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Transcript of International Banking Regulation Manjunath
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INTERNATIONAL BANKING
REGULATION
Manjunath H. Mannapur
M.A-II
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•When banking systems weakened in the number of industrial countries in1980’s, there was a large pressure on developed countries to regulate banks.
• This was brought in the form of regulating the banks thus reducing the
likelihood of individual failures that could spread the adverse effects across
national boundaries and also because banks in different countries would notbenefit from any competitive advantages due to subsidies from their
governments, such as lower capital – ratios in an environment of implicit or
explicit deposit insurance or other government support.
Why International Banking
Regulation?
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• This regulation reflects the limited market discipline on banks in most
countries because of the existence of actual or speculative government
guarantees.
•Also, the greater difficulty in monitoring banks in non-home jurisdictionsby both private stakeholders and government regulators. This is particularly
true if the regulations differ significantly across jurisdictions.
• The international regulations would resemble domestic prudential
regulations, but taken into account any differences in institutional and legalstructures in different countries that, in particular, impact the quality of
regulatory supervision and private market discipline.
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History of Basel committee
• The Basel Committee on Banking Supervision (BCBS) was
established as the Committee on Banking Regulations and
Supervisory Practices by the central-bank Governors of the Group
of Ten countries at the end of 1974 in the aftermath of serious
disturbances in international currency and banking markets.
• The meeting took place in February 1975 and usually it meets four
times a year.
• Chairman: Stefan Ingves, Governor of Sveriges Riksbank .
• Secretary General :Wayne Byres, supported by a staff of 17
members.
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Basel committee members
Countries Institutions represented
Argentina Central bank of Argentina
Australia Reserve Bank of Australia
Australian Prudential Regulation Authority
Belgium National Bank of Belgium
Banking, Finance and Insurance Commission
Brazil Central Bank of Brazil
Canada Bank of Canada
Office of the Superintendent of Financial Institutions
China People’s Bank of China
China Banking Regulatory CommissionFrance Bank of France
Banking Commission
India Reserve Bank of India
Sweden Sveriges Riksbank
Finansinspecktionen
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Indonesia Bank of Indonesia
Italy Bank of Italy
Japan Bank of Japan
Financial services agency
Korea Bank of korea
Financial supervisory service
Luxembourg Surveillance commission for the financial sector
Mexico Bank of mexico
Comisio’n Nacional Bancaria Y De Valores
Netherlands The Netherlands bank
Russia Central bank of the Russian federation
Saudi Arabia Saudi Arabian monetary agency
Singapore Monetary authority of Singapore
South Africa South African reserve bank
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Germany Deutsche bundesbank
German financial supervisory authority(BAFin)
Hong Kong SAR Hong Kong Monetary Authority
Spain Bank of Spain
Switzerland Swiss National Bank
Swiss Federal Banking Commission
Turkey Central Bank of The Republic of Turkey
Banking Regulation and Supervision Agency
United Kingdom Bank of England
Financial Services Authority
United states Board of Governors of the Federal Reserve System
Federal Reserve Bank of New York
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation
Office of Thrift Supervision
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a) Operational Risk Subgroup - addresses issues related to Advanced
Measurement Approach for Operational Risk.
b) Task Force on Colleges - develops guidance on the Basel Committee's
work on supervisory colleges.
c) Task Force on Remuneration - promotes the adoption of sound
remuneration practices.
d) Standards Monitoring Procedures Task Force - develops procedures to
achieve greater effectiveness and consistency in standards monitoring and
implementation.
The Standards Implementation
Group(SIG)
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The Policy Development Group(PDG)
• Risk Management and Modeling Group - point of contact with the industry
on the latest advances in risk measurement and management.
• Research Task Force - facilitates economists from member institutions to
discuss research on financial stability in consultation with the academic
sector.
•Trading Book Group - reviews how risks in the trading book should becaptured by regulatory capital.
• Working Group on Liquidity - works on global standards for liquidity risk
management and regulation.
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• Definition of Capital Subgroup - reviews eligible capital instruments.
• Capital Monitoring Group - co-ordinates the expertise of national
supervisor in monitoring capital requirements.
• Cross-border Bank Resolution Group - compares the national policies,
legal frameworks and the allocation of responsibilities for the resolution of
banks with significant cross-border operations.
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The Accounting Task Force(ATF)
• Ensures that accounting and auditing standards help promote sound risk
management thereby maintaining the safety and soundness of the bankingsystem.
• Audit subgroup - explores key audit issues and co-ordinates with other
bodies to promote standards
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Functions
• The Committee provides a forum for regular cooperation on banking
supervisory matters. Over recent years, it has developed increasingly into a
standard-setting body on all aspects of banking supervision.
• Its objective is to enhance understanding of key supervisory issues and
improve the quality of banking supervision worldwide.
•This committee formulates broad supervisory standards and guidelines,recommends statements of best practice in banking supervision in the
expectation that member authorities and other nations' authorities will take
steps to implement them by directly committees’ recommendations or
through their own national laws and regulations
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• Also its regulations are not compulsory to be followed.
• It seeks to fulfill its objective in three principal ways:
by exchanging information on national supervisory arrangements;
by improving the effectiveness of techniques for supervising international
banking business and
by setting minimum supervisory standards in areas where they are
considered desirable.
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Basel Accords
• The Committee encourages convergence towards common approaches and
common standards without attempting detailed management of member
countries’ supervisory techniques.
• The BCBS proposed three agreements or accords (on the recommendations
on banking regulations) – BASEL I, BASEL II, BASEL III.
• The committee normally meets in Basel, Switzerland at the Bank for
International Settlements (secretariat).
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Basel I
• In 1988, The first round i.e. Basel I was created. Also known as 1988
Basel Accord.
• But was later on adopted by banks of G10 countries by end of 1992.
• Focused on credit risk.
• They were subsequently amended in 1996 (effective January 1, 1998) to
accommodate market risk alongside credit risk.
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• Assets of banks were classified and grouped in five categories according to
how risky they are.
• The five categories are risk weights of 0%, 10%, 20%, 50% and upto
100%.
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• All banks with international transactions are required to hold capital upto
8% under the risk weights.
• This framework has been progressively introduced in member countries of
G-10. Most other countries over 100, have also adopted the principles
prescribed under Basel I.
• The efficiency with which they are enforced varies, even within nations of
the Group of Ten.
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Basel II
• Basel II is the second of the Basel Accords which are recommendations on
banking laws and regulations issued by the BCBS.
• Initially published in June 2004, was planned to create an international
standard for banking regulators to control how much capital banks need to
put aside to guard against the types of financial and operational risks banks
face.
• Advocates of Basel II believed that such an international standard could
help protect the international financial system from the types of problems
that might arise when a major bank or a series of banks collapse.
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• This was achieved by setting up risk and capital management requirements
designed to ensure that a bank has adequate capital for the risk the bank
exposes itself to through its lending and investment practices.
•
i.e. the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall
economic stability.
• Basel II was not successfully implemented because of global financial
crisis that hit during 2008.
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• Basel II requires to hold 2% of common equity of risk weighted assets
• Basel II uses a ‘‘three Pillars’’ concept
Minimum capital requirements (addressing risk)[Pillar i]Supervisory review [Pillar ii]
Market discipline [Pillar iii]
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Pillar i
• Deals with maintenance of minimum capital which is calculated for three
major components of risk that a bank faces: credit risk, operational risk,
and market risk.
• Banks can choose from
Credit risk
• Standardized
approach• FoundationInternal RatingBasedApproach(IRBA)
• Advanced IRBA
Operational risk
• Basic Indicator
Approach (BIA)• Standardizedapproach(STA)
• AdvancedMeasurementApproach
Market risk
• VaR (Value at
Risk) approach
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• Credit risk is an investors risk of loss arising from a borrower who does
not make payments as promised (also called as default risk or counterparty
risk).
• Operational risk arises from execution of company’s business operations
or functions,
focuses on risk arising from the people, systems and process through which
a company operates. Included risks such as fraud risks, legal risk, physicalor environmental risk, etc.
• Market risk means the value of a portfolio (either an investment portfolio
or trading portfolio) will decrease due to change in value of market risk
factors,
the four standard market risk factors are: stock prices, interest rates, forex
rates and commodity prices.
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• Standardized approach: In this credit assessments was done external
agency for less sophisticated banks, more sophisticated banks used internal
rating based approach (IRB),
In IRB, banks were generally encouraged to improve their internal risk
management process.
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• where;
Probability of default – Likelihood that customers will default in the next
12 months.Exposure at default – Expected amount of exposure at the point of
default.
Loss given default – Likely financial loss associated with the default.
• Banks can use their internal estimates of borrower credit worthiness to
assess credit risk.
Overall the credit risk = Exposure at default X Probability of defaultX Loss given at default.
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Pillar ii
• Deals with supervisory review: where early supervision is encouraged by
giving them tools to measure risks of banks.
•
Supervisors should review & evaluate banks assessments and strategies forcalculating capital requirements.
• Supervisors should expect banks to operate above the minimum regulatory
capital ratios and should have the ability to require banks to hold more than
the required capital level and are expected to intervene when capital fallsbelow the required levels.
• This pillar also involves a set of principles to promote cooperation and
information exchange among supervisors or regulators.
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Pillar iii
• This Pillar complements the minimum capital requirements (Pillar i) and
supervisory review process (Pillar ii) by developing a transparency which
will allow the market participants to determine the capital adequacy of an
institution.
• The aim of Pillar iii is to allow market discipline to operate by requiring
institutions to disclose details on the scope of application, capital, risk
exposures, risk assessment processes and the capital adequacy of the
institution.
• It must be consistent with how the senior management including the board
assess and manage the risks of the institution.
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• When market participants have a sufficient understanding of a bank’s activities and the controls it has in place to manage its exposures, they are
better able to distinguish between banking organizations so that they can
reward those that manage their risks carefully and penalise those that do
not.
• Banks are forced to make disclosures twice a year about capital structure,
risk exposures and capital adequacy except qualitative disclosures
providing a summary of the general risk management objectives and
policies which can be made annually.
• Institutions are also required to create a formal policy on what will be
disclosed, controls around them along with the legalization and frequency
of these disclosures.
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Basel III
• It was developed in response to the deficiencies in financial regulationduring late 2000’s financial crises. Implementation expected by the end of 2012.
• Basel III strengthens bank capital requirements and introduces newregulatory requirements on bank liquidity and bank leverage.
• When using Basel II, where mortgage-backed securities, credit defaultswaps and other instruments had AAA ratings which were not properly
supervised or regulated by official agencies which proved to be bad creditrisks.
• Basel III will require banks to hold 4.5% of common equity of risk weighted assets.
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• Also introduces additional capital buffer .
• Mandatory capital conversion buffers of 2.5%.
• Discretionary countercyclical buffer, allowing national regulators torequire up to range of 0% to 2.5% of capital during periods of high creditgrowth.
• It also introduces minimum 3% leverage ratio and two required liquidityratios.
• The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash flows over 30 days.
• The Net Stable Funding Ratio requires the available amount of stablefunding to exceed the required amount of stable funding over a one-yearperiod of extended stress.
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International Banking Regulation
and India
• Indian banking has continually upgraded from the system of on-site
Annual Appraisal of the banks by the RBI followed in the 1970s
to the system of Annual Financial Review during the 1980s,
then on to the Annual Financial Inspection of stand-alone banks during the
1990s and further on to the consolidated supervision of financial
conglomerates so as to address the supervisory concerns on a group-wide
basis.
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• The Off-site Monitoring & Surveillance (OSMOS) of the banking system
was also introduced in 1995 as a part of the supervisory strategy of ongoing
supervision of the banks, so as to supplement the periodical full-scope on-
site bank examinations.
• The supervisory rating models CAMELS {i.e. Capital adequacy, Asset
quality, Management, Earnings, Liquidity & System and control} based on
crucial prudential parameters, were also developed by the RBI to provide a
summary view of the overall health of the banks.
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• The Prompt Corrective Action (PCA) Framework was put in place to
enable timely intervention in case of any incipient stress in a bank.
• The RBI has introduced risk-based supervision of the banks so as to move
away from transaction audit and to enable the modulation of the supervisory
efforts in tune with the risk profile of the banks and to achieve optimal
deployment of the scarce supervisory resources.
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• Also, the Board for Financial Supervision, constituted in 1994 under the
Chairmanship of the Governor, RBI led the transformation in the regulatory
and supervisory apparatus of the banking system.
• Limit on Inter-bank Exposures to reduce the ill-effects of inter-bank
exposures, in March 2007,RBI limited a bank’s inter-bank liabilities (IBL)
to twice its net worth.
• A higher IBL limit up to 300 per cent of the net worth was allowed for
banks whose CRAR was at least 25 % more than the minimum CRAR
(nine per cent) i.e., 11.25 %.
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• Regulation of NBFCs: The systemic significance of non-banking financial
institutions and hence, the need for their regulation, wherein the RBI Actwas amended to bring the non-banking financial institutions within the
regulatory domain of the Reserve Bank.
• Implementation of Basel II – Advanced Approaches: RBI have announced
a timetable for the gradual and calibrated adoption of advanced approachesof the Basel II Accord by the banks in India. The challenges include the
absence of long-enough history of economic/business cycles.
• Also, using past data may not be appropriate in cases where the sector has
undergone structural transformation.
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• Another issue with regard to adoption of the advanced approaches is the
possibility that the risk weights assigned to employment-intensive retailand SME sectors may increase in certain circumstances, which may
obstruct the credit flow to these sectors or make it costlier.
• Thus there is a need to develop an appropriate risk mitigants for the
borrowers of these sectors on the basis of which lower risk weights couldbe assigned in order to ensure continued flow of credit to them.
• Credit Rating: There is an urgent need to ensure accuracy and reliability of
credit ratings assigned by the rating agencies. The RBI has recently
completed a detailed process of review of the accredited credit ratingsagencies for their continued accreditation under Basel II.
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• RBI is liaisoning with Securities Exchange Board of India (SEBI) with
regard to credit ratings agencies adherence to the IOSCO (International
Organisation of Securities Commission) Code of Conduct Fundamentals.
• The issue of strengthening the regulation of credit ratings agencies is under
the consideration of the HLCCFM (High Level Co-ordination Committee
on Financial and Capital Markets ).
• Risk Management Capabilities (HR and IT Issues): In the future, banks
would need to upgrade their infrastructure, including human resources, to
face the growing complexity of risk management.
• Apart from traditional risks such as credit risk, market risk and operational
risk, new genre of risks including reputation risk, liquidity risk,counterparty credit risk, and model risk have emerged on the horizon,
management of which obviously requires skills of a higher order.
• These issues are engaging the attention of the stakeholders of the Indian
banking industry.
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References'
• History of the Basel Committee and its Membership (August 2009)
(www.bis.org/bcbs/history.pdf ).
• The Evolution of Banking Regulation in India – A Retrospect on Some Aspects (http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/81434.pdf ).
•INTERNATIONAL BANKING REGULATION, Maximilian J.B. Hall andGeorge G. Kaufman
(www.luc.edu/faculty/.../InternationalBankingRegulation7-12-02.doc).
• Fact sheet - Basel Committee on Banking Supervision.
• INDIAN PERSPECTIVE ON BANKING REGULATION.pdf, address byMrs. Usha Thorat, Deputy Governor, Reserve Bank of India, at the
International Conference on “Financial Sector Regulation and Reforms in AsianEmerging Markets” on February 8, 2010.
• http://www.investopedia.com/