Category Archive

A newsletter out from the Basel Committee gives some information on the progress towards implementation globally, but, to be honest, it pulls all its punches. It just gives broad information on where most of the countries implementing the Accord are - and does not give any specific information on those that are failing or even giving any concern. On the progress front it is a bit of wasted space.

The interest is in the bits on the new workstreams. Read the rest of this entry »

It is confirmed that APRA are seeking to impose a doubling of the minimum capital required for home loans - the banks have all received their letters confirming this over the last couple of days. This will mean two things - a home loan will be both more expensive and difficult to get in Australia.

As background (and without getting too technical) the amount of capital (the safety margin, in a way) that a bank is required to keep against any lending it makes is calculated based on past losses and the current economic situation. The ‘LGD’ is one of the factors in there. Double one of the factors and the safety margin doubles with it. This safety margin costs the bank money - so this is passed on in the form of increased interest charges on the home loan. Read the rest of this entry »

I have heard an ugly rumour that APRA is imposing a 20% LGD floor for residential mortgages, rather than the Basel II mandated 10%. Has anyone heard anything on this? If so, this represents a significant new burden on the banks - and one unjustified by the models or records.

Note to home borrowers as well - this will probably make our mortgages more expensive than they otherwise would be.

First of all: an apology. There seems to be a lot of posts recently on the US implementation of Basel II (or Basel IA or Basel I). This is largely because in Australia we have a few things going well - the regulator is progressing well on implementation, the banks know what the rules are and either are very busy putting them in to practice or have done so and are now refining then and the market is well informed.

This is not the case in the US. Even the basic rules are not yet clear, as a speech by Ben Bernanke has made clear. The US has consistently proposed (to the combined, at best, polite comment and, at worst, outright derision of fellow regulators) that Basel II needed another layer of conservatism - a layer that is not risk sensitive.

Bernanke’s speech has now thrown that, as well as whether their “Basel IA” rules up in the air. Essentially, he is saying that the US regulators will now review whether those additional rules make sense (note to the Fed, they do not) and therefore whether they should drop them.

The so called “Basel IA” rules are also under re-consideration for at least the smallest banks. Apparently, they may be too complex for the very smallest to implement, so they should be allowed to remain under Basel I.

The ”Basel IA” (I use inverted commas as they are a US formulation, not a Basel Committee formulation) are essentially dumbed-down Basel II standardised rules. In Australia, even the smallest ADI is using Basel II (the standardised approach). I cannot see why an Australian ADI can do it and a US one cannot.

Maybe we are getting some sense from the US regulators, at long last - but it comes too late and is going to introduce more uncertainty into the US implementation. The sooner they can get this sorted oout, the better. About 3 years ago would have been right.

[UPDATE]Looks like Sheila Bair at the FDIC is fighting back - at the ABA convention in Phoenix yesterday she is reported to have said that the leverage ratio “would ensure a minimum cushion of capital for safety-and-soundness throughout the global banking system”.
Looks like we are in for a nice little stoush. Arguments in bank regulation - always good fun. Lets see who wins.[/UPDATE]

[UPDATE 2]Ben Bernanke fights back! This just gets better. On the linked speech, look at the 6th and 7th paragraph on the section on bank capital (the section is on page 2, with those paras on page 3). Bernanke’s focus is on what is “…likely to add to implementation costs and home-host issues…” rather than Bair’s emphasis on “…safety-and-soundness…”.

I would like to be a fly on the wall when they next meet.[/UPDATE2]

Just in case your printers have not finished printing out the November 2005 update to the accord, you can now save the expense of printing it out. The BCBS have now released a consolidated version of the new Accord.

At 347 pages we are now comfortably more than 11 times the length of the original accord, so make sure you have a new ream of paper in your printer and try to double side it, please. Your shareholders will notice the difference in the dividends.

Here is the BCBS’s summary of their latest publication:

This document is a compilation of the June 2004 Basel II Framework, the elements of the 1988 Accord that were not revised during the Basel II process, the 1996 Amendment to the Capital Accord to Incorporate Market Risks, and the November 2005 paper on Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework. No new elements have been introduced in this compilation.

The BIS seems pretty happy that the various QIS have given them a correct result, with the scaling factor remaining at 1.06. This was the expected result, but I do not think the Americans will derive much comfort from it and they are likely to maintain their cautious approach to capital reductions under the new Accord

A lot of work over the last few years has gone into the practical applications of the advanced methodologies for Basel II compliance. This is logical, as most of the work that has needed to be done up front has been in developing the credit and operational risk models for the larger institutions.

I believe though, that the time has come for some serious work to be done on the standardised approaches. Banks in the more advanced jurisdictions should not have too much trouble complying with the standarised method for credit risk (except perhaps in collateral management) and the market risk also gives little cause for worry.

Operational risk, where the Sound Principals will have to be implemented, will be a bit more work than the credit or market changes. This will require the development and implementation of whole new systems and processes for every bank. I will be posting more on this area over the next few weeks. In the meantime, feel free to give me a few war stories or let me know where you think the main effort will be.

There was a revised version of the Accord released on 15 November 2005. The revised version is available from the BIS website.
This is acting to add in the double defaults paper released in July and also to make some other changes related to market risk. There are also detail changes throughout the document.
 

Pillar 1
The changes incorporated may be important if you are dealing with credit risk mitigation techniques including the use of guarantees and / or VaR modelling (particularly as it relates to repos).
The new paras 284(i) to (iii), 307(i) and (ii) and 435 (i)  incorporate the main changes relating to commercial banks, with credit derivative treatment varied by the changes to 689. The trading / VaR changes are more spread out, but 687(i) and (ii) may be of particular interest.
Para 710 on government-traded paper under standardised has also changed, but the changes do not look large in an Australian context; AAA to AA- minus paper is still zero rated.
 

Pillar 2
Paras 738 and 778, relating to market risk, have been greatly expanded, adding in a lot more on stress testing and VaR use. Para 772 has been slightly changed and 777 has had major changes, both relating to credit and counterparty risk. There does not appear to be any other changes of any substance.
 

Pillar 3
There is a new table 8 in para 826 for disclosures relating to counterparty credit risk and some detail changes relating to the market risk disclosures in the old table 10 (now table 11), but no further changes of any substance.
 

Note 
My compare algorithm was getting a bit confused towards the end of the document, so this analysis should be treated as preliminary.