Friday, 18 December 2009

Some light weekend reading

It is one of those stories that I sense is of considerable importance but I don't have the expertise to actually explain why. The best I can do is draw the original source material here and here to your attention and refer you to some commentators more knowledgeable than me.

These proposed new rules drawn up by the Basel Committee of central bankers are a reaction to the global financial crisis and are bound to make life more difficult for commercial banks throughout the world including Australia. The London Daily Telegraph says the proposals are stricter-than-expected in demanding lenders hold more capital. The Financial Times of London reported that banks will be blocked from paying dividends to shareholders or bonuses if their capital levels fall below a minimum threshold, under the terms of a new, more invasive international regulatory regime.
The Bank for International Settlements itself described the proposals as designed to to improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy. 

The key elements of the proposals are the following:
  • First, the quality, consistency, and transparency of the capital base will be raised. This will ensure that large, internationally active banks are in a better position to absorb losses on both a going concern and gone concern basis. For example, under the current Basel Committee standard, banks could hold as little as 2% common equity to risk-based assets, before the application of key regulatory adjustments.
  • Second, the risk coverage of the capital framework will be strengthened. In addition to the trading book and securitisation reforms announced in July 2009, the Committee is proposing to strengthen the capital requirements for counterparty credit risk exposures arising from derivatives, repos, and securities financing activities. These enhancements will strengthen the resilience of individual banking institutions and reduce the risk that shocks are transmitted from one institution to the next through the derivatives and financing channel. The strengthened counterparty capital requirements also will increase incentives to move OTC derivative exposures to central counterparties and exchanges.
  • Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework with a view to migrating to a Pillar 1 treatment based on appropriate review and calibration. This will help contain the build up of excessive leverage in the banking system, introduce additional safeguards against attempts to game the risk based requirements, and help address model risk. To ensure comparability, the details of the leverage ratio will be harmonised internationally, fully adjusting for any remaining differences in accounting. The ratio will be calibrated so that it serves as a credible supplementary measure to the riskbased requirements, taking into account the forthcoming changes to the Basel II framework.
  • Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress. A countercyclical capital framework will contribute to a more stable banking system, which will help dampen, instead of amplify, economic and financial shocks. In addition, the Committee is promoting more forward looking provisioning based on expected losses, which captures actual losses more transparently and is also less procyclical than the current "incurred loss" provisioning model.
  • Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio. The framework also includes a common set of monitoring metrics to assist supervisors in identifying  and analysing liquidity risk trends at both the bank and system wide level. These standards and monitoring metrics complement the Committee's Principles for Sound Liquidity Risk Management and Supervision issued in September 2008.
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