INTERNATIONAL REGULATION OF BANKING

Transcription

1 INTERNATIONAL REGULATION OF BANKING Basel II: Capital and Risk Requirements SIMON GLEESON OXFORD UNIVERSITY PRESS

2 CONTENTS SUMMARY Tables of Legislation xxiii List of Abbreviations v xxv I THE ELEMENTS OF BANK FINANCIAL SUPERVISION 1. Introduction to Banks and Banking 3 2. Why are Banks Supervised? International Bank Regulation The Bank Capital Calculation 43 II COMMERCIAL BANKING 5. Credit Risk The Standardized Approach Model Based Approaches to Risk Weighting The Internal Ratings Based Approach Netting, Collateral, and Credit Risk Mitigation 159 III INVESTMENT BANKING 10. The Trading Book Securities Underwriting Trading Book Models Credit Derivatives Counterparty Risk Counterparty Credit Risks for Derivatives, Securities Financing, and Long Settlement Exposures Securitization and Repackaging 239

3 Summary IV OTHER RISKS 17. Operational Risk Requirements Concentration and Large Exposures Liquidity 297 V BANK GROUP SUPERVISION 20. Group Supervision, Financial Conglomerates Cross-Border Supervision of Bank Groups Pillar Three Disclosure Requirements 349 Index 371

4 CONTENTS Tables of Legislation xxiii List of Abbreviations, xxv I THE ELEMENTS OF BANK FINANCIAL SUPERVISION 1. Introduction to Banks and Banking A. Banks Considered as Risk Takers 1.03 B. A Prototypical Bank 1.05 Business summary N 1.06 Risk analysis 1.11 Credit risk 1.20 Market and asset liquidity risks 1.26 Funding liquidity risk 1.33 Interest rate risk 1.35 Operational risk 1.36 Risk consolidation 1.38 Economic capital Why are Banks Supervised? A. Basis of Bank Supervision the Basel Principles 2.02 B. Capital Regulation 2.28 C. The Constraints on Bank Capital Regulation 2.33 D. The Quantum of Bank Capital Requirements 2.39 E. Did Risk Capital-based Regulation Fail in ? 2.40 Quantitative risk modelling and the crash 2.41 F. Market Crisis and Regulation 2.49 G. Protecting the Public from the Consequences of Bank Failure 2.53 Bank insolvency regimes International Bank Regulation A. The Basel Committee and the Basel Accord 3.01 B. Addressing Failures of Multinational Banks 3.09 XI

5 C. International Institutional Co-Operation in Bank Regulation The Bank Capital Calculation A. The Basic Bank Capital Calculation 4.01 B. What is Capital? 4.04 C. The Bank Capital Hierarchy 4.09 D. Capital Monitoring v 4.12 E. 'Gearing'Rules 4.14 F. The Components of Capital 4.16 G. Tier one 4.17 Issuance 4.19 Redeemability 4.20 Permanence 4.22 Power to defer payments 4.29 Loss absorption 4.30 Subordination 4.31 Moral hazard 4.32 Associate transactions 4.33 Reserves 4.34 Share premium account 4.37 Externally verified profits 4.38 Innovative tier one 4.39 Convertible and exchangeable instruments 4.44 Deductions from tier one 4.46 H. Tier two 4.49 Upper tier two 4.50 Lower tier two 4.51 Upper tier two requirements 4.53 Lower tier two requirements 4.61 Provisioning and expected loss 4.67 I. Deductions 4.79 Qualifying holdings (holdings in non-financial undertakings) 4.79 Material holdings (holdings infinancialundertakings) 4.82 Connected lending of a capital nature 4.87 Expected losses and other negative amounts 4.89 Securitization positions 4.90 J. Tier three 4.92 Upper tier three 4.93 Lower tier three 4.94 Deductions from tier three 4.95 xn

6 K. Capital Arising from Revaluation of Assets 4.96 L. Deductions for Investment Firms 4.99 M. Bank Capital Resources Summary Table Credit Risk II COMMERCIAL BANKING A. Background v 5.01 B. Risk Weighting of Assets 5.04 C. The Basel Approaches 5.06 D. Valuation of Exposures 5.13 E. Mark to Market 5.16 Financial assets at fair value through profit or loss 5.17 Available-for-salefinancialassets 5.20 Loans and receivables 5.21 Held-to-maturity investments other than loans and receivables The Standardized Approach A. Classification of Exposures, Credit Conversion Factors, and Credit Risk Mitigation 6.03 B. Ratings and Rating Agencies 6.04 C. Exposures to Sovereigns 6.13 Regional governments or local authorities 6.16 Public sector entities 6.19 Multilateral Development Banks (MDBs) 6.20 D. Exposures to Banks and Financial Institutions 6.21 E. Exposures to Corporates 6.25 F. Exposures to Retail Customers 6.28 Retail mortgage lending 6.29 G. Commercial Mortgage Exposures 6.34 H. Overdue Undefaulted Exposures 6.36 I. High-Risk Exposures 6.37 J. Covered Bonds 6.38 K. Securitization Exposures 6.42 What is a securitization? 6.44 Tranching 6.45 Performance dependent payment 6.46 XHl

7 Subordination Securitization and the specialized lending regime Weighting of securitization positions standardized approach Asset backed commercial paper L. Short-Term Claims on Financial Institutions and Corporates M.Fund Exposures N. Other Assets O. Off-Balance Sheet Items 7. Model Based Approaches to Risk Weighting A. Introduction to the Basel Risk Model B. VaR and the Basel Framework C. The Basic Basel Formula Maturity adjustment Default tail Consequences D. Putting It All Together E. The Retail Exposures Formula F. Translating between Capital Requirements and Risk Weightings G. Model Types H. Illustrative Risk Weights I. Modelling in Practice J. Variations in Credit Risk Weightings between Firms K. Inputs and Outputs The 'use' test The meaning of default Validation of PD estimates Loss given default Exposure at default L. Becoming an IRB Firm Eligibility for the IRB approach Corporate governance 8. The Internal Ratings Based Approach A. Corporate, Sovereign, and Bank Exposures PD LGD XIV

8 B. Exposure at Default 8.23 Netting and EAD 8.31 Commitments -when should a CF/EAD be applied? 8.33 Maturity 8.37 C. Specialized Lending 8.40 D. Retail and Mortgage Exposures 8.46 Retail exposures 8.46 Specialized retail exposures 8.50 Default in the retail portfolio > E. Eligible Purchased Receivables 8.57 F. Equity Exposures 8.60 The simple risk weight approach for equity 8.67 The PD/LGD approach for equity 8.70 The internal models approach for equity ^ Netting, Collateral, and Credit Risk Mitigation A. Introduction 9.01 B. Netting 9.04 On balance sheet netting 9.06 Offbalance sheet netting and master netting agreements 9.08 C. Collateral 9.13 The simple approach 9.14 The comprehensive approach 9.17 Haircuts 9.21 Secured lending transactions 9.24 Government repo market concession 9.26 D. Unfunded Credit Protection 9.29 Effect of unfunded credit protection 9.32 Multiple default credit derivatives The Trading Book III INVESTMENT BANKING A. Introduction B. Trading and Market Exposures Position risk requirement Interest rate PRR Position netting Notional legs Specific risk General market risk xv

9 C. Equity PRR and Basic Interest Rate PRR for Equity Derivatives Standard equity method Standard equity model specific risk Standard equity method general market risk Simplified equity interest rate PRR D. Commodity PRR The simplified approach The maturity ladder approach The extended maturity ladder approach E. Foreign Currency PRR F. Option PRR The option standard method Options on funds G. Annex A Guide to Option Terminology Securities Underwriting 12. Trading Book Models A.'CADI'Models B. VaR Models C. The Multiplication Factor Credit Derivatives A. Introduction B. Notional Positions C. Recognition of Risk Reduction Counterparty Risk A. Introduction B. Credit Derivatives C. Collateral in the Trading Book D. Double Default in the Trading Book E. Rules Common to Banking and Trading Books Unsettled transactions Free deliveries xvi

10 15. Counterparty Credit Risk for Derivatives, Securities Financing, and Long Settlement Exposures A. Introduction B. Calculating Exposures C. The Mark to Market Method PFE calculation Netting within the mark to market method D. The Standardized Method v E. Credit Risk Exposure Calculation F. The CCR Internal Model Method Contractual netting within the CCR regime CCR models and securities financing transactions 16. Securitization and Repackaging A. Introduction B. What is a Securitization? C. True Sale and Derecognition of Assets 'Derecognition' for synthetic securitizations Implicit support, or 'de-derecognition' D. Risk Weighting of Securitization Exposures E. Weighting Holdings of Securitization Positions the Standardized Approach Liquidity facilities, F. The IRB Approach The ratings based approach The supervisory formula approach TheABCPIAA { G. Revolving Credit Securitizations Treatment of the originator's share Operational Risk Requirements IV OTHER RISKS A. Operational Risk B. The Basic Indicator Approach C. Standard and Advanced Measurement Approaches Criteria for Use xvn

11 D. The Standardized Approach The Charge E. Advanced Measurement Approach The Charge F. Corporate Governance and Operational Risk Concentration and Large Exposures A. The Large Exposures Regime B. Exposure v C. Counterparty Connected counterparties Total exposure D. Exposure Limits Parental guarantees Collateralization Advanced IRB firms Treasury concession Intra-group securitiesfinancingtransactions National integrated groups The UK Integrated Group Liquidity A. Liquidity Supervision B. Qualitative Supervision of Liquidity C. Quantitative Supervision of Liquidity 'Global concession' policy Liquidity assessment D. Mismatch Liquidity Inflows and outflows Committed facilities available to the bank Marketable assets E. Sterling Stock Liquidity 'Net wholesale sterling outflow' Sterling retail deposits Sterling liquid assets V BANK GROUP SUPERVISION 20. Group Supervision A. Introduction B. Consolidated Supervision C. Scope of Consolidation xviii

12 D. Minority Interests E. Solo Consolidation F. Consolidated Capital G. Consolidated Capital Resources Requirements Operational risk Advanced IRB approaches Large exposures Financial Conglomerates " " " A. Issues with Conglomerates Double or multiple gearing Debt downstreamed as equity Unregulated intermediate holding companies Unregulated entities engaged infinancialbusiness Participations and minority interests in regulated entities B. Banks in Non-Financial Groups C. Mixed-Activity Groups D. Methods of Regulating Financial Conglomerates Method Method Method Method E. Consolidating Unconnected Entities F. Groups Headquartered Outside the EU Cross-Border Supervision of Bank Groups A. International Group Supervision B. EU Group Supervision \ Pillar Three Disclosure Requirements A. Introduction B. Scope of the Pillar Three Regime C. Basic Requirements D. Capital Structure xrx

13 E. Capital Adequacy F. Credit Risk: General Disclosures for All Banks G. Credit Risk: Disclosure for Portfolio Subject to the Standardized Approach and Supervisory Risk Weights v in the IRB Approaches H. Credit Risk: Disclosures for Portfolio Subject to IRB Approaches I. Credit Risk Mitigation: Disclosures for Standardized and IRB Approaches J. General Disclosure for Exposures Related to Counterparty Credit Risk K. Securitization: Disclosure for Standardized and IRB Approaches L. Market Risk: Disclosures for Banks using the Standardized Approach M. Market Risk: Disclosures for Banks using the Internal Models Approach (IMA) for Trading Portfolios N. Operational Risk XX

14 O. Equities: Disclosures for Banking Book Positions P. Interest Rate Risk in the Banking Book Index 371 xxi