Professional Documents
Culture Documents
Outline
What
is the risk based approach? How does it apply to banks? How does it apply to regulation? How does it apply to supervision? Challenges arising from Basel II
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Identify risks and apply resources where the risks are greatest
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Competition is increasing
The tools are available
2. Risk-Based Regulation
The central Pillar of banking regulation is capital adequacy
Starting with the first Capital Accord in 1988 banking regulators began imposing risk-weighted capital adequacy requirement The philosophy is straightforward greater risk requires greater capital
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As noted - banks now allocate capital internally to activities and areas according to the risks taken Not widespread before the first Basel Accord in 1988 Accord encouraged banks to think in terms of risk-based capital allocation Since then, banks have generally gone well beyond the 1988 Accord - hence one of the primary motivations for Basel II Case for change is in the divergence between regulatory capital and banks assessments of economic capital required for risk - illustration .
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Economic
30 25 20 15 10 5 0
Basel I 8%
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Need for greater risk sensitivity than Basel 1 and its one size fits all Approach Need for a framework that is credible, sound and reflective of industry practices Need to be more incentive compatible with desire of regulators to promote and enhance good credit risk management Problem - there is no standardized approach agreed by industry for the measurement and management of credit risk (unlike market risk)
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The Outcome
A menu approach:
Standardized (modified from Basel I); IRB Foundation IRB Advanced
Standardized is still blunt like Basel I IRB approaches are an attempt to approximate what the industry is doing It stops short of allowing banks to use their own models entirely for assessing capital adequacy It allows banks to use some of the critical inputs to their models (PD, LGD, EAD) but constrains the way they are combined to assess capital adequacy
3. Risk-Based Supervision
Again the idea of a risk-based approach = apply resources where the risks are greatest
Thus a supervisor following a risk-based approach will attempt to:
Identify those banks in which risks are greatest Identify within each bank those areas in which risks are greatest Apply scarce supervisory resources so as to minimizing the overall regulatory risk
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Example - PAIRS
APRA Reviewed developments in US, UK and Canada Developed PAIRS system (Probability and Impact Rating System) As in banking - risk grading system should not eliminate subjectivity but the discipline imposed by a structured approach should increase objectivity Back up with peer review and quality control
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Risk of Failure PF
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MEDIUM high
MANDATED IMPROVEMENT
HIGH
EXTREME
RESTRUCTURE
RESTRUCTURE
MANDATED
HIGH
NORMAL
OVERSIGHT
IMPROVEMENT
RESTRUCTURE
MANDATED
MEDIUM
NORMAL
NORMAL
OVERSIGHT
IMPROVEMENT
RESTRUCTURE
MANDATED
LOW
NORMAL
NORMAL
IMPROVEMENT
RESTRUCTURE
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Review the risk assessment processes for relevance and comprehensiveness - does the bank recognise other risks such as interest rate risk? Identify inconsistencies Check that management is engaged Assess application and controls - are processes followed? Require stress tests
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Specific Guidance
Interest Rate Risk in the banking book Operational Risk Definition of default Risk mitigation Concentration Risk
Securitization
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It is just an extension of the already growing riskbased approach to supervision It does provide detailed guidance - but many countries already exercised this type of approach
Summary
The risk-based approach is about identifying risks and devoting resources to where they will be most effective in reducing risks This approach is as critical in banking as it is in regulation and supervision In regulation it requires that capital requirements are greater where risks are greater In supervision it requires supervisors to:
Assess where the risks are greatest Intervene and enforce standards flexibly where the risks are greatest
Pillar 2 of Basel II provides a framework for the assessment and intervention process Pillar 2 is a fundamental component of Basel II
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Thank You
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ARMICHAEL
ONSULTING Pty Ltd