Basel Committee on Banking Supervision

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See also bank capital, Bank for International Settlements, Basel 2, Basel 3, capital adequacy and liquidity.

Contents

Overview

The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.

It seeks to do so by exchanging information on national supervisory issues, approaches and techniques, with a view to promoting common understanding. At times, the Committee uses this common understanding to develop guidelines and supervisory standards in areas where they are considered desirable. In this regard, the Committee is best known for its international standards on capital adequacy; the Core Principles for Effective Banking Supervision; and the Concordat on cross-border banking supervision.

Committee membership

The Committee's members come from:

  • Argentina
  • Australia
  • Belgium
  • Brazil
  • Canada
  • China
  • France
  • Germany
  • Hong Kong SAR
  • India
  • Indonesia
  • Italy
  • Japan
  • Korea
  • Luxembourg
  • Mexico
  • Netherlands
  • Russia
  • Saudi Arabia
  • Singapore
  • South Africa
  • Spain
  • Sweden
  • Switzerland
  • Turkey
  • United Kingdom
  • United States

The present Chairman of the Committee is Mr Nout Wellink, President of the Netherlands Bank.

The Committee encourages contacts and cooperation among its members and other banking supervisory authorities. It circulates to supervisors throughout the world both published and unpublished papers providing guidance on banking supervisory matters. Contacts have been further strengthened by an International Conference of Banking Supervisors (ICBS) which takes place every two years.

The Committee's Secretariat is located at the Bank for International Settlements in Basel, Switzerland, and is staffed mainly by professional supervisors on temporary secondment from member institutions. In addition to undertaking the secretarial work for the Committee and its many expert sub-committees, it stands ready to give advice to supervisory authorities in all countries. Mr Stefan Walter is the Secretary General of the Basel Committee.

Basel Sub-Committees

The Committee's work is organised under four main sub-committees (organisation chart):

  • The Standards Implementation Group
  • The Policy Development Group
  • The Accounting Task Force
  • The International Liaison Group

Standards Implementation Group

The Standards Implementation Group (SIG) was originally established to share information and promote consistency in implementation of the Basel II Framework. In January 2009, its mandate was broadened to concentrate on implementation of Basel Committee guidance and standards more generally. It is chaired by Mr José María Roldán, Director General of Banking Regulation at the Bank of Spain.

Currently the SIG has two subgroups that share information and discuss specific issues related to Basel II implementation. The Validation Subgroup explores issues related to the validation of systems used to generate the ratings and parameters that serve as inputs into the internal ratings-based approaches to credit risk. The group is chaired by Mr Maarten Gelderman, Head of Quantitative Risk Management at the Netherlands Bank.

The Operational Risk Subgroup addresses issues related primarily to banks' implementation of advanced measurement approaches for operational risk. Mr Kevin Bailey, Deputy Comptroller, Office of the Comptroller of the Currency, United States, chairs the group.

Policy Development Group (PDG)

The primary objective of the Policy Development Group (PDG) is to support the Committee by identifying and reviewing emerging supervisory issues and, where appropriate, proposing and developing policies that promote a sound banking system and high supervisory standards. The group is chaired by Mr Stefan Walter, Secretary General of the Basel Committee.

Seven working groups report to the PDG: the Risk Management and Modelling Group (RMMG), the Research Task Force (RTF), the Working Group on Liquidity, the Definition of Capital Subgroup, a Basel II Capital Monitoring Group, the Trading Book Group (TBG) and the Cross-border Bank Resolution Group.

The Risk Management and Modelling Group serves as the Committee's point of contact with the industry on the latest advances in risk measurement and management, and is chaired by Mr Klaas Knot, Director of Supervisory Policy at the Netherlands Bank. It focuses on assessing the range of industry risk management practices and the development of supervisory guidance to promote enhanced risk management practices.

The Research Task Force serves as a forum for research economists from member institutions to exchange information and engage in research projects on supervisory and financial stability issues. It also acts as a mechanism for facilitating communication between economists at member institutions and in the academic sector. It is co-chaired by Mr Myron Kwast, Senior Associate Director of the Division of Research and Statistics at the Board of Governors of the Federal Reserve System, United States, and Mr Peter Praet, Executive Director at the National Bank of Belgium and member of the Management Committee of the Banking, Finance and Insurance Commission, Belgium.

The Trading Book Group adresses issues relating to the application of Basel II to certain exposures arising from trading activities. A current focus of this group is the appropriate capital treatment of event risk in the trading book. It is co-chaired by Ms Norah Barger, Associate Director, Board of Governors of the Federal Reserve System, United States, and Mr Thomas McGowan, Assistant Director, Securities and Exchange Commission, United States.

The Working Group on Liquidity serves as a forum for information exchange on national approaches to liquidity risk regulation and supervision. In September 2008, the Working Group issued Principles for Sound Liquidity Risk Management and Supervision, the global standards for liquidity risk management and supervision. The Working Group is also examining the scope for additional steps to promote more robust and internationally consistent liquidity approaches for cross-border banks. The group is co-chaired by Mr Nigel Jenkinson, Executive Director for Financial Stability at the Bank of England, and Mr Marc Saidenberg, Senior Vice President in the Banking Supervision Group of the Federal Reserve Bank of New York, United States.

The Definition of Capital Subgroup explores emerging trends in eligible capital instruments in member jurisdictions. It currently is reviewing issues related to the quality, consistency and transparency of capital with a particular focus on Tier 1 capital. The group is co-chaired by Mr Hirotaka Hideshima, Director, Deputy Head of the International Affairs Section at the Bank of Japan, and Mr Richard Thorpe, Head of Capital Adequacy Policy Department and Accounting and Audit Sector Leader at the Financial Services Authority, United Kingdom.

In the course of implementation of Basel II, national supervisors are monitoring capital requirements to ensure that banks in their jurisdiction maintain a solid capital base throughout the economic cycle. The Basel Committee has established a Basel II Capital Monitoring Group that will from time to time share national experiences in monitoring capital requirements. This group is chaired by Mr Thilo Liebig, Head of Banking Supervision Research at the Deutsche Bundesbank.

Cross-border Bank Resolution Group: the CBRG is comparing the national policies, legal frameworks and the allocation of responsibilities for the resolution of banks with significant cross-border operations. It is co-chaired by Ms Eva Hüpkes, Head of Regulation, Swiss Financial Market Supervisory Authority (FINMA), and Mr Michael H Krimminger, Special Advisor for Policy to the Chairman of the Federal Deposit Insurance Corporation.

Accounting Task Force

The Accounting Task Force (ATF) works to help ensure that international accounting and auditing standards and practices promote sound risk management at financial institutions, support market discipline through transparency, and reinforce the safety and soundness of the banking system. To fulfil this mission, the task force develops prudential reporting guidance and takes an active role in the development of international accounting and auditing standards. Ms Sylvie Mathérat, Director of Financial Stability, Bank of France, chairs the ATF.

Three working groups report to the ATF: the Conceptual Framework Issues Subgroup, the Financial Instruments Practices Subgroup, and the Audit Subgroup. The Conceptual Framework Issues Subgroup monitors and responds to the conceptual accounting framework project of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board in the United States. The Subgroup is co-chaired by Mr Jerry Edwards, ATF member and Senior Advisor on Accounting and Auditing Policy, Bank for International Settlements, Switzerland, and Mr Patrick Amis, Head of Accounting Affairs, Commission Bancaire, France.

The Financial Instruments Practices Subgroup assesses implementation of international accounting standards related to financial instruments, and the links between accounting practices in this area and prudential supervision. The Subgroup is chaired by Mr Ian Michael, Technical Specialist, Accounting and Auditing Policy, Financial Services Authority, United Kingdom.

The Audit Subgroup promotes reliable financial information by exploring key audit issues from a banking supervision perspective. It focuses on responding to international audit standards-setting proposals, other issuances of the International Auditing and Assurance Standards Board and the International Ethics Standards Board for Accountants, and audit quality issues. The Subgroup is chaired by Mr Marc Pickeur, Advisor for Supervisory Policy at the Banking, Finance and Insurance Commission, Belgium.

International Liaison Group

The International Liaison Group (ILG) provides a forum for deepening the Committee's engagement with supervisors around the world on a broader range of issues. It gathers senior representatives from Argentina, Australia, Brazil, Chile, China, the Czech Republic, France, Germany, Hong Kong, India, Italy, Japan, Korea, Mexico, the Netherlands, Poland, Russia, Saudi Arabia, Singapore, South Africa, Spain, the United Kingdom, the United States and the West African Monetary Union, the European Commission, the International Monetary Fund, the World Bank, the Financial Stability Institute , the Association of Supervisors of Banks of the Americas and the Islamic Financial Services Board. The ILG is chaired by Mr Giovanni Carosio, Deputy General Director, Bank of Italy.

Two working groups report to the ILG: the ILG working group on Capital (ILGC) and the Anti-Money Laundering and Countering the Financing of Terrorism Expert Group (AML/CFT EG).

The ILGC is working together with the SIG on Basel II implementation issues and both groups regularly hold joint meetings. The ILGC is chaired by Mr Karl Cordewener, Deputy Secretary General of the Basel Committee.

The AML/CFT EG is responsible for monitoring AML/CFT issues that have a bearing on banking supervision. It is co-chaired by Mr Errol Kruger, Registrar of Banks and Executive General Manager, South African Reserve Bank, and Mr Edouard Fernandez-Bollo, Director of Legal Services, Commission Bancaire, France.

Coordination with other standard setters

Formal channels for coordinating with supervisors of non-bank financial institutions include the Joint Forum, for which the Basel Committee Secretariat provides the secretariat function, and the Coordination Group.

The Joint Forum was established in 1996 to address issues common to the banking, securities and insurance sectors, including the regulation of financial conglomerates.

The Coordination Group is a senior group of supervisory standard setters comprising the Chairmen and Secretaries General of the Committee, the International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS), as well as the Joint Forum Chairman and Secretariat.

The Coordination Group meets twice annually to exchange views on the priorities and key issues of interest to supervisory standard setters. The position of chairman and the secretariat function for the Coordination Group rotate among the member representatives of the three standard setters every two years.

Basel 3

Basel III being watered down

European banks, rattled by investor uncertainty about their ability to withstand a sovereign-debt crisis, are poised to win a reprieve in Basel, Switzerland, this week as regulators from 27 countries shape new capital rules.

A push to water down stringent standards proposed last year by the Basel Committee on Banking Supervision, and to allow more time to implement them, is led by France and Germany, according to bankers, regulators and lobbyists involved in the talks. Representatives from the U.S. and the U.K., who have sought to rein in risk-taking, are willing to compromise on how capital is defined to reach an agreement at a committee meeting that begins tomorrow, the people said.

Another concession may involve granting transition periods of up to 10 years to ease concerns of some member countries that their banks and economies won’t be able to bear the burden of tougher capital requirements until a recovery takes hold. As a result, the amount of capital European banks will be forced to raise in the next two years won’t be as much as investors fear.

“Politicians in France and Germany are worried about the impact of the rules on their economies,” said Chris Bates, a regulatory lawyer at Clifford Chance LLP in London. “Basel has managed to bring diverging banking systems and economies together. It’s more than just a capital regime. It’s a showcase of global cooperation. So the U.S. and the U.K. cannot let it break down.”

G-20 Request

The 36-year-old Basel committee, a body of central bankers and regulators that sets capital standards for banks worldwide, was asked by the Group of 20 nations to draft new rules after the worst financial crisis in 70 years caused lenders to write off $1.8 trillion. G20 leaders urged the committee to improve the quantity and quality of bank capital, strengthen liquidity requirements and discourage excessive leverage. They set a deadline of December for making the rules and originally gave countries until the end of 2012 to implement them.

Three months ago, European leaders and finance ministers, including those from Germany and France, were as adamant as their American and British counterparts in pushing back against banks’ objections to proposed rules that UBS AG estimated could force banks to raise $375 billion of capital, according to the regulators and bankers, who asked not to be identified because they weren’t authorized to speak. Fifty-five percent of that would have to be raised by European banks, UBS said.

Then Greece’s debt woes unnerved investors, making European leaders more receptive to what the banks were saying, according to the people.

‘Wiggle Room’

At their meeting in Toronto last month, G-20 leaders hinted at delays. While continuing to urge stricter capital and liquidity standards, they said implementation could take economic conditions of member states into account.

“The challenge of the eurozone crisis clearly played into the Toronto document,” said Barbara Matthews, a former bank lobbyist and now managing director of BCM International Regulatory Analytics LLC in Washington. “It gave wiggle room on implementation.”

Even if they’re softened and delayed, the new capital rules, known as Basel III, will force banks to take fewer risks and be better capitalized, said Paul Miller, an analyst for FBR Capital Markets Corp. based in Arlington, Virginia.

“There’s a misperception out there that Basel III isn’t going to happen, or if it does it will be so watered down it won’t matter,” Miller said. “Even with the tweaks in the next few months, they’ll come up with a pretty strong framework.”

Fixing Basel II

The Basel III proposal attempts to fix the shortcomings of an earlier revision, known as Basel II, which was initiated by lenders in the late 1990s and lowered capital requirements by as much as 29 percent for some banks. The new rules would tighten control of what goes into the banks’ calculation of risk, redefine what counts as capital and impose higher charges against holdings such as derivatives.

The committee is expected to decide on the definition of capital this week and defer issues such as capital ratios until its meetings in September and October, according to members.

One part of the definition would exclude minority interests that banks hold in other financial institutions when calculating common equity on the theory that they can’t readily withdraw the capital. Many European lenders, which have lobbied against the rule, have non-controlling stakes in emerging-market banks that would no longer count as the highest level of capital, while the assets of the subsidiaries would have to be included in the banks’ risks.

New capital requirements to have minimal economic impact

Executive summary

In December 2009, the Basel Committee on Banking Supervision (BCBS) proposed a set of measures to strengthen global capital and liquidity regulations. The aim of these measures is to improve the resilience of the financial system. The proposed reforms will generate substantial benefits by reducing both the frequency and intensity of financial crises, thereby lowering their very large economic costs.

A key factor determining banks’ responses to new capital and liquidity standards is the length of the period during which the new requirements are phased in. If the transition period is short, banks may choose to curtail credit supply in order to lift capital ratios and adjust asset composition and holdings quickly. A longer transition period could substantially mitigate the impact, allowing banks additional time to adapt by retaining earnings, issuing equity, shifting liability composition and the like.

Whether the transition is long or short, decisive action to strengthen banks’ capital and liquidity positions could boost confidence in the long-term stability of the financial system as soon as implementation starts. Giving banks time to use these adjustment mechanisms would almost certainly mitigate any adverse effects on lending conditions and, eventually, on aggregate activity.

Cognisant of the need to phase in the new regulations in a manner that is compatible with the ongoing economic recovery, the BCBS and the Financial Stability Board (FSB) set up a group to assess the macroeconomic effects of the transition to higher capital and liquidity requirements. This Macroeconomic Assessment Group (MAG) brings together macroeconomic modelling experts from central banks, regulatory agencies and international institutions; and is chaired by Stephen G Cecchetti, Economic Adviser of the BIS. The MAG’s work is intended to complement that of the BCBS’s Long-Term Economic Impact Group. Close collaboration with the IMF is an essential part of the process.

The MAG has applied common methodologies based on a set of scenarios for shifts in capital and liquidity requirements over different transition periods. These scenarios served as inputs into a broad range of models developed for policy analysis in central banks and international organisations (semi-structural large-scale models, reduced-form VAR-type models, DSGE models).

Ideally, one would like these models to capture the impact of the implementation of the new standards through all relevant mechanisms – including changes in lending spreads, short-term credit supply constraints and international spillover effects – and to take into account behavioural responses from banks and other market participants as well as monetary policy responses from central banks in line with their mandates. Unfortunately, standard macroeconomic models do not readily allow for direct investigation of the effects of prudential policy changes. While different models employed by the MAG capture many of the key aspects, there is no single model that incorporates all the relevant mechanisms.

In an effort to address the problem of model incompleteness and a greater than normal level of uncertainty about model specification, the study draws on results from a diversity of models and countries. Against this background, the presentation of the results focuses on the median outcome as a central estimate of the impact across models and countries, while also showing the range of responses obtained. These results can therefore be viewed as reasonably robust estimates of the costs of transition to the stronger standards in a representative case.

Basel Committee proposes new capital definitions

  • Source: Annex Basel Committee on Banking Supervision, July 26, 2010

The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, met on 26 July 2010 to review the Basel Committee's capital and liquidity reform package.

Governors and Heads of Supervision are deeply committed to increase the quality, quantity, and international consistency of capital, to strengthen liquidity standards, to discourage excessive leverage and risk taking, and reduce procyclicality.

Governors and Heads of Supervision reached broad agreement on the overall design of the capital and liquidity reform package. In particular, this includes the definition of capital, the treatment of counterparty credit risk, the leverage ratio, and the global liquidity standard. The Committee will finalise the regulatory buffers before the end of this year. The Governors and Heads of Supervision agreed to finalise the calibration and phase-in arrangements at their meeting in September.

Mr Jean-Claude Trichet, President of the European Central Bank and Chairman of the Group of Governors and Heads of Supervision, said that "the agreements reached today are a landmark achievement to strengthen banking sector resilience in a manner that reflects the key lessons of the crisis." He emphasised that "the Group of Governors and Heads of Supervision have ensured that the reforms are rigorous and promote the long term stability of the banking system. We will put in place transition arrangements that ensure the banking sector is able to support the economic recovery."

Mr Nout Wellink, Chairman of the Basel Committee and President of the Netherlands Bank added that "a strong banking sector is a necessary condition for sustainable economic growth." He added that the announcements today should provide additional transparency about the design of the Basel Committee reforms, thus reducing market uncertainty and further supporting the economic recovery. Mr Wellink underscored that "many banks have already made substantial strides in strengthening their capital and liquidity base. The phase-in arrangements will enable the banking sector to meet the new standards through reasonable earnings retention and capital raising."

In reaching their broad agreement, the Governors and Heads of Supervision considered the comments received during the public consultation on the Basel Committee's proposed reforms, which were published in December 2009. They also took account of the results of the Quantitative Impact Study, the assessments of the economic impact over the transition and the long run economic benefits and costs. The Basel Committee will issue publicly its economic impact assessment in August. It will issue the details of the capital and liquidity reforms later this year, together with a summary of the results of the Quantitative Impact Study.

The key broad agreements of the Governors and Heads of Supervision are summarised in the Annex below.

Main design elements

I. Definition of capital The Committee retained most of the definition of capital proposals set out in the December 2009 consultative package. However, it concluded that certain deductions could have potentially adverse consequences for particular business models and provisioning practices, and may not appropriately take into account evidence of realisable valuations during periods of extreme stress.

Therefore, the following amendments to the December 2009 proposal have been agreed.

Minority interest

The Committee will allow some prudent recognition of the minority interest supporting the risks of a subsidiary that is a bank. The excess capital above the minimum of a subsidiary that is a bank will be deducted in proportion to the minority interest share.

Investments in other financial institutions

The December 2009 reform package required that unconsolidated investments in financial institutions be deducted when the holdings exceed certain thresholds.3 These thresholds continue to apply. The December paper also stated that gross long positions may be deducted net of short positions only if the short positions involve no counterparty risk. The Committee agreed to eliminate this counterparty credit restriction on hedging of financial institution investments and to include an underwriting exemption.

Allow IFRS treatment where different from national GAAP (eg software)

A level playing field is established through an option to use IFRS in determining the level of intangible assets if national GAAP results in a wider range of assets (eg certain software assets) being classified as intangible.

Treatment of significant investments in the common shares of unconsolidated financial institutions (banks, insurance and other financial entities); mortgage servicing rights, and deferred tax assets from timing differences Instead of a full deduction, the following items may each receive limited recognition when calculating the common equity component of Tier 1, with recognition capped at 10% of the bank’s common equity component:

  • Significant investments in the common shares of unconsolidated financial institutions (banks, insurance and other financial entities). “Significant” means more than 10% of the issued share capital;
  • Mortgage servicing rights (MSRs); and
  • Deferred tax assets (DTAs) that arise from timing differences.

A bank must deduct the amount by which the aggregate of the three items above exceeds 15% of its common equity component of Tier 1 (calculated prior to the deduction of these items but after the deduction of all other deductions from the common equity component of Tier 14). The items included in the 15% aggregate limit are subject to full disclosure.

Basel Committee nearing agreement on definition of "capital"

The Basel Committee on Banking Supervision, nearing agreement on how to redefine capital and when to impose borrowing caps on banks worldwide, has left a final decision to its governing board, which meets next week.

The committee, a body of regulators and central bankers from 27 countries that sets capital standards, narrowed differences about how to count minority stakes in other financial institutions, deferred tax assets and mortgage- servicing rights, according to people with knowledge of the discussions that took place in Basel, Switzerland, last week.

It plans to present to its governing board two or three choices on how much of each of these items should be deducted from a bank’s capital, the people said. The board, which is made up of central bank governors and heads of supervisory agencies, will also decide on a time frame for making the leverage ratio binding on banks, they said.

“Before the committee makes big decisions, they’d like to run it through the board,” said Barbara Matthews, who used to lobby the committee on behalf of banks and now follows it as managing director of BCM International Regulatory Analytics LLC in Washington. “These issues are so contentious that it’s not surprising the board is summoned at this point. Something concrete will come out of the meeting next week.”

Basel III on track despite industry resistance

Stefan Walter said yesterday that the Basel Committee had no intention of changing the timetable of its calibrated package for reforms to Banking Supervision, despite the unpopularity of the proposals within the financial industry. The Committee "is conducting a wide range of analyses to ensure the design of the reforms is appropriate," said Waleter, "and that they produce a more stable financial system and economy over the long run without jeopardising growth in the near term."

One head of Basel implementation told Risk.net that the reform package "will require unprecedented and extraordinary levels of additional capital to be pumped into the banking system. It could lead to the killing of the banking industry in some countries and, if it's not altered sufficiently, could result in excessive fragmentation of implementation across jurisdictions and ruin all attempts at international harmonisation."

With macro-economic studies still pending, the committee's insistence to complete the package is being painted by some as a foolhardy measure.

Basel III liquidity rules

Regulators accept reform package will need to be reshaped but claim no decisions will be taken until July's committee meeting

The Basel Committee on Banking Supervision has not yet made a formal decision to shelve any parts of its proposed reforms to the Basel II framework, despite reports this morning claiming bank lobbyists have won their battle to limit the new rules.

The committee has not agreed to the elimination of any parts of the proposal, I can say that definitively.

Senior committee members have told Risk they were shocked to see reports suggesting the proposal for a net stable funding ratio (NSFR) would be shelved, as they don't intend to make any firm plans until the next Basel Committee meeting on July 15 at the earliest - although notes and suggestions are being circulated between committee members in advance.

"Leading up to the July meeting, there are a lot of efforts to see if we have an agreement among committee members on the direction forward, but we haven't got there yet. The committee has not agreed to the elimination of any parts of the proposal, I can say that definitively," says one US-based regulator and committee member.

"People should be very cautious about reaching conclusions prematurely, we haven't even discussed the issue yet. The committee is still in the process of going through the comments and impact assessments, and decisions haven't been reached on these issues," says a European committee member.

Regulators have admitted in recent weeks that aspects of the current proposals - including the NSFR and a proposed capital charge for the credit valuation adjustment - might need to be reworked before the measures are finalised later this year, but no firm decision has been reached on how that should be done.

The July 15 meeting in Basel is expected to be a watershed, at which decisions could be taken to postpone parts of the package, but those decisions would then need approval from the group of central bank governors and heads of supervision that oversee the Basel Committee's work.

"It is possible the committee could decide that certain parts of the agreement have to be finalised sooner than other parts of the agreement. Could the NSFR fall into that category? Yes it could, but I would challenge anybody to say there is agreement to that effect yet," says the US regulator.

If the NSFR is to be scrapped, the move would be welcomed by the many banks that have been lobbying against the proposals. Some reports this morning claimed gains by UK bank stocks reflected relief that concessions may be in the pipeline.

Although the FTSE 100 was down 0.44% shortly after 14:00 BST, some banking stocks were up - HSBC gaining 1.6% and Standard Chartered 2.2%. RBS had at one point been the biggest riser on the index, but by early afternoon had given up gains of more than 2%.

Press reports have also suggested a draft of the Basel Committee's current thinking will be presented at this weekend's meeting of the Group of 20 (G-20) leading economies in Toronto. But committee members don't expect significant Basel-related decisions to be made at the meeting.

"I'm sure it will be discussed this weekend, but my understanding is the outcome of that discussion is going to be continued support for raising the standards in support of the resilience of financial institutions, and commitment to the timetable of completion by the G-20 meeting in November," says the US regulator.

Basel Committee adjusts market risk framework

A formal 8% floor is set for correlation trading capital charge following analysis of QIS results.

The Basel Committee on Banking Supervision has adjusted parts of its new market risk framework, six months after the end of a quantitative impact (QIS) study on the measures.

The most significant amendment is the setting of a floor on the capital held for correlation trading. When the revisions to the market risk framework were published last July, the Basel Committee declared that banks would be able to use their own internal models to calculate the capital charge for correlation books, covering incremental default and migration risks and specific price risks. The Basel Committee said at the time it would determine a minimum floor for the new internally modelled charge after an impact study.

Under the revisions announced today, the floor is set at 8% of the capital charge for specific risk based on the standardised measurement approach.

The 8% floor was widely expected, and attracted significant criticism from banks during the QIS, which ended in January this year. Some have argued the floor is arbitrary and prevents banks from benefiting from investments in internal models, and so should be removed. Others claim the rules on correlation trading are too punitive and led to capital charges being higher than the floor in many cases anyway (Risk February 2010, page 8).

Correlation traders concede the rules are a significant improvement on the original proposals published in January 2009. In that draft, the Basel Committee stated that securitisation positions would be excluded from incremental risk charge models and subjected to a stricter banking book charge based on credit ratings. The loose definition of securitisation exposures meant correlation trading would have become uneconomical, dealers claimed.

Meanwhile, the Basel Committee has implemented a transition period of two years for a capital charge on non-correlation trading securitisation positions. Rather than basing the capital charge on the sum of the charges for net long and net short positions, the charge can be based on the larger of the capital levels for net long and net short positions until December 31, 2013.

The Basel Committee also reaffirmed its intention for the new rules to increase market risk capital requirements by an average of three to four times. However, it extended the deadline for implementation by one year, from December 31, 2010 to December 31, 2011.

Final document on supervisory colleges

The Basel Committee on Banking Supervision has issued a set of principles which aims to promote and strengthen the operation of supervisory colleges. Supervisory colleges are an important component of effective supervisory oversight of an international banking group.

The paper Good Practice Principles on Supervisory Colleges supplements broader guidance issued by the Basel Committee on cross-border cooperation and information-sharing by outlining expectations for both home and host supervisors in relation to college objectives, governance, communication and information, as well as potential areas for collaborative work.

Following a principle-based approach, the good practice principles are designed to allow adequate flexibility in the way that they are implemented for a wide range of banks across different jurisdictions. They are not intended to represent a definitive or exhaustive set of guidance regarding college functioning.

The financial crisis highlighted the importance of supervisory colleges in supporting the effective supervision of international banking groups. The Basel Committee intends to build upon its ongoing efforts to assist supervisors in running colleges as effectively as possible and continue to take stock of the evolving role and operation of colleges after the issurance of these principles.

A consultative version of this paper was released for public comment in March, 2010.

IMF publishes study debunking Basel principles

The recent financial crisis has sparked widespread calls for reforms of regulation and supervision. The initial reaction to the crisis was one of disbelief: how could such extensive financial distress emerge in countries where the supervision of financial risk had been thought to be the best in the world? Indeed, the regulatory standards and protocols of the advanced countries at the center of the financial storm were being emulated worldwide through the progressive adoption of the international Basel capital standards and the Basel Core Principles for Effective Bank Supervision (BCPs).

The crisis exposed significant weaknesses in the financial system regulatory and supervisory framework worldwide, and has spawned a growing debate about the role these weaknesses may have played in causing and propagating the crisis. As a result, reform of regulation and supervision is a top priority for policymakers, and many countries are working to upgrade their frameworks. But what should the reforms focus on? What constitutes good regulation and supervision? Which elements are most important for ensuring bank soundness? What should be the scope of regulation?

To date, the best practices in supervision and regulation have been embodied by the BCPs (Table 1). These principles were issued in 1997 by the Basel Committee on Bank Supervision, comprising representatives from bank supervisory agencies from advanced countries.2 Since then, most countries in the world have stated their intent to adopt and comply with the BCPs, making them a global standard for bank regulators. Importantly, since 1999, the IMF and the World Bank have conducted evaluations of countries’ compliance with these principles, mainly within their joint Financial Sector Assessment program (FSAP).3 The assessments are conducted according to a standardized methodology developed by the Basel Committee and therefore provide a unique source of information about the quality of supervision and regulation around the world. Hence the international community has made significant investments in developing these principles, encouraging their wide-spread adoption, and assessing progress with their compliance.

In light of the recent crisis and the resulting skepticism about the effectiveness of existing approaches to regulation and supervision, it is natural to ask if compliance with the global standard of good regulation is associated with bank soundness. This is the subject of this paper. Specifically, we test whether better compliance with BCPs is associated with safer banks. We also look at whether compliance with different elements of the BCP framework is more closely associated with bank soundness to identify if there are specific areas which would help prioritize reform efforts to improve supervision...

...All in all, we do not find support for the hypothesis that better compliance with BCPs results in sounder banks as measured by Z-scores. This result holds after controlling for the macroeconomic environment, institutional quality, and bank characteristics. We also fail to find a significant relationship when we consider different samples, such a sample of rated banks only, a sample including only commercial banks, and samples including only the largest financial institutions. In an additional test, we calculate aggregate Z-scores at the country level to try to capture the stability of the system as a while rather than that of individual banks, but also this measure of soundness is not significantly related to overall BCP compliance.

Basel Committee told to address gaps in reform

"The Basel Committee on Banking Supervision must make further progress on several areas not fully tackled in its two major consultative documents published on December 17, the Committee's oversight board of central bank governors and heads of supervision said this weekend.

Meeting in Basel on January 10 to review the proposals, the board highlighted several areas requiring further work. First, it asked that the Committee produce a practical proposal for a provisioning approach based on expected credit losses rather than incurred losses by March 2010. Although guiding principles have already been issued to help accounting standard setters and regulators reach a common approach in the replacement of International Accounting Standard (IAS) 39, the oversight board is pushing for something more concrete.

This could put regulators on a collision course with the International Accounting Standards Board (IASB), which published proposals for consultation on November 5 to replace the incurred loss model with an expected loss model as part of the overhaul of IAS 39. But the IASB proposals require future losses to be estimated using volatile point-in-time measures rather than the more counter-cyclical through-the-cycle estimates the Basel Committee's oversight board is pushing.

Regulators hope the introduction of a through-the-cycle approach to provisioning would address some of the widespread concerns over pro-cyclicality in the Basel II framework, but the oversight board also renews calls for a framework of counter-cyclical capital buffers – something the December package addressed from a high level but failed to explain in detail. Committee members have attributed the lack of progress to a split between central banks and supervisors over how the buffers would be structured.

Second, the board calls on the Basel Committee to tackle the risk posed by systemically important banks – something that was on its agenda last year but was not addressed in any detail in the consultation documents. The Committee has now created a new Macro-prudential Group with a mandate to evaluate a range of options including capital and liquidity surcharges, resolution mechanisms and structural adjustments.

Third, the board stresses the need for the Committee to review the role of contingent capital and convertible capital instruments in the regulatory capital framework and to use the quantitative impact study to review the details of its proposed minimum liquidity standards.

The board also repeated its call for the Committee to deliver a final, fully calibrated reform package by the end of 2010 with the aim of implementation by the end of 2012. To make that possible, it stressed the importance of the current period of industry consultation and quantitative testing that aims to capture the impact of the proposals on the banking sector and the broader economy.

"The group of central bank governors and heads of supervision will provide strong oversight of the work of the Basel Committee during this phase, including both the completion and calibration of the reforms," said Jean-Claude Trichet, president of the European Central Bank and chair of the oversight board.

It was a busy weekend in Basel, with two other high-profile meetings taking place at the same time: a plenary meeting of the Financial Stability Board (FSB) and a Bank for International Settlements (BIS) board meeting.

The FSB said it is reviewing the implementation of its September 2009 principles for sound compensation practices in FSB member countries and will report back to the Group of 20 (G-20) leaders in March. It also said it is pushing forward with proposals to address the problems associated with systemically important financial institutions and will present preliminary policy options at the G-20 summit in June.

In contrast to the FSB and Basel oversight board meetings, the BIS board meeting took place behind firmly closed doors, with press reports last week claiming it was a crisis meeting to which top banking chiefs had been summoned to discuss a worrying rise in risk-taking.

The BIS played down the reports. "The board meeting weekend always entails a lot of different closed meetings of central bankers and different financial organisations. This is a regular January board meeting at which commercial bankers come together with central bankers and it's nothing new. We never issue an agenda or list of participants for security reasons," said a BIS official.

Why do we trust the financial priests?

"The Icelanders have risen up and humiliated their political class over its handling of the financial crisis, as I mentioned on Thursday.

But there's nothing terribly unusual about their sense of powerlessness and alienation from the writing of the rules of the banking and finance game.

When it comes to how banks are allowed to behave, sovereignty over decision-making rarely rests with citizens.

Did anyone actually ask us whether we wanted our banks rescued to the tune of £1.2 trillion during and after the crisis of 2008?

If they had, we might have said no.

So perhaps it's a good thing that politicians and central bankers simply did what they thought was best for us, without consulting - because if the banks had gone down, the contraction in our economy would have been far far worse than it turned out to be.

Better to leave it to the experts, eh?

But hang on a tick: who actually got us into this mess in the first place?

It wasn't the fault of ordinary citizens like you and me.

It was those self-proclaimed experts who allowed our banks to become too huge, too complicated, too addicted to taking crazy risks, and too poorly endowed with life-preserving capital.

We trusted the Treasury, the Financial Services Authority and the Bank of England to make the right decisions about the structure and stewardship of our banking industry - and they got it spectacularly wrong.

That's representative democracy - but actually normal representative democracy doesn't really operate in this sphere,

How so? Well, most of our elected representatives - including ministers - understand less about banking and finance than even those who actually ran the banks.

So, little did we know, we have been delegating most of the really important decisions about all this to a financial priesthood: faceless, unelected, unaccountable technocrats who make up a committee that meets in the picture-postcard Swiss town of Basel - what's known as the Basel Committee on banking supervision.

These financial priests let us down too.

The rules they imposed on banks that were intended to limit dangerous risk-taking actually had the effect of encouraging banks to behave imprudently.

Their rules made the financial system more fragile, not less.

Here's the funny thing. Although we as taxpayers have come to the rescue of the financial system on an unprecedented scale, we're allowing those aloof financial priests to design the new system.

It's true that ministers have published policy papers on the structure of regulation and the method for limiting the contagion when a bank gets into difficulties.

And the Tories have proposed that the Bank of England should have much more power to police banks.

As for the Basel Committee, it has set out plans to revise and rehabilitate its own flawed rules for the banking industry (and this weekend, the Basel Committee's host, the Bank for International Settlements - known as the central bankers' central bank - will warn commercial bankers that they may already be taking silly risks again).

But none of this represents a proper public debate on the big questions that matter, such as:

  • whether there should be a limit on the size of banks;
  • whether those banks that take our deposits and lend to business, and will always be supported by taxpayers because of their importance to the economy, should be prohibited from engaging in certain kinds of more speculative business; or
  • whether our economy is excessively dependent on the City.

Since we've picked up an enormous bill for the banks' recklessness and fecklessness, you might think we should be having a proper say over what kind of banks we want, for our money."

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