14 Sep 2006, Katherine Fluke, Operational Risk & Regulation
“We would love it if there were a template we could follow.” – Richard Ellis
Richard Ellis, the adviser on banking supervision to the Bahrain Monetary Authority, spoke about the key challenges facing Bahrain, especially with regard to what the regulator should do concerning Islamic products not handled by Basel II.
While standards set out by the Accounting and Auditing Organization for Islamic Financial Institutions (AOFI) could measure these products, banks were reluctant to have to adopt two different sets of accounting standards.
Responding to a question from the audience, Ellis said the Basel Committee have said that: “Basel II applies to banks full stop. Islamic banking is just another business line.”
The lack of default data in the region is also cause for concern, and hinders the implementation of the internal ratings-based approach (IRB). To remedy this, banks may use surrogate data. Likening the situation to a company basing bonus rates based on another company’s results, Richard added: “This has led to unease, as you can imagine.”
Ellis also discussed various issues surrounding rating agencies in Bahrain. While traditional credit rating agencies will be used, other smaller rating agencies do exist in the region. Ellis stressed that the US needs to clarify that the smaller rating agencies would be accepted by US regulators, or a range of competitive issues will arise.
“To us, it’s an opportunity to catch up and revise the banking system.” – Simon Topping
Hong Kong has been one of the keenest adopters of Basel II, according to Simon Topping, the executive director of banking policy at the Hong Kong Monetary Authority (HKMA). Though implementing the revised Accord has not been an easy task, banks have embraced the chance to put in place a sound risk management system.
To this end, Topping expanded on how banks have been working closely with the HKMA, which in turn is working closely with other regulators to ensure a smooth transition to Basel II and reduce home-host friction.
Topping noted that some supervisors tend to “flex their own muscles and demand their own version of Basel II”, but pointed out that there was no point making matters difficult for foreign banks. He promised that the HKMA is “bending over backwards” to try to make Basel II simple for foreign banks operating in the region.
Hong Kong will begin to start the parallel run for Basel II in the next three months.
To make things as easy as possible, the HKMA has not mandated any single approach for Basel compliance. The HKMA is also trying to assist banks by being easy with implementation dates. “Though we’re hard task masters, we’re flexible on the timing of adoption,” he said.
“We decided to go AMA to become the market leader” – Dominic Wu
Dominic Wu, the head of risk and control services at ABN Amro in Hong Kong described how ABN Amro is preparing for operational risk management requirements for the advanced measurement approach (AMA).
Wu said that risk mapping was a key element of risk management at ABN Amro, as well as meaningful and presentable data that could be understood from the board down.
“We try to identify potential problems before they arise,” he said.
“AMA is challenging. Banks are revamping all their models to meet Basel II requirements” – Bernie Eagan
Key banks will be going to the AMA early, though these banks are expected to prove that they will meet the same robust standards as banks adopting AMA later on, according to Bernie Eagan, programme director for Basel II at the Australian Prudential Regulation Authority (APRA), and banks in Australia need to extensively prove readiness to the authority before they are given permission to use the advanced approaches.
Six out of the 60 banks in Australia are expected to use the advanced credit and operational risk approaches, though these banks have assets that make up 70% of the banking system.
Regarding the rest of the banks, Eagan said the standardised approach has been tailored to suit Australia-based banks, and is ideal for business not fit for the advanced approaches. The standardised approach is “not inferior”, he said, and the best choice for many institutions.
Regarding challenges facing Australian banks was that operation risk is still an emerging discipline, and determining capital requirements for operational risk is a new art.
“Having an operational risk framework is a common-sense business proposition – though this view is not widespread” – Gerald-Paul Sampson
Uncertainty over what the US is going to do about the standardised approach was cited as the reason why fewer firms are expected to apply to use the advanced approaches, said Gerald-Paul Sampson, the manager of the operational risk team of the risk review department of the Financial Services Authority in the UK. Only two firms are expected to apply to use the AMA this year, though four more are expected in 2007, which is down from an expected number of 12 applications.
Sampson discussed other issues surrounding the advanced approaches in the UK, including the fact that, from briefings, the FSA has learned that many firms have left models to the last minute, with a “worry about the maths later” attitude.
He also was critical about the lack of a risk appetite in the UK, and that user-tests were “limping along”. “Few people see a clear benefit for operational risk frameworks,” he said, but added that such frameworks make sound business practices.
“There are more differences between the EU and other countries than within the EU member states” – Erik Kersten
The regulatory process in the Netherlands is more complex than in other countries, as the regulators have used the Basel II process to totally overhaul the system. “All the rules and regulations have changed,” said Erik Kersten, the senior policy adviser of quantitative risk management at the Bank of the Netherlands.
From the law, to the structure of ministry, to regulation, everything in the Netherlands has changed to update the financial system and become more able to manage risk.
“The plan is to get through the cycle” – Bruce Porteous
As a relatively new bank that has existed only in a benign credit risk environment, Bruce Porteous, the head of financial and operational risk at Standard Life bank points out that there is a shortage of data to work with that will also satisfy regulators that the bank is ready to use the advanced approaches.
In the meantime, the bank has had to estimate the probability of default throughout the economic cycle, including looking at downturn risk. For now, though, “regulatory capital and capital for business purposes will be two separate things”, he said
“Pillar II is becoming the issue of the day” – Patrick Pearson
Pillar II challenges exacerbate home-host conflicts, said Patrick Pearson, the head of the banking and financial conglomerates unit at the European Commission.
The definition of regulatory capital and International Financial Reporting Standards (IFRS) still need a large amount of work, which is coming to a head now that the implementation date for Basel II is looming.
Pearson pointed out that there are 10,237 licensed banks and more than 1,700 investment banks that will be implementing Basel II measures in the 25 separate nations making up the EU.
Among these banks, Pearson stressed that the new member states are the most keen and eager to implement Basel II, as they saw it as a way to update their risk management systems.
Concerning home-host issues, Pearson stressed that work is ongoing with US regulators to ease problems between jurisdictions. “The US regulators aren’t doing anything we’re not aware of,” he said, and added that the current events in the US do little but “give rise to impatience that things aren’t going quickly enough”.
“We encourage comments of the extent of operational burdens” – Barbara Bouchard
Barbara Bouchard, the deputy associate director for supervisory and risk policy in the division of banking supervision and regulation at the board of governors of the federal reserve, addressed the most recent events for Basel II in the US.
With the audience listening in, Bouchard acknowledged that the new question on page 42 to seek comment on the use of the standardised approach in the Notice of Proposed Rulemaking was one of the biggest changes, though she pointed out that the inclusion of the question was a joint decision of all four US regulators.
“With Basel II implementation, the US is an outlier” – Philip Chamberlain
“We’re seven years into Basel II… and if you look at the timetable, you’ll notice how the years keep slipping,” said Phillip Chamberlain, the managing director and head of credit modelling at the Bank of New York. Chamberlain took the audience through the various delays and deferrals of Basel II in the US, which now has a very tentative date to go live with capital floors some time between 2008 and 2009.
Regarding the recent request of banks and associations, Chamberlain reminded the audience of industry’s concerns that Basel II was becoming a compliance exercise. “There’s something in that,” he agreed.
Chamberlain also criticised the current progress of Basel II implementation, and the lack of information from the regulators. “There has been no public assessment made of how far implementation has progressed. Overall, the sense is that there’s a long way to go.
Another criticism was that US regulators have “created arbitrary, fixed capital requirements, even though arbitrary, fixed capital requirements are not compatible with sound, dynamic risk modelling”.
‘Fixed’ and ‘risk-sensitive’ don’t belong in the same sentence,” Chamberlain added.
Chamberlain summed up his presentation by arguing that the US was an outlier. “We’re the only country to rule out two approaches in the Basel Accord and invent another approach that’s not in the Basel Accord… We can talk with the regulators, but I don’t think the talking’s going to penetrate much.”
“No one should bet against Basel II” – George French
Though he refused to speculate on the outcome of the US congressional hearing on Basel II, George French, the director of policy and examination oversight at the FDIC, stressed that all the agencies are working together to complete the Basel II process.
One of the main issues was the capital requirements. “It’s fair to say that different expectations existed… We have to confront the fact that AIRB will significantly reduce the risk-based capital levels,” he said.
Regulatory burden was another problem, as banks are becoming more vocal about the cost, system requirements continue to escalate and the bureaucracy surrounding the 471-page NPR is considerable.
Whether or not the standardised approach should be allowed in the “core banks”, the largest and most internationally active banks that are compelled to implement Basel II in the US. “That’s the issue: should AMA and AIRB be used? If not, which approach should be used?” French reminded the audience that the comments on the NPRs are due in January of next year, when the final decisions regarding the methodologies will be made.
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