Berat BAŞAT

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BISBasel CommitteeBASEL IBASEL IIComparison of Basel I – Basel IIBASEL IIIImplications on SME’s

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- To operate as the Central Bank of Europe,

- To organize international payments system formed by central banks of countries.

- The oldest international financial institution

- Remains the principal center for international central bank cooperation.

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Basel Committee

- Founded in 1975 by the central bank governors of the Group of Ten countries

Main Goals:

- To improve the understanding of key challenges in supervision

- To improve quality of banking supervision worldwide

Basel Committee on Banking Supervision

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BASEL I

The purpose of Basel I standards was to introduce a uniform way of calculating capital adequacy

Risk Weight % Asset Category

0 % for governments of OECD countries

10 % public institutions of OECD countries

20 % OECD countries’ banks

50 % credits for housing mortgage securities.

100 % for other countries’ governmental and private institutions

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Capital

Credit Risk + Market Risk≥ 8%CAR:

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The bank has to maintain capital equal to at least 8% of its risk-weighted assets.

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- Substantial increases in capital adequacy ratios of internationally active banks;

- Relatively simple structure;

- Worldwide adoption;

- Increased competitive equality among internationally active banks;

- Greater discipline in managing capital;

- A benchmark for assessment by market participants.

BENEFITS OF BASEL I STANDARDS

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Limited differentiation of credit risk

Static measure of default risk

No recognition of term-structure of credit risk

Lack of recognition of portfolio diversification effects.

WEAKNESSES OF BASEL I STANDARDS

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Basel I to set the minimal capital requirements

Basel II to remove the deficiencies of Basel I Accords

to measure the risks with more sensitive methods

to set an effective risk management system,

to develop a market discipline,

To increase the efficiency of measurement of capital requirements constructing a robust banking system and ensuring financial stability

BASEL II STANDARDS Prepared in 2001Published in 2004Applied in 2007

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Pillar one explains the new capital adequacy ratio. Basel II standards added the operational risk to the denominator of capital adequacy ratio for the first time. In addition, credit risk is detailed whereas the market risk remains the same. So the new ratio shaped like the following

Capital

Credit Risk + Market Risk≥ 8%

Capital Adequacy Ratio:

+ Operational Risk

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Pillar two basically focuses on the duty and responsibilities of the regulatory authorities

According to the pillar two, banks need to construct more powerful risk management systems and increase the importance of internal control.

Provides a framework for dealing with all the other risks a bank may face (such as systematic risk, liqudity risk)

Recommends active interaction between banks and their supervisors

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Basel II should maintain security and robustness in financial system therefore protect the capital at least in its current state.

Aims to promote greater stability in the financial system.

Encourages prudent management and transparency in financial reporting of banks.

Focuses on effective disclosure of information and specifies the nature and type of information that should be reported to market participants.

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BASEL 1Consideration of only credit and market risks.

BASEL 2A more comprehensive approach to CAR and consideration of ‘operational risk’. Use of risk ratings given by credit rating institutions to determine credit risks.Alternative methods for each risk category and use of banks’ risk measurement methods. Emphasis on risk management.3 pillars concept, emphasis on supervisory and market discipline and regulations on these issues.

• Differentiation of OECD membership to determine credit risks.

• Use of only one method of risk quantification.

• Same supervisory approach for all financial institutions.

• Emphasis is only on minimum CAR.

COMPARISON

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Basel III is a new global regulatory standards on bank capital adequacy, leverage and liquidity to strenghten supervision and risk management of banking sector.

Requires banks to hold more capital and higher quality of capital than Basel II requirements.

BASEL III

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1 - The quality, consistency, and transparency of the new capital base will be raised.

Tier1: Capital must be common shares and retained earnings.

Tier2: Instruments will be harmonized.

Tier3: Capital will be eliminated

PROPOSED CHANGES

2 - The risk coverage of the capital framework will be strengthened.

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3 - The committee will introduce a leverage ratio as a supplementary measure to the Basel II risk based framework

4 - The committee is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systematically important situations.

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- SMEs tend to employ more labor-intensive production processes than large enterprises. Accordingly, they contribute significantly to the new employment opportunities, the generation of income and ultimately, the reduction of poverty.

- SMEs are keys to the transition of agricultural to industrial economies as they provide simple opportunities for processing activities

- SMEs are good examples for entrepreneurship development, innovation and risk taking behavior and the transition towards larger enterprises

IMPORTANCE OF SME’s

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SMEs

support the building up of systemic productive capacities.

help to absorb productive resources at all levels of the economy

contribute to the creation of flexible economic systems in which small and large firms are interlinked.

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In order to determine capital adequacy in Basel II, SME classification limits are determined according to total gross sales.

IMPLICATIONS ON SME’s

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If banks do not use the advanced methodologies that Basel II proposes, their capital needs will increase and this will bring out the situation that they convey this extra cost to their credit packages. The consequence has noticeable implications on SMEs especially in developing countries.

In contrast, if banks apply Basel II Standard and its total loan exceed one million Euros, it will be evaluated in the corporate portfolio and the risk rating note that is given by external rating agencies will be considered by the banks.

This situation will inevitably affect the enterprises that use high amount of loans.

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The percentage of SMEs out of the total number of firms in OECD countries is greater than 97 percent, generating over half of private sector employment.

Their contribution to employment, adoptability to new developments due to their flexible nature, creation of product differentiation, provision of intermediate goods are considerable attribution for an economy. 

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Ratings and Interest Rates

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- Definition of SMEs has been changed

- Credit pricing will be made related to risk

- SME’s will have to take a degree from banks or rating agencies in order to determination of its credit risk

- The assets that can be showed as a warranty has been redefined.

-Registration and reporting of financial information and transparency has become much more important.

-The SMEs will try to seek different sources of finances

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