FINANCIAL SERVICES RISK MANAGEMENT

Implications of Subprime Mortgage Crisis for Basel II Risk Models and the Potential Impact on Securitizations

Peter O. Davis December 11, 2007

IIB Seminar

Confidential – All Rights Reserved – Ernst & Young LLP 2007 2

Financial ServicesRisk ManagementCurrent Market Conditions

• Some estimates of losses related to US subprime assets now exceed $400 billion • Unprecedented level of downgrades of RMBS and CDO securities• Credit quality concerns has now spread to many other asset types

Confidential – All Rights Reserved – Ernst & Young LLP 2007 3

Financial ServicesRisk ManagementBasel II Capital Treatment of Securitizations

• For institutions using the Ratings Based Approach, the capital charges are rating and seniority driven, but are not specific to asset type

– As a result, impact of current credit crunch on regulatory capital will be driven by rating agencies

• For institutions using the Supervisory Formula Approach, banks will determine own internal inputs that entered into a supervisory formula

– Will require higher capital charges as own internal estimates of credit quality of underlying assets increases

• In addition to the Pillar I capital charges, the impact of the current credit conditions on financial institutions can also be expected to impact Pillar II capital adequacy assessment

• Regulatory attention being paid under Pillar 2’s ICAAP may also expand– For example, treatment of concentration risk regarding products, industries and geographic

regions etc are highlighted in the current environment credit crisis– Expectation of an Integrated credit/market risk stress testing scenario may result

• Scenario involving increasing delinquencies with contagion spreading to market liquidity