Assurance and Advisory Business Services

#!@Financial Services Advisory

Risk Management WorkshopColombia

BIS 2 Implementation Experience inLatin America: Brazil and Mexico

Cartagena de Indias

February 16-18, 2004

Jose E. Molina

#2 !@Financial Services Advisory

Table of Content

• Some implications from BIS 2 implementation experiences

• Industry initiatives

• Ernst &Young / Risk Magazine Global Survey

• Latin America iniciatives and experience: Mexico and Brasil

• Conclusions


BIS 2 convenes important messages • In general,

» Promotes a strong Risk management culture» It is NOT just about compliance with regulatory requirements» Approach to Economic Capital concept» Risk Pricing» Risk models consolidation aimed at integrated approaches» Risk adjusted performance measurements

• For Retail and Commercial banks:» It is about Managing risk actively and dynamically» Focus on Risk quantification: impact on prices, limits, risk/return management

• For Publicly-owned and Development Banks:» Ex-ante quantification of sustainability prices

• For Regulators and Supervisors: » Reinforce initiatives of systematic risk monitoring» Promotes change from inspection to self-monitoring» International coordination among regulatory bodies


BIS 2 Implications

Three Pillar Concept

Pillar 2Supervisory Review

Economic capital management

Operational risk framework development

Policies and procedures enhancement

Senior management awareness

Self assessment process Internal reporting and risk

monitoring

Pillar 3Market Discipline

Policies and procedures regarding disclosure frequency and materiality

Qualitative and quantitative disclosures Credit risk Market risk Operational risk Other risks Capital adequacy

Pillar 1Minimum Capital Charge

Credit Risk Dual rating system Risk quantification

(PD, LGD, EAD) Data collection, aggregation

and storage

Operational Risk Loss event segmentation by

type and business unit Quantification of net losses Process development

Risk Management Integrated Infrastructure


BIS 2 Implications

Pilar IMinimum

Capital Charge

Pilar IISupervisory

Review

Pilar IIIMarket

Discipline

BIS 2

Corporate Governance and Internal Controls

Strategies,Limits,

RM Policies

OrganizationalStructure,Corporate

Governanceand RM Human

Resources

KeyBusinessProcesses

and RMReporting

ValuationMethodologies,

RMMeasurement

DataArchitecture

and RMInformation

RMTechnologySolutions

Integrated RM Infrastructure

Dia

gnos

tic I

mpl

emen

tatio

nD

esig

n


Some implications from BIS 2 implementation experiences

• Complex framework with implementation challenges: Operations Risk Management infrastructure Allocation of resources Change Management

• Data challenge: Mature data (5 and 7 years) Complexity and cost Operational change management

• Changes in the calculation rules of regulatory capital

• Regulatory discretionality may prompt competitive strategic decisions Interest of local regulators

» Impact in large international financial groups» Regulators may favor the use of intermediate approaches instead of advanced models


• Focused on regulatory compliance and basic alternatives Smaller initial investment Potential larger cost of regulatory capital Public disclosure "Follower" Role in pricing and client attraction

» Risk of having worse client portfolios» Under optimization of risk/return» Strategic deterioration

• Adoption of intermediate and advanced models may imply significant investment depending on current status Strategic investment Investment will have a positive effect in ROI and ROE Incentives for Economic Capital optimization

» Exploitation of market niches Incorporates risks in pricing contributing to competitive strategy Promotes competitive advantage in key markets and product lines

Some implications from BIS 2 implementation experiences


BIS 2 Business Incentives beyond compliance

Shareholder ValueSome Value Drivers

Operational Income Operational Costs Capital Expectations

• Target profitable clients and segments with products aligned with strategy

• Effective Risk Pricing

• Optimal Provisions to invest in better risks

• Possible decrease in required regulatory capital

•BIS 2 implementation has sinergy with other initiatives related to cost efficiency and process optimization

•Credit and risk process reingeneering imrpoves Efficiency Indices

• Regulatory and risk capital optimization

• Capital optimization goals by business line

•Improved decision-making through integration or risk management and MIS

•Increase in transparency, reputation, and public image


• Banks with significant retail portfolios require less capital. (SME and mortgages). Increase in competition on these market segments.

• Exposures with no rating and sovereigns are penalized.

• Banks with standardized approach usually require more capital.

• Impact on Securitizations process.

• Dual rating may impact commercial credit portfolios.

• More scrutiny from rating agencies as new approaches depend on ratings.

• Some strategic refocusing may be necessary to maintain/attack market niches.

• Intense swapping of "good" risk vs. "bad" risk probably to be warehoused in local institutions with non significant international presence.

• Likely Industry consolidation process of local/regional banks.

How is the industry preparing for BIS 2 ?


E&Y / Risk Magazine Global BIS 2 Survey

• E&Y/Risk Magazine conducted a Web-based survey about BIS 2 implementation between July and September ’03.

• Responses from 142 financial institutions were obtained including largest LatAm institutions.

• Perceptions: Basel II implementation will increase competitive advantage. But uncertainty remains regarding the potential impact on regulatory capital

requirements. Most survey participants are targeting Internal Ratings Based (IRB) approach, Basel II will drive significant investments in risk management infrastructure over the

next three years. Implementation cost is a major concern with a wide range of estimated

implementation costs. Treatment of credit risk mitigants and securitizations are areas that respondents

would most like to see changed.


North America

18%

U.K.13%

Europe26%

Asia32%

EmergingMarkets

11%

Total Assets

Commercial Banks

<$50 Billion

41%

No Response

6%

>$150 Billion

32%

$100 - $150 Billion

5%

$50 - $100 Billion

16%

Geographic Dispersion

Commercial Banks



Wholesale Bank50%

Retail Bank50%

Type if Institution (LatAm Response)

Retail Bank82%

Wholesale Bank18%

Type if Institution (Global Response)



Global 50 29 13 8LatAm 73 9 9 9

Increase No change Decrease Don't

know

• Implementation of Basel II is perceived to enhance risk management and will improve competitive advantage.

• Improved competitive advantage was not generally perceived as a result from regulatory capital savings.

• LatAm participants perceived greater competitive advantage resulting form Basel II implementation.


Competitive Advantage Perception

%



Uncertain impact on regulatory capital

Decrease> 20%

Decrease10 - 20%

Decrease0 - 10%

Increase 0 - 10%

Increase10 - 20%

Increase> 20%

Don't know

QIS 3 Participants (71) Participating Banks (142)

14%

7%

1%

32%

18%

8%

20%

13% 27% 24% 13% 8% 14%


• Over 85% of banks see Basel II as a significant or primary driver of investments in credit risk measurement methodologies and risk exposure systems over the next three years.


BIS 2 Key Improvement Investment Driver

Minor8%

Primary driver36%

Significant50%

No impact0%

Don't know6%


Very important 37 9 31 45 35 45

Important 37 64 36 9 41 9

Relavant 16 18 23 36 15 36

Not relevant 2 0 3 0 1 0

Doen't know 8 9 7 9 7 9

GLOBAL regulatory compliance

LATAM regulatory compliance

Capital allocation and perfor GLOBAL

Capital allocation and perfor LATAM

Imrpovements in GLOBAL RM

Improvements in LATAM RM


BIS 2 Key Drivers by Region


Wholesale Banks Retail Banks

25% total: Standardised 30% total: Foundation IRB45% total: Advanced IRB

54%

30%26%

20%

37%33%


Most banks with assets over $100 billion, particularly wholesale banks, are targeting the Advanced IRB approach.

50% of banks with assets under $50 billion are pursuing an IRB approach.

Bank types planning IRB alternative


LatAm BIS 2 initiatives and experience: Mexico and Brazil

• Differences between local subsidiaries of international groups and local institutions

Subsidiaries from International Groups: » Usually Global guidelines.

– Definition of expectations and roles and responsibilities.– Still uncertainty on Home-Host issues but indication on BIS 2 alternatives. – Global and local teams in coordination.– Dynamic planning.

» Local variation,– Senior management’s involvement is increasing with local impact understanding.– Risk culture is improving but still RM is in "silos".– Data is major concern.– Accountability remains unclear due to BIS 2 Implementation program still pending.– Lack of proper investment (resources, time, and tools).– Lack of cost/benefit analysis.– Lagging in deadlines.


Local Institutions: » Large local players

– Publicly-owned banks: – Some institutions have invested heavily.– Robust market methodologies.– Evolving Credit methodologies.– Operational risk methodologies to be defined (Brazil is the exception).

– Private Banks:– Implementation of adapted "best-practices” for market risk.– Credit risk methodologies is a focal concern due to strategic business impact.– Initial stages of Operational Risk Management.– Increasing focus on RAPM and Economic Capital allocation.– Risk management integration efforts to be defined.– MIS and RM Information in evolution.

Local regulatory bodies:» Important evolution but still "1st. Generation" RM Regulations.» "Regulatory cost" might be optimized by rationalizing monitoring overlapping.» Adaptations and definitions to BIS 2 pending.» Monitoring expertise and experience evolving.

LatAm BIS 2 initiatives and experience: Mexico y Brazil


Steps currently "in-progress":

• Perform Impact analysis – BIS 2 Alternatives» Benefit/Cost» Incentives» Assimiliation and RM Culture endoctrination» Country specific issues

• Determination of desired future-state based on current-state diagnoses» Rating and scoring tools, Monitoring, and Portfolio Mgmt. adapted to local enviroment» Strategic definition of operational risk approach» Historical Database and RM information architectures» RM integration efforts» Economic capital and RAPM» Validation procedures

• Initial attempts with internal “part-time” teams.• Initial BIS2 program/action plan/timeline taking in consideration other internal initiatives.• Awareness of the long-road ahead and criticality of starting NOW.• Increasing awareness of needed discipline and "full time" dedication to successfully

implement BIS 2 Program.• Inital lobbying with Local regulators.



Steps to be taken in next months/years:

• Desing BIS 2 implementation strategy.

• Complete BIS 2 Impementation Program including Program Management and Resource Planning.

• Organize Multi-disciplinary BIS 2 teams with accountable senior management.

• Obtain expertise and experience to optimize BIS 2 Implementation and fulfill specific needs.

• Approval of BIS 2 Investment Plans and Allocations» Credit risk factors modeling» Operatioanal risk management deployments» Integrated Risk Management Solutions» Pricing and RAPM methodologies based on Economic Capital» RM Information Architectures (managerial, accounting, risk management, compliance, etc.)» Compliance – Internal Audit accountability» Etc.



Some final observations on LatAm

• International players will likely implement home-office definition.

• Large local players leaning towards “best-practices” Evaluating cost/benefit of advanced models Potential implementation of risk adjusted indicators Increase in competitive advantage and identification of market niches

• Local Regulators are expected to provide some guidelines Waiting for final Accord from Basel Committee (expected in mid-2004) Internal discussions between monetary and fiscal authorities Request input from key players, local and foreign in a consultative approach


Thank you for your attention.


Contact

• [email protected]


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