The
Financial Stability Board
has been established to address vulnerabilities and to develop and
implement strong regulatory, supervisory and other policies in the
interest of financial stability.
It comprises
senior representatives of national financial authorities (central
banks, regulatory and supervisory authorities and ministries of
finance), international financial institutions, standard setting
bodies, and committees of central bank experts.
The Financial Stability Board is supported by a secretariat based
at
the Bank for International Settlements in Basel, Switzerland.
Institutions represented on the Financial Stability Board include
international
standard-setting bodies like the Basel Committee on Banking
Supervision (BCBS), the Committee on the Global Financial System (CGFS),
the Committee on Payment and Settlement Systems (CPSS), the
International Association of Insurance Supervisors (IAIS), the
International Accounting Standards Board (IASB) and the
International Organization of Securities Commissions (IOSCO)
We move towards Basel iii
Some really important changes:
1. The predominant form of
Tier 1 capital must be common shares and retained earnings.
2.
The Basel Committee on Banking Supervision is working urgently to
build stronger buffers into the financial system, covering
capital, liquidity and provisioning, that will raise defenses and
constrain the procyclical build-up of leverage in the system.
New
rules will be set out by end-2009, calibrated in 2010 and phased
in as financial conditions improve and economic recovery is
assured.
3. The
level and quality of minimum capital requirements will increase
substantially over time.
4. The Basel Committee will issue by the end of 2009 a new minimum
global liquidity standard. This new regulatory framework
introduces a liquidity coverage ratio that can be applied in a
cross-border setting.
5.
The
Basel Committee will issue new standards by mid-2010
to take full account of counterparty credit risks, the benefits of
centrally cleared contracts and collateralisation.
Improving Financial Regulation
Report of the Financial Stability Board to G20 Leaders
25 September 2009
1. Since the London Summit, the Financial Stability
Board (FSB) and its members have advanced a major
program of financial reforms based on clear principles
and timetables for implementation that are designed to
ensure that a crisis on this
scale never happens again.
2. Much has already been achieved, and much is
underway that when implemented will result in a very
different financial system than the one that brought
us this crisis.
However, policy development is
not completed, and detailed implementation of the full
set of needed reforms will take time and perseverance.
3. In a globally integrated market economy, where
concerns about a level playing field and protectionist
pressures are real, it is vital that G20 Leaders
strongly support the international policy development
underway and signal their determination to implement
fully and consistently the reforms at national levels.
4. In recent months, expectations have taken hold in
some parts of the private financial sector that the
financial and regulatory system will remain little
changed from its pre-crisis contours.
These expectations – that business will be able to go
on just as before – need to be dispelled.
5. Our objective is to create a
more disciplined and less procyclical financial system
that better supports balanced sustainable economic
growth.
This system will not allow
leverage to increase to the extent that it did.
Nor will we allow
risks to be taken where profits accrue to individual
actors but ultimate losses are borne by governments
and
the wider public.
6. To these ends, our program
includes substantially higher requirements for the
quantity and quality of capital and liquidity at
financial institutions.
It also includes reforms to
accounting standards and compensation regimes that
improve transparency and limit incentives to excessive
risk taking.
We will constrain risks in trading-related activity by
improving market infrastructure and by significantly
raising capital charges for trading books.
7. Our reform plans set reasonable implementation
windows to avoid aggravating the present crisis.
While the financial system will continue to face
challenges for some time, the faster our financial
systems and economies recover, the faster we should
implement finalised reforms.
8. This crisis has highlighted the moral hazard risks
posed by institutions that have become too big to fail
or that, by their interconnected nature, are too
complex to resolve.
We need to address the
deeper-seated challenges that these institutions pose.
We are committed to developing the solutions to these
problems over the next twelve months.
9. In recent quarters, many
financial institutions have returned to profitability.
These profits owe much to the
extraordinary official measures taken to stabilise the
system, many of which remain in place.
It is imperative that these profits be retained in
financial institutions to rebuild capital necessary to
support lending, allow official support measures to be
removed and prepare institutions to meet future higher
capital requirements.
10. The international supervisory and regulatory
community is agreed that restricting dividend
payments, share buybacks and compensation rates are
appropriate means to these ends.
11. The support of G20 Leaders
will be vital for the major decisions that will need
to be made in these important areas, and we ask that
you support us in these endeavours.
Achievements to date
12. Bolstering the resilience of the international
financial system is a broad project encompassing a
considerable number of related measures.
Substantial
progress has been made on the many measures
recommended in the Financial Stability Forum (FSF)’s
April 2008 and 2009 Reports, the G20 Washington Action
Plan and the London Summit Statement, especially at
the level of international policy development.
Significant actions have been
taken since the London Summit:
• The shortcomings in the Basel capital framework that
generated incentives for off-balance sheet
securitisation activity have been removed;
• The weaknesses in accounting practices and national
standards that generated similar incentives for
off-balance sheet activities have been addressed.
New standards have been set out that enhance the
consolidation of special purpose vehicles and the
transparency of banks’ relationships with such
entities;
• The risks that banks assume in their trading
activities have been brought under better control.
Substantially higher capital
requirements against risks in banks’ trading
activities have been issued;
• Strong new risk management standards for financial
institutions have been issued and are being
implemented, covering bank governance, the management
of liquidity risk, underwriting and concentration
risks, stress testing, valuation practices and
exposures to off-balance sheet activities;
• Banks’ disclosures of their on- and off-balance
sheet risk exposures have been materially improved.
New disclosure standards for banks have been issued
covering valuation and liquidity risk, securitisation
and off-balance sheet activities;
• The FSB Principles for Sound
Compensation Practices have been
integrated into the Basel
capital framework, and international guidance
is under development to reinforce their
implementation;
• Central counterparties have been introduced to clear
credit default swaps, reducing the systemic risks from
this market.
Transparency and
standardisation in this market have been increased and
dealers have reduced their cross exposures through
trade compression;
• Stronger oversight regimes for credit rating
agencies have been developed.
New legislation creating
oversight regimes has been approved in Japan and is
close to final approval in the EU; in the US,
amendments to the existing oversight regime have been
proposed or already made;
• Internationally agreed principles for the oversight
of hedge funds have been issued, and national and
regional legislation has been or is in the process of
being introduced to implement them;
• Good practices for due diligence by asset managers
when investing in structured finance products have
been issued, which will reduce their reliance on
credit rating agencies;
• Abusive short selling has been
addressed. Internationally agreed principles have been
issued to counteract the abusive use of short selling
while maintaining the benefits of short selling for
the functioning of the markets, and their
implementation will be monitored;
• Supervisory coordination and cooperation in the
oversight of the most important global financial firms
have improved. Supervisory colleges have now been
established for all the large complex financial groups
that the FSB has identified as needing colleges;
• Strengthened arrangements for system-wide oversight
have been developed in many jurisdictions, bringing
together the relevant authorities to better assess
risks to financial stability and identify mitigating
actions;
• Firm-by-firm contingency planning is underway to
implement the FSB Principles for Cross-border
Cooperation on Crisis Management.
Relevant authorities will hold contingency planning
meetings for major cross-border banks within the first
half of 2010 and assess the barriers to coordinated
action that may arise in handling severe stress at
these firms;
• Depositors will be protected in a more consistent
way around the world.
Core Principles for Effective Deposit Insurance
Systems have been developed and an assessment
methodology is under preparation.
Critical work underway
13. Beyond the areas above, a large body of critical
work is underway to take forward other parts of the
London Summit Statement. In some areas, policy
development is reaching a phase in which difficult
decisions will need to be made.
Strengthening the global capital framework
14. The Basel Committee on Banking Supervision is
working urgently to build stronger buffers into the
financial system, covering capital, liquidity and
provisioning, that will raise defences and constrain
the procyclical build-up of leverage in the system.
15. New rules will be set out by
end-2009, calibrated in 2010 and phased in as
financial conditions improve and economic recovery is
assured.
Government capital injections will be grandfathered.
Banks should be retaining profits now to prepare to
meet these future additional capital requirements.
Restricting dividends, share buybacks and compensation
rates is a necessary part of that process.
16. The new rules will require a clear step up in the
amount and quality of capital that the system as a
whole will need to carry, so that banks holding the
minimum required capital levels will be clearly viable
in a crisis and confidence in the system as a whole
will be maintained.
17. To these ends, the Basel II capital framework is
being revised.
We are agreed that:
• the level and quality of minimum capital
requirements will increase substantially over time;
• capital requirements will
operate countercyclically,
so that financial
institutions will be required to build capital buffers
above the minimum requirements during good times that
can be drawn down during more difficult periods;
• significantly higher capital requirements for risks
in banks’ trading books will be implemented, with
average capital requirements for the largest banks’
trading books at least doubling by end-2010;
• the quality, consistency and transparency of the
Tier 1 capital base will be raised.
The predominant form of Tier 1
capital must be common shares and retained earnings.
Appropriate principles will be developed for non-joint
stock companies to ensure they hold comparable levels
of high quality Tier 1 capital.
Moreover, deductions and prudential filters will be
harmonised internationally and generally applied at
the level of common equity or its equivalent in the
case of non-joint stock companies;
• the definition of capital will
be harmonised across jurisdictions and all components
of the capital base will be fully disclosed so as to
allow comparisons across institutions to be easily
made;
• a leverage ratio will be introduced as a supplement
to the Basel II risk-based framework with a view to
migrating to a Pillar 1 treatment based on appropriate
review and calibration.
To ensure comparability, the details of the leverage
ratio will be harmonised internationally, fully
adjusting for differences in accounting.
18. We will also examine the use of “contingent
capital” and comparable instruments as a potentially
cost-efficient tool to meet a portion of the capital
buffer in a form that acts as debt during normal times
but converts to loss-absorbing capital during
financial stress, thus acting as a shock-absorber for
the capital position.
19. We will also assess the need for a capital
surcharge to mitigate the risk of systemic banks.
Making global liquidity more robust
20. The crisis vividly demonstrated that adequate
liquidity is a prerequisite for financial stability.
The drying up of liquidity at the level of financial
institutions, countries and ultimately the global
system caused the seizing up of credit provision and
of financial flows.
Cross-border flows are often the
most vulnerable during financial crisis, and emerging
markets can face damaging volatility in foreign
exchange and liquidity flows.
21. Just as strong capital is a necessary condition
for banking system soundness, so too is a strong
liquidity base.
Many banks that
had adequate capital levels still experienced
difficulties during the crisis because they did not
manage their liquidity in a prudent manner.
The lesson is that banks’ resilience to system-wide
liquidity shocks – affecting both market and funding
liquidity – must be significantly increased and their
management of this risk strengthened.
22. To this end, we are substantially raising the bar
for global liquidity risk regulation:
• The Basel Committee will issue
by the end of 2009 a new minimum global liquidity
standard.
This new regulatory framework
introduces a liquidity coverage ratio that can be
applied in a cross-border setting.
It establishes a harmonised framework to ensure that
global banks have sufficient high-quality liquid
assets to withstand a stressed funding scenario
specified by supervisors.
• The Basel Committee will also formulate a structural
ratio to address liquidity mismatches and promote a
strong funding profile over longer-term horizons.
• This new standard complements the supervisory
guidance for banks’ liquidity risk management
practices, the implementation of which is being
assessed in supervisory reviews.
23. Shortages of cross-border liquidity caused
problems at the national level for many countries.
Ex ante measures to reduce the risk of instability are
needed, as well as ex post mechanisms to provide a
coordinated official response if shortages arise:
• Regulators and supervisors in
emerging markets will enhance their supervision of
banks’ operations in foreign currency funding markets.
• The Committee on the Global Financial System will
investigate policy options to reduce system-wide
cross-border liquidity risk, including through
strengthening the infrastructure of the foreign
exchange swaps market and other aspects of funding
liquidity markets.
• National and regional authorities and the
international financial institutions will use the
results of this investigation to review together the
scope for improved cooperation over liquidity
provision when liquidity shortages arise.
Reducing the moral hazard posed by systemically
important institutions
24. Notwithstanding the actions above to strengthen
capital and liquidity,
additional steps are needed to reduce the moral hazard
risks and economic damage associated with institutions
that are “too big to fail” (or, more accurately, too
big and too complex to fail).
25. Action in this area is essential to contain the
costs to governments and economies of future crises.
We will develop
over the next 12 months measures that can be taken to
reduce the systemic risks these
institutions pose.
Possible measures include
specific additional capital, liquidity and other
prudential requirements as well as other measures to
reduce the complexity of group structures and, where
appropriate, encourage stand-alone subsidiaries.
More intense and internationally coordinated
regulation and supervision of firms presenting greater
risks can help to reduce the probability of their
failure.
26. For all major cross-border firms we will require
the development of specific contingency plans that aim
at preserving the firm as a going concern, promoting
the resiliency of key functions and facilitating rapid
resolution or wind-down, should that prove necessary.
The Basel Committee’s
consultation document on cross border bank resolution
proposes specific actions to achieve an effective,
rapid and orderly wind-down of large cross-border
financial firms.
27. We will assess the implications of different
responses for systemic cross-border institutions with
different group structures, and the impact of these
different measures for the stability and efficiency of
cross-border capital flows.
We ask you to support us in this important future
work.
Strengthening accounting standards
28. In April 2009, the G20
Leaders stated that standard setters should “make
significant progress towards a single set of high
quality global accounting standards.”
There is significant progress in this area and nearly
all FSB member jurisdictions have programmes underway
to converge with or adopt the standards of the
International Accounting Standards Board (IASB) by
2012.
29. In addition, the G20 Leaders
welcomed the FSF’s procyclicality recommendations
relating to accounting and called on “accounting
standard setters to work urgently with supervisors and
regulators to improve standards on valuation and
provisioning and achieve a single set of high-quality
global accounting standards.”
Important steps have been taken to improve existing
standards and to enhance dialogue with prudential
authorities.
But in some
instances, achieving improved valuation and
provisioning standards alongside the goal of
convergence need further attention by standard
setters.
30. At present, the IASB and the US Financial
Accounting Standards Board (FASB) are considering a
variety of approaches which could possibly lead to
divergences between IASB and FASB standards with
respect to:
• improving and simplifying financial instruments
accounting, where FASB is considering an approach that
is based on fair value measurement for most financial
instruments, which would be proposed by early 2010,
while the IASB has proposed a mixed model of
historical cost and fair value, to be available for
use in 2009 year-end financial statements;
• provisioning and impairment, where the IASB plans to
propose a standard using an expected loss or expected
cash flow approach to loan loss provisioning in
October 2009, which would generally recognise credit
losses earlier and mitigate procyclicality,1 whereas
the FASB continues to consider changes toimpairment
recognition, including an approach based on fair value
with plans to issue its proposal by early 2010;
• off-balance sheet standards,
where the IASB’s proposal on derecognition, which is
now subject to consultation, would require repurchase
agreements to be treated as sales and forward
contracts in certain situations (thus leading to
off-balance sheet treatment), instead of as financing
transactions on the balance sheet as under current
IASB and FASB standards.
31. Moreover, continuing differences in accounting
requirements of the IASB and FASB for
netting/offsetting of assets and liabilities also
result in significant differences in banks’ total
assets, posing problems for framing an international
leverage ratio.
32. Therefore, additional work in the areas above is
urgently needed in order to meet the important
objectives of convergence, transparency and the
mitigation of procyclicality, as standard setters
continue their efforts to improve the quality of their
standards and reduce the complexity of their standards
on financial instruments.
33. We strongly encourage the IASB and FASB to agree
on improved converged standards that will:
• incorporate a broader range of available credit
information than existing provisioning requirements,
so as to recognise credit losses in loan portfolios at
an earlier stage as part of an effort to mitigate procyclicality.
We are particularly supportive of continued work on
impairment standards based on an expected loss model;
and
• simplify and improve the
accounting principles for financial instruments and
their valuation.
We are
particularly supportive of continued work in a manner
that does not expand the use of fair value in relation
to the lending activities (involving loans and
investments in debt instruments) of financial
intermediaries.
34. While respecting the independence of accounting
standard setters, the FSB is urging renewed efforts by
the IASB and FASB to achieve these objectives, working
with supervisors, regulators and other constituents.
The Basel Committee has issued for consideration by
accounting standard setters principles for the
revision of accounting standards for financial
instruments, agreed by all G20 banking supervisors,
that address issues related to provisioning, fair
value measurement and related disclosures.
35. We welcome the IASB’s recent initiatives with
respect to provisioning and its enhanced technical
dialogue with prudential supervisors and other
stakeholders, and encourage the IASB to continue its
dialogue with stakeholders as it moves forward.
We request G20 Leaders to support the call for action
set forth in this section.
Improving compensation practices
36. National regulatory and supervisory initiatives
are being taken to implement the FSB Principles for
Sound Compensation Practices.
The Principles
call for wide ranging private and official sector
action to ensure that governance of compensation is
effective; that financial firms align their
compensation practices with prudent risk taking; and
that compensation policies are subject to
effective supervisory oversight and engagement by
stakeholders.
37. Given competitiveness
concerns, speedy and determined coordinated action in
all major financial centres is needed to achieve
effective global implementation of the Principles.
We must ensure that the Principles are rigorously and
consistently implemented and applied to significant
financial institutions and especially large,
systemically relevant firms across the financial
services sector.
38. To this end, we have set out in a separate report2
to the Summit specific implementation standards for
the Principles, focusing on areas in which especially
rapid progress is needed.
These cover:
• independent and effective
board oversight of compensation policies and
practices;
• linkages of the total variable compensation pool to
the overall performance of the firm and the need
to maintain a sound capital base;
• compensation structure and risk alignment, including
deferral, vesting and clawback arrangements;
• limitations on guaranteed bonuses;
• enhanced public disclosure and transparency of
compensation; and
• enhanced supervisory oversight of compensation,
including sanctions if necessary.
39. The Basel Committee, the International Association
of Insurance Supervisors (IAIS) and the International
Organization of Securities Commissions (IOSCO) will
undertake measures to support implementation.
40. We will undertake a FSB thematic peer review of
actions taken by national authorities to implement our
Principles and implementation standards.
We will assess whether these actions have had their
intended effect and propose additional measures as
required.
This review will
be completed in March 2010.
41. These actions are in addition to our call for
banks to conserve capital by limiting bonus payments
today and so be in a better position to meet future
additional capital requirements.
Expanding oversight of the financial system
42. In addition to strengthening the buffers in the
banking system, work is progressing to ensure that,
throughout the broader financial system, all
systemically important activity is subjected to
appropriate oversight and regulation.
In particular:
• Regarding hedge funds,
regulators are working, including through IOSCO, to
set out for consideration by legislatures a consistent
framework for oversight and regulation of hedge funds
and/or hedge fund managers, including requirements for
mandatory registration, ongoing regulation, provision
of information for systemic risk purposes, disclosure
and exchange of information between regulators.
Regulators are
coordinating their respective work in order to ensure
the best possible consistency with regard to
implementation of hedge fund regulation in different
jurisdictions.
By March 2010, IOSCO will report on the level of
implementation in these areas and on proposed industry
standards.
• On credit rating agencies,
regulators are working, including through IOSCO, to
evaluate whether national and regional regulatory
initiatives are consistent with the IOSCO Principles
and Code of Conduct Fundamentals and to identify
whether divergences between initiatives might cause
conflicting compliance obligations for credit rating
agencies.
Regulators should
work together towards appropriate, globally compatible
solutions as early as possible in 2010.
• Regarding the perimeter of regulation more
generally, supervisors and regulators working through
the Joint Forum will identify by end-2009 other key
areas where the perimeter needs to be expanded.
• By the November 2009 meeting of G20 Finance
Ministers and Central Bank Governors, the
International Monetary Fund (IMF), Bank for
International Settlements and FSB will have developed
preliminary guidance for national authorities to
assess the systemic importance of financial
institutions, markets or instruments.
43. To guard against regulatory arbitrage, it is
imperative that initiatives to expand the perimeter of
regulation are effectively and consistently
implemented across key jurisdictions.
The FSB will benchmark the regulations implemented in
these jurisdictions to assess whether they are well
aligned with each other.
Strengthening the robustness of the OTC derivatives
market
44. Global regulatory efforts to reduce systemic risks
in the over-the-counter (OTC) derivatives market have
intensified since the London Summit.
Given the global nature of the market, international
standards must be established and consistently applied
to address these risks, and regulators must coordinate
their efforts.
45. To these ends, the official sector will:
• strengthen capital requirements to reflect the risks
of OTC derivatives and further incentivise the move to
central counterparties and, where appropriate,
organised exchanges.
The Basel Committee will issue
new standards by mid-2010 to take full account of
counterparty credit risks, the benefits of centrally
cleared contracts and collateralisation.
Regulators need to ensure that equivalent rules are
applied outside the banking sector;
• strengthen standards for central counterparties by
mid-2010 to address the issues specific to clearing
OTC derivatives, and develop international
recommendations for OTC derivatives trade
repositories, working through the Committee on Payment
and Settlement Systems and IOSCO;
• coordinate efforts to oversee and apply
international standards to OTC derivatives central
counterparties and trade repositories. We strongly
support the ongoing work of the OTC Derivatives
Regulators’ Forum to develop international cooperative
oversight frameworks by end-2009, including for
sharing information among regulators and developing
common expectations for data reporting; and
• identify legal or other impediments to implementing
the OTC derivatives market reforms, which regulators
or legislative authorities will then take action to
resolve.
46. The private sector needs to meet its commitments
to supervisors to expand central clearing of OTC
derivatives trades; improve risk management for trades
that are not cleared, meet increasingly stringent
targets for operational improvements and report data
on their performance to their regulators; and report
all non-cleared trades to regulated trade
repositories.
If they do not meet these and future commitments,
supervisors will develop alternative approaches to
ensure the improvements are made.
Re-launching securitisation on a sound basis
47. The revival of securitisation markets is needed in
many countries to support the provision of credit to
the real economy.
Although industry
initiatives are underway to standardise terms and
structures, reduce complexity and enhance
transparency, the official sector must provide the
framework that ensures discipline in the
securitisation market as it revives.
48. To this end, during 2010, supervisors and
regulators will
• implement the measures decided
by the Basel Committee to strengthen the capital
treatment of securitisation and establish clear rules
for banks’ management and disclosure, including:
o higher risk weights for securitisations and
re-securitisations;
o requirements on banks to conduct more rigorous due
diligence of externally rated securitisations, with
higher capital requirements imposed where this does
not take place;
o tighter prudential guidance for bank management of
off-balance sheet exposures arising from
securitisation vehicles; and
o improved disclosures of securitisation exposures in
the trading book, sponsorship of off-balance sheet
vehicles, re-securitisation exposures, valuation
assumptions and pipeline risks;
• implement IOSCO’s proposals to
strengthen practices in securitisation markets,
including by:
o reviewing the due diligence practices and associated
disclosures of participants in the securitisation
chain;
o better informing and protecting investors by
requiring greater disclosure by issuers, including
initial and ongoing information about underlying asset
pool performance;
o reviewing and, as appropriate, strengthening
investor suitability requirements;
o considering what enhancements are needed to
regulatory powers to allow authorities to implement
the recommendations in a manner promoting
international coordination of regulation;
• examine other ways to align
incentives of issuers with investors, including
considering requirements on issuers of securitisations
to retain a part of the economic exposure of the
underlying assets;
• encourage greater use of the contractual form used
in covered bonds, which tie issuers to the instruments
by obliging them to act as the de facto guarantor in
the event of underperformance by the underlying
assets, provided that depositors are not
disadvantaged;
• support implementation of industry initiatives to
standardise terms and structures, reduce complexity
and enhance transparency and, as securitisation
markets restart, adjust measures as appropriate.
Adherence to international standards
49. The FSB will put in place by the end of 2009 a
framework to strengthen adherence to international
regulatory and prudential standards. The framework,
which will build upon IMF and World Bank assessments,
is envisaged to provide comprehensive and updated
compliance information.
FSB member countries have agreed to lead by example in
disclosing their degree of
compliance.
The FSB will report on the development of this
framework at the November 2009 meeting of G20 Finance
Ministers and Central Bank Governors.
50. We will apply this framework to identify
non-cooperative jurisdictions with reference to
cooperation, information exchange and other prudential
standards, focusing on jurisdictions of concern due to
weaknesses in compliance and systemic importance.
The FSB will work as quickly as possible to develop:
• a global compliance “snapshot”
for the relevant standards building on Financial
Sector Assessment Program (FSAP) assessments where
available and other relevant information, by November
2009;
• criteria for identifying jurisdictions of concern by
November 2009;
• procedures for an evaluation process to build on and
complement FSAP assessments, to be launched by
February 2010 at the latest; and
• a toolbox of measures to promote adherence and
cooperation among jurisdictions, by February 2010 at
the latest.
51. Within this framework, we are also developing a
system of peer reviews among FSB members, based among
other evidence on the findings of IMF and World Bank
assessments, and will report on their outcome.
These will comprise both single-country and thematic
reviews to assess our implementation of international
financial standards and of policies agreed in the FSB
and determine whether additional steps are needed to
reach the intended results.
Both modalities
will be developed in parallel. Actual reviews will
start by end-2009 with the thematic peer review on the
implementation of the FSB compensation principles.
The need for perseverance and consistent national
implementation
52. While reforms are well underway, as we detail in a
separate report, they are far from complete.
Effective work to strengthen the global financial
system requires policies that are well designed and
will be robust over the long run.
This necessarily takes time.
It is important, therefore, that Leaders send a strong
message that they are determined to see these reforms
through.
Where international policy development is ongoing, we
need Leaders’ continued support; where such policy
work has concluded, we need Leaders’ commitment to
consistent national implementation.
53. Achieving our objectives of
a well regulated open financial system requires the
maintenance of a level playing field.
Delivering this is
one of the reasons why the FSB exists.
However, the speed with which jurisdictions develop
and change financial regulation differs, and
consistency in what comes into place should not be
taken for granted.
While the FSB can
develop coherent policy proposals, only national
authorities can assure implementation that is
effective and
is consistent across borders.
Given the commitment we have all made to coherent
approaches as we improve the regulation of the system,
we must strive to overcome differences in our final
rule making.
We will continue
to take actions to ensure achievement of this end.
54. To maintain ongoing attention to this issue and
foster the pace and consistency of implementation, we
will launch a project to compare national
implementation measures and identify cross-country
differences and any need for policy actions to address
them.
55. As our economies recover, it
is crucial that national momentum for significant
reforms be maintained.
The FSB will
continue to work to ensure that the goals remain
ambitious, that clear targets are set to move us
forward towards those goals, and that their importance
is not lost even if markets seem to be calmer for the
time being.
The
Basel iii Accord is near...
Shortcomings
in Basel ii
"Supervisors should, at a minimum, be aware of
the increasing sophistication with which banks are responding
to the existing regulatory
framework"
Alan
Greenspan, October 1998 (Alan Greenspan
was the chairman of the Board of Governors of the US Federal
Reserve System)
Basel II
is much better than Basel I. But, it does not mean that it is
good enough.
There are some very serious
shortcomings
and has so many loose
ends.
Basel II
is more risk sensitive than Basel
I but it is NOT really risk sensitive.
We do have
a new risk, operational risk, but...
-
Reputational risk is not an operational
risk
-
Systemic risk (disruption at a firm or a
market segment causes difficulties to other firms or market
segments) is not an operational risk
-
Strategic risk (the risk of losses or reduced
earnings due to failures in implementing strategy) is not an
operational risk
Basel I:
-
A $100,000 commercial loan with a AAA credit
rating would necessitate $100,000 x 100% x 8% = $8,000
capital charge
-
A $100,000 commercial loan with a B credit
rating would necessitate $100,000 x 100% x 8% = $8,000 – the
same capital charge
Basel
II:
-
A $100,000 commercial loan with a AAA credit
rating would necessitate less capital charge, even $370
(Advanced IRB)
-
A $100,000 commercial loan with a B credit
rating would necessitate more capital charge, even $42,000!
(Advanced IRB)
The logic behind Basel
II:
Capital requirements should
increase for banks that hold risky assets and decrease
significantly for banks that hold safer
portfolios
What is really
happening:
-
Basel II has become an
international competition for consultants: How to help banks
allocate less capital.
-
Basel II creates incentives for banks to move risky
assets to unregulated parts of the holding company.
-
Banks
take advantage of the opportunity to transfer risk to
investors - use securitization.
-
We
have important opportunities for regulatory
arbitrage
It is interesting to follow the thoughts of Alan
Greenspan. This is what he said in
1998
"Despite
the attempt to make capital requirements at least somewhat
risk-based, the main criticisms of the (Basel I) Accord—at
least as applied to the activities of our
largest, most
complex banking organizations—appear to be
warranted.
In
particular, I would note three:
First,
the formal capital ratio requirements, because they do not
flow from any particular insolvency probability standard, are
for the most part arbitrary. All corporate loans, for example,
are placed into a single, 8 percent
bucket
Second,
the requirements account for credit risk and market risk but
not explicitly for operating and other forms of risk that may
also be important
Third,
except for trading account activities, the capital standards
do not take account of hedging,
diversification, and differences in risk management
techniques, especially portfolio
management.
These
deficiencies were understood even as the Accord was being
crafted. "
"The
Basle standard lumps all corporate loans into the 8 percent
capital bucket, but the banks’
internal capital allocations for individual loans vary
considerably—from less than 1 percent to well over 30 percent—
depending on the estimated riskiness of the
position in
question.
In
the case in which a group of loans attracts an internal
capital charge that is very
low
compared with the Basle 8 percent standard, the bank has a
strong incentive to undertake regulatory capital
arbitrage to
structure the risk position in a manner that allows it to be
reclassified into a lower regulatory risk
category
At
present, securitization
is, without a doubt, the major tool used by large U.S. banks
to engage in such arbitrage.
Regulatory
capital arbitrage, I should emphasize, is not necessarily
undesirable. In many cases, regulatory capital arbitrage acts
as a safety valve for attenuating the adverse effects of those
regulatory capital requirements that activity’s underlying
economic risk.
Absent
such arbitrage, a regulatory capital requirement that is
inappropriately high for
the economic risk of a particular activity could cause a bank
to exit that relatively low-risk business by preventing the
bank from earning an acceptable rate of return on its capital.
That
is, arbitrage may appropriately lower the effective capital
requirements against some safe activities that banks would
otherwise be forced to drop by the effects of
regulation.
It
is clear that our major banks have become quite efficient at
engaging in such desirable forms of regulatory capital
arbitrage, through securitization and other
devices.
However,
such
arbitrage is not costless and therefore not without
implications
for resource allocation. Interestingly, one reason that the
formal capital standards do not include very
many risk buckets is that regulators did not want to influence
how banks make resource allocation
decisions.
Ironically,
the “one-size-fits-all” standard does just that, by forcing
the bank into expending effort to negate the capital standard,
or to exploit it, whenever there is a
significant disparity
between the relatively arbitrary standard and internal,
economic capital requirements.
The
inconsistencies between internally required economic capital
and the regulatory capital standard create another type of
problem:
Nominally
high regulatory capital ratios can be used to mask the true
level of insolvency probability. For
example, consider
the case in which the bank’s own risk analysis calls for a 15
percent internal economic capital assessment against its
portfolio.
If
the bank actually holds 12 percent capital, it would, in all
likelihood, be deemed to be well capitalized in a regulatory
sense, even though it might be undercapitalized in
the economic
sense.
The
possibility that regulatory capital ratios may mask true
insolvency probability becomes more acute as banks arbitrage
away inappropriately high capital requirements on their safest
assets by removing these assets from the balance sheet via
securitization.
The
issue is not solely whether capital requirements on the bank’s
residual risk in the securitized assets are appropriate.
We
should also be concerned with the sufficiency of regulatory
capital requirements on the assets remaining on the book.
In
the extreme, such
“cherry picking” would leave on the balance sheet only those
assets for which economic capital allocations are greater than
the 8 percent regulatory standard.
Given
these difficulties with the one-size-fits-all nature of our
current capital regulations, it is understandable that calls
have arisen for reform of the Basle
standard.
It
is, however, premature to try to predict exactly how the next
generation of prudential standards will evolve. One set of
possibilities revolves around market-based tools and
incentives. Indeed, as banks’ internal risk measurement and management technologies improve, and as the depth and
sophistication of financial markets increase,
bank supervisors
should continually find ways to incorporate market advances
into their prudential policies, when appropriate.
"
|
| |
Download
Our Consulting and Training Services
Catalog
Download
Our Consulting and Training Services Catalog for
Banks
Our Web Sites
E-book: 100 Job Descriptions in Risk and Compliance Management
Certified Basel ii Professional (CBiiPro)
Certified Pillar 2 Expert
(CP2E)
Certified Pillar 3
Expert (CP3E)
Certified Stress Testing Expert (CSTE)
|
