HKMA to rule out AMA approach

Banks operating in Special Administrative Region will instead be limited to using the standardised and basic indicator approaches to operational risk in the initial stages, and will be encouraged to focus on the management of op risk rather than the calculation of an operational risk capital charge, says Simon Topping, executive director, banking policy, at the HKMA.

“It’s the only thing in Basel II we’re not going to allow initially because we don’t believe that building up elaborate systems for operational risk is helping banks manage risk too much,” he says. “We are expecting banks to focus their dollars on the management of operational risk, so implementing the Basel Committee’s paper on sound practices on the management of operational risk, rather than building up systems to calculate an AMA capital charge.”

The ruling out of the AMA approaches is part of the HKMA’s draft guidelines on Basel II implementation, expected to be released publicly within weeks. The formulation of domestic guidelines follows the finalisation of the Basel II framework at the end of June.

In an exclusive interview with Asia Risk magazine, a sister publication of RiskNews, Topping says that the publication of national guidelines will allow banks operating in the territory to begin preparations for Basel II in earnest.

“This will help because everyone has been searching for concrete information on what our qualifying criteria are going to be, and we couldn’t really finalise that until we saw what was in Basel II,” says Topping. “We have taken a fairly pragmatic approach and we’ve tried to be as mainstream as we can, but at the same time take account of the particular characteristics in Hong Kong.”

The 124-page draft document will describe the HKMA’s qualifying criteria for banks aiming to implement the internal ratings-based (IRB) approaches for credit risk, outline the minimum requirements for IRB banks, provide loss-given default and exposure-at-default parameters, and detail how the regulator will treat the various items of national discretion.

The territory’s nine largest locally incorporated banks are currently aiming to apply one of the two IRB approaches, covering 75-80% of the territory’s banking assets, says Topping. As part of the transition to Basel II, Hong Kong’s banks will be expected to submit their implementation plans to the HKMA by the end of this year, with Basel II coming in force at the end of 2006. However, in a change to the Basel II framework, the HKMA will allow those banks aiming for IRB to have a transition period of three years.

“One feature of our implementation of IRB is that we are envisaging a three-year transition period, not just a one year transition,” says Topping. “So in Hong Kong, it will be from end-2006 to end-2009. And that’s partly to allow banks to build up their data and use of the models, but also to account of the fact that they are not going to be putting all their efforts into IRB and frontloading it the way banks may be elsewhere.”

The HKMA’s guidelines will also include an additional approach for smaller banks with under HK$10 billion in assets. Called the basic approach, it will be similar to the current Basel I approach for credit risk, but will include an operational risk charge and incorporate Pillars II and III on supervisory review and disclosure.

“IRB is only intended for internationally active banks,” explains Topping. “The standardised approach is intended for a wider array of banks and goes a bit further down the food chain, but it is still not really intended for the very small banks. We think it is very important in Hong Kong that everybody gets the benefit of Basel II and that everyone gets a bit of an impetus to improve risk management, and that’s why we developed the basic approach.”

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