This is set out in the table below. Basel II Reference Paragraph 24. To the greatest extent possible, all banking and other relevant financial activities (both regulated and unregulated) conducted within a group containing an internationally active bank will be captured through consolidation. Paragraph 27. If any majority-owned securities and other financial subsidiaries are not consolidated for capital purposes, all equity and other regulatory capital investments in those entities attributable to the group will be deducted, and the assets and liabilities, as well as third-party capital investments in the subsidiary will be removed from the bank s balance sheet. Supervisors will ensure that the entity that is not consolidated and for which capital investment is deducted meets the regulatory MAS Proposal For National Discretion MAS will implement this national discretion. Page 2

3 . Paragraph 25. Supervisors will assess the appropriateness of recognising in consolidated capital the minority interests that arise from consolidation of less than wholly owned banking, securities or other financial entities. Supervisors will adjust the amount of such minority interests that may be included in capital in the event the capital from such minority interests is not readily available to other group entities. Paragraph 30: When measuring regulatory capital for banks, the Committee believes that at this stage it is, in principle, appropriate to deduct banks equity and other regulatory capital investments in insurance subsidiaries and also significant minority investments in insurance entities. MAS will implement this national discretion. MAS will maintain the existing practice in MAS Notice 637 to require any capital investments held by a bank in an insurance subsidiary to be deducted from regulatory capital. Alternative approaches that can be applied, should, in any case, include a group-wide perspective for determining capital adequacy and avoid double counting of capital. Paragraph 43: Where the total expected loss amount is less than total eligible provisions, banks may recognise the difference in Tier 2 capital up to a maximum of 0.6% of credit riskweighted assets. At national discretion, a limit lower than 0.6% may be applied. MAS will allow banks to recognise the excess provisions as Upper Tier 2 capital up to a maximum of 0.6% of credit risk-weighted assets. Part IV Minimum Capital Adequacy Ratios The requirements are the same as those under the existing MAS Notice 637. Part V Transitional Arrangements MAS will be implementing the Basel II capital floors for Reporting s adopting the internal ratingsbased approach to credit risk during the transition period from 1 January The capital floors will not be reduced automatically but will depend on substantive and continual progress in Basel II implementation by the Reporting. From 1 January 2007 to 31 December 2007 From 1 January 2008 to 31 December 2008 From 1 January 2009 to 31 December 2009 or such longer period as the Authority may notify to a Reporting IRBA adoption date on or after 1 January 2007 but before 1 95% of minimum 90% of minimum 80% of minimum Page 3

4 January 2008 IRBA adoption date on or after 1 January 2008 but before 1 January 2009 N.A. 90% of minimum such lower percentage as the Authority may notify to a Reporting 80% of minimum such lower percentage as the Authority may notify to a Reporting Part VI Definition Of Capital Most of the requirements here are similar to those in MAS Notice 637. MAS will implement the Basel II requirement for deductions from capital to be effected through equal deductions from Tier 1 and Tier 2 Capital. Reporting s will be allowed to recognise excess provisions as Upper Tier 2 Capital subject to a limit. This is set out in the table below. Basel II Reference Paragraph 43: Where the total expected loss amount is less than total eligible provisions, banks may recognise the difference in Tier 2 capital up to a maximum of 0.6% of credit riskweighted assets. At national discretion, a limit lower than 0.6% may be applied. MAS Proposal For National Discretion MAS will allow banks to recognise the excess provisions as Upper Tier 2 capital up to a maximum of 0.6% of credit risk-weighted assets. Part VII Operational Risk This part sets out the simpler approaches (ie Basic Indicator Approach and Standardised Approach) for calculating for operational risk. A Reporting is also expected to adopt the practices set out in the report Sound Practices for the Management and Supervision of Operational Risk issued by the BCBS in February A Reporting is expected to adopt an approach for calculating its operational RWA that is commensurate with the complexity and sophistication of its businesses and operations. A Reporting with significant operational risk exposures is expected to use an approach other than the Basic Indicator Approach. Page 4

5 List Of Specific Questions For Consultation Question 1: Comments on the proposed method for calculating annual gross income as contained under the section dealing with the Basic Indicator Approach. Question 2: Comments on the proposal to allow negative operational risk capital charges (resulting from negative gross income) in any business line to offset positive operational risk capital charges in other business lines, in relation to the risk measurement under the Standardised Approach. Question 3: Comments on the proposed principles for mapping business activities to business lines, which are adapted from Basel II, in relation to the risk measurement under the Standardised Approach. Question 4: Comments on the proposed minimum requirements for adopting SA(OR), which are adapted from Basel II, in relation to the risk measurement under the Standardised Approach. Question 5: Comments on the proposal to allow a Reporting to use ASA to calculate its operational RWA, in relation to the Alternative Standardised Approach. Concluding Words This Update has provided only a quick overview of the proposed changes. Rajah & Tann will be happy to discuss the proposed changes and the likely implications at greater lengths with you. Please feel free to eoasis@rajahtann.com. Rajah & Tann is one of the largest law firms in Singapore, with a representative office in Shanghai. It is a full service firm and given its alliances, is able to tap into resources in a number of countries. Rajah & Tann is firmly committed to the provision of high quality legal services. It places strong emphasis on promptness, accessibility and reliability in dealings with clients. At the same time, the firm strives towards a practical yet creative approach in dealing with business and commercial problems. The information contained in this Update is correct to the best of our knowledge and belief at the time of writing. The contents of the above are intended to provide a general guide to the subject matter and should not be treated as a substitute for specific professional advice for any particular course of action as the information above may not necessarily suit your specific business and operational requirements. It is to your advantage to seek legal advice for your specific situation. In this regard, you may call the lawyer you normally deal with in Rajah & Tann or the Knowledge & Risk Management Group at eoasis@rajahtann.com. Page 5