4 week four global regulation of banks. introduction meaning of bank regulation the principles...

4WEEK FOUR

GLOBAL REGULATION OF BANKS

Introduction Meaning of Bank RegulationThe Principles and Requirements of Bank RegulationsTypes of Bank Regulation International Regulations

Prudential Regulation Basel I Basel II Basel III

Drawbacks of Regulation Conclusion

OUTLINE

Outline the rational for banking regulationAppreciate the diff erent types of regulationExplain the causes of the persistent changes in bank

regulations Identify the general principles and requirement of

bank regulationAssess the shortcomings and costs of bank

regulations

OBJECTIVES

This lecture focuses on the rationale for the regulation of both national and international banks.

The banking industry is relatively the most regulated. Prudential RegulationBasel I, II, and III

The lecture focuses on the nature and types of bank regulation and the pros and cons of such regulations

INTRODUCTION

Bank Regulation is a form of government regulation which subjects banks to certain requirements, restrictions and guidelines.

These government regulations or controls are stricter than those on business in generals. The justification for stricter controls is that; bank failures

may disrupt the rest for the financial system in a way that can affect other businesses.

Bank provide intermediation services serves as the backbone of every economy.

The failure of this function will have rippling effects on the economy hence the tight regulation.

MEANING OF BANK REGULATION

The regulator is normally a bank and therefore a participant in the market. This is very uncommon in the regulation of other businesses.

The business of banking gives birth to a contractual relationship between the bank and customers. Agency issues or problems with this relationship makes it imperative for government to regulate the market.

THE RATIONALE FOR REGULATION

The Rationale:To protect the bankers and customersTo ensure prudence in the banking industryTo reduce systemic risk To avoid misuse of banks (Money laundering activities, terrorist financing etc)

To protect the banking confidentialityTo allocate credit to most needed sector of the economy

To check the abuse of Oligopolistic and Monopoly powers

THE RATIONALE FOR REGULATION

General principles of bank regulation are the canons upon which bank regulation is carried out. These have been developed over time by the Basel Committee on Banking Supervision.

These are: Minimum Capital Requirements Supervisory Review Market Discipline

GENERAL PRINCIPLES OF BANK REGULATION

Minimum CapitalThis requirement is normally imposed to promote the objective of the regulator.

The requirement differs for different classes of financial institutions.

The requirement cut across all issues relating to capital of banks Minimum Capital Minimum Capital Ratio Approval of banks business plan Shareholders’ requirements etc


Supervisory Review Requirement Licensing requirements prior to commencement of business Giving directives Imposition of penalties for breaching laws

Market Discipline Disclosure of financial and relevant non-financial

information This enables the regulator to assess the financial health of

the commercial banks. It also helps other stakeholders to reasonably make

investment decisions on the basis of the risk profile of the banks


Capital RequirementsReserve RequirementsCorporate Governance RequirementFinancial Reporting and Disclosure RequirementsCredit Rating RequirementsLarge Exposure RequirementsRelated Party Exposure Restrictions

REQUIREMENTS OF BANK REGULATION

Structural (or Systemic) RegulationPrudential RegulationConduct of Business Regulation

Structural (Systemic) Regulation: Concerned with safety and soundness of the financial

system. Considers all public policy regulation designed to

avoid bank runs Normally in the form of government safety nets:

Deposit insurance Lender of Last Resort

TYPES OF BANKING REGULATION

Prudential RegulationConcerned with consumer protection Involves the regulations of deposit-taking institutions Supervision Risk-taking limits etc

Conduct of Business RegulationFocuses on how banks and other financial institutions conduct their business

Relates to Information disclosureFair business practicesCompetence

TYPES OF BANKING REGULATION

The growth of banks and emergence of banks that operate in multiple jurisdictions have called for bank regulation on a global scale.

Key issues in this arena include:The complexity of international banking regulation

The level of oversight requiredThe regulatory bodyHow should the implementation be done and where?

Prudential RegulationBasel Accord

INTERNATIONAL BANKING REGULATION

Prudential Regulation in the International Arena:Prudential regulation is an appropriate legal framework for financial operations which is a significant contributor to preventing financial sector problems.

There is the need for global coordination of prudential banking regulation as a result of:Policy makers, bank management, and regulators recognition of the fact that the stability of the global financial system can compromised

Where a branch is located in other jurisdiction, who has supervisory authority?

Global regulation, when implemented will standardize bank operations and level the competitive playing field


Basel AccordBasel IBasel IIBasel III

Basel IA round table of central bankers from around the world in 1988

The Basel Committee was formed in response to the messy liquidation of a Cologne-based bank (Herstatt) in 1974.

The deliberations were lead by the Bank of International Settlements (BIS) in Basel, Switzerland.


Basel I, Main Framework Focused on credit risk Assets of banks were grouped into five categories with

risk weights 0%, 10%, 20%, 30%, 40%, to 100% Banks with international presence are required to hold

capital equal to 8% of risk weighted assets Implemented progressively among G-10 nations. Several other countries including Ghana adopted the

core principles of the Basel AccordPurpose of Basel I

Strengthen the stability of international banking system

To set up a fair and consistent international banking system in order to decrease competitive inequality among international banks


Basel I, Major AchievementA working definition of bank capital ratioThis definition of bank capital has been universally accepted

Basel I – Capital RequirementCapital Ratio by definition was categorized into two tiers; Tier 1 Tier 2


Basel I – Capital Requirement: Step One (Definition of Capital)Tier 1 Capital (Core Capital)

Include stock issue and declared reserves.Tier 2 (supplementary Capital)

Includes gains on investment assets, long-term debt with maturity greater than five years and hidden reserves (excess allowances for losses on loans and leases)


Basel I – Capital Requirement: Step Two (Risk Weighting of Capital)Defined bank capital in terms of credit risk exposure of the bank

The level of credit risk exposure is determined by the risk weighted assets of the banks.

The accord identifies three types and level of credit risk exposure On-balance sheet risk Trading Off-balance sheet risk Non-trading off-balance sheet risk


RISK WEIGHTS ASSET CLASS

0% Cash and gold held in the bank

20% Claims on OECD banksClaims issued by U.S government agenciesClaims on municipalities

50% Residential Mortgages

100% All other claims such as corporate bonds, less-developed countries debt.Claims on non-OECD banks, equities real estate, plant and equipment


Example on risk weights


Asset category Risk weight

Capital ratio

Amount RWA Capital

Treasury bond 0% 8% $1000 $0 $0

Municipal bond 20% 8% $1000 $200 $16

Residential mortgage

50% 8% $1000 $500 $40

Unsecured loan 100% 8% $1000 $1000 $80

Revision of Basel I in 1996 To include Market RiskMarket risk emanates from four economic variables Interest rates Foreign exchange Equities commodities

This risk is calculated in two different ways: Standardized Basel Model Value at Risk (VaR)


Pitfalls in Basel ILimited Differentiation of Credit RiskStatic Measure of Default riskNo recognition of term structure on credit riskSimplified calculations of potential future counterparty risk

Lack of recognition of portfolio diversification effects

The culmination of these factors lead to the introduction of the Basel II


Basel II Second of the Basel Accords published in 2004

Aimed at: Ensuring that capital allocation is more risk sensitive Separating operational risk from credit risk, and

quantifying both risks Aligning economic and regulatory capital more closely

to reduce the scope for regulatory arbitrage


Basel II in OperationFundamentally based on three pillars, same as those contained in Basel II, but deeper in term of coverage

Minimum capital Requirements (1), Supervisory (2) Review, and Market Discipline (3)

Basel I dealt with only one aspect of these pillars.

Basel II introduces more dimensions to each of the canons or pillars.


Pillar 1 Maintenance of Regulatory Capital This is calculated for three major risks: Credit Risk,

Operational Risk, and Market Risk


Risk Measurement

Credit Risk Standardized Approach, Foundation IRB and Advanced IRB

Operational Risk Basic Indicator Approach, Standardized Approach

Market Risk Value At Risk

Pillar 2Deals with regulatory response to Pillar 1. Provides a framework for dealing with residual risks: systemic risk, pension risk, concentration risk, strategic risk, reputation risk, liquidity risk, and legal risk.

Introduced more forward looking approach to capital supervision by encouraging banks to identify potential risks they may face in the future and try to mange them.


Basel IIIThese are ongoing new updates to the Basel Accord

The draft Basel III include: Tighter definition of tier 1 capital The introduction of leverage ratio A framework for counter-cyclical capital buffers Measures to limit counter-party credit risk, and Short and medium term quantitative liquidity ratio


Regulation comes at a cost despite its benefits. These include:Cost of administering and monitoringCost of supervisionPoor record keepingControl of interest ratesCapital requirements Impediment to growth and economic development

DRAWBACKS OF REGULATIONS

This lecture reviewed the issue of bank regulation

Began with a rationale for bank regulationFocused on regulation in the local contextFocused on regulation in the international

arena

CONCLUSIONS

4END OF LECTURE

FOURQUESTIONS?

4 week four global regulation of banks. introduction meaning of bank regulation the principles...

Documents

requirement of bank

banking regulation

tight regulation

bank failures

different types of regulation

form of government regulation

regulations introduction

business of banking