Central Bank of the Republic of TurkeyImplementation, Compliance and Rating Agencies16-18 May 2005, Istanbul

Frederik C. MuschChairman, Global Financial Services Regulatory Practice

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• Basel II about risk management

• Standardised approach

Most banks for long time still:

Many if not all in emerging markets

Many smaller institutions in G-10

Many IRB in beginning still standardized

Some institutions for selected businesses cannot apply IRB uniformity

• Regulators: IRB for all sizes of banks

Little attention so far for standardized approach

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Reasons for change Basel I to Basel II-  Arbitrage: misunderstood-  OECD (including Turkey)-  US banks focusing on risk

After LDC debt crisis in 1987

Real estate debacle early 90’s

Unexpected loss of economic capital

Introduction of ratings – internal

For risk, pricing, control, earnings, capital / risk - At same time financial world much more complex

 Structured finance: prominent role rating agencies

 

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Hence IRB A-IRB approaches

But how standardized approach ?

Solution: external ratings / rating agencies

Risk element in standardized 

- Claims on corporates: Unrated 100%

First incentive: one of many

Unrated clients: too high – banks distressed from lending

Too low – suffering from easy money

Unrated lower risk-weight than loans to companies rated B and below

April 19, 2023Page 5

PricewaterhouseCoopers Source: PricewaterhouseCoopers’ analysis

Table 1 The standardised approach risk weightings

 Claim

 Assessment

     AAA to

AA-

 A+ to A-

 BBB+ to

BBB-

 BB+ to B-

 Below B-

 Unrated

Sovereigns (if export credit agencies

  0%(1)

20%(2)

50%(3)

100%(4-6)

150%(7)

100%

Banks Option 11   20% 50% 100% 100% 150% 100%

Option 22   20%(20%)3

50%(20%)3

50%(20%)3

100%(50%)3

150%(150%)3

50%(20%)3

Corporates   (20%) (50%) (100%) BB+ to BB-100%

BelowBB-

150%

 

100%

1 Risk weighting based on risk weighting of sovereign in which the bank is incorporated (but one category is less favourable)2 Risk weighting based on the assessment of the individual bank3 Claims on banks of a short original maturity, lass than three months, would generally receive a weighting that is one category more favourable than the usual risk weight on the bank’s claim

The Standardised approach risk weightings

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Faced with this choice, banks will choose lending to unrated

Impact to be settled

Recognised Rating agencies

ECAI status will be conferred by domestic regulators

Issues of applicability

For banks which operate internationally

AIG will have to play big role here

CESR recognition

Lack of rating agencies and ratings

Issue from beginning

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So far: Moody’s, Standard & Poors, Fitch

Not well spread over countries

Many countries 2% corporates rated – lack of default data

-Reputation rating agencies

-Performance rating agencies

Example

Germany: few corporates have ratings

Implementation Issues Standardized Approach

Approach based on set of defined categories and external ratings

Need to map this framework across own business

 

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Principle challenges DataThe wider process

Opportunity to review and formalise the wider credit risk management function

Go further to ensure calculations element of coherent risk management function

 Good foundation for next IRB approach

- Systems to support new process

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Conclusion:

- Vast numbers of smaller banks using a risk-sensitive system

- Cruder than IRB approach

 Still revolution for many institutions

- Opportunity to align risk with business objectives

Rating agencies

Encouragement for new rating agencies ?

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Thresholds: Reliability Record of several years Rating agencies do affiliationsor banks start own rating agency

Danger: better ratings than banks want to lend on

Tension + conflict of interest

Issue: higher requirements emerging markets

Many emerging market regulators:

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Standardized approach e.g 10% (8%) Basel I

Supported by rating agencies views on emerging market debt

Banks believe 10% not sensible on Pillar I

PwC Impact Study for EU Commission

Aim New Accord create a risk management continuum

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Average change in minimum capital requirements (incl. credit and operational risk)

1,98%

-2,10%-3,24%

1,91%

-14,68%

-34,22%

1,92%

-6,86%-8,74%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

SA FIRB AIRB

Group 1 Group 2 Likely

Source: QIS3, EU Commission analysis

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Expected capital changes by country

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%Austria Belgium France Germany Greece Netherlands Portugal Spain UK

Credit Risk Operational Risk Total

Source: QIS3 country reports, EU Commission analysis, PricewaterhouseCoopers analysis

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Expected Change in Risk Weighted Assets for SMEs

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%Austria Belgium France Germany Greece Netherlands Portugal Spain Sweden UK

Standardised FIRB

Source: QIS3 country reports, PricewaterhouseCoopers’ analysis

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Likely beneficiariesBeneficiary

Country Retail SME Corporate Overall

Austria € € Either €Belgium Either Either

Denmark € Either

Finland France € € Either €Germany € € €Greece Ireland Either € € Either

Italy € € Either €Luxembourg Either € € Either

Netherlands € Either Either Either

Portugal € Spain € Either Either

Sweden € € Either Either

United Kingdom € Either € €

Source: PricewaterhouseCoopers’ analysis

€ Customer Bank

April 19, 2023Page 16

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Encourage to move along Risk continuum

 Better grip on Credit portfolios

 Better pricing In tune with complex

products (derivatives etc)

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Key Question for Turkey

Gradual evolvement

Or directly to latest technology

Baumol on competition and innovation

“Innovation is the central feature that drives the market process, more than competition”

 And

“Innovation comes mostly from existing companies”

April 19, 2023Page 18

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Basel II is not necessarily the driving force behind risk management and corporate governance improvements

Credit risk

 5C’sCharacter – reputation of firmCapital - (leverage)Capacity – (volatility of earnings)CollateralCycle – (especially for cycle dependent industries)

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Towards internal ratings

All in transition at various levels

Much is not there:Economic capital

Only 10% of the interviewed by PwC regarded their approach to economic capital as fully developed and operational

Corporate governance:

From our questionnaire together with EIU:

Banks uncertain how to improve own standards of disclosure and governance

Sarbox to be only ticking the boxes

Does not reflect quality of controls

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-

Increasing complexity of systems worldwide

Further standards the only way out

The Challenge of Compliance

Financial institutions face a major challenge

Sheer complexity of regulatory environment

At same time corporate reporting structures continue to be very much fragmented

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Where do financial institutions stand ?

PwC Compliance Study

+ 8th Annual CEO survey

1. Regulators increasingly focusing on role and responsibility of compliance function

2. Compliance office has developed significantly over last 3 years

Moving from enforcement towards trusted adviser

Increasing independence of compliance function

3. Interesting : Organisations have made minimal efforts in the compliance area until forced by regulatory requirements

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4. Expectations industry and regulators have of each other:

Both need to firm up on their understanding of ‘compliance risk’

Internally and across borders

Many regulatory / market changes

IAS, Corporate Governance, Value Reporting / Corporate Reporting, Cost of capital / Economic Capital – Pillar II Basel II, and the many in the securities and Insurance industry: examples

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Advisable to look for adding value from it as a wider agenda:

Key = Recognition of strong impact on fundamentals

Recognition of interactions / linkages

Among implementation projects

Requires financial institutions to re-orientate

PwC started many joint projects with clients

Not just a technical challenge

It is a management challenge

In fact, two to one CEO’s prefer to see compliance as an investment rather than a cost

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CONCLUSION

Aim to make business and strategy more risk-sensitive

Banks and regulators start to “behave” in more risk aware fashion

Take wide perspective

Innovation step by step