BIS: Basel Accord Application and Its Implementation

About BIS and Its Basel implementation in South Africa.

About BIS
Established on 17 May 1930

Mission

Is to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.

Meeting place for central banks Other meetings of senior central bank officials BIS Activities Research and statistics

Banking services for central banks

Basel Accord
The BIS hosts the secretariats of the Basel Committee on Banking

Supervision .
The Basel Committee established by the central-bank Governors

of the Group of Ten countries at the end of 1974.

The Committee reports to the central bank Governors and Heads

of Supervision of its member countries. It seeks their endorsement for its major initiatives
In 1988, the Committee decided to introduce a capital

measurement system commonly referred to as the Basel Capital Accord

Why Basel Accord???

Established to create a level playing field for internationally

active banks. The soundness of the banking system is one of the most important issues for the regulatory authorities.

Answer of two questions

How should banking soundness be defined and

measured?
What should be the minimum level of soundness set by

regulators?

Soundness????
The soundness of a bank can be defined as the

likelihood of a bank becoming insolvent. The lower this likelihood the higher is the soundness of a bank.

Minimum level of soundness???

Reasons behind the establishment of the Basel Accord

Banks from different countries competing for the

same loans would have to set aside roughly the same amount of capital on the loans.
The new framework should serve to strengthen the

soundness and stability of the international banking system.

The framework should be in fair and have a high

degree of consistency in its application to banks in different countries.

Basel I to III
Basel I (1988) Basel II (June, 1999) Basel 2.5 (July, 2009) Basel III ( December, 2010 and

Implementation period starts from January, 2013)

Status of Basel Implementation (As of end September 2012)

Argentina Australia Belgium Brazil Canada China France Germany Hong Kong SAR India Indonesia Italy Japan Korea Luxembourg Mexico The Netherlands Russia Saudi Arabia Singapore South Africa Spain Sweden Switzerland Turkey United Kingdom European Union United States Basel II Implementation in process Implementation completed Implementation completed Implementation completed Implementation completed Implementation in process Implementation completed Implementation completed Implementation completed Implementation completed Implementation in process Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation in process Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation in process Basel 2.5 No implementation Implementation completed Implementation completed Implementation completed Implementation completed Implementation in process Implementation completed Implementation completed Implementation completed Implementation completed No implementation Implementation completed Implementation completed Implementation completed Implementation completed No implementation Implementation completed Implementation in process Implementation in process Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation completed Implementation in process Basel III Draft regulation not published Draft regulation published & final rule published Draft regulation published Draft regulation published Draft regulation published Final rule published Draft regulation published Draft regulation published Draft regulation published Final rule published Draft regulation published Draft regulation published Final rule published Draft regulation published Draft regulation published Draft regulation published Draft regulation published Draft regulation published Final rule published Final rule published Draft regulation published Draft regulation published Draft regulation published Final rule published Draft regulation not published Draft regulation published Draft regulation published Draft regulation published

Status of Basel Implementation in South Africa

Country

Basel II

Basel 2.5

Basel III

South Africa

Implementatio Implementatio Draft n completed n completed regulation published

Implementation of Basel II in South Africa

PLANNING FOR I MPLEMENTATION

Institutional Issues

TIMETABLE FOR IMPLEMENTATION

REGULATORY STRUCTURES FOR IMPLEMENTATION

PLANNING FOR BASEL II IMPLEMENTATION IN SOUTH AFRICA

Stable macroeconomic policies and fiscal policy transparency and discipline.

Preconditions fulfilled by South Africa

World class accounting and disclosure procedures.

Transparent auditing framework. Good corporate governance. Ongoing risk management. Stringent bank supervision. A favorable legal environment.

Legislation with regard to banks, companies, insolvency, money laundering, bank supervision, accounting and the legal environment.

PLANNING FOR BASEL II IMPLEMENTATION IN SOUTH AFRICA(Contd)

Successful Implementation of Basel II in South Africa requires

An amendments to Bank Act

In 2007

Banks Amendment Bill was put before and approved by the South African parliament.

TIMETABLE FOR IMPLEMENTATION

Extent of implementation All banks (internationally active and
domestically based banks)

Preparation for implementation

Parallel run period for Basel I and II

1999-2006
1st January 2007 to 31st December 2007.

Final implementation date

1st January 2008

REGULATORY STRUCTURES FOR IMPLEMENTATION

South African Reserve Bank (SARB)

Regulatory Structure to oversee Basel II implementation

Bank Supervision Department (BSD) Accord Implementation Forum (AIF) and its subcommittees.

CAR of South African Banks during implementation process

CAR

Implementation of Basel III in South Africa

In December 2009, the Basel Committee on Banking Supervision (BCBS) proposed a set of bank supervision reforms (Basel III).

1. Improving bank capital. Some of the key proposals for reform 2. Reducing pro-cyclicality. 3. Leverage ratio. 4. Liquidity ratio.

Implementation of Basel III in South Africa (Contd..)

Domestic banks are already capitalized above the new levels and the current leverage ratio is far more conservative than the proposed change.

But Domestic banks do not presently meet the new global liquidity standards.

Reserve Bank has made proposals to amend the existing regulations to the Banks Act.

Next step for implementation is Draft amendments to legislation.

In a nut-shell
1. South Africa made remarkable amendments to the Banking Act. 2. The country opted to apply all the Basel II approaches uniformly and consistently. 3. Clearly defined regulatory bodies help in speeding up the implementation process in line with the international standards.

4. In terms of capital adequacy, the country remained adequately.

5. The implementation status of Basel III in South Africa is that the Draft regulation is published and next step for implementation is Draft amendments to legislation issued on 28 September 2012 for final review.

Basel accord in U.S.A

Level 1 Assessment:

Basel II:
Basel 2.5:

In the process of assessing their banks progress toward meeting all the qualifying criteria for the advanced approaches. adopted a bifurcated approach to the implementation of Basel II

issued final regulations for Basel 2.5 that come into effect from 1 January 2013.

Basel III

banking agencies intend to finalize the rule after consideration of public comments.

Bifurcated Approach of Basel II in U.S.A

Large, internationally active US banks with more than $250 billion in total assets or with foreign

exposures greater than $10 billion would be required to qualify for and implement the advanced approaches for calculating capital charges for credit risk and operational risk under Basel II. Small Banks than this cannot implement the Basel II. Based on an assessment that the prospective benefits were meager relative to the costs. Against their Regulatory policies under FDICIA.

Continued

FEDs argue: it includes the Cost of safety for the small Banks
The balance sheet and operational structure of these institutions is straightforward relative to

the much larger, internationally active banks and does not need the sophisticated riskmanagement infrastructure required by the Advanced Internal ratings-based(A-IRB). currently maintain far more capital than the Basel II regulatory minimum would produce, already benefit from the enhanced supervisory oversight envisioned under Pillar 2 and currently disclose considerable information comparable to the Pillar 3 standard.

FEDs argument
requiring these banks to bear the cost of

shifting to Basel II was not justified by the probable benefits. Because they have to also comply their regulations according to the FDICIA.

More importantly the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)

FDICIA requires the regulators to define

criteria to classify depository institutions in four different categories

Well-capitalized, Adequately capitalized, Undercapitalized, and Significantly undercapitalized.

FED argument
The core banks that are well-capitalized

would be required to adopt Basel II already had risk management systems in place that were close to the infrastructure required to implement the advanced approaches and so they were expected to be able to comply at relatively small marginal cost.

Core Banks can adopt the Basel II Because..

the A-IRB was calibrated to yield lower capital

charges than the SA, which had substantially lower risk weights than Basel I for high quality borrowers, residential mortgages and most retail business. officials at the Federal Reserve Board (Fed) gave core banks reason to expect that over time the FDICIA leverage ratio would be relaxed.

Kanes Argument
Is the Basel II truly sufficient for the

safeguards of the capital?? FDIC is accountable for the costs of capital forbearance and argued most forcefully for the additional prudential safeguards. None of the other members of the Basel Committee is explicitly responsible for the costs inflicted on other financial institutions and/or taxpayers if the Basel II capital standards prove to be inadequate.

Basel III and DODD-FRANK act..

In order to protect unsuspecting borrowers

against abusive lending and mortgage practices, the reform bill established government agencies to monitor banking practices and oversight of troubled financial institutions.

Dodd-Frank Act continued.

Dodd-Frank sets the generally applicable

risk-based capital requirements as a floor that regulated financial institutions must satisfy in addition to any other minimum riskbased capital requirements that the regulators may impose.

MINIMUM RISK-BASED CAPITAL REQUIREMENTS

The appropriate Federal banking agencies

shall establish minimum risk-based capital requirements on a consolidated basis for insured depository institutions, depository institution holding companies, and nonbank financial companies supervised by the Board of Governors.

Difference
In Basel III the minimum risk-based capital

requirement is not consolidated like the Dodd-Frank act.

But they are findings ways

To implement Basel II and set the final rules

for Basel III.

STATUS OF BASEL II, BASEL 2.5 AND BASEL III IMPLEMENTATION

Rules
Basel II Basel 2.5 Basel III

Grading
4 4 2

Next stepsImplementation plan

5th Council Presidency's compromise proposal agreed on 15 May 2012; Draft European Parliament Legislative Resolution agreed on 14 May 2012; The European Parliament, Council and the Commission currently in discussions to agree on a final text.

1 = draft regulation not published; 2 = draft regulation published; 3 = final rule published; 4 = final rule in force. Green = implementation completed; Yellow = implementation in process; Red = no implementation.

Background of Basel III Implementation in the European Union

current capital requirements based upon two

capital requirements directives adopted in 2006, collectively CRD I Amended by two further Directives-

CRD II (2009)

CRD III (2010)

EU Basel III proposals

Implement Basel III through two legislative acts

new Capital Requirements Regulation (the CRR)

CRD IV consolidate the existing framework of existing legislation and amend that framework in order to implement Basel III.

Capital Requirements Directive (the CRD

Role of EBA to implement Basel III

EBA developed and published Regulatory

Technical Standards, or RTSs, which will flesh out certain parts of CRD IV. Produced a number of consultation papers containing draft RTSs Covering areas such as the CVA capital charge and reporting requirements in relation to the proposed leverage ratio.

CRD IV current status

The CRD IV proposals are yet to be finalized. EU were intended to result in an agreed position by the end of

June 2012, adopted in early July 2012.

As at the date of this publication, there is still no agreed text. The EU Council published compromise texts on May 21, 2012

which are expected to closely resemble the final drafts of the CRR and CRD.
It is currently expected that the EU Parliament will adopt final

texts in October or November 2012, but this is still not certain.

Basel III will be implemented in the EU as soon as possible in

2013, if the deadline is not met.

IN A NUT- SHELL
The EUs Basel implementation task is more complex than in other

jurisdictions, given its membership. In most parts, the proposed CRDIV and CRR have fully transposed the Basel framework. The assessment team has identified several key gaps and differences, some of which have been explained by the EC. In many cases, the CRR has provided safeguards or the EBA will develop legally binding technical standards to limit the impact of the gaps or deficiencies. The EU has asserted that tailored supervisory approaches by national supervisors to internationally active banks would remedy the identified differences. The Level 2 assessment has produced findings showing that the proposed CRDIV and CRR have departed from the Basel framework in many areas. Some and possibly many of the identified non-compliant items may be resolved as the CRDIV/CRR proposals progress to their conclusion.

Basel II Accord
Pillar 1 Specifies new standards for minimum

capital requirements, along with the methodology for assigning risk weights on the basis of credit risk and market risk; Also specifies capital requirement for operational risk. Pillar 2 Enlarges the role of banking supervisors and gives them power to them to review the banks risk management systems. Pillar 3 Defines the standards and requirements for higher disclosure by banks on capital adequacy, asset quality and other risk management processes.

Regulatory initiatives

The regulatory initiatives taken by the Reserve Bank of India include: Ensuring that the banks have suitable risk management framework oriented towards their requirements dictated by the size and complexity of business, risk philosophy, market perceptions and the expected level of capital. The framework adopted by banks would need to be adaptable to changes in business size, market dynamics and introduction of innovative products by banks in future. Introduction of Risk Based Supervision (RBS) in 23 banks on a pilot basis. Encouraging banks to formalize their Capital Adequacy Assessment Programme (CAAP) in alignment with business plan and performance budgeting system. This, together with adoption of Risk Based Supervision would aid in factoring the Pillar II requirements under Basel II. Enhancing the area of disclosures (Pillar III), so as to have greater transparency of the financial position and risk profile of banks. Improving the level of corporate governance standards in banks. Building capacity for ensuring the regulators ability for identifying and permitting eligible banks to adopt IRB / Advanced Measurement approaches

Pre Basel II Indian Norms

All banks operating in India to maintain minimum Capital Funds at

9% of Total Risk Weighted Assets.

Capital Funds is an addition of Tier-I Capital (consisting of Capital,

Permanent Reserves and Profits retained for this purpose) and Tier-II Capital (consisting of Subordinated Debt, General Reserves, Hybrid Debt Capital Instruments )
Total Risk Weighted Assets is computed on the basis of risk weights

assigned for different asset types and obligors:

Government - 0% Banks - 20%

Others - 100% [except Housing (50-75%), Consumer (125%) loans, equity/ capital market exposure (125%) and Venture capital funds (150%)]

Market Risk Capital Charge is based on modified duration

methodology.

Basel II Changes :Credit Risk

Previous norms prescribed single credit risk factor across a class of obligors thus ignoring the default probability or risk rating of different obligors. This results in assigning same amount of capital for exposures to AAA rated and BB rated corporate. Under Basel II, Risk Weights are more risk sensitive being based on risk rating of the obligor and tenor of the loan. E.g. AAA 20%, AA 30% etc. Basel II - Changes : Operational Risk Operational Risk is defined as the risk of loss arising from inadequate or failed internal processes, people and systems or from external events. Basel II requires Banks to compute capital charge for Operational Risk. It defines three approaches for this calculation: Basic Indicator Approach: Capital Charge computed at 15% of Gross Income of the Bank. Standardized Approach: Capital Charge ranges between 12-18% of gross income of different business lines. Advanced Measurement Approach: Banks to use internal model for computing potential operational loss. To start with RBI has asked all banks to apply the Basic Indicator Approach. Basic Indicator Approach is required to be implemented by all banks operating in India. Roadmap for Advanced approaches is prescribed by RBI. We will migrate to advanced approaches in once Citi decides to roll out advanced approaches for local jurisdictions. Broadly no changes in the computation of Market risk capital charge under Basel II except a few minor differences.

RBIs current approach:

`They are now not debating whether to go forward with Basel II but how to implement Basel II. In fact, understanding Basel II concepts is one step away from agreeing to it in principle. Implementing Basel II is another long step away from understanding it.

`RBIs approach to the institution of prudential norms has been one of gradual convergence with international standards and best practices with suitable country specific adaptations. Our aim has been to reach global best standards in a deliberately phased manner through a consultative process evolved within the country. RBI had in April 2003 itself accepted in principle to adopt the new capital accord. `RBI has announced, in its Annual Policy statement in May 2004 that banks in India should examine in depth the options available under Basel II and draw a road-map by end December 2004 for migration to Basel II and review the progress made thereof at quarterly intervals. `At a minimum all banks in India, to begin with, will adopt Standardized Approach for credit risk and Basic Indicator Approach for operational risk. After adequate skills are developed, both in banks and at supervisory levels, some banks may be allowed to migrate to IRB Approach.

RBIs current approach:

`India has three established rating agencies in which leading international credit rating agencies are stakeholders. However, the level of rating penetration is not very significant as, so far, ratings are restricted to issues and not issuers. Encouraging ratings of issuers would be a challenge. `Basel II could actually imply that the minimum requirements could become pro-cyclical. No doubt prudent risk management policies and Pillars II and III would help in overall stability. We feel that it would be preferable to have consistent prudential norms in good and bad times rather than calibrate prudential norms to counter pro-cyclicality. `Banks adopting IRB Approach will be much more risk sensitive than the banks on Standardised Approach, (so) the banks on Standardised Approach could be inclined to assume exposures to high risk clients, which were not financed by IRB banks. Due to concentration of higher risks, Standardised Approach banks can become vulnerable at times of economic downturns

In a Nut Shell:
Implementation of Basel II is likely to improve the risk

management systems of banks as the banks aim for adequate capitalisation to meet the underlying credit risks and strengthen the overall financial system of the country. In India, over the short term, commercial banks may need to augment their regulatory capitalisation levels in order to comply with Basel II. However, over the long term, they would derive benefits from improved operational and credit risk management practices. Basel III is going to be applicable from January 1, 2013. BASEL III should provide a solution which is tailored made for the developing economies.Thus ,though BASEL III will make banks more capable of handling a financial crisis, it will have a negative impact on the GDP of the economies like India which should be a matter of concern.

Basel Accord: Its Application and Implementation In Bangladesh

Comparative Capital Adequacy Ratio (CAR) (Bangladesh):

CAR is the proportion between the total RWA and total eligible capital for any bank. In Bangladesh, minimum CAR for the banks regarding Basel-II has been scheduled as follows: 8% from January 2010 to June 2010, 9% from July 2010 to June 2011, 10% from July 2011 to till date

Comparative CAR in Different Banks

Comparative CAR in Different Banks

Comparative CAR in Different Banks

If the intra-industry situation is observed, it is found that foreign banks are operating well above the regulatory requirement, though they faced slight fall in the middle of the period which has been recovered later on. Private Banks move around the regulatory compulsion. Although the SCBs stood significantly below the requirement, they recovered their position at later phase. But, the DFIs especially BKB and RAKUB which were established for agricultural development of the country have been standing significantly below the regulatory requirement and have experienced worsen situation.

Risk Weighted Asset (RWA) Composition

RWA for CR of Total RWA

Risk Weighted Asset (RWA) Composition

In Bangladesh, at least 65% of the RWA comes against Credit Risk (CR). The dominance of CR in determining RWA is prevalent in foreign banks and private banks. The graph shows that, almost 85-90% of RWA sources from credit risk in foreign banks whereas private banks have RWA against CR at 70-95%. The situation is almost replicated in SCBs and DFIs except Bangladesh Development Bank Ltd (BDBL). This bank was created from the amalgamation of BSB and BSRS which were instituted for industrial development of the country. Thus, this bank has much higher RWA against Market Risk (32-39%) (Table-3) whereas the percentage lies between 1-15% for other banks except Agrani Bank Ltd. Agrani bank has RWA against Market Risk 16-21% of total RWA. As capital charge for Operational Risk (OR) is a function of Gross profit, those banks having large credit portfolio or operating efficiency have higher portion of RWA from OR. That is seen in Table-4. Foreign banks have better operating efficiency and SCBs have larger credit portfolio that makes the higher portion of RWA against Operational Risk compared to others.

Risk Weighted Asset for Market Risk as % of Total Risk Weighted Asset
RWA for Market Risk are much higher (10.54%-15.46%) for the SCBs in comparison to others and the proportion has been increasing over time

RWA for Operational Risk

The graph shows that RWA for Operational Risk have been very steady for all sub sectors over the whole period which implies the steady movement of their gross profit

Capital Composition:
Comparison of Core Capital among banks

Capital Composition:
In context of capital composition, the graph shows that every bank in Bangladesh has much higher core capital than the required capital (50% of the total capital). Foreign banks have high dependence on the core capital (almost 90%) for their capital base and 75%-80% of the private banks' capital comes from core capital. Some exception observed for BKB, RAKUB, BCBL, ICB Islamic Bank Ltd, as these banks are having huge provision shortfall and accumulated loss. Only 10%-11% of foreign banks capital sources from supplementary capital while the percentage is 30%-40% for SCBs (Table-6). In case of DFIs, capital composition scenario is bit complex because of their huge accumulated loss and provision shortfall (Figure-7, 8 & 9). For these reasons, in spite of having ample paid up capital, they always lie below the regulatory requirement. Capital Composition scenario is much balanced in private banks where the ratio of Tier-2 and Tier-I capital retains up to 60% (Table-7), which implies the usage of hybrid capital instruments by private banks.

Continued.
Risk based capital adequacy is first step for establishing risk based supervision. With a view to replacing the transaction based supervision with the risk based supervision, ensuring capital adequacy by addressing asset risks properly is the only way to move forward. Moreover, maintaining capital adequacy under apposite and structured risk based assessment is the foundation to build up a resilient banking sector. So, taking into account of the present financial market scenario, supervisor as well as banks have to renovate them to actually cope-up with the challenge of Basel II. Banks should reinforce their internal control systems, and make every effort to develop internal risk models and management systems. In a nutshell, from a regulators perspective, a relevant standards and apt guidelines commensurate to BASEL framework should be set for the banking industry so that the benefits of risk management can be maximized and the undesired outcomes of financial turmoil can be mitigated.

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