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I have been away from the purely banking risk area for a little while, so I had dropped my regular visits to the BIS website. Having headed over there for some stats recently I noticed how much they had beefed up their coverage.

A few interesting things have also appeared.

Deposit Insurance

The CP on deposit insurance that they issued in March has been updated into a full set of recommendations – the paper is here. Regular readers would know my opinion on deposit insurance, but in general the principles in this paper are sound. A worthwhile note is on page one:

The introduction or the reform of a deposit insurance system can be more successful when a country’s banking system is healthy and its institutional environment is sound. In order to be credible, and to avoid distortions that may result in moral hazard, a deposit insurance system needs to be part of a well-constructed financial system safety net, properly designed and well implemented. A financial safety net usually includes prudential regulation and supervision, a lender of last resort and deposit insurance. The distribution of powers and responsibilities between the financial safety-net participants is a matter of public policy choice and individual country circumstances.

Advice to our PM and Treasurer – do not do this in a hurry and in a poorly thought out manner. Nuff said.

Basel II Changes

Pillar I

The latest tweaks to the main Basel framework seem to be trying to do a little stable-door shutting on securitisation – with a fair bit of language added around understanding the risks and a few risk weights being increased.

Pillar II

The language of the amendments to Pillar II is also interesting – this places a large amount of emphasis on improved risk management at the banks, including reporting structures, concentration management and, in particular, the off-balance sheet stuff.

One recommendation in particular is interesting – the separation of the CRO’s office out of the business lines to report directly to the CEO and Board (pillar II amendments – 19).


This one is also good (pillar II, para 40):

A bank should conduct analyses of the underlying risks when investing in the structured products and must not solely rely on the external credit ratings assigned to securitisation exposures by the CRAs [credit ratings agencies]. A bank should be aware that external ratings are a useful starting point for credit analysis, but are no substitute for full and proper understanding of the underlying risk, especially where ratings for certain asset classes have a short history or have been shown to be volatile. Moreover, a bank also should conduct credit analysis of the securitisation exposure at acquisition and on an ongoing basis. It should also have in place the necessary quantitative tools, valuation models and stress tests of sufficient sophistication to reliably assess all relevant risks.

I would agree – but it should not take a regulator to tell a bank this. I wonder who is going to pay for all the extra analysts – or will banks just walk away from this market?
The whole document is worth a close read and I should get around to it soon. From my scan, though, I cannot see it having a significant impact in Australia. APRA was already doing most of this – but the changes to securitisation may cause some heartache amongst those institutions that rely on them, such as many credit unions and other smaller ADIs. I would be looking to the specialist mortgage providers and the bigger banks to benefit from these.


As expected, as well, the BCBS has boosted its look at liquidity – with almost as many mentions in the 41 pages of this as in the 400 of the Accord itself. Given much of the problems (like those at Northern Rock) at least started as liquidity issues this is not surprising. The language looks mostly drawn from the relevant Sound Practices document, but this incorporates it into the Accord itself. Again – not much to see here, as much of this is already in the relevant Australian liquidity regulation, and APRA is well across this.

Stress Testing

Brand new is a whole two pages on stress testing. As I highlighted nearly three years ago in one of the perennial favourite blog posts here – the original accord had little to say on the subject beyond telling you that it had to be done. The two pages here go some of the way to addressing that gap, but not nearly all the way. They are obviously leaving the wording fairly general here and leaving it up to national regulators still.

Pillar III

Much of this is focussed (as can be expected) on improving disclosure around the areas that have caused problems recently. Almost all of the changes to Pillar III are about increasing disclosure of securitisation exposures – with some consequential changes to the CRM stuff. None of this should cause any banks to sweat too much – these sorts of numbers have been demanded of the banks by the regulators for a while. It is just publishing the disclosures rather than sending them to the regulators.

Wrap Up

All of these comments, though, are fairly preliminary. I will need to go through this in a bit more detail and give it some thought. If I have missed anything, feel free to point it out in comments.

The new paper from the BIS on stress testing looks to be an important one. I have not had a chance to go over it in detail yet, but if you are in this area it is one you should read urgently. I would also add that much of this is likely to be incorporated in the next version of the Accord.

I will put together some comments on it over the next week as time allows.

One question I get asked about reasonably regularly (or at least I did while anyone was doing any more than firefighting) is “What’s next?”. Where are we going next with global bank regulation?

Having had a good look at the recent problems, I would have thought the answer is fairly obvious. Basel II said a lot about capital minima and regulatory oversight of them, but precious little about liquidity. If we assume that the magic number is still 8 I can see little more that can be done in terms of capital – the calculation of capital for the Advanced banks is pretty much a done deal and there is enough flexibility to accomodate many changes to the calculation1 methodologies used.

The only other real scope for change I see is the way the ratings agencies’ ratings are used in the calculation of the Standardised methods – but I cannot see this as being any more than tinkering around the edges.

The major changes, then, are likely to affect the way that liquidity is measured. Other than abandoning fractional reserve entirely2, what suggestions would everyone make for the way that liquidity should be measured and enforced3?  The regulators are currently thinking of how to go about putting together a global scheme. Let’s see if we can come up with a workable methodology. If you like the one used in any particular jurisdiction, feel free to link to it.

Personally, I think the Australian method is not too bad, with a “Standardised” method of calculating it using holdings of certain, defined, “highly liquid” assets (in this case with a magic number of nine), or and “Advanced” method using modelling at the discretion of the regulator. It largely mirrors a Basel II-type framework, and allows for innovation at the same time.


1. Although it is in no way perfect.
2. You know who I am talking about.
3. I should add that it is my personal belief that this should be left alone, but I do not think this is a realistic option at this point.

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.

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