fsvc/central bank of libya seminar - january 2009 1 day 3 establishing a modern risk management...
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FSVC/Central Bank of Libya Seminar - January 2009
1
Day 3
Establishing a Modern Risk Management Department
Basel II and Bank Risk Management
Garrett R. Glass
FSVC/Central Bank of Libya Seminar - January 2009
2
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
Prepared by Garrett R. Glass
FSVC/Central Bank of Libya Seminar - January 2009
3
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach(1988)
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
6. Trading Book/Market Risk
(1996)
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
Basel I
FSVC/Central Bank of Libya Seminar - January 2009
4
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –StandardisedApproach
Notional Amountsx Risk Weights =Risk Assets
Investment BanksTreated Like Banks
Off-Balance-SheetAssets Get NewRisk Weights
AcceptableCollateralExpanded
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
5
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
3. Credit Risk –Internal-RatingsBased Approach
Calculate Probabil-ity of Default; LossGiven Default;Exposure at Default;Effective Maturity
New Risk Weightsand Parameters
Assets Now in 5Categories
Securitised AssetsProvide Deductions
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
6
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
4. SecuritisationFramework
New standardisedtable provides riskweights for most securities
Banks can useinternal measureswith approval
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
7
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
New capital chargebut excludes legaland reputation risk
Basic IndicatorApproach = 15%charge on grossannual income
Standardised Approach looks at8 businesses, and12% - 18% charge on income of thesebusinesses
Advanced Approachonly with approval
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
8
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
6. Trading Book/Market Risk
Book must havedaily MTM andS/T horizon
Position limits andliquidity controlsrequired
Mark to modelallowed if used prudently
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
9
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
Helps banksimprove riskmanagement
Captures risksand risk factors not in Pillar I(such asbusiness cycle effects)
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
10
BIS Capital Adequacy Framework – Basel II
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Judges qualityand type ofpublic informa-tion
Greater disclosure leadsto less capital
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
FSVC/Central Bank of Libya Seminar - January 2009
11
Challenges to Basel II from Credit Crisis
1. Tier 1, 2 and 3 Capital ratios were inadequate
2. Off-balance-sheet assets not counted correctly
3. Securitisation seen as a benefit, not a risk or cost
4. Liquidity risk not incorporated
5. Systemic risk not captured, measured or managed
FSVC/Central Bank of Libya Seminar - January 2009
12
Challenges to Basel II from Credit Crisis
6. Parallel banking structure not brought into system
(investment banks, securities firm, hedge funds,
private equity, insurance companies)
7. Mark to market leads to Ponzi finance (demand for
ever greater volumes of business to meet growth targets)
8. Mark to model abused:– Models too complex and opaque (black boxes)
– Over reliance on quantitative assumptions of market
behavior
– Data non-existent or limited
FSVC/Central Bank of Libya Seminar - January 2009
13
Challenges to Basel II from Credit Crisis
9. Monetary policy issues:
– No controls over growth in fiat currency (paper/electronic money); inflation was targeted but inflation measurements were altered, giving false impression of inflation risk
– U.S. eliminated M3– U.S. claimed it was impossible to identify or control asset bubbles
10. Reliance on public debt ratings to determine risk categories is questionable now that ratings agencies have shown that their rating system is flawed
FSVC/Central Bank of Libya Seminar - January 2009
14
Challenges to Basel II from Credit Crisis
11. Pro-cyclical banking culture as economy expands
_ Credit pricing and covenant standards weaken
_ Maturities are extended
_ Products become more complex and harder to value
_ Increased profitability leads to demands for higher growth
rates
_ Risk managers lose power to line managers
_ Regulators reduce their oversight and vigilance
_ Impossible to shut down a profitable but high/risk business
FSVC/Central Bank of Libya Seminar - January 2009
15
Areas of Basel II Framework Likely to be Revised
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk
6. Trading Book/Market Risk
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
Areas likely tobe revised
FSVC/Central Bank of Libya Seminar - January 2009
16
Areas of Basel II that Libyan Banks Can Implement
1. Defining Parent/Subs
2. Credit Risk –Standardised
Approach
3. Credit Risk –Internal-RatingsBased Approach
4. SecuritisationFramework
5. OperationalRisk –
Basic Indicatoror
StandardisedApproach
6. Trading Book/Market Risk
(1996 Accordonly)
SupervisoryReview
MarketDiscipline
Setting Minimum Capital Requirements
Pillar One Pillar Two Pillar Three
Libyan Central Bankmay implement Pillar IIOpinion of author only!