L Henry and M Majid

8/9/2019 L Henry and M Majid

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Lester Henry and Michelle Majid

Financial Crisis and the Implementation

of Basel II:

Potential Economic Impact for Trinidad

and Tobago

11


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IntroductionIntroduction• Financial Crisis "artly seen as re%ulatory failureFinancial Crisis "artly seen as re%ulatory failure• Basel I and Basel II were su""osed to "revent suchBasel I and Basel II were su""osed to "revent such• 'any Cari((ean Countries were e)"ected to ado"t'any Cari((ean Countries were e)"ected to ado"t

Basel II over the ne)t few years *fro + or $ inBasel II over the ne)t few years *fro + or $ in

$,,- to ./0 (etween $,+, 1 $,+23$,,- to ./0 (etween $,+, 1 $,+23• 4)aine Basel II5s role in the crisis4)aine Basel II5s role in the crisis• Identify issues arisin% fro "ossi(le ado"tin%Identify issues arisin% fro "ossi(le ado"tin%

Basel IIBasel II

• deterine the e)tent to which Basel II ay i"actdeterine the e)tent to which Basel II ay i"act T&T and (y e)tension the re%ion T&T and (y e)tension the re%ion• Infor "olicyakers whether focus should (e onInfor "olicyakers whether focus should (e on

%ettin% Basel I ri%ht or introducin% Basel II or not%ettin% Basel I ri%ht or introducin% Basel II or notado"tin% any at allado"tin% any at all

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Overview of Basel IOverview of Basel I

Basel I

Pillar 1:

Minimum capital

requirements

Risk!eighted

"ssets

#$enominator%

$efinition of

Capital

#&umerator%

Credit Risk

#'())%

Market Risk

#'((*%

+tandardi,ed

"pproach

Models

"pproach

Regulatory capital

Risk-weighted assets

8%≥

..


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Shortcomings of Basel IShortcomings of Basel I

• Ca"ital re7uired did not irror aCa"ital re7uired did not irror a(ank5s true risk "ro8le(ank5s true risk "ro8le

• Too si"le for advanced (anks Too si"le for advanced (anks• In9e)i(le a%ainst new develo"entsIn9e)i(le a%ainst new develo"ents

• Covers only credit and arket risksCovers only credit and arket risks

• Only 7uantitative in natureOnly 7uantitative in nature

• iited reco%nition of collateraliited reco%nition of collateral

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Basel II in a NutshellBasel II in a Nutshell

Three

Pillars

Minimum capitalrequirements

+uper-isor. re-ie!process

Marketdiscipline

Risk !eighted

assets

$efinition of

capital

Credit risk /perational

risk

Market

risks

+tandardi,ed

"pproach

Internal

Ratingsbased

"pproach

Basic

Indicator

"pproach

+tandardi,ed

"pproach

"d-anced

Measurement

"pproaches

+tandardi,ed

"pproach

Models

"pproach

Core

Capital

+upplementar.

Capital

Basel II

Pillar 1 Pillar 2 Pillar 3

00


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Objectives of Basel IIObjectives of Basel II

• ;reater e"hasis on (anks5 own;reater e"hasis on (anks5 ownassessent of riskassessent of risk

• Co"rehensive fraework for credit


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Basel II and the Financial CrisisBasel II and the Financial Crisis

• I the avera%e level of ca"ital re7uired (y the newI the avera%e level of ca"ital re7uired (y the newdisci"line is inade7uate and this is one of the reasonsdisci"line is inade7uate and this is one of the reasons

of the recent colla"se of any (anks=of the recent colla"se of any (anks=

• II the new Ca"ital Accord< interactin% with fair/valueII the new Ca"ital Accord< interactin% with fair/valueaccountin%< has caused rearka(le losses in theaccountin%< has caused rearka(le losses in the

"ortfolios of interediaries="ortfolios of interediaries=

• III ca"ital re7uireents (ased on the Basel IIIII ca"ital re7uireents (ased on the Basel IIre%ulations are cyclical and therefore tend to reinforcere%ulations are cyclical and therefore tend to reinforce

(usiness cycle 9uctuations=(usiness cycle 9uctuations=

• I> in the Basel II fraework< the assessent of creditI> in the Basel II fraework< the assessent of creditrisk is dele%ated to non/(ankin% institutions< such asrisk is dele%ated to non/(ankin% institutions< such as

ratin% a%encies< su(ect to "ossi(le con9icts of interest=ratin% a%encies< su(ect to "ossi(le con9icts of interest=

@@


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Basel II and the FinancialBasel II and the Financial

Crisis….continuedCrisis….continued

• > the key assu"tion that (anks5 internal> the key assu"tion that (anks5 internalodels for easurin% risk e)"osures areodels for easurin% risk e)"osures are

su"erior than any other has "roved wron%=su"erior than any other has "roved wron%=

• >I the new Fraework "rovides incentives>I the new Fraework "rovides incentivesto interediaries to deconsolidate froto interediaries to deconsolidate fro

theirtheir

(alance/sheets soe very risky e)"osures(alance/sheets soe very risky e)"osures

Source:Source: Francesco Cannata Mario Quagliariello (2009)Francesco Cannata Mario Quagliariello (2009)


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In Defense of Basel IIIn Defense of Basel II

• Only recently i"leentedOnly recently i"leented

• In S only a""lies to to" tier (anks o"eratin%In S only a""lies to to" tier (anks o"eratin%internationally // ost of syste is e)e"tedinternationally // ost of syste is e)e"ted

• #illar II and #illar II have (een %iven very little#illar II and #illar II have (een %iven very littleattention< a careful a""lication would involve=attention< a careful a""lication would involve=1 !euneration "acka%es in investent (ankin% and of!euneration "acka%es in investent (ankin% and of

ana%eent (oards=ana%eent (oards=

1 Trans"arency of a (anks risk "ro8le= Trans"arency of a (anks risk "ro8le=

1 'ana%eents true understandin% of (oth the (anks risk "ro8le'ana%eents true understandin% of (oth the (anks risk "ro8le

and its risk "ositionsand its risk "ositions

• source >an De"er< Cris *$,,3source >an De"er< Cris *$,,3

+,+,


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Can Basel wor!" # $ins!%ianCan Basel wor!" # $ins!%ian

alternative &iewalternative &iew

• Can hel" in soe cases (ut ultiately liited inCan hel" in soe cases (ut ultiately liited in"reventin% crises"reventin% crises

• Sources of insta(ility are E(uilt/in to the systeSources of insta(ility are E(uilt/in to the syste

• Gurin% e)"ansions ana%ers co"etence will (eGurin% e)"ansions ana%ers co"etence will (e7uestioned if they don5t %o after hi%her returns7uestioned if they don5t %o after hi%her returns

• In noral ties the Ethree/si)/three rule a""liesIn noral ties the Ethree/si)/three rule a""lies

• Gurin% Busts credit su""ly dries u" re%ardless ofGurin% Busts credit su""ly dries u" re%ardless of

any stiulus "olicyany stiulus "olicy

++++


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Sna'shot of (n( FinancialSna'shot of (n( Financial

S%stem)S%stem)

#sset *rowth#sset *rowth• 4i%ht coercial (anks and +4i%ht coercial (anks and +HBFIsHBFIs

+$+$


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Sna'shot of the FinancialSna'shot of the Financial

S%stem)S%stem)

Ca'ital #de+uac%Ca'ital #de+uac%

+6+6


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Sna'shot of the FinancialSna'shot of the Financial

S%stem)S%stem)

#sset ,ualit%#sset ,ualit%NPL to Gross otal loa!s "% #

0

1

2

3

4

5

6

1999 2000 2001 2002 2003 2004 2005 -Mar

Source: Financial Sector Assessment Program Report, 200

+.+.


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FS#- /0012) (3(4sFS#- /0012) (3(4s

de5cienciesde5ciencies• Inade7uate 8nancial sector lawsInade7uate 8nancial sector laws

• i%h/levels of connected e)"osuresi%h/levels of connected e)"osures

across (ankin% and insuranceacross (ankin% and insuranceco"aniesco"anies

• BC# Hon Co"liance with 'arket !isk


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Some #reas of ConcernSome #reas of Concern

• Credit !isk AssessentsCredit !isk Assessents• 'acroeconoic Issues'acroeconoic Issues

• Ca"ital !e7uireentsCa"ital !e7uireents• Gistortion of allocation of creditGistortion of allocation of credit• Inter(ank endin%Inter(ank endin%• !e%ulators in eer%in% econoies!e%ulators in eer%in% econoies

• oe/host Issuesoe/host Issues• ocal Banks in T&Tocal Banks in T&T• BC# Co"lianceBC# Co"liance

+0+0


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Credit 6is! #ssessmentsCredit 6is! #ssessments

• Shallow credit ratin% arket *reduced toShallow credit ratin% arket *reduced to9at rate39at rate3

• !atin% linked to level and volatility of!atin% linked to level and volatility ofca"ital 9owsca"ital 9ows• #rohi(itive cost and incentive to (ecoe#rohi(itive cost and incentive to (ecoe

ratedrated

• Kho will rate the ratin% a%ency?Kho will rate the ratin% a%ency?• #otential "ro/cyclicality and circularity#otential "ro/cyclicality and circularity

*#owell< $,,$3*#owell< $,,$3

+-+-


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$acroeconomic Issues$acroeconomic Issues

• Three factors indicate that ti%hter Three factors indicate that ti%hterre%ulatory ca"ital re7uireents arere%ulatory ca"ital re7uireents are

likely to cause a doestic creditlikely to cause a doestic credit

crunch:crunch:L econoies are shallowL econoies are shallow

L (ankin% sector concentratedL (ankin% sector concentrated

L "resence of %overnent in the realL "resence of %overnent in the realeconoyeconoy

+@+@


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6egulators6egulators

• Ge8cient re%ulators can (e anGe8cient re%ulators can (e ani"ortant deterinant of (ankin%i"ortant deterinant of (ankin%

crisis *uch ore than ade7uatecrisis *uch ore than ade7uateca"ital "rovisions3 *Barth< Ca"rio andca"ital "rovisions3 *Barth< Ca"rio and

evine *$,,+33evine *$,,+33

• Increased skills of e)ainersIncreased skills of e)ainers• Shift fro %eneralists to s"ecialistsShift fro %eneralists to s"ecialists*BCBS< $,,.3*BCBS< $,,.3

++


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7imitations and #reas of7imitations and #reas of

Further 6esearchFurther 6esearch

• iitations:iitations:

ack of data to do NISack of data to do NIS

Basel I shortfalls to addressBasel I shortfalls to address

Credit ratin% assessentsCredit ratin% assessents

!e%ional worksho" to resolve!e%ional worksho" to resolve

coon issuescoon issues

$+$+


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(he 8a% Forward for (3((he 8a% Forward for (3(

• ;et the >ision co(ined with "reconditions;et the >ision co(ined with "reconditionsri%htri%ht

• Create detailed and s"eci8c %a" assessentsCreate detailed and s"eci8c %a" assessents

• #roduce detailed "lans to address %a"s with#roduce detailed "lans to address %a"s withsucient lead tiessucient lead ties

• 4sta(lish a "rocess to oversee and de"loy4sta(lish a "rocess to oversee and de"loy

Basel II i"leentationBasel II i"leentation• There is no su(stitute for e)tree vi%ilance There is no su(stitute for e)tree vi%ilance

on the "art of re%ulatorson the "art of re%ulators

$$$$


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Selected 6eferencesSelected 6eferences

• Francesco Cannata and Mario Quagliariello (2009)Francesco Cannata and Mario Quagliariello (2009)““ The role of Basel II in the su("rie 8nancial The role of Basel II in the su("rie 8nancial

crisis: %uilty or not %uiltycrisis: %uilty or not %uilty"9:"9: CA!4FIH Korkin%CA!4FIH Korkin%

"a"er 6P,"a"er 6P,..

• Kray< !andall can Basel II enhance 8nancialKray< !andall can Basel II enhance 8nancialsta(ility? A #essiistic >iew< Korkin% "a"er @.iew< Korkin% "a"er @.<

Qeroe evy Institute Qeroe evy Institute

$6$6


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(han! ;ou and enjo% the(han! ;ou and enjo% the

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L Henry and M Majid