BCBS chairman speaks out on recent events

Nout Wellink speaks on the implications for risk managers of the current market turmoil at the GARP conference

NEW YORK – Nout Wellink, President of De Nederlandsche Bank and chairman of the Basel Committee on Banking Supervision, told delegates at the Global Association of Risk Professionals (GARP) annual risk management conference that there were three fundamental shortcomings that contributed to and amplified the turmoil. These were the failure of the subprime mortgage lending market to employ sound underwriting standards, which was amplified by the fact that firms “also neglected to define prudent firm-wide risk limits on these exposures”; the failure of risk management and measurement capabilities to keep up with the rapid pace of financial innovation; and that certain aspects of regulation, supervision and market transparency “failed to reflect financial market developments and therefore contributed to weak practices at banks”.

Wellink was keen to point out that the crisis played out under the outdated Basel I supervisory rules, which was simply unable to accurately capture the “types of risks that banks face in today’s increasingly market-based credit intermediation environment. As a result, off-balance-sheet exposures as well as operational, legal and reputational risks were not appropriately identified and measured”. He also admitted that liquidity supervision and regulation had failed to keep up with banks’ changing risk profiles and growing vulnerability to market-based shocks. These factors, he said, “underscore the need for Basel II and the necessity to continuously improve the framework”.

The Basel Committee is working on three initiatives, which are the implementation of and further improvements to Basel II; enhancing global standards for liquidity risk management and supervision; and strengthening other risk management practices, particularly with respect to stress testing and valuations.

Improvements to Basel II identified by Wellink concern the Pillar 1 capital treatment of certain securitisations of complex products, where most banks lost money, but also in Pillar 2 the committee aims to make sure that banks “perform adequate stress tests and hold capital for uncertainties related to exposures coming back to the balance sheet for legal, reputational or liquidity reasons”, and also to build on Pillar 3 disclosure requirements in order to “strengthen banks’ transparency around exposures to structured credit products and securitised assets, including banks’ involvement as sponsors”.

“There are no simple, quick-fix measures that will prevent the next crisis. But I believe that the steps I have outlined will make the banking sector more resilient to the next set of shocks, whatever their source,” said Wellink.