reynolds printable
TRANSCRIPT
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How Basel II is changing the world
Diane Reynolds
Sr. Director, Economic Capital Solutions
Algorithmics Inc.
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Agenda
Context
- What is capital and why does it matter to a bank?
Basel II
- What is Basel II and why is it important?
Impact
- What has changed because of Basel II?
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Context
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Who are the stakeholders in a bank?
How is this different from other firms?
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Typical Stakeholders
Its shareholders
Represented by equity analysts
Its bondholders and those to whom it owes money
Represented by rating analysts
Its depositors
Represented by deposit insurance schemes & governments
The public
Represented by regulators & governments
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The Regulatory Perspective
fundamental objective: to develop a framework that would further strengthenthe soundness and stability of the international banking system
While maintaining sufficient consistency that capital adequacy regulation will notbe a significant source of competitive inequality among internationally activebanks.
major benefit: promote the adoption of stronger risk management practices bythe banking industry,
improving capital regulation to take into account changes in banking and riskmanagement practices
preserving the benefits of a framework that can be applied as uniformly aspossible at the national level.
Definition from Basel II document, paragraph 4.
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What is capital?
What do you need it for?
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Accounting
Capital
= Equity
= Assets - Liabilities
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Regulatory Capital
Tier 1 Capital
Tier I capital is core capital, this includes equity capital and disclosed reserves.
Equity capital includes instruments that can't be redeemed at the option of theholder.
Tier 2 Capital
Tier II capital is secondary bank capital that includes items such as undisclosedreserves, general loss reserves, subordinated term debt, and more.
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Risk-based Capital
Measures how much you need, not how much you have
Why do you need capital?
To ensure that the business can continue
To cover unexpected events that lead to losses
To reassure investors (and the markets)
To reassure depositors (and the regulators)
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Three Pillars & Three Risks
Three Pillars of Basel II:
Minimum Capital Requirements
Supervisory Review
Market Discipline
Three Major Sources of (Quantifiable) Risk:
Market Risk
Credit Risk
Operational Risk
I
II
III
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Credit
Standardized
Foundation
IRB
Advanced
IRB
Pillar 1: Minimum Capital
Operational
BasicIndicator
Standardized
AdvancedMeasurement
Market
Standardized
InternalModels
Risks
Soph
istication
Bank
Provides RiskComponents
SupervisorProvides RiskComponents
Approaches to Regulatory Capital Calculations
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Basel II
RWA = Risk Weighted Assets
RWA
= RWA (Market Risk)
+ RWA (Credit Risk)
+ RWA (Operational Risk)
Capitalization RequirementsTier 1 Capital > 4% of RWA
(Tier 1 + Tier 2) Capital > 8% of RWA
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Impact
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A change in philosophy
Capital is related to risk!
Capital alone is not sufficient: Pillars 2 and 3.
Credit risk divides into at least three elements:
PD
LGD
EAD
Operational risk is a measurable risk.
Risk is a key determinant of performance and a factor in measuring reward.
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A change in emphasis
Sr. management and boards are:
More aware of risk management
More accountable for the risks they take not having realized it is a risk is no longer a
defense! Spending more money on identifying, quantifying, managing and mitigating risks
Risk became such a cost centre that
Costs had to be viewed as investments
Many people are looking for ways to leverage that investment
USbank spending on Basel II-related risk management IT will increase 30% over the nexttwo years to exceed $1bn in 2009, according to Aite Group.
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HSBC Annual Report 2006
2006 2002
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HSBC Annual Report 2005
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HSBC Annual Report 2005
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HSBC Annual Report 2006
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How Basel II is changing the world
Diane Reynolds
Sr. Director, Economic Capital Solutions
Algorithmics Inc.
+1 416 217 4126