international banking regulation manjunath

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INTERNATIONAL BANKING

REGULATION

Manjunath H. Mannapur

M.A-II



•When banking systems weakened in the number of industrial countries in1980’s, there was a large pressure on developed countries to regulate banks.

• This was brought in the form of regulating the banks thus reducing the

likelihood of individual failures that could spread the adverse effects across

national boundaries and also because banks in different countries would notbenefit from any competitive advantages due to subsidies from their

governments, such as lower capital – ratios in an environment of implicit or

explicit deposit insurance or other government support.

Why International Banking

Regulation?



• This regulation reflects the limited market discipline on banks in most

countries because of the existence of actual or speculative government

guarantees.

•Also, the greater difficulty in monitoring banks in non-home jurisdictionsby both private stakeholders and government regulators. This is particularly

true if the regulations differ significantly across jurisdictions.

• The international regulations would resemble domestic prudential

regulations, but taken into account any differences in institutional and legalstructures in different countries that, in particular, impact the quality of

regulatory supervision and private market discipline.



History of Basel committee

• The Basel Committee on Banking Supervision (BCBS) was

established as the Committee on Banking Regulations and

Supervisory Practices by the central-bank Governors of the Group

of Ten countries at the end of 1974 in the aftermath of serious

disturbances in international currency and banking markets.

• The meeting took place in February 1975 and usually it meets four

times a year.

• Chairman: Stefan Ingves, Governor of Sveriges Riksbank .

• Secretary General :Wayne Byres, supported by a staff of 17

members.



Basel committee members

Countries Institutions represented

Argentina Central bank of Argentina

Australia Reserve Bank of Australia

Australian Prudential Regulation Authority

Belgium National Bank of Belgium

Banking, Finance and Insurance Commission

Brazil Central Bank of Brazil

Canada Bank of Canada

Office of the Superintendent of Financial Institutions

China People’s Bank of China

China Banking Regulatory CommissionFrance Bank of France

Banking Commission

India Reserve Bank of India

Sweden Sveriges Riksbank

Finansinspecktionen



Indonesia Bank of Indonesia

Italy Bank of Italy

Japan Bank of Japan

Financial services agency

Korea Bank of korea

Financial supervisory service

Luxembourg Surveillance commission for the financial sector

Mexico Bank of mexico

Comisio’n Nacional Bancaria Y De Valores

Netherlands The Netherlands bank

Russia Central bank of the Russian federation

Saudi Arabia Saudi Arabian monetary agency

Singapore Monetary authority of Singapore

South Africa South African reserve bank



Germany Deutsche bundesbank

German financial supervisory authority(BAFin)

Hong Kong SAR Hong Kong Monetary Authority

Spain Bank of Spain

Switzerland Swiss National Bank

Swiss Federal Banking Commission

Turkey Central Bank of The Republic of Turkey

Banking Regulation and Supervision Agency

United Kingdom Bank of England

Financial Services Authority

United states Board of Governors of the Federal Reserve System

Federal Reserve Bank of New York

Office of the Comptroller of the Currency

Federal Deposit Insurance Corporation

Office of Thrift Supervision



a) Operational Risk Subgroup - addresses issues related to Advanced

Measurement Approach for Operational Risk.

b) Task Force on Colleges - develops guidance on the Basel Committee's

work on supervisory colleges.

c) Task Force on Remuneration - promotes the adoption of sound

remuneration practices.

d) Standards Monitoring Procedures Task Force - develops procedures to

achieve greater effectiveness and consistency in standards monitoring and

implementation.

The Standards Implementation

Group(SIG)



The Policy Development Group(PDG)

• Risk Management and Modeling Group - point of contact with the industry

on the latest advances in risk measurement and management.

• Research Task Force - facilitates economists from member institutions to

discuss research on financial stability in consultation with the academic

sector.

•Trading Book Group - reviews how risks in the trading book should becaptured by regulatory capital.

• Working Group on Liquidity - works on global standards for liquidity risk

management and regulation.



• Definition of Capital Subgroup - reviews eligible capital instruments.

• Capital Monitoring Group - co-ordinates the expertise of national

supervisor in monitoring capital requirements.

• Cross-border Bank Resolution Group - compares the national policies,

legal frameworks and the allocation of responsibilities for the resolution of

banks with significant cross-border operations.



The Accounting Task Force(ATF)

• Ensures that accounting and auditing standards help promote sound risk

management thereby maintaining the safety and soundness of the bankingsystem.

• Audit subgroup - explores key audit issues and co-ordinates with other

bodies to promote standards



Functions

• The Committee provides a forum for regular cooperation on banking

supervisory matters. Over recent years, it has developed increasingly into a

standard-setting body on all aspects of banking supervision.

• Its objective is to enhance understanding of key supervisory issues and

improve the quality of banking supervision worldwide.

•This committee formulates broad supervisory standards and guidelines,recommends statements of best practice in banking supervision in the

expectation that member authorities and other nations' authorities will take

steps to implement them by directly committees’ recommendations or

through their own national laws and regulations



• Also its regulations are not compulsory to be followed.

• It seeks to fulfill its objective in three principal ways:

by exchanging information on national supervisory arrangements;

by improving the effectiveness of techniques for supervising international

banking business and

by setting minimum supervisory standards in areas where they are

considered desirable.



Basel Accords

• The Committee encourages convergence towards common approaches and

common standards without attempting detailed management of member

countries’ supervisory techniques.

• The BCBS proposed three agreements or accords (on the recommendations

on banking regulations) – BASEL I, BASEL II, BASEL III.

• The committee normally meets in Basel, Switzerland at the Bank for

International Settlements (secretariat).



Basel I

• In 1988, The first round i.e. Basel I was created. Also known as 1988

Basel Accord.

• But was later on adopted by banks of G10 countries by end of 1992.

• Focused on credit risk.

• They were subsequently amended in 1996 (effective January 1, 1998) to

accommodate market risk alongside credit risk.



• Assets of banks were classified and grouped in five categories according to

how risky they are.

• The five categories are risk weights of 0%, 10%, 20%, 50% and upto

100%.



• All banks with international transactions are required to hold capital upto

8% under the risk weights.

• This framework has been progressively introduced in member countries of

G-10. Most other countries over 100, have also adopted the principles

prescribed under Basel I.

• The efficiency with which they are enforced varies, even within nations of

the Group of Ten.



Basel II

• Basel II is the second of the Basel Accords which are recommendations on

banking laws and regulations issued by the BCBS.

• Initially published in June 2004, was planned to create an international

standard for banking regulators to control how much capital banks need to

put aside to guard against the types of financial and operational risks banks

face.

• Advocates of Basel II believed that such an international standard could

help protect the international financial system from the types of problems

that might arise when a major bank or a series of banks collapse.



• This was achieved by setting up risk and capital management requirements

designed to ensure that a bank has adequate capital for the risk the bank

exposes itself to through its lending and investment practices.

•

i.e. the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall

economic stability.

• Basel II was not successfully implemented because of global financial

crisis that hit during 2008.



• Basel II requires to hold 2% of common equity of risk weighted assets

• Basel II uses a ‘‘three Pillars’’ concept

Minimum capital requirements (addressing risk)[Pillar i]Supervisory review [Pillar ii]

Market discipline [Pillar iii]



Pillar i

• Deals with maintenance of minimum capital which is calculated for three

major components of risk that a bank faces: credit risk, operational risk,

and market risk.

• Banks can choose from

Credit risk

• Standardized

approach• FoundationInternal RatingBasedApproach(IRBA)

• Advanced IRBA

Operational risk

• Basic Indicator

Approach (BIA)• Standardizedapproach(STA)

• AdvancedMeasurementApproach

Market risk

• VaR (Value at

Risk) approach



• Credit risk is an investors risk of loss arising from a borrower who does

not make payments as promised (also called as default risk or counterparty

risk).

• Operational risk arises from execution of company’s business operations

or functions,

focuses on risk arising from the people, systems and process through which

a company operates. Included risks such as fraud risks, legal risk, physicalor environmental risk, etc.

• Market risk means the value of a portfolio (either an investment portfolio

or trading portfolio) will decrease due to change in value of market risk

factors,

the four standard market risk factors are: stock prices, interest rates, forex

rates and commodity prices.



• Standardized approach: In this credit assessments was done external

agency for less sophisticated banks, more sophisticated banks used internal

rating based approach (IRB),

In IRB, banks were generally encouraged to improve their internal risk

management process.



• where;

Probability of default – Likelihood that customers will default in the next

12 months.Exposure at default – Expected amount of exposure at the point of

default.

Loss given default – Likely financial loss associated with the default.

• Banks can use their internal estimates of borrower credit worthiness to

assess credit risk.

Overall the credit risk = Exposure at default X Probability of defaultX Loss given at default.



Pillar ii

• Deals with supervisory review: where early supervision is encouraged by

giving them tools to measure risks of banks.

•

Supervisors should review & evaluate banks assessments and strategies forcalculating capital requirements.

• Supervisors should expect banks to operate above the minimum regulatory

capital ratios and should have the ability to require banks to hold more than

the required capital level and are expected to intervene when capital fallsbelow the required levels.

• This pillar also involves a set of principles to promote cooperation and

information exchange among supervisors or regulators.



Pillar iii

• This Pillar complements the minimum capital requirements (Pillar i) and

supervisory review process (Pillar ii) by developing a transparency which

will allow the market participants to determine the capital adequacy of an

institution.

• The aim of Pillar iii is to allow market discipline to operate by requiring

institutions to disclose details on the scope of application, capital, risk

exposures, risk assessment processes and the capital adequacy of the

institution.

• It must be consistent with how the senior management including the board

assess and manage the risks of the institution.



• When market participants have a sufficient understanding of a bank’s activities and the controls it has in place to manage its exposures, they are

better able to distinguish between banking organizations so that they can

reward those that manage their risks carefully and penalise those that do

not.

• Banks are forced to make disclosures twice a year about capital structure,

risk exposures and capital adequacy except qualitative disclosures

providing a summary of the general risk management objectives and

policies which can be made annually.

• Institutions are also required to create a formal policy on what will be

disclosed, controls around them along with the legalization and frequency

of these disclosures.



Basel III

• It was developed in response to the deficiencies in financial regulationduring late 2000’s financial crises. Implementation expected by the end of 2012.

• Basel III strengthens bank capital requirements and introduces newregulatory requirements on bank liquidity and bank leverage.

• When using Basel II, where mortgage-backed securities, credit defaultswaps and other instruments had AAA ratings which were not properly

supervised or regulated by official agencies which proved to be bad creditrisks.

• Basel III will require banks to hold 4.5% of common equity of risk weighted assets.



• Also introduces additional capital buffer .

• Mandatory capital conversion buffers of 2.5%.

• Discretionary countercyclical buffer, allowing national regulators torequire up to range of 0% to 2.5% of capital during periods of high creditgrowth.

• It also introduces minimum 3% leverage ratio and two required liquidityratios.

• The Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets to cover its total net cash flows over 30 days.

• The Net Stable Funding Ratio requires the available amount of stablefunding to exceed the required amount of stable funding over a one-yearperiod of extended stress.



International Banking Regulation

and India

• Indian banking has continually upgraded from the system of on-site

Annual Appraisal of the banks by the RBI followed in the 1970s

to the system of Annual Financial Review during the 1980s,

then on to the Annual Financial Inspection of stand-alone banks during the

1990s and further on to the consolidated supervision of financial

conglomerates so as to address the supervisory concerns on a group-wide

basis.



• The Off-site Monitoring & Surveillance (OSMOS) of the banking system

was also introduced in 1995 as a part of the supervisory strategy of ongoing

supervision of the banks, so as to supplement the periodical full-scope on-

site bank examinations.

• The supervisory rating models CAMELS {i.e. Capital adequacy, Asset

quality, Management, Earnings, Liquidity & System and control} based on

crucial prudential parameters, were also developed by the RBI to provide a

summary view of the overall health of the banks.



• The Prompt Corrective Action (PCA) Framework was put in place to

enable timely intervention in case of any incipient stress in a bank.

• The RBI has introduced risk-based supervision of the banks so as to move

away from transaction audit and to enable the modulation of the supervisory

efforts in tune with the risk profile of the banks and to achieve optimal

deployment of the scarce supervisory resources.



• Also, the Board for Financial Supervision, constituted in 1994 under the

Chairmanship of the Governor, RBI led the transformation in the regulatory

and supervisory apparatus of the banking system.

• Limit on Inter-bank Exposures to reduce the ill-effects of inter-bank

exposures, in March 2007,RBI limited a bank’s inter-bank liabilities (IBL)

to twice its net worth.

• A higher IBL limit up to 300 per cent of the net worth was allowed for

banks whose CRAR was at least 25 % more than the minimum CRAR

(nine per cent) i.e., 11.25 %.



• Regulation of NBFCs: The systemic significance of non-banking financial

institutions and hence, the need for their regulation, wherein the RBI Actwas amended to bring the non-banking financial institutions within the

regulatory domain of the Reserve Bank.

• Implementation of Basel II – Advanced Approaches: RBI have announced

a timetable for the gradual and calibrated adoption of advanced approachesof the Basel II Accord by the banks in India. The challenges include the

absence of long-enough history of economic/business cycles.

• Also, using past data may not be appropriate in cases where the sector has

undergone structural transformation.



• Another issue with regard to adoption of the advanced approaches is the

possibility that the risk weights assigned to employment-intensive retailand SME sectors may increase in certain circumstances, which may

obstruct the credit flow to these sectors or make it costlier.

• Thus there is a need to develop an appropriate risk mitigants for the

borrowers of these sectors on the basis of which lower risk weights couldbe assigned in order to ensure continued flow of credit to them.

• Credit Rating: There is an urgent need to ensure accuracy and reliability of

credit ratings assigned by the rating agencies. The RBI has recently

completed a detailed process of review of the accredited credit ratingsagencies for their continued accreditation under Basel II.



• RBI is liaisoning with Securities Exchange Board of India (SEBI) with

regard to credit ratings agencies adherence to the IOSCO (International

Organisation of Securities Commission) Code of Conduct Fundamentals.

• The issue of strengthening the regulation of credit ratings agencies is under

the consideration of the HLCCFM (High Level Co-ordination Committee

on Financial and Capital Markets ).

• Risk Management Capabilities (HR and IT Issues): In the future, banks

would need to upgrade their infrastructure, including human resources, to

face the growing complexity of risk management.

• Apart from traditional risks such as credit risk, market risk and operational

risk, new genre of risks including reputation risk, liquidity risk,counterparty credit risk, and model risk have emerged on the horizon,

management of which obviously requires skills of a higher order.

• These issues are engaging the attention of the stakeholders of the Indian

banking industry.



References'

• History of the Basel Committee and its Membership (August 2009)

(www.bis.org/bcbs/history.pdf ).

• The Evolution of Banking Regulation in India – A Retrospect on Some Aspects (http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/81434.pdf ).

•INTERNATIONAL BANKING REGULATION, Maximilian J.B. Hall andGeorge G. Kaufman

(www.luc.edu/faculty/.../InternationalBankingRegulation7-12-02.doc).

• Fact sheet - Basel Committee on Banking Supervision.

• INDIAN PERSPECTIVE ON BANKING REGULATION.pdf, address byMrs. Usha Thorat, Deputy Governor, Reserve Bank of India, at the

International Conference on “Financial Sector Regulation and Reforms in AsianEmerging Markets” on February 8, 2010.

• http://www.investopedia.com/

http://www.bis.org/bcbs/history.pdf

http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/81434.pdf

http://www.luc.edu/faculty/.../InternationalBankingRegulation7-12-02.doc

http://www.investopedia.com/









































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