The Role of Basel 2 Schemes in International Banking

8/12/2019 The Role of Basel 2 Schemes in International Banking

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InternationalBanking Finance


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GROUP NO. - 1

SEMESTER NO. - 5


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Introduction

Basel II

Objectives:-Capital Allocation

Disclosure Requirements

Credit Risk, Operational Risk & Market RiskEconomic & Regulatory Capital


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The Accord in Operation:-

Pillar I- Minimum Capital Requirements

Pillar II- Supervisory Review Process

Pillar III- Market Discipline


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Basel II-Strengths & Weaknesses

Strengths

WeaknessesImprovement over existing accord; addresses capital

arbitrage that were prevalent under Basel I Major banking risks not reflected in Pillar One: interest

rate risk in the banking book, concentration risk,strategic business risk, reputation risk; structural

interest rate risk not covered by capital requirements,

but included in Pillar II.Brings regulatory capital closer to the concept of

underlying risk-based economic capital Differences in view of relative riskiness of certainbusiness lines: high-risk corporate, mortgage banking,consumer lending

Reinforces trends already firmly in place:- Scientific portfolio risk management, increasing

use of credit mitigators and risk transfer

techniques

Increased disclosure

Shift to retail, high quality corporate lending and

potentially SMEs

Underwriting then selling and trading corporate

risk (with more use of credit derivatives or CRMtechniques to hedge risk and free up economic

and regulatory capital)

Better pricing of risk for Specialized Lending (SL)-

disintermediation potential

Impact on securitization market and selling of

equity tranches or moving toward covered bonds

Pro-cyclicalitythe Basel II:-Framework may give rise to pro-cyclical effects due to

the fact that the three main components of the IRB

system are themselves influenced by cyclical

movements. In particular, the higher risk sensitivity of

banks ratings systems may lead to increases in

regulatory capital requirements in an economic

downturn. However, such concerns have been

addressed and pro- cyclicality has been significantlyreduced in the latest proposals for the Basel II

framework.

Banking industry already uses advanced credit riskmanagement Model risk looms large


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Basel II emphasizes the measurement and

management of key banking risks Heavy burden on regulatorsPillar I includes, credit risk, market risk and

operational Basel II is overly complex and still contains somefundamental flawsPillars II and III fortify Pillar I High implementation costsIncreased emphasis on stress testing is welcome Total capital ratio remains at 8%, although no

rationale has been provided for why the ratio is set at

this level, and there are no changes to the definition of

capital (although this is planned for review in both

Basel and EU forums between now and 2009).The philosophy of Basel IImore in tune with

industry:-

Pillar I embodies a more economic view of credit

risk

Pillar IIs guiding principles aligned

with our rating criteria

Pillar III emphasis on disclosure backs our call for

increased transparency

Newly calculated capital ratios under Basel II will be

difficult to compare among banks, unless extensivedisclosure is provided by banks.

However, even if disclosure were extensive, the

investor community may not have the expertise and

resources to analyze such complex data.

Basel II promotes modern and effective risk

management. Insufficient history for calculation of IRB variables maylead to wrong assumptions for LGD and othervariables in a recessionary scenario.

Base II reinforces a trend already in place for banks to

shift towards retail lending, given a more attractive

risk-return trade off.Large banking groups already use economic risk-

based capital approach.


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Key Approaches of Basel

II

1] The Standardized RatingsApproach

Table: - Summary of risk weights determined by credit ratings as

used in the Standardized Approach:-

Impact of the Standardized Approach


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2] The Internal Ratings Based (IRB)Approach

Equity exposures under IRB approach


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Basel II-Impact on Banks

Based on the workings of Basel II, we broadlyexpect the following banks to benefit from lowercapital requirements under BIS II:-

Highly sophisticated banks which already apply scientificportfolio risk management and use credit mitigation techniques

Banks with highly rated loan and securities portfolios

Banks with a strong retail and mortgage lending focus

Smaller, domestically oriented banks using the IRB approaches.

1] Impact on banks capital levels:-


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We see the following significant limitations to

assessing the impact of Basel II:-

Lack of sufficient public knowledge about banks portfolios and

their future risk-weightings, since this will also depend on

whether banks will use the standardized or IRB approaches.

Lack of precise knowledge as to how operational risk costs will

be charged. According to QIS 3, the results for the standardizedapproach were not significantly different from the results under

the advanced approach. However, the banks are expected to

benefit from sharpening up some aspects of their risk

management practices in preparation for the introduction of the

operational risk charge.

Lack of consistency, at least at this stage, as to how insuranceactivities will be accounted for. One treatment outlined in the

Capital Accord is that banks deduct equity and other regulatory

capital investments in insurance subsidiaries and significant

minority investments in insurance entities

An alternative to this treatment is to apply a risk weighting to

insurance investments.


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2] Market and spread impactBank Bonds:-


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3] Impact of Basel II on sovereign risk

weightings:-


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Conclusion


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Group MembersNames Roll Nos

OAdrian DCostaOHazel DSilvaOAnthony FernendesODave FernandesO Karen GonsalvesOJohann MisquittaOAditya Pinto

O 8206

O 8211

O 8218

O 8220

O 8224

O 8229

O 8235


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The Role of Basel 2 Schemes in International Banking

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