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Basel II Update

Dubrovnik, 27-28 May 2004

Charles FreelandDeputy Secretary General

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Future schedule

Mid-year 2004 Finalisation of new framework

2004-2005 National processes• Further testing/impact studies, to guide

national discretion choices• Legislation and national rule-making• Banks plan for implementation

End-2006 G10 implementation of simpler methodologies

End 2007 G10 implemention of advanced methods

2007-? Extended transition period for non-G10

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Parallel running and floors

2006 2007 2008 2009

Foundation IRB Parallel calculation

95% 90% 80%

Advanced approaches for credit and/or operational risk

Parallel calculation/ impact studies

Parallel calculation/ impact studies

90% 80%

The floor is expressed as a percentage of the bank's capital requirement under Basel I

There is a possibility that further testing (QIS) will result in the need for recalibration or a scaling factor

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IRB issues resolved this month

1. Securitisation simplified

– Same treatment for originating and investing banks

– Internal Assessment Approaches permitted

2. Credit cards resolved

– One single default correlation factor

– Treatment of securitised credit card receivables

3. Stress LGDs to be consulted on further

– One single calculation required

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The Madrid "breakthrough"

The BCBS had previously decided to calibrate IRB against expected plus unexpected losses (EL + UL)

The reason was essentially a lack of uniformity in national provisioning rules and accounting rules

In Madrid, the BCBS decided to respond to industry requests to calibrate IRB to UL only

In addition, a calculation of EL will be made by each IRB bank and the numerator of the ratio will be adjusted accordingly

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Adjustment to the numerator

General provisions will be removed from the numerator for IRB banks

EL will be compared with the sum of general plus specific provisions for the portfolios in question

If provisions < EL, the deficiency will be deducted 50% from Tier 1 and 50% from Tier 2

If provisions > EL, the excess will be added to Tier 2 (to a limit of 0-6% of risk-weighted assets at national discretion)

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Why did we correct EL/UL?

It is how the banks calibrate their IRB

The new proposal:

– Is conceptually purer

– Simplifies the framework

– Recognises different provisioning practices in different jurisdictions

Accountants continue to insist on "incurred losses“ but they acknowledge "experienced credit judgement"

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Position of non-BCBS/EU member countries

Australia, Hong Kong, Singapore and South Africa will be ready by 2006

Brazil, Chile, Malaysia, Mexico may be a bit slower

China and India have NOT rejected Basel II (their opinions are public)

China have already introduced Pillars 2 and 3 but will wait for an appropriate time to adopt Pillar 1

India is now introducing market risk and intends to adopt Basel II subject to some local adjustments

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Simple standardised approach (Annex 9)

Establish sovereign risk weights - assuming no external ratings, export credit agency scores established by the OECD are a sound alternative

Banks and regulated securities firms get one risk weight worse than the sovereign (i.e. 50% if sovereign is 20%)

New risk buckets for mortgages (35%) and retail (75%) 150% weighting band for past due loans Conversion factor for undrawn commitments up to one

year raised to 20% of principal (from zero) Operational risk charge (15% of gross income)

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OECD Export Credit classifications (April 2004)

0% (grade 1) "old" OECD members, Singapore, Taiwan

20% (grade 2) Chile, China, Czech Republic, Hong Kong SAR, Hungary, Malaysia, Poland, Slovenia

50% (grade 3) India, Israel, Mexico, Saudi Arabia, Slovakia, South Africa, Thailand

100% (grade 4) Bulgaria, Croatia, Romania, Russia,

100% (grade 5) Turkey

100% (grade 6) Brazil, Ukraine

150% (grade 7) Argentina, Bosnia, Macedonia, Nigeria, Pakistan, Venezuela, Serbia/Montenegro, Surinam

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Assistance for countries proposing to implement Basel II

BCBS has established an Accord Implementation Group

AIG has already conducted extensive fact-finding/ information-sharing

FSI is planning intensive training programmes (e-learning project)

IMF/WB technical assistance programmes

Private sector consultants

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"Practical considerations" circulated to supervisors (August 2003)

Basel II should not take precedence over other supervisory priorities such as the implementation of the Basel Core Principles

Countries need to decide soon what banks or set of banks should move to Basel II and when

Commence national legislative/regulatory processes

Strengthen supervisory resources and training

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High-level Principles for crossborder implementation (August 2003)

1. Legal responsibilities of supervisors will not change

2. The home supervisor of a banking group is responsible for oversight of implementation on a consolidated basis

3. Host supervisors, particularly of subsidiaries, have requirements that need to be understood and recognised

4. There will need to be enhanced cooperation between supervisors, led by the home supervisor

5. Where possible, supervisors should avoid performing uncoordinated approval and validation work

6. Supervisors should communicate the rules of home and host supervisors to banking groups operating in multiple jurisdictions

About 20 case studies now in train - if you have questions, contact the home supervisor not the bank

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The level playing field!

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Eligible capitalON-BALANCE-SHEET

CREDIT RISK+

Off-balance-sheet credit risk+

Market risk+

OPERATIONAL RISK

Four out of six parameters basically unchanged

= 8%

Pillar 1

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Pillar 1

Key changes:

Wider spectrum of credit risk weights

Greater recognition of collateral

More refined treatment of securitisation

Charge for operational risk introduced

Undrawn commitments weighted at 20% of principal

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1 Risk weighting based on risk weights of sovereign in which the bank is incorporated, but one category less favourable.

2 Risk weighting based on the assessment of the individual bank.3 Claims on banks of an original maturity of less than three months generally receive a weighting that is

one category more favourable than the usual risk weight on the bank’s claim.

Standardised Approach – Risk Weights

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Standardised ApproachRisk weights for individuals and corporates

Basel II

Risk Weight

Basel I

Risk Weight

Exposures (other than residential mortgages)

AAA, AA 20% 100%

A 50%

BBB, BB, unrated 100%

B, CCC and below, 90 days past due 150%

Non-mortgage performing retail:

Exposure below 1 million euros and (at discretion) less than 0.2% of total non-mortgage retail portfolio of the bank

75%

Residential mortgages

Performing 35% 50%

90 days past due 100%

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0

10

20

30

40

50

AAA AA A+ A- BBB BB+ BB- B CCC

Default

Historical Default Rates

Main reason for using ECAIs: increases the risk sensitivity

High correlation between ratings and default rates

S&Ps PD over 5-year horizon

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Capital charge for corporates under SA and IRB

048

1216202428

Probability of default

Capitalcharge

%

IRB (C&I)

SA

8% (current Accord)

Capital Charge under SA versus other measures

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Operational risk

Basic indicator (15% of average gross income over 3 years)

Standardised approach (based on separate scaling factors for gross income from defined business lines) between 12% and 18% of gross income

A range of advanced methods based on loss experience, subject to addition risk control criteria

Op risk is growing, both from unexpected external events and internal problems (ie “friendly fire”)

Choice of three approaches proposed:

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Pillars 2 and 3

Critical to the “balance” of the proposal

Pillar 2 (Supervisory review) includes attention to risk management generally, including:

– Concentration risk

– Interest rate risk

– Collateral management risk

Pillar 3 (disclosure) is designed to enforce market discipline

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The challenge for banks and supervisors

Initial phase

– Determine approach to be used

– Revise legislation/administrative guidance (e.g. EU Directives)

– Draw up reporting forms/guidance notes

– Train staff for implementation

Ongoing

– Activate Pillar 2

– Review standards for IRB banks

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What are the basic aims of Basel II?

To deliver a prudent amount of capital in relation to the risk that is run

To provide the right incentives for sound risk management

Basel II is not intended to be neutral between different banks/different exposures

However, there is a desire not to change the overall amount of capital in the system

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Keep an eye on BCBS website

www.bis.org/BCBS