Basel II An Australian Banker s Insert perspective

Transcription

1 Basel II An Australian Banker s Insert perspective Name of Presenter Insert Title Of Presenter Page 0

2 Today s discussion Basel Origins and impacts - Addressing the shortcomings of Basel I - A Banker s view of Basel II: Strengths and weaknesses Extracting the business benefits Page 1

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4 Basel II s comprehensive coverage of risk The amount of capital a bank holds is a principle factor supporting its soundness and solvency The Basel II framework is intended to improve the linkage of key factors that contribute to bank solvency to a bank s level of capitalisation. Not only does capitalisation become more a function of the risk profile of the organisation than under Basel I, the Basel Committee is aiming to improve individual bank soundness through reinforcing sound risk management practices. These include: Sound governance and compliance disciplines Improved (statistical) quantification of the various risks a bank faces Sophisticated tests of a bank s ability to withstand and manage changes to economic conditions Greater market discipline on reporting and disclosure Page 3

5 The 1988 Basel Accord (Basel I) Objectives: Provide a common basis to strengthen the soundness and stability of the Banking system by boosting capital Adopt a standard approach across banks in different countries The structure was intended to: Make regulatory capital more sensitive to risk Encourage risk-based pricing Consider off-balance sheet exposures Lower the disincentives to hold liquid, low risk assets. Page 4

6 Immediate impacts of Basel I Positives: Undercapitalised banks improved their capital ratios in response to Basel I The ratio of Capital to Risk Weighted assets for major G10 banks rose from 9.3% in 1988 to 11.2% in 1996 Common definitions of capital and capital adequacy globally An industry-wide appreciation of the concept of capital management Negatives: Exacerbated the impact of a slowdown in world economic growth? Simplicity of Basel I encouraged rapid growth in products that avoided regulatory capital (364 day facilities, insurance companies selling credit wraps etc) Page 5

7 The problems with Basel I Unable to distinguish between good and poor quality credits Little impact on the risk appetite decisions of banks Capital arbitrage opportunities supported growth in securitisation Capital ratios (potentially) a misleading indicator of bank risk Focussed only on financial measures lacked mechanisms to improve risk management processes Page 6

8 Australian Majors capital ratios since 1988 ANZ Nab % of Risk Weighted Assets Total risk-based capital ratio Tier 1 Ratio Tier 2 Ratio % of Risk Weighted Assets Total riskbased capital ratio Tier 1 Ratio Tier 2 Ratio Year CBA Year Westpac % of Risk Weighted Assets Total risk-based capital ratio Tier 1 Ratio Tier 2 Ratio % of Risk Weighted Assets Total risk-based capital ratio Tier 1 Ratio Tier 2 Ratio Year Year Page 7

9 Economic Capital - addressing the shortcomings of Basel I Capital provides sufficient assurance to prevent insolvency (i.e. the financial state where liabilities exceed assets). Economic Capital is the amount of capital that shareholders require in the absence of regulation. Factors to consider are: Leverage influencing target debt rating, and the cost of debt Earnings volatility influencing analyst ratings, and the cost of equity Distress costs (liquidity risks, impact on strategy, increased regulatory burden, management time) Given the shortcomings of Basel I, economic capital has been the primary focus with regulatory capital as the constraint. The requirements of rating agencies also have to be considered. The actual capital requirement for the Bank will therefore be the amount of capital required to satisfy economic, regulatory and rating agencies. Required Capital = Max(Economic, Regulatory, Rating Agency) Max Rating Agency, Regulatory, Economic = Required Page 8

10 How much capital is required? How much capital a bank requires and the structure of assets it needs to hold to avoid insolvency (expressed in terms of a confidence interval) are key determinants of its economic capital framework. Banks aspiring to be an advanced bank under the new Basel II rules are expected to have in place sophisticated economic capital modelling methodologies to support their determination of capital requirements and be able to explain its relationship with the new regulatory capital models. Probability of loss For measurement purposes, banks typically choose to hold capital to a confidence interval consistent with their target rating agency rating (generally 99.99% for AAA, 99.97% for AA and 99.93% for A etc) which is based on the chance of a corporate entity of equivalent rating defaulting in one year. Economic Capital requirement Zero losses Expected loss 1 in 10 1 in 20 year year event event Loss Rate I in 50 year event 1 in 100 year event 1 in 3000 year event (99.97% confidence) 0% 100% Expected level of losses for which a provision should be created Potential unexpected loss for which capital should be held Potential unexpected loss against which it would be too expensive to hold capital Page 9

11 Objectives of Basel II Maintenance of overall capital levels globally Promote competitive equality Promote comprehensive risk management Sensitive to risk A focus on internationally active banks but applicable to all Page 10

12 Changes for the better in Basel II A more complex and potentially better credit risk model compared with Basel I. A bank s own rating system is a foundation for the capital allocation Addresses a number of capital arbitrage issues in Basel I (eg securitisation) Improved focus on the range of risks a bank faces not just credit risk Encouraged industry participation in developing better risk measurement and management solutions Page 11

13 But still not perfect.. Concerns over the potential for Basel II to introduce greater procyclicality Loss data availability - particularly for banks, sovereigns and large corporates where defaults are rare. (Validation standards must deal with this pragmatically.) There is the potential for greater model risk. A potential for multiple layers of supervisory caution to produce capital levels about the same as the current levels. Challenges in achieving consistent implementation across national jurisdictions (regulators are working to address this issue). The risk of regulator moral hazard Page 12

14 Bank readiness for Basel II Australia s major banks are regarded as some of the most well prepared for the introduction of Basel II. In the case of ANZ, credit, market and operating risk methodologies already incorporated many of the Basel II requirements. For instance: Basel II credit rating methodology and system requirements are consistent with ANZ s rating methodology and approach. ANZ s methodology for determining loss given default (LGD) is consistent with Basel II requirements. ANZ has an advanced economic capital model (in use since 1995) Independence in the assignment or review of ratings and development of rating methodologies is a key platform of the document ANZ s processes align with this requirement. ANZ s approach to Operational Risk Management is consistent with that required under the more advanced approaches within the new framework. ANZ applies the more advanced models and calculation methodologies applicable to market risk (and obtains capital relief in line with the 1996 Basel Market Risk capital amendments). Page 13

15 Bank readiness for Basel II (continued) Areas where banks have typically needed to improve to achieve accreditation at the more advanced levels within the new Accord include: Time series data on defaults Loss information and meeting the cycle adjustment requirements of Basel II. Enhancements to existing risk management systems Increased rigour in rating tool development, testing and validation to meet the more stringent requirements of Basel II. Improvements to data warehouses, data interrogation and back testing capabilities. Page 14

16 Extracting the business benefits from Basel II Better risk assessment Industry improvements in risk management infrastructure Actively encourage and support the shift to the new framework (eg use of Basel II by rating agencies) Consider impacts on the current business model Look for opportunities to grow Optimise capital structure Exploit pricing opportunities Seek out takeover opportunities Page 15

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