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AN EVOLUTION
Hasan Ersel
HSE
May 23, 2011
INTERNATIONAL REGULATION
COOKE RATIO
Named after Peter Cooke (Bank of England), the
chairman of the Basel committee)
Cooke Ratio=Capital/ Risk Weighted Assets8%
Definition of Capital
Capital= Core Capital
+ Supplementary Capital
- Deductions
2)
TIER 2
Undisclosed reserves (bank has made a profit but this
has not appeared in normal retained profits or in general
reserves of the bank.)
Asset revaluation reserves (when a company has an
asset revalued and an increase in value is brought to
account)
General Provisions (created when a company is aware
that a loss may have occurred but is not sure of the
exact nature of that loss) /General loan-loss reserves
Hybrid debt/equity instruments (such as preferred stock)
Subordinated debt
Cash,
Claims on central governments and central
banks denominated in national currency and
funded in that currency
Other claims on OECD countries, central
governments and central banks
Claims collateralized by cash of OECD
government securities or guaranteed by OECD
Governments
CRITIQUE OF BASEL-I
Basel-I accord was criticized
i) for taking a too simplistic approach to setting
credit risk weights
and
ii) for ignoring other types of risk
CAPITAL ARBITRAGE
If a loan is calculated to have an internal capital
charge that is low compared to the 8% standard,
the bank has a strong incentive to undertake
regulatory capital arbitrage
Securitization is the main means used especially
by U.S. banks to engage in regulatory capital
arbitrage
BASEL-II
BASEL-II
Basel-II consists of three pillars:
Minimum capital requirements for credit risk, market
risk and operational riskexpanding the 1988 Accord
(Pillar I)
Supervisory review of an institutions capital adequacy
and internal assessment process (Pillar II)
Effective use of market discipline as a lever to
strengthen disclosure and encourage safe and sound
banking practices (Pillar III)
BASEL-II (1)
Minimum Capital Requirement (MCR)
Capital
MCR
8%
Credit Risk Market Risk Operational Risk
BASEL-II (2)
PILLAR I: Minimum Capital Requirement
1) Capital Measurement: New Methods
2) Market Risk: In Line with 1993 & 1996
3) Operational Risk: Working on new methods
BASEL-II (3)
Pillar I is trying to achieve
If the banks own internal calculations show that they
have extremely risky, loss-prone loans that generate
high internal capital charges, their formal risk-based
capital charges should also be high
Likewise, lower risk loans should carry lower riskbased capital charges
BASEL-II (4)
Credit Risk Measurement
1) Standard Method: Using external rating for
determining risk weights
2) Internal Ratings Method (IRB)
a) Basic IRB: Bank computes only the probability of
default
b) Advanced IRB: Bank computes all risk components
(except effective maturity)
BASEL-II (5)
Operational Risk Measurement
1) Basic Indicator Approach
2) Standard Approach
3) Internal Measurement Approach
BASEL-II (6)
Pillar I also adds a new capital component for
operational risk
Operational risk covers the risk of loss due to system
breakdowns, employee fraud or misconduct, errors in
models or natural or man-made catastrophes, among
others
BASEL-II (7)
PILLAR 2: Supervisory Review Process
1)
2)
BASEL-II (8)
PILLAR 3: Market Discipline
Aims to reinforce market discipline through enhanced
disclosure by banks. It is an indirect approach, that
assumes sufficient competition within the banking sector.
ASSESSING BASEL-II
To determine if the proposed rules are likely to
yield reasonable risk-based capital requirements
within and between countries for banks with
similar portfolios, four quantitative impact studies
(QIS) have been undertaken