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It's all in the vault
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An international framework may help to curb future banking disasters, says Susan Campbell CPA. |
Banks have under three years to sharpen their risk management practices under an international agreement that is set to affect their costs and profits. The Swiss-based Basel Committee on Banking Supervision has been working to secure international convergence on revisions to supervisory regulations governing the capital adequacy of internationally active banks.
Its international framework (Basel II) has toughened its measures on the risks banks can take with their capital. This steps up the 1988 capital adequacy framework which set the general requirement for banks to hold total capital equivalent to at least eight per cent of their risk-weighted assets. This requirement still holds today, but the new framework uses the assessments of risk provided by banks internal systems as inputs to capital calculations.
The new framework requires banks to establish a robust framework to track information. They must create a strong risk culture across the organisation and accurately aggregate exposure across the enterprise portfolio, to reliably measure and mitigate risk. Banks must also reliably assess credit and operating risks. Banks and financial institutions in Australia will now be preparing their organisations to meet the new requirements by 2007.
The incentive is now there for banks to show they have an internal model that deals with risk. If their model is approved the bank reduces its risk-weighted capital and ultimately lends more.
Banking is unique in relying heavily upon global accords, rather than national rules and legislation. These accords are developed and voluntarily entered into by participating nations, with general coordination provided by the Basel Committee on Banking Supervision, which is associated with the Bank for International Settlements.
Firms can use Basel II as a catalyst for an enterprise-wide examination and refinement of their infrastructure and processes, to potentially achieve significant operational efficiencies and improvements.
It has been suggested that this new framework has moved the accord from a prescriptive procedure towards best practice risk management. But best practice is a two-edged sword and a moving target, and regulators are empowered under the new regime to insist on continuous improvement in methods and systems as theory and technology permit.
Financial firms will need to define the data requirements, the mechanism to collect, analyse and report the data, and have a methodology for cost-effectively implementing the system and processes to make it happen. Basel II gives institutions the processes and guidance to improve internal controls and measurement and management for operational risk.
National Australia Bank is one outfit looking at an approved internal model, as allowed by Basel II. The Australian Prudential Regulatory Authority has recently withdrawn its approval for an internal model put forward by the bank to determine its market risk capital. This is likely to increase the costs to NAB.
As Charles Littrell, executive general manager of policy research and consulting at APRA, said in a recent speech: 'Regulatory capital rules are important because approved deposit institutions maintaining a sound capital position are most unlikely to fail, and in fact should remain strong enough to perform their important credit allocation function even in challenging economic environments.
'Their strength is not only important as so many people have substantial funds deposited with them, but the ability and willingness to lend is a substantial input in commercial, construction, and household sectors economic health,' he says.
It is interesting to note that in the US, the largest capital market in the world, only a small number of banks will be required to adopt Basel II. US regulators are requiring the top eight banks to adopt it while an additional 10 banks are expected to comply voluntarily, according to the American Bankers Association.
In Australia, APRA has made its position clear about the importance of this accord within the Australian context. 'By better aligning regulatory capital requirements with economic risk, Basel II makes the Australian deposit-taking sector, and therefore the Australian economy, safer and more efficient.' says Littrell.
'With a better capital model we are more assured of sufficiency, and less reliant upon rules of thumb that might require excessive capital. Not to put too fine a point upon it, Australians will be beneficiaries over time when Basel II is adopted in this country.'
Basel II aims:
About the author: Susan Campbell
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http://www.cpaaustralia.com.au/cps/rde/xchg/cpa/hs.xsl/724_10407_ENA_HTML.htm
