Basel II Workshop One_070205

7/31/2019 Basel II Workshop One_070205

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BASEL II

Introduction and BackgroundIntroduction and Background

Errol KrugerErrol Kruger

7 February 20057 February 2005


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AGENDA

Banks and bankingBanks and banking

Basel Committee on Banking SupervisionBasel Committee on Banking Supervision

Basel IBasel I

Is Basel II appropriate for South Africa?Is Basel II appropriate for South Africa?

ConclusionsConclusions


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Agenda

Banks and bankingBanks and banking

Basel Committee on Banking SupervisionBasel Committee on Banking SupervisionBasel Committee on Banking Supervision

Basel IBasel IBasel I

Is Basel II appropriate for South Africa?Is Basel II appropriate for South Africa?Is Basel II appropriate for South Africa?

ConclusionsConclusionsConclusions


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Why do we need banks?

Safeguard savings of general publicSafeguard savings of general public

Financial intermediationFinancial intermediation

From surplus econ units to deficit econ unitsFrom surplus econ units to deficit econ units

Channel savings and provide creditChannel savings and provide credit Bridges preferences [Bridges preferences [egeg. time ]. time ]

Pooling of funds for large scale projectsPooling of funds for large scale projects

Payments and settlements systemPayments and settlements system

Risk intermediationRisk intermediation

Conclusion: Banks are very importantConclusion: Banks are very important


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Why should banks be regulated

Banks failBanks fail

Free entryFree entry

[Public interest; Fit and proper; Min capital][Public interest; Fit and proper; Min capital]

Banks wish to survive and growBanks wish to survive and grow

Accordingly, expose themselves to riskAccordingly, expose themselves to risk

Importance of risk managementImportance of risk management

Free exitFree exit [Shareholders stand last in line][Shareholders stand last in line] Avoid systemic riskAvoid systemic risk

National goodNational good material economic benefitsmaterial economic benefits

Market failureMarket failure to be counteractedto be counteracted


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Ultimate regulatory goals To add value toTo add value to

banking system; andbanking system; and financial system; andfinancial system; and

economyeconomy

By facilitatingBy facilitating stability and soundnessstability and soundness

efficiency and effectivenessefficiency and effectiveness

consumer protectionconsumer protection

ThroughThrough

sound corporate governancesound corporate governance

best practice risk managementbest practice risk management

best practice disclosurebest practice disclosure


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SARB MissionThe achievement and maintenance of price stability

BSD Mission

To promote the soundness of banks through the

effective application of international regulatory

and supervisory standards

Strategic imperatives


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South African banking sector

Registered banks 37Registered banks 37Locally controlled: 15Locally controlled: 15

Foreign controlled (subsidiaries): 5Foreign controlled (subsidiaries): 5

Branches of foreign banks: 15Branches of foreign banks: 15

Mutual banks: 2Mutual banks: 2

Total banking assets: Around R1 484.8Total banking assets: Around R1 484.8 bnbn(as at the end of November 2004)(as at the end of November 2004)

Capital adequacy: 13,2%Capital adequacy: 13,2%


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Distribution of total assets ofbanking sector

November 2004

88.0%

3.0% 9.0%

A1 rated banksLocal controlled A2 rated banksForeign controlled A2 rated banks

Total Assets (as at the end of Nov 2004): R1484.8 bn


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Key banking sector indicators

--18,418,420.320.324.924.9Gross amount classified as doubtful andGross amount classified as doubtful andloss (loss (RRbnbn))

--18,218,28.38.310.210.2Market value of security held (Market value of security held (RRbnbn))

64,264,263,563,5Efficiency ratio = costEfficiency ratio = cost--toto--incomeincome--ratioratio

(smoothed) (%)(smoothed) (%)

5,75,71484.81484.81404.81404.8Total assets (Total assets (RRbnbn))

14,514,51108.31108.3967.9967.9Loans and advances (Loans and advances (RRbnbn))

12,112,11126.91126.91004.91004.9Funding related liabilities to the publicFunding related liabilities to the public

((RRbnbn))

22,322,3898.0898.0734.0734.0NonNon--bank funding (bank funding (RRbnbn))

10,210,2122.5122.5111.1111.1Capital and reserves (Capital and reserves (RRbnbn))

13,213,212,612,6Capital adequacy (%)Capital adequacy (%)

--16,216,213.113.115.715.7Specific provisions (Specific provisions (RRbnbn))

3,03,03,13,1Interest margin (%)Interest margin (%)

%%GrowthGrowth

NovemberNovember20042004

NovemberNovember20032003


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Agenda

Banks and BankingBanks and BankingBanks and Banking

Basel Committee on Banking SupervisionBasel Committee on Banking Supervision

Basel IBasel IBasel I




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Basel Committee on BankingSupervision [BCBS] FoundedFounded

By central bank governors of G10By central bank governors of G10

Date: 1974Date: 1974

Focus: Banking supervisionFocus: Banking supervision

ObjectivesObjectives

Adequate supervisionAdequate supervision

No internationally active bank should escapeNo internationally active bank should escape

supervisionsupervision Meets 4 times per yearMeets 4 times per year

Around 30 working groups / task forcesAround 30 working groups / task forces

Location of secretariat: Basel, SwitzerlandLocation of secretariat: Basel, Switzerland


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BCBS

Legal nature: Voluntary associationLegal nature: Voluntary association

AuthorityAuthority No formal supraNo formal supra--national authoritynational authority

Thus, pronouncements: No legal forceThus, pronouncements: No legal force

OutputOutput series of publicationsseries of publications

Broad supervisory guidelinesBroad supervisory guidelines

Statements of best practiceStatements of best practice

Desired outcomesDesired outcomes

Convergence in approachesConvergence in approaches

Convergence in standardsConvergence in standards


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Agenda



Basel IBasel I




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Basel I Basis is capital RationaleRationale

Foundation for economic growthFoundation for economic growth Buffer against unexpected lossesBuffer against unexpected losses

Inadequate capital leads toInadequate capital leads to

Disruptions,Disruptions, egeg. of payments system. of payments system

Inefficient allocation of capitalInefficient allocation of capital

NoteNote

No amount of capital will protect against weakNo amount of capital will protect against weakmanagementmanagement

Even the best management may make mistakesEven the best management may make mistakes

and are exposed to possibility of unexpectedand are exposed to possibility of unexpectedlosseslosses


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Basel I - Achievements CapitalCapital

Definition of capitalDefinition of capital

first to be internationallyfirst to be internationally

acceptedaccepted

Capital adequacyCapital adequacy first international benchmarkfirst international benchmark

Regulatory capital adequacyRegulatory capital adequacy -- AcceptedAccepted

soundness indicatorsoundness indicator Risk management orientationRisk management orientation

Credit risk: Simple measureCredit risk: Simple measure

Market risk: Simple and advanced measuresMarket risk: Simple and advanced measures Simple to applySimple to apply contributed to its acceptancecontributed to its acceptance

Outcome: Basel I adopted in over 100 countriesOutcome: Basel I adopted in over 100 countries


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What changes have occurred since

introduction of Basel I?

GlobalisationGlobalisation

Physical geography not an impediment toPhysical geography not an impediment tomovement of moneymovement of money

Growth in crossGrowth in cross--border trade, finance,border trade, finance,

investmentinvestment Technological advancesTechnological advances

Computing power and storageComputing power and storage

Networks and communicationsNetworks and communications Financial engineering (development of highlyFinancial engineering (development of highly

sophisticated/complex products)sophisticated/complex products)

The above causes precipitated the need for change


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Which dimensions of Basel I have

been highlighted by foregoingchanges?

BackwardBackward

--lookinglooking

based on historic informationbased on historic information

Risk approachRisk approach

Limited risk sensitivityLimited risk sensitivity a blunt instrumenta blunt instrument

Not comprehensiveNot comprehensive

Regulatory arbitrageRegulatory arbitrage

Simplistic and staticSimplistic and static

Does not cater for sophisticated banksDoes not cater for sophisticated banks

Not flexible and dynamicNot flexible and dynamic

Growing divergence between regulatory andGrowing divergence between regulatory andeconomic capitaleconomic capital

Did not keep up with market developmentsDid not keep up with market developments


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Outcomes of developments RiskRisk

Evolving methodologies for measuring and managingEvolving methodologies for measuring and managing New ways to unNew ways to un--bundle and transfer riskbundle and transfer risk

Financial derivative instrumentsFinancial derivative instruments

SecuritisationSecuritisation

DataData -- improvements in technology andimprovements in technology andtelecommunications speed up collection and analysistelecommunications speed up collection and analysis

Operational risk management as new disciplineOperational risk management as new discipline[Quantifying the risk of losses from failure of internal[Quantifying the risk of losses from failure of internal

processes and systems versus damages from externalprocesses and systems versus damages from externaldisruptions]disruptions]

Cause: Barriers of time and geography have been lowered

Effect: Reduced life span of existing competitive strengths

Outcome: Tidal wave of structural change


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Basel I 1988 Accord

Regulatory capital ratio =Qualifying capital

Credit risk

exposures

Minimum regulatory capital ratio 8%=

Capital

Requirements

Qualifying

Capital

Risk

Exposures

Minimum

Ratio


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Basel I 1988 Accord plus 1996additions

Regulatory

capitalratio

=

Regulatory capital

RW Credit exposure + Capital for market risk x 12.5

Minimum regulatory capital ratio 8%=

Minimum

Capital

Requirements

Qualifying

Capital

Risk

Exposures

Minimum

Ratio


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Basel I

Guarantees from nonGuarantees from non--banksbanks

All other irrevocable facilitiesAll other irrevocable facilities

Residential mortgage exposuresResidential mortgage exposures --

LTVLTV 80%80%

50%50%

--All other counterpartiesAll other counterparties100%100%

Irrevocable facilities with longerIrrevocable facilities with longer

maturitymaturity

Public Sector Bodies in RSA, CMAPublic Sector Bodies in RSA, CMA

& OECD banks& OECD banks

20%20%

Guarantees from RSA Banks &Guarantees from RSA Banks &

OECD BanksOECD Banks

RSA Public Sector BodiesRSA Public Sector Bodies

Sovereigns in common monetarySovereigns in common monetary

areaarea

10%10%

Irrevocable facilities with shortIrrevocable facilities with short

maturitymaturity

--5%5%

CollateralCollateral cash & goldcash & gold

Guarantees by Sovereign (RSA &Guarantees by Sovereign (RSA &

OECD)OECD)

SovereignSovereign RSA & OECDRSA & OECD

IntragroupIntragroup advances to banksadvances to banks

0%0%

Credit Risk MitigationCredit Risk MitigationExposureExposureRiskRiskWeightWeight


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Agenda

Banks and bankingBanks and bankingBanks and banking


Basel IBasel IBasel I Is Basel II appropriate for South Africa?Is Basel II appropriate for South Africa?

ConclusionConclusionConclusion


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Realities for SA we have bothDevelopingDeveloping

componentcomponentDevelopedDeveloped

componentcomponent

TheG

reat

Divid

e60% of South Africans

dont havetransactional

bank account

FinMark Trust

International Accessto Finance

e-Banking Stokvels

Village BanksInformation Systems

Data warehousing Lim it ed t elephone& int ernet AccessRisk Adj usted

Return on Capit al No exposure rat ings

I s Basel I I Appropriate for SA???


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Per IMF and World Bank

AvoidAvoid adoption at all costs approachadoption at all costs approach

Priority is to ensure financial sector safety andPriority is to ensure financial sector safety andsoundness by ensuring compliance with B I, BCP,soundness by ensuring compliance with B I, BCP,

IAS, etc.IAS, etc.

FSAPFSAPss and Article 4 assessmentsand Article 4 assessments

Will not negatively score nonWill not negatively score non--adoption of B IIadoption of B II Once a country decides to adopt B II, it will beOnce a country decides to adopt B II, it will be

assessed based on the quality of its adoptionassessed based on the quality of its adoptionplans and its implementation of B IIplans and its implementation of B II


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Is Basel II for SA? SASA

Emerging marketEmerging market

Sophisticated financial sectorSophisticated financial sector

Important regional financial centreImportant regional financial centre

Banking is one of the most global industriesBanking is one of the most global industries

Physical boundaries have little relevance in the bankingPhysical boundaries have little relevance in the bankingindustry [money moves anywhere at the click of a button]industry [money moves anywhere at the click of a button]

To play this game you must play by itsTo play this game you must play by its[international/universal] rules[international/universal] rules

Outcome: > 100 countries committed to Basel IIOutcome: > 100 countries committed to Basel II


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Pre-conditions to Basel II

1) Banking industry developing1) Banking industry developing

cultureculture

of riskof risk

management [Pillar I]management [Pillar I]

2) Effective supervision exists2) Effective supervision exists

Compliance withCompliance with

Basel Core Principles for Effective SupervisionBasel Core Principles for Effective Supervision[Pillar II][Pillar II]

3) Market has clear rules for disclosure and moving3) Market has clear rules for disclosure and movingto greater transparency [Pillar III]to greater transparency [Pillar III]

Source: Making diligent preparations for Basel II; Speech by Jaime Caruana at ICBS held in Madrid, 2004 09 22


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SAs state of readiness

LegislationLegislation

BanksBanks

CompaniesCompanies

InsolvencyInsolvency

FICA/FAIS/Etc.FICA/FAIS/Etc. AccountingAccounting

AuditingAuditing

Corporate governanceCorporate governance Risk managementRisk management

DisclosureDisclosure

Payments systemPayments system

SupervisionSupervision

Up to standardUp to standard

YesYes

YesYes

(?) Yes(?) Yes

YesYes IFRS compliantIFRS compliant

IAS compliantIAS compliant

Best practiceBest practice Best practiceBest practice

Best practiceBest practice

Basel CPSS compliantBasel CPSS compliant

BCP and B I compliantBCP and B I compliant

Area Status quo


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Agenda


Banking in South AfricaBanking in South AfricaBanking in South Africa

Is Basel II appropriate for South AfricaIs Basel II appropriate for South AfricaIs Basel II appropriate for South Africa

ConclusionsConclusions


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Conclusions Why must SA change to B II?Why must SA change to B II?

Events have overtaken Basel IEvents have overtaken Basel I

Material economic and other benefits [cost of capital;Material economic and other benefits [cost of capital;

credit ratings; pursuit of robust institutions and sector]credit ratings; pursuit of robust institutions and sector]

Is SA capable and ready to change to B II?Is SA capable and ready to change to B II?

Infrastructural framework is in placeInfrastructural framework is in place Standards and checks and balances OKStandards and checks and balances OK

What are the implications of B II?What are the implications of B II? Improved safety and soundnessImproved safety and soundness

Improved governance, risk management, etcImproved governance, risk management, etc

Forward lookingForward looking

QIS 4 and Economic Impact StudyQIS 4 and Economic Impact Study


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The end

Thank you for the opportunityThank you for the opportunity

Documents

Basel II Workshop One_070205