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Basel II Update


Dubrovnik, 27-28 May 2004
Charles Freeland
Deputy 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 capital
ON-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 banks claim.
Cl ai m Assessment

AAA -
AA-
A+ - A-
BBB+ -
BBB-
BB+ - B- Bel ow B- Unr at ed
Sover ei gns
( Expor t cr edi t agenci es)
0%
( 1)
20%
( 2)
50%
( 3)
100%
( 4- 6)
150%
( 7)
100%
Opt i on 1
1
20% 50% 100% 100% 150% 100%
Banks
Opt i on 2
2

20%
( 20%)
3

50%
( 20%)
3

50%
( 20%)
3

100%
( 50%)
3

150%
( 150%)
3

50%
( 20%)
3

Cor por at es 20% 50% 100%
BB+ - BB-
100%
Bel ow BB-
150%
100%
Mor t gages 35%
Ret ai l
Ot her r et ai l

75%

Standardised Approach Risk Weights
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Standardised Approach
Risk 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
0
4
8
12
16
20
24
28
0
.
0
3
0
.
1
0
.
4
0
.
7
5
1
.
2
5 2 3 5 7 9
1
5
Probability of default
Capital
charge
%
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