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Resource Library

Resource(s) Found: 49

October 29, 2012

The Role of External Ratings Under Basel II

Author: Bogie Ozdemir


External Ratings can play important roles in IRRs design, quantification and validation – but we need to be careful about the appropriate usage. External Ratings can be used in: Risk Rating Assignment, Utilizing the Ratings, Utilizing the Methodology, Risk Rating Quantification, Validation, Benchmarking, and Becktesting.


Keywords: external ratings, IRRS design, risk rating, Financial rations, benchmarking, monitoring


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October 29, 2012

Principles for enhancing Corporate governance

Author: Bank for International Settlements


Given the important financial intermediation role of banks in an economy, the public and the market have a high degree of sensitivity to any difficulties potentially arising from any corporate governance shortcomings in banks. Corporate governance is thus of great relevance both to individual banking organisations and to the international financial system as a whole, and merits targeted supervisory guidance.The Basel Committee on Banking Supervision (the Committee) has had a longstanding commitment to promoting sound corporate governance practices for banking organisations. It published initial guidance in 1999, with revised principles in 2006.2 The Committee’s guidance assists banking supervisors and provides a reference point for promoting the adoption of sound corporate governance practices by banking organisations in their countries. The principles also serve as a reference point for the banks’ own corporate governance efforts.


Keywords: risk management, OECD, Financial Stability Board, FSB


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October 29, 2012

Enhancements to the Basel II framework

Author: Bank for International Settlements


The proposals for enhancing the Basel II framework in the area of securitisation and more specifically for dealing with resecuritisations have been finalised. Banks are expected to comply with the revised requirements by 31 December 2010. These enhancements are intended to strengthen the framework and respond to lessons learned from the financial crisis. There are several changes that the Committee is making to Pillar 1.


Keywords: Pillar 1, minimum capital requirements, Standardised Risk Weights, Resecuritisation Risk Weights, Credit Analysis, Liquidity


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October 29, 2012

The international financial crisis and policy challenges in Asia and the Pacific

Author: Bank for International Settlements


The international financial crisis has become a defining event in economic history and will probably cast a long shadow over policymaking for years to come. Even though it may be risky to draw firm conclusions from this event for Asia and the Pacific before the cessation of the financial market headwinds, a number of lessons have already emerged for Asia-Pacific central banks that are likely to stand the test of time. Such lessons learned, though naturally still tentative, can contribute to the ongoing discussions in various national, regional and international forums. In particular, these lessons should help guide discussions about possible reforms of the financial system and also about the design of exit strategies to help ensure a return to sustainable and less crisis-prone growth while maintaining price stability. To that end, the special background paper prepared for the conference examines the impact of the international financial crisis on Asia and the Pacific and the implications of this episode in economic history for central banks in the region. Part I presents a stylised timeline of the spillovers to the region, as well as key factors that account for the cross-country variations in the impact of the crisis. Part II explores some of the policy challenges posed by the crisis, through three lenses that correspond to the research priorities of the BIS Asian Research Programme: development of financial markets; monetary policy and exchange rates; and financial stability. Annex A details the range of actions taken by authorities in Asia and the Pacific since September 2008 to stimulate growth and stabilise financial markets and institutions.


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October 29, 2012

Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability

Author: Bank for International Settlements


"In the December 2009 consultative document Strengthening the resilience of the banking sector1, the Basel Committee on Banking Supervision noted that “[the Committee] continues to review the role that contingent capital and convertible capital instruments should play in the regulatory capital treatment. The Committee intends to discuss specific proposals at its July 2010 meeting on the role of convertibility, including as a possible entry criterion for Tier 1 and/or Tier 2 to ensure loss absorbency, and on the role of contingent and convertible capital more generally both within the regulatory capital minimum and as buffers.”


Keywords: loss absorbancy, capital instrument buyers, global bank, investor base


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October 29, 2012

Minimum Capital Requirements For Banks & DFIs Revised Regulatory Capital Framework under Basel II

Author: State Bank of Pakistan


"The instructions contained in this circular cover capital requirements against credit and operational risks. Besides, it requires banks to allocate capital against market risk emanating mainly from their trading activities. Nevertheless, there are other risk factors that can lead to significant loss to the institutions against which there is as such no specific capital requirement under part I. Though higher level of capital may act as a buffer against loss arising out of these other risks, it cannot be a substitute of other means available for addressing risk, such as strengthening risk management, applying internal limits, strengthening the level of provisions and reserves, and improving internal controls. In order to ensure the long term viability of institutions, it is important that they not only maintain capital well above the minimum capital requirements set out in part I of instructions described hereinafter, but also institute a robust risk management framework covering all major risks the institution is exposed to. Since there is a relationship between the amount of capital required and the effectiveness of bank’s risk management and internal control processes, there should be a process of capital allocation based on institution’s internal risk assessment and overall risk appetite.


Keywords: SRP, ICAAP, minimum capital requirements, Development Financial Institutions, penalties


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October 29, 2012

Guiding principles for the replacement of IAS 39

Author: Basel Committee on Banking Supervision


The replacement of IAS 39 should improve the decision usefulness and relevance of financial reporting for stakeholders, including prudential regulators. Information is useful to users if it enables them to assess amounts, timing, and uncertainty of future cash flows of the reporting entity and stewardship and accountability of the entity’s management.


Keywords: IAS 139, transparency, disclosure, crisis


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October 29, 2012

Basel II and Recent Market Development

Author: Nobuyoshi Chihara


Strengthening of Basel II framework in Japan through rigorous application of look-through approach, disclosure requirement for eligible securitization ratings, and prompt implementation of Pillar 3.


Keywords: Basel II, Pillar 3, Investment funds, disclosure requirement, market development


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October 29, 2012

Quality of bank capital in New Zealand

Author: Kevin Hoskin and Stuart Irvine


The four largest banks in New Zealand have been accredited to operate as ‘internal models’ (IM) banks under the Basel II capital framework. Under this approach, banks are allowed to use their own models as a basis of determining their minimum capital requirements, subject to their models being accredited by the Reserve Bank. In this article, we explore the quality of capital in New Zealand. We explain the Reserve Bank’s capital philosophy, and discuss the key issues that have been considered during the implementation of the IM approach within the New Zealand context. In doing so, we highlight areas in which the Reserve Bank has diverged from international practice to ensure that the New Zealand banking system operates within a conservatively capitalised framework, commensurate with the risks faced by New Zealand banks.


Keywords: Pillar 1, minimum capital holdings, PIT TCC, capital requirements, Basel II


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October 29, 2012

Calibrating regulatory minimum capital Requirements and capital buffers: a top- down approach

Author: Bank for International Settlements


As part of its work to strengthen global capital requirements, the Basel Committee on Banking Supervision established a working group to conduct a “top-down” assessment of the overall level of capital requirements that should be held within the banking system. The working group was tasked with undertaking empirical analysis to inform the calibration of the common equity and Tier 1 risk-based ratios and the Tier 1 leverage ratio, as well as the regulatory buffers above the common equity and Tier 1 risk-based ratios. This analysis represented one of the inputs to the Committee’s calibration of the new capital framework, and complements the cost-benefit analysis conducted by the Long-Term Economic Impact (LEI) group and the detailed “bottom up” Quantitative Impact Study (QIS) of the effects of the proposed regulatory reforms on individual banks.This note summarises the findings of the top-down calibration work. In particular, it provides a conceptual framework for the calibration work, describes the various empirical exercises that were performed, and summarises the results.


Keywords: capital buffers, regulatory requirements, risk-weighted assets, financial crisis, losses


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October 29, 2012

Spanish-Provisions under IFRS

Author: Financial Accounting Standards Board


Under IAS 39 loan loss provisions are determined based on an incurred loss model, supported by objective evidence of impairment (either due to a single loss event or to a group of events). This includes observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group. IAS 39 states that loan loss provisions cannot reflect losses based on expected future events.


Keywords: IFRS, IAS, Spanish provisioning system


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October 29, 2012

Economic Loan Loss Provision and Expected Loss

Author: Stefan Hlawatsch and Sebastian Ostrowski


The intention of a loss prevention is the anticipation of credit’s expected losses by adjusting the book values of the credits. Furthermore, the loan loss provision has to be compared to the expected loss accordig to Basel II and if necessary, equity has to be adjusted. This however assumes that the loan loss provision and the expected loss are comparable, which is only valid conditionally in current loan loss provisioning methods according to IAS. The provisioning and accounting model developed in this paper overcomes the before mentioned shortcomings and is consistent with an ecenomic rationale of expected losses. We introduce a definition of expected loss referring to the whole maturity of the loan and sow that this measure can be reasonably compared with loan loss provisions. Additionally, this model is based on a close-to-market valuation of the loan. Suggestions for changes in current accounting and capital requirement rules are provided.


Keywords: Loan loss provision, expected loss, IAS Basel II


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October 29, 2012

Understanding the framework- Adopting the Basel II Accord in Asia Pacific

Author: Deloitte Financial Services


Although Basel II is primarily intended for ‘internationally active banks’ among the G–101 countries, many countries have announced their intention to adopt the Basel II Capital Accord. Bank regulatory bodies around the world have been studying how Basel II can be incorporated into national regulations and are developing implementation guidelines and timeframes for compliance. Similar to the 1988 Accord, Basel II is expected to become an industry standard with the actual scope of application beyond the ‘internationally active banks’. Adoption will inevitably, over time, be as extensive as for the current Accord (Basel I), which is followed in over 100 countries. In many countries, regulators are using the Basel II framework to drive the largest banks in particular toward adoption of best practices in the areas of risk measurement, risk management and capital allocation. Given the regulatory imperative, banking institutions are expected to face significant challenges to achieving Basel II compliance in a timely manner. These challenges include project management and system issues, data availability, technical interpretation, institutional awareness and training.


Keywords: Basel II, 1988 Capital Accord, Bank for International Settlements, regulatory requirements, Asia, banking, banking markets


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October 29, 2012

2010 FSI Survey on the Implementation of the New Capital Adequacy Framework

Author: Bank for International Settlements


Over the past several years, the Financial Stability Institute has carried out surveys on topics of interest to supervisors around the world. Basel II implementation has been one such important topic, with surveys conducted in 2004, 2006 and 2008. In order to ascertain the latest status of implementation of Basel II, especially against the backdrop of the recent financial crisis, the survey was carried out again this year. This paper presents the results of the 2010 survey on Basel II implementation. Consistent with the earlier surveys, the 2010 survey findings indicate that Basel II will be implemented by the overwhelming majority of jurisdictions.


Keywords: pillar 1, credit risk, operational risk, pillar 2, pillar 3, financial crisis, market discipline


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October 29, 2012

Countercyclical capital buffer proposal

Author: Bank for International Settlements


The agreement of the Group of Central Bank Governors and Heads of Supervision, set out in its 7 September 2009 press release, included a commitment to introduce a framework for countercyclical capital buffers above the minimum requirement. Subsequently, the Basel Committee agreed that a building block approach should be adopted to organize the work on procyclicality. The aim of this approach was to align the development of tools to address procyclicality according to a specific set of objectives. The four key objectives identified by the Committee were set out as follows in the December 2009 Consultative Document Strengthening the resilience of the banking sector:   dampen any excess cyclicality of the minimum capital requirement;  promote more forward looking provisions; conserve capital to build buffers at individual banks and the banking sector that can be used in stress; and achieve the broader macroprudential.


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October 29, 2012

Earnings and Capital Management in Alternative Loan Loss Provision Regulatory Regimes

Author: Daniel Pérez, Vicente Salas and Jesús Saurina


The paper sets an accounting and behavioral framework from which we derive a reduced-form equation to test income smoothing and capital management practices through loan loss provisions (PLL) by Spanish banks. Spain offers a unique environment to perform those tests because there are very detailed rules to set aside loan loss provisionsand they are not counted as regulatory capital. Using panel data econometric techniques,we find evidence of income smoothing through PLL but not of capital management. The paper draws some lessons for accounting rule setters and banking regulators regardingthe current changes in the accounting framework (introduction of IFRS/IAS in Europe) as well as the new capital framework (Basel II). In particular, a very detailed set of rules to set aside loan loss provisions does not prevent managers from decreasing earnings volatility, similarly to what happens in a more principles-oriented accounting framework.


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October 29, 2012

Regulatory use of system-wide estimations of PD, LGD and EAD

Author: JAE Flores, Tania Lemus Basualdo, Ana Regina Quintana Sordo, and Comisión Nacional Bancaria y de Valores


The objective of prudential regulation has for a long time been the solvency of individual entities and hence a vast range of prudential tools were developed to address this priority. Most recently, due to the period of financial stress and the failure of seemingly solvent institutions, the international supervisory community has expanded the relevance of prudential tools in promoting the stability of the financial system as a whole in addition to individual institutions. In this sense the Basel Committee has concluded that the issue of systemic risk is probably the most important and most difficult one confronted by the international regulatory community and that progress requires, among other things, a combination of better regulation and the inclusion of a macro perspective into prudential tools.


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October 29, 2012

Stress testing with incomplete data A practical guide

Author: Stacia Howard


With the ever-increasing diversification and inter-connectedness of financial systems, regulators have been dedicating more resources to understanding the relationships within their financial systems and investigating any inherent vulnerability. As such, a number of methodologies have been developed to analyse the stability of the financial sector. One of the more popular ways in which financial stability is assessed is through the use of stress tests. Stress tests, in the commercial banking literature, refer to assessing the impact of a rare but plausible shock to the financial system. Countries have to determine whether the financial institutions to be included in the analysis would conduct their own individual stress tests and then the regulator would aggregate the submitted data to arrive at a macro stress test; or whether the regulators would collect the necessary data and conduct one stress test based on the information received. Based on the stability reports published by various regulatory bodies throughout the world, the preference seems to be to collect the data to perform the stress test rather than rely on individual institutions to submit their results.


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October 29, 2012

From Basel II to Basel III — Changes, Improvements, and Proposals

Author: Peter Went


Strengthen the Global Financial System by Raising Capital Requirements, Increasing Capital Levels, Improving Risk Management Practices, and Expanding Disclosure


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October 29, 2012

Good practice principles on supervisory colleges

Author: Bank for International Settlements


Colleges of supervisors are an important component of effective supervisory oversight of an international banking group. This message has been reinforced by the G20 in the wake of the financial crisis. Accordingly, the Basel Committee on Banking Supervision (BCBS) has issued this paper, which builds on previous publications outlining established good practices in colleges and provides some enhanced principles that can be used as a basis for continuing to improve the operation of supervisory colleges. This document does not intend to represent a definitive or exhaustive set of guidance regarding college functioning. These principles are, however, designed to help both home and host supervisors ensure that they work as effectively as possible by clearly outlining expectations in relation to college objectives, governance, communication and information, as well as potential areas for collaborative work. The BCBS has adopted a principle-based approach so that the good practice principles in this paper are relevant to a wide range of banks across different jurisdictions. Therefore, the principles are designed to allow adequate flexibility in the way that they are implemented by different jurisdictions. To this end, it is reasonable to expect supervisors to discuss and agree on the most appropriate approach for their specific circumstances.


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October 29, 2012

Comment piece: IFRS implementation in Asia Pacific and Japan

Author: FRSGlobal Centre of Risk & Regulatory Excellence


International Financial Reporting Standards (IFRS) are the accounting standards issued by the London-based International Accounting Standards Board (IASB), an independent standard-setting board. The purpose of the IASB is to develop a single set of high quality accounting standards that are accepted globally, so that financial statements may be produced, read and understood by both local and international market players. The IASB has also adopted the International Accounting Standards (IAS) issued by its predecessor, the Board of the International Accounting Standards Committee (IASC). These continue to be designated International Accounting Standards (IAS) but are being superseded by International Financial Reporting Standards as the standards are reviewed and updated over time.


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October 29, 2012

Economic Loan Loss Provision and Expected Loss

Author: Stefan Hlawatsch, Sebastian Ostrowski


The intention of a loss provision is the anticipation of credit’s expected losses by adjusting the book values of the credits. Futhermore, this loan loss provision has to be compared to the expected loss according to Basel II and if necessary, equity has to be adjusted. This however assumes that the loan loss provisioning methods according to IAS. The provisioning and accounting model developed I this paper overcomes the before mentioned shortcomings and is consistent with an economic rationale of expected losses. We introduce a definition of expected loss referring to the whole maturity of the loan and show that this model is based on a close-to market valuation of the loan. Suggestions for changes in current accounting and capital requirement rules are provided.


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October 29, 2012

Downturn LGDs for Basel II

Author: RMA Capital Working Group


The Basel II Framework requires that Loss-Given-Default (“LGD”) be measured “to reflect economic downturn conditions where necessary to capture the relevant risks.” Each of the Advanced Internal-Ratings-Based (“AIRB”) banks has been analyzing how to estimate such a downturn LGD (“DLGD”) for each of its credit products, and this month the Basel Committee released new Guidance regarding a “principles-based” approach to satisfying the requirements of paragraph 468.2 This paper provides a brief comment on the new Guidance, discusses our major concerns regarding DLGDs, and also provides the results of new research on the cyclicality of LGDs for several credit product categories within the U.S. The RMA Capital Working Group appreciates the principles-based nature of the Guidance and agrees in broad terms with those principles. We also appreciate the regulators’ recognition of the problems associated with estimating downturn LGDs and the lack of industry consensus on the issue. However, we remain concerned over the lack of recognition of a cross-product diversification benefit associated with Basel II’s treatment of downturn LGD. That is, it would be an overly conservative approach to require that AIRB banks use a downturn LGD, measured in terms of LGDs observed over the cycle, for each of its credit products, without considering that LGDs for various types of loan respond to the cycle with diverse timing or respond to differing macro factors that are product specific. This lack of correlation in downturn LGDs (“DLGDs”) across products may be quite significant in affecting the measurement of tail-risk for the portfolio as a whole. The next section summarizes this and other important issues surrounding the downturn LGD (“DLGD”) concept. An appendix discusses the new research results.


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October 29, 2012

Regulation: Basel III Surfing the Regulatory Tsunami

Author: GARP


In December 2009, the Basel Committee on Banking Supervision issued far-reaching proposals to strengthen global capital and liquidity regulation, with the goal of promoting a more resilient banking sector. While important details will not be finalized until the end of 2010, it is clear that the proposals entail profound changes for the banking industry, and that the regulatory tsunami has hit the shore. The package of proposals covers five main areas: (1) increasing the quality, consistency and transparency of capital, including enhancing the composition of Tier 1 capital; (2) introducing a number of measures to promote the build-up of capital buffers in good times, and to counteract the procyclicality of capital requirements; (3) introducing a leverage ratio as a supplementary measure to the Basel risk-based framework; (4) enhancing the risk coverage of the capital framework by better capturing counterparty risk; and (5) establishing a new regulatory requirements to ensure that banks carry sufficient levels of liquidity to sustain a size-up of funding markets. This article reviews these proposals


Keywords: Basel III, capital buffers, Basel committee


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October 29, 2012

Competitive Effects of Basel II on US Bank Credit Card Lending

Author: William W. Lang


We analyze the potential competitive effects of the proposed Basel II capital regulations on U.S. bank credit card lending. We find that bank issuers operating under Basel II will face higher regulatory capital minimums than Basel I banks, with differences due to the way the two regulations treat reserves and gain-on-sale of securitized assets. During periods of normal economic conditions, this is not likely to have a competitive effect; however, during periods of substantial stress in credit card portfolios, Basel II banks could face a significant competitive disadvantage relative to Basel I banks and nonbank issuers.


Keywords: Basel Accord, Basel II, capital requirements, bank regulation, competition


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October 29, 2012

Bank Loan Loss Provisions and Capital Management Under the Basel Accord

Author: Zhou Yunxia


This thesis empirically examines capital management mechanisms of the U.S. banks under the Basel capital adequacy accord. An important finding is that Tier I capital (primary capital under the regulatory regime prior to the Basel accord) and Tier II capital management incentives and their associated manipulation mechanisms are significantly different. Banks are likely to decrease (instead of increasing) loan loss provisions for Tier I capital management. In contrast, banks increase loan loss provisions for Tier II capital management. This dichotomy in capital management via loan loss provisions is completely missed out in prior literature. The conflicting effects of loan loss provisions on Tier II capital and earnings are also studied. Results suggest that, among banks with the same level of Tier II capitals, banks would prefer to decrease loan loss provisions for earnings management purpose if there is an earnings decrease from the previous year.


Keywords: loan classification, nonaudit services, earnings quality measures


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October 29, 2012

Credit Risk Capital for Retail Credit Products: A Survey of Sound Practices

Author: The Risk Management Association


This paper represents RMA's response to informal requests by the U.S. banking agencies for information regarding an appropriate regulatory capital treatment of retail credit products. The subject of capital for retail credit products was essentially ignored within the 1999 Consultative Paper on capital issued by the Basel Committee. The Committee did request comment, however, on an "internal ratings-based" approach to capital for commercial loan products, and RMA previously has expressed its views on this subject in a March 2000 response to the Consultative Paper.3 In that document, we argued that the minimum regulatory capital requirements should be based on several of the important, measurable risk characteristics that typically are used by advancedpractice institutions as inputs into so-called "economic capital" (for credit risk) models. Further, this risk-characteristic-based process should be viewed as an interim step until a "full-models" approach to regulatory capital for credit risk can be implemented.


Keywords: credit risk capital, retail credit, commercial lending, mark-to-model, mark-to market


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October 29, 2012

Earning and Capital Management in Alternative Loan Loss Provision Regulatory Regimes 2006

Author: Daniel Pérez, Vicente Salas and Jesús Saurina


"The paper sets an accounting and behavioral framework from which we derive a reduced-form equation to test income smoothing and capital management practices through loan loss provisions (PLL) by Spanish banks. Spain offers a unique environment to perform those tests because there are very detailed rules to set aside loan loss provisions and they are not counted as regulatory capital. Using panel data econometric techniques, we find evidence of income smoothing through PLL but not of capital management. The paper draws some lessons for accounting rule setters and banking regulators regarding the current changes in the accounting framework (introduction of IFRS/IAS in Europe) as well as the new capital framework (Basel II). In particular, a very detailed set of rules to set aside loan loss provisions does not prevent managers from decreasing earnings volatility, similarly to what happens in a more principles-oriented accounting framework."


Keywords: loan loss, economic model, regulatory, capital maagement, earning management


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October 29, 2012

Risk Topography

Author: Markus K. Brunnermeier, Gary Gorton, and Arvind Krishnamurthy


The aim of this paper is to conceptualize and design a risk topography that outlines a data acquisition and dissemination process that informs policymakers, researchers and market participants about systemic risk. Our approach emphasizes that systemic risk (i) cannot be detected based on measuring cash instruments, e.g., balance sheet items and income statement items; (ii) typically builds up in the background before materializing in a crisis; and (iii), is determined by market participants’ response to various shocks. We propose that regulators elicit from market participants their (partial equilibrium) risk as well as liquidity sensitivities with respect to major risk factors and liquidity scenarios. General equilibrium responses and economThe aim of this paper is to conceptualize and design a risk topography that outlines a data acquisition and dissemination process that informs policymakers, researchers and market participants about systemic risk. Our approach emphasizes that systemic risk (i) cannot be detected based on measuring cash instruments, e.g., balance sheet items and income statement items; (ii) typically builds up in the background before materializing in a crisis; and (iii), is determined by market participants’ response to various shocks. We propose that regulators elicit from market participants their (partial equilibrium) risk as well as liquidity sensitivities with respect to major risk factors and liquidity scenarios. General equilibrium responses and economy-wide system effects can be calibrated using this panel data set.y-wide system effects can be calibrated using this panel data set.


Keywords: financial crisis, risk, risk topography, benchmark, liquidity mismatch, Rehypothecation, Synthetic Leverage


October 29, 2012

Loss Given Default models for UK retail credit cards

Author: Tony Bellotti and Jonathan Crook


Loss Given Default is an important measure of credit loss used by financial institutions to compute risk within credit portfolios, expected loss on individual loans and capital requirements. The Basel II Capital Accord gives banks the opportunity to calculate their own estimates of Loss Given Default. Based on UK data for major retail credit cards, we build several models of Loss Given Default based on account level data including Tobit, a decision tree model, a Beta and fractional logit transformation. However, we find that Ordinary Least Squares models with macroeconomic variables perform best for forecast of Loss Given Default at account and portfolio level on independent hold-out data sets. The inclusion of macroeconomic conditions in the model is important since it provides a means to model Loss Given Default in downturn conditions as required by Basel II and enables stress testing.


Keywords: Loss given default; retail credit; regression; model comparison; macroeconomic; forecast.


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October 29, 2012

Aggregate outcome of the 2010 EU wide stress test exercise coordinated

Author: CEBS in cooperation with the ECB


The Committee of European Banking Supervisors (CEBS) was mandated by the ECOFIN of the European Council to conduct in cooperation with the European Central Bank (ECB), the European Commission and the EU national supervisory authorities a second EU-wide stress test exercise. The overall objective of the 2010 exercise is to provide policy information for assessing the resilience of the EU banking system to possible adverse economic developments and to assess the ability of banks in the exercise to absorb possible shocks on credit and market risks, including sovereign risks. The stress test has been conducted on a bank-by-bank basis and using bank’s specific data and supervisory information.


Keywords: stress test, aggregate, EU banks, macro-economic scenerios


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October 29, 2012

Loan Loss Reserves, Regulatory Capital, and Bank Failures: Evidence from the 2008-2009 Economic Crisis

Author: Jeffrey Ng, Sugata Roychowdhury


"We examine the influence of regulatory capital guidelines on the link between banks’ loan loss reserves in 2007 and the risk of bank failure during the 2008-2009 economic crisis. We find that increases in loan loss reserves are positively associated with bank failure risk, but only for banks that are allowed to add back loan loss reserves as Tier 2 capital. These results suggest that the ability to add back loan loss reserves to regulatory capital creates the illusion of non-declining financial health, which can contribute to increased likelihood of eventual bank failure. Our results thus challenge the notion that the buffer created by loan loss reserves lowers bank failure risk. Simultaneously, they question the soundness of allowing even more loan loss reserves to be added back as regulatory capital."


Keywords: bank failure, bank risk, regulatory capital, capital adequacy, loan loss reserves, loan loss provisions, loan charge-offs


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October 29, 2012

K C Chakrabarty: Banking and beyond – new challenges before Indian financial system

Author: Dr K C Chakrabarty


Address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at the Mint’s Clarity Through Debate, Mumbai, 15 March 2011. The address included a focus on financial inclusion, capital, liquidity management, IFRS implementation, and risk management.


Keywords: India, Indian financial system, risk, capital, liquidity management, banking


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October 29, 2012

Banks and financial intermediation in emerging Asia: reforms and new risks

Author: M S Mohanty and Philip Turner


The conventional view is that microeconomic reforms after the 1997–98 Asian financial crisis have greatly strengthened banking systems in Asia. Banks have become better capitalised, external exposures have been reduced and credit risk has been managed more effectively. But this conventional view does not take enough account of the macroeconomic background. A sharp rise in domestic savings, combined with the recent large-scale sterilised intervention and easy monetary policy, has led to very easy financing conditions for banks. Bank credit expanded. Banks have accumulated a large stock of government bonds. How these conditions will change and how this will affect banks in Asia is uncertain. Supervisory authorities therefore need to be sure that the present very liquid position of most banking systems in Asia does not allow significant (but so far only latent) increases in market and credit risk to go undetected.


Keywords: Banking system, Asia, Financial markets, foreign exchange intervention.


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October 29, 2012

Razor White Paper: Liquidity Risk Management

Author: Razor Risk Technologies


From October 2009, the Financial Services Authority (FSA) requires all UK banks, building societies and investment firms to report their liquidity risk. Given the level of detail, frequency and stress testing requirements, as well as the implementation deadlines, the new rules present a significant challenge to most financial institutions. Central to the new regime is the need for institutions to evaluate their financial stability under various scenarios, including stress tests of severe but plausible scenarios. Institutions must examine the impact of 10 key liquidity risk drivers, including wholesale funding, intra-day liquidity and offbalance sheet liquidity. The FSA specifies three major stresses that institutions must test – a name-specific shock, market-wide dislocation and a combination of the two. Institutions taking a best practice approach will want to explore a wider range of possible scenarios.


Keywords: liquidity risk management, wholesale funding risk, cross-currency liquidity risk, franchise viability risk


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October 29, 2012

IAS 39 and the Practice of Loan Loss Provisioning Throughout Australasia

Author: Nigel Finch


This paper examines the response of a sample of Asian banks to the recognition of loan loss provisions before, during and after the Global Financial Crises. Drawing on empirical data from 2006 through 2009, this paper focuses on the level of loan loss provisioning undertaken by the banks, with a view to generating insights into the effectiveness of the approach to loan impairment and provisioning prescribed by IAS 39 – Financial Instruments: Measurement and Recognition. Given that the focus of impairment decision making under IAS 39 is historically oriented rather than future oriented, we argue this may result in the diminution in the decision usefulness of the content of bank financial statements in the face of imminent, though not yet manifested economic distress. Despite mounting evidence that substantial portions of the globe’s financial and economic fabric lay in a state of severe distress, our analysis of the financial disclosures of the sample of Asian banks shows a picture at odds with this larger reality. We argue that this response is shaped by the requirements of the newly introduced accounting standard and that a broadening of the legitimate sources of evidence upon which loan impairment recognition decisions may be based pursuant to IAS 39 should be a matter of priority.


Keywords: Impairment, Loan loss provision, Banking, IFRS


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October 29, 2012

Risk Management Lessons Worth Remembering From the Credit Crisis of 2007 – 2009

Author: Bennett W. Golub and Conan C. Crum


"In our lead article we discuss the changing face of regulation and what are the likely outcomes from the current process. The limited global vision is particularly highlighted and the changing roles that are required. I remain hopeful that new organisational responsibilities will be implemented which will significantly reduce the level of risk in the system – what cannot be appropriate is for the capital levels within firms to be distributed at stress levels globally. A major change to the UK regulatory structure is the Bribery Act, whose implementation has been delayed by six months. This places significant additional responsibilities on firms which they need to be aware of. David Blackmore’s article considers the impact of this important legislation. Solvency 2 for the insurance industry has many parallels to Basel 2 for the banking industry. It is a major change programme which impacts both risk management and consequently internal audit as discussed by John Webb. Developing a programme to efficiently deal with these issues while adding value to your firm will remain a prime issue for insurers."


Keywords: Bank for International Settlements, BIS, regulatory structure, Basel III, global risk, regulation, crisis


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October 29, 2012

Insurance Risk Management in the Light of Basel II

Author: Paul Embrechts


Regulators are on a world wide search for the assessment of solvency for insurance companies. This presentations faces that issue, and is based upon the several reports and solvency tests from across the globe.


Keywords: solvency test, Basel II, Principle-based thinking, Solvency 2, Insurance analytics


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October 29, 2012

Aggregation of Risk: Issues and Perspectives

Author: Sumit Mathur


"Estimating a single risk capital metric that summarizes all risks and explains the risk profile of a financial conglomerate is a critical process of risk management. Particularly in this context, banks find drawing a conclusive roadmap an arduous exercise as there is no standard regulatory guidance, the way it exists for calculation of regulatory capital and it is a difficult exercise to benchmark with peers due to disparities in existing or planned risk profile. For instance while an overwhelming majority of banks cite integrated stochastic scenarios as primary method for risk aggregation within each risk type, this approach has limited appeal when integrating risk across an enterprise. Another source of complexity arises due to mapping of risk with different products / business units originating risk. There are products and business units in which the risks are primarily concentrated in a single risk category. And sometimes there are situations where multiple risk categories are present at product and business unit levels. The challenge is to combine risk across all of the products and business units in an organization. Therefore, decision making in the area of risk aggregation presents the CRO (Chief Risk Officer) with other host of issues and challenges. This paper is aimed at identifying most of such issues, explain their cause and suggest options that banks can make use for implementing an effective risk aggregation strategy."


Keywords: risk aggregation, risk capital metric, Bank Capital, risk measures


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October 29, 2012

Governance Risk and Compliance: A Survey

Author: Norman Marks, SAP, OCEG Fellow


"In late 2010, Norman Marks1 ran a survey asking for opinions on GRC (the term stands for governance, risk, and compliance): what it means, its value, and more. 143 people responded: followers of his blogs, Twitter activity, LinkedIn discussions, and professional networking circles. This group can be expected to be more familiar with GRC than the general business population, so the results may not be a solid indication of the sentiments of the broader professional community.


Keywords: GRC, Governance Risk and Compliance, risk strategy, risk mitigation, risk culture


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October 29, 2012

Capital Discipline

Author: Andrew G. Haldane


The Basel Committee sets capital standards for international banks. There are now three vintages of these standards: so-called Basel I dating from 1988, Basel II dating from around 2004 and Basel III which was agreed at the end of last year.  These international capital standards are supported by three pillars. Pillar I defines the regulatory rules, Pillar II provides scope for supervisory discretion, while Pillar III seeks to foster market discipline through disclosure. In countering systemic shocks, three supporting pillars have understandably been felt to be better than one. But the success of international capital standards in forestalling banking distress has been mixed. Basel I regulatory rules were arbitraged due to their risk insensitivity. This gave rise to Basel II with its greater focus on risk calibration. But Basel II buckled under the weight of the recent crisis. Repairs have since been applied through Basel III. Historical experience suggests this is unlikely to be the end of road. This paper assesses and suggests means of improving the robustness of this regulatory framework. The quest for risk sensitivity in Pillar I rules caused regulatory complexity and opacity to blossom. This may have inhibited the effectiveness of supervisory discretion and market discipline (Section 1). In consequence, Pillar I may have borne too much of the load and Pillars II and III too little. This paper focuses on Pillar III.


Keywords: BIS, Pillar 3, capital, market discipline, Basel II reporting


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October 29, 2012

Policy & Practical Challenges of Implementing Basel II

Author: Banco Central Do Brasil


Challenges faced in Brazil:  1.  Few internationally active banks 2. higher market volatility 3. some financial systems dominated by foreign banks 4. significant presence of state owned banks 5.  few countries released the agenda for Basel II implementation.


Keywords: Basel II, Brazil, Pillar 1, risk management, supervision, market discipline


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October 29, 2012

Supervisory Guidance on Model Risk Management

Author: Board of Governors of the Federal Reserve System (US)


Banks rely heavily on quantitative analysis and models in most aspects of financial decision making. They routinely use models for a broad range of activities, including underwriting credits; valuing exposures, instruments, and positions; measuring risk; managing and safeguarding client assets; determining capital and reserve adequacy; and many other activities. In recent years, banks have applied models to more complex products and with more ambitious scope, such as enterprise-wide risk measurement, while the markets in which they are used have also broadened and changed. Changes in regulation have spurred some of the recent developments, particularly the U.S. regulatory capital rules for market, credit, and operational risk based on the framework developed by the Basel Committee on Banking Supervision. Even apart from these regulatory considerations, however, banks have been increasing the use of data-driven, quantitative decision-making tools for a number of years.


Keywords: quantitiative analysis, banking, US, risk management, model development, model validation, governance, policies


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October 29, 2012

Loan-to-Value Ratio as a Macro-Prudential Tool- Hong Kong’s Experience and Cross-Country Evidence

Author: Eric Wong, Tom Fong, Ka-fai Li and Henry Choi


This study assesses the effectiveness and drawbacks of maximum loan-to-value (LTV) ratios as a macroprudential tool based on Hong Kong’s experience and econometric analyses of panel data from 13 economies. The tool is found to be effective in reducing systemic risk stemming from the boom-and-bust cycle of property markets. Although the tool could impose higher liquidity constraints on homebuyers, empirical evidence shows that mortgage insurance programmes (MIPs) that protect lenders from credit losses on the portion of loans over maximum LTV thresholds can mitigate this drawback without undermining the effectiveness of the tool. This finding indicates the important role of MIPs in enhancing the net benefits of LTV policy. Our estimations also show that the dampening effect of LTV policy on household leverage is more apparent than its effect on property market activities, suggesting that the policy effect may mainly manifest in impacts on household sector leverage.


Keywords: systemic risk, macroprudential policy, loan-to-value ratio, Hong Kong


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October 29, 2012

Loss Coverage and Stress Testing Mortgage Portfolios: A Non-Parametric Approach

Author: Adolfo Rodríguez and Carlos Trucharte


In this paper we outline the development of a practical approach to simulating a credit loss distribution function and to implementing a stress test exercise. This approach focuses on what is currently one of the banks' key loan portfolios: the mortgage portfolio, in particular, the entire Spanish mortgage portfolio. Specifically, we first determine, via regression model, the main factors that explain why households fail to meet their mortgage payment commitments. This allows us to consistently assign individual borrowers' PDs and to estimate a rating system for the mortgage portfolio of the entire credit system. Then, we simulate the empirical distribution function of mortgage loss rates for a whole economic cycle using a Monte-Carlo resampling method, and compare the loss rates from this function with those provided by the Basel II IRB formulas. Finally, we assess, by running a stress exercise, the ability of banks to withstand certain adverse situations. The main result from this exercise is that, in general terms, Basel II IRB regulatory loss coverage offers fairly adequate protection for banks. All in all, this paper shows the usefulness and importance of stress and simulation tools for supervisory authorities to analyse and properly define banks' risk profile and loss protection adequacy measures to account for possible future losses.


Keywords: loss coverage, stress test, mortgage rating structure, Monte-Carlo simulation, Basel II.


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October 29, 2012

The Future of Risk-Adjusted Credit Pricing in Financial Institutions

Author: Scott D. Aguais and Lawrence R. Forest Jr.


The current tool of choice for many institutions opting for risk-adjusted credit pricing, RAROC, doesn’t reconcile the prices of loans with those of similar instruments available in the market, such as bonds, other loans, or credit derivatives. Thus, it can’t assess arbitrage situations arising from relative price mismatches. The future is in improved credit valuation engines.


Keywords: risk analysis, risk-adjusted credit pricing, RAROC, credit pricing models, NPV, net present value, risk-adjusted return on capital


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