Transcript MA Pakistan's presentation

BASEL II / EU Capital
Requirements Directive:
The UK Approach
Michael Ainley
Head of Wholesale Banks
& Investment Firms Department
Financial Services Authority
1
Agenda
• Overview
• Pillar 1
• Pillars 2 and 3
2
Basel II
• What is the Basel II agreement?
– Closer alignment of regulatory capital
and economic risks;
– Incentives to improve risk management;
– Maintenance of overall level of capital in
the system.
3
The Three Pillars
Pillar 1
• Minimum capital
requirements
Pillar 2
• Ensure adequate
capitalisation of
firms
• Encourage the
development and
usage of better risk
management
techniques
Pillar 3
• Market discipline
4
Basel 2
• Basel agreements and related publications do not have the
force of law; and they are of limited application to G:10
Internationally active banks
CRD
•
Across the EU the Basel II agreement is given legal “life” by the
Capital Requirements Directive:
– Scope: 27 EU Member States;
– Legal Basis: EC Directive
– Coverage: Credit institutions and investment firms i.e. potentially very
broad e.g. banks, mutually-owned deposit takers, investment banks,
asset managers…
5
CRD
• The Capital Requirements Directive is already in
force:
– The EC legislative process ran broadly in tandem with
the Basel Committee’s deliberations over Basel II;
– Came into force at 1 January 2007 (though some
elements subject to transitional arrangements until 1
January 2008);
– Basel II has therefore already been adopted across the
EU.
6
CRD to FSA Handbook
•
Member States should take steps to implement CRD:
– “National discretions” allow tailoring of policy to suit local
circumstances; and
– CRD establishes only minimum capital standards;
– Our overall policy-making approach was no “superequivalence”, instead, “copying-out” the CRD text into our
handbook with minimal extra guidance;
– Handbook changes came into effect at 1 January 2007. Except
where transitional provisions apply, firms must now comply
with the new prudential module of our handbook.
7
CEBS Guidance
• The EU established a Committee of European Banking
Supervisors (CEBS)
• CEBS has produced guidance documents for firms and for
supervisors on both Pillars 1 and 2
• CEBS guidance aims to ensure that consistent practices
are adopted throughout Europe on technical issues
• We have tried to ensure that our rulebook and supervisory
approach are fully consistent with CEBS guidance
8
Pillar 1: Waiver application process
•
Firms must apply for a formal “waiver” of our rules to allow use of the
advanced approaches;
•
The application should be detailed enough to allow us, in conjunction with
on-site review work, to form a complete view on a firm’s compliance with
our standards;
•
A strict timetable governs the process, telling firms when they should
apply; and, when we will reach a decision;
•
Key deadline: we will process any application for a CRD advanced
approach received by 31/12/2006 in time for first-use at 1/1/2008;
•
For firms that apply during 2007 we offer no such service standard.
•
At end-2006 we had received around 30 applications, we expect several
further applications for IRB in the coming weeks.
9
Pillar 1: Waiver application process
•
Our internal process gives supervisors a key role throughout:
– On-site review work, assisted by risk specialists;
– Liaising with other regulators;
– Scrutinising firms’ application packs;
– Presenting to the decision making body.
•
There are 4 possible outcomes for firms:
– Accept unconditionally
– Accept with conditions
– “Minded to grant” – reasonable compliance but uncertainty
over ability close gaps
– Reject
•
Most decisions are likely to be conditional acceptance or minded
to grant.
10
Risk-based approach
• FSA has conducted “risk-based” supervision for many years via
ARROW but Basel II poses even greater challenges to
supervisors;
• This is particularly so for the supervision of internationally
diversified groups:
– FSA is Home regulator to a number of UK-parent firms with
complex overseas operations e.g. HSBC, Standard Chartered;
and
– FSA is Host regulator to many subsidiaries of complex foreignparent groups e.g. Citigroup, Goldman Sachs.
11
Risk-based approach
• We have responded to this challenge in a number of
ways, for example:
– Not publishing rules that unnecessarily differ from
the minimum standards of the CRD;
– Conducting proportionate reviews of applications for
Pillar 1 advanced approaches for example, limiting
our on-site review work where we can rely on the
work of a foreign subsidiary’s parent company
supervisor.
12
Pillar 2: process
•
Pillar 2 operates on a separate, though related, timescale to Pillar 1;
– A firm must have its individual capital adequacy assessment
(ICAAP) in place at the time it begins to use any of the Pillar 1
approaches, and no later than 1/1/2008;
– We will review the ICAAP, and issue Individual Capital
Guidance, as soon as possible once it is ready;
– Some firms have chosen to submit a draft ICAAP at the same
time as their application for a Pillar 1 advanced approach.
13
Other: transparency and governance
•
Emphasising senior management responsibility is a
fundamental axiom of FSA’s approach to supervision:
– E.g. the requirement for the Board and Senior
Management to have, respectively, general and
good understanding of AMA and IRB models.
•
Governance is a key area of focus in CRD model review work
and more generally for standardised approach firms;
•
Pillar 3 disclosures help to enhance transparency and promote
market discipline. FSA approach in line with CRD – details for
firms to decide.
14
Other: organising supervisors for delivery
• Training – technical and practical training rolled out to
supervisors and DMC members;
• Central Project Team – established to coordinate
implementation;
• Basel Implementation Project Teams – established in all
supervisory divisions to coordinate implementation;
• Risk Review Specialist teams to lead on-site review work for
advanced approaches.
15
Other: CRD for smaller banks
•
Our approach to smaller banks is embedded within our Pillar 1
approvals process and ARROW, which give us the flexibility to
be proportionate;
•
Most smaller banks in the UK are adopting the standardised
approaches to risks under CRD;
•
But we are not compelling smaller banks to adopt a particular
approach - some intend to progress to IRB soon.
•
Special circumstances apply to EU-parent banks - the CRD
assumes that all EU supervisors are equivalent:
– For subsidiaries adopting the Pillar 1 advanced approaches
there is only one application, to the EU-parent Member State.
16
Key Home-Host Considerations
• Different implementation timetables
– U.S. delay
• Different approaches to implementation
– National discretions
• E.g. Different definitions of default and implications for
consolidation
– Different interpretations of Basel 2
•
Pillar 2, stress tests, Basel 1A
• Allocation from Group models
– Pillar 2, AMA
17
Example 1: Standard Chartered
and HSBC
• UK Home Supervisor
• IRB approach being rolled out
• Over 50 (SC) and 80 (HSBC) host
supervisors, mostly non-EEA
• Close cooperation and information
sharing key.
• Colleges hosted in UK since 2005
18
Example 2: UK Subs of U.S.
Groups
• US Delay should not be a barrier to UK subs
of US groups applying for advanced
approaches in the UK to the CRD timetable.
• Close cooperation and information sharing
with US home regulators has been key and
has included joint visits by FSA staff with
Fed/ OCC colleagues at the head offices of
US groups in New York.
19
Concluding remarks
• Basel II challenges supervisors as well as firms,
particularly in the context of internationally active
groups;
• Supervisors can respond to this challenge by
adopting a proportionate, risk based approach. For
example, in the UK we have:
– “Copied out” our rules from the CRD text;
– Been clear and consistent about how we handle Pillar 1 advanced
approach applications;
– Embedded Pillar 2 in our ARROW II risk based approach to
supervision;
– Equipped our supervisory staff with the necessary resources for
delivery.
20
Pillar 1
21
Credit risk under Basel II
• A critical innovation under Basel II is the use of credit ratings to
differentiate the credit quality of assets held by banks
• In measuring the amount of capital to allocate against credit risk,
Basel II permits banks to use either:
– External ratings from credit rating agencies (the
“standardised” approach); or
– Banks’ own internal ratings and associated loss
estimates (the “internal ratings based” approach)
22
Credit risk – standardised
approach
• Standardised approach is intended for banks with less complex
operations
• Exposures with better external credit ratings generally receive
lower capital charges
• Most UK banks will adopt the standardised approach at 1/1/08:
– We currently regulate around 350 banking subsidiaries (not
including building societies and securities firms) but we
have only received around 25 applications for IRB
23
Credit risk – Internal Ratings
Based approach (IRB)
•
IRB is intended for banks with more complex books
•
It allows substitution of banks’ own internal ratings for the rating agency
assessments of credit risk
•
Two types of IRB approach permitted
– Foundation (F-IRB)
– Advanced (A-IRB)
•
IRB models estimate some or all of the elements in the risk weighting
calculation
– Risk Weight comprises Probability of Default (PD); Loss Given
default (LGD); Exposure at Default (EAD) and Effective Maturity (M)
24
Credit risk – foundation IRB
• The Foundation IRB approach allows firms to estimate some, but not
all, of the risk weighting factors – principally PD
• F-IRB also only applies to a limited range of exposures - corporate /
sovereign / institutional exposures
• F-IRB is therefore proving attractive to securities firms and
commercial banks with wholesale-only exposures:
– Of the 9 IRB applications currently being considered
within the FSA Wholesale Firms Division, 5 are for FIRB
25
Credit risk – advanced IRB
• Advanced IRB (A-IRB) approach allows all of the factors to be
estimated:
– PD, LGD, EAD and M
• A-IRB applies to all asset classes, including retail exposures:
– It is therefore proving particularly attractive to the
large UK retail banks
• A-IRB requires substantial technical / modelling capability because
of its increased complexity
26
Credit risk – applications
experience
•
A number of areas are causing difficulties, for example:
– Low default portfolios – how to estimate PD for exposures that have
never defaulted e.g. sovereigns, corporates
– Immaterial exposures – large numbers of small exposures to a
particular type of counterparty e.g. hedge funds
•
Our approach to these issues is to be flexible where possible to allow
firms to develop their own cost-effective solutions
•
We have also given guidance to firms via our Industry Standing Groups
e.g. on stress testing
27
Credit risk – lines in the sand
• We have also indicated to industry several areas of IRB
policy where we will not tolerate imperfect compliance,
which we call the “lines in the sand”:
– Documentation
– Validation
– Stress testing
– Senior management understanding
– Use test
28
Credit risk – lines in the sand
• Documentation
– IRB models and processes need to be well
documented both from the user and the
development perspectives;
– There should be enough information for an
independent reviewer to understand how a final
rating was arrived at for a specific borrower.
29
Credit risk – lines in the sand
• Validation
– IRB models need to be validated independently of the
model development unit;
– Validation aims to assess the performance of internal
systems consistently and meaningfully;
– Supervisors need to have regard to a number of
issues, including the involvement of senior
management; and, that firms have a regular ongoing
cycle of model validation
30
Credit risk – lines in the sand
• Stress testing
– It is essential that firms are able to understand how the
ratings system performs and what happens to the risk
portfolio under stressed conditions:
• What happens in a mild, relatively frequent, recession?
• What happens in a severe recession – say, a 1:25 year
event?
– Stress testing procedures for credit risk are proving to
be less well developed than for market risk
31
Credit risk – lines in the sand
• Senior management should have a reasonable understanding of
what the IRB model is telling them:
– This mitigates “black box” risk where the risk management
approach is only understood by the risk managers
• For IRB we ask for a board member to demonstrate a “general”
understanding
• Senior individuals within the risk management function need to
have a “good” understanding
• Supported by appropriate management information and
reporting.
32
Credit risk – lines in the sand
• Use test
– make effective and non-marginal use of internal ratings, for
example in:
•
•
•
•
•
Credit approval
Management of risk e.g. setting limits
Internal capital allocation
Loan pricing
Provisioning
33
Market risk
• The market risk (trading book) rules were impacted by Basel II
– The Trading Book Review looked at the definition of the trading
book
– The scope of the trading book is possibly broader than in the
past:
• e.g. includes traded loans and hedge fund positions for
the first time
• Use of the trading book is governed by a policy statement
• Firms are required to value trading positions prudently, which
may be different to accounting “fair” valuations
34
Operational risk
• Basel II for the first time introduced a Pillar 1 capital
charge relating to:
– “the risk of losses resulting from inadequate or
failed internal processes, people and systems, or
external events”
• It is expected that it will account for around 12% of Pillar 1 capital
in the financial system
• There are 3 permitted approaches to operational risk capital
35
Operational risk – Basic Indicator Approach (BIA)
• Average gross income for whole business over three years
• Capital charge is 15% of the result
• Encouraged to comply with Statement of Sound Practices
Operational risk – The Standardised Approach
(TSA)
• Gross income for eight business types considered separately
• Capital charges range from 12% to 18%
• Qualitative entry criteria including Policies for managing operational
risk, a framework for managing operational risk, processes and
systems for monitoring operational risk / losses, internal and
external reporting
36
Review of BIA/ TSA approaches
• No approval required for BIA/ TSA
• Scale, nature and complexity of the firm are
key determinants of what we expect in risk
management
• Review through:
– Thematic work
– Included in standardised visits/ meetings
37
Operational risk – Advanced
Measurement Approach
• Qualitative criteria apply, building on those for TSA
• Independent operational risk management function
• Three years historical internal loss data
• Modelling based on combination of inputs
• External verification
38
Operational risk – key issues for
AMA
• AMA allows diversification benefits to be
recognised
– Key difference is between branches and subsidiaries
– OK if capital is freely transferable to support risks
– Not OK if there are restrictions on capital mobility
– Not just an operational risk issue
39
Operational risk – our
experience
• AMA is proving to be a big challenge for firms
• Many firms that had earlier indicated an intention
to apply for AMA have delayed
• We are currently considering only 4 applications
for AMA:
– Though more firms may apply later this year
40
Investment Firms and Basel II
• CRD applies Basel II to investment firms as well as banks in
Europe
• Many of these investment firms are small – we want to be easy
for them to do business with
• So we have written to over 2000 affected firms since summer
2006 clarifying the impact of CRD:
– E.g. some types of firm need to calculate the operational risk charge, others do
not
• Another new EU Directive – MiFID – will bring further investment
firms into the CRD’s scope later in 2007
41
Pillar 2
42
Pillar 2: What is it?
• An assessment of risks and mitigation
• Risk based
• Proportionate
• Not a model
• A dialogue with the firm
• A review of firm’s assessment
43
Pillar 2: What is it?
Firm’s
assessment
Identify and assess
material risks
Supervisory
assessment
Dialogue
Review and evaluate
risk and control factors
and
Review and assess the
firm’s risk assessment
challenge
Supervisory conclusion
Identify mitigating controls
Identify amount of capital
in relation to business
plan, strategies, and profile
Produce capital number
and assessment
44
Principles for an ICAAP:*
1: A firm must have an ICAAP
2: Is the responsibility of the Firm
3: Management body to take responsibility
4: Should be:
An integral part of the management process
Reviewed regularly
Risk based
Comprehensive
Forward looking
Based on adequate measurement and assessment
process
* CEBS guidance
45
Consolidation:
UK Group with Overseas Subsidiaries
UK Firm e.g. Standard Chartered
UK Firm
UK non reg
US sub
DE sub
UK consolidation group
•
•
ICAAP should be at the level of the UK consolidation group and should be
capable of allocating the group capital number to individual firms
It also covers the business of the group’s overseas operations.
46
Consolidation:
UK Sub-group of an EEA or Non-EEA Group
EEA/non EEA parent e.g. Habib
UK Firm
Firm
Firm
UK consolidation group
The ICAAP:
• is at the level of the UK consolidation group;
• covers the business of the UK consolidation group;
• must be capable of allocating the group capital number to the
individual firms.
47
Consolidation:
UK Sub-group of an EEA or Non-EEA Group
• This does not mean the UK consolidation group must
have its own set of processes, strategies and systems.
EEA/non EEA
parent
• the global group can
have a single set of
processes, strategies
and systems which are
used by the UK group
UK consolidation group
Firm
Firm
Firm
• Must be capable of:
– explaining the risks within the UK consolidation group;
– determining a capital number for the UK consolidation group and
each firm.
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FSA’s approach to the SREP
ICAAP
SREP
Capital
planning
CRR or ICAAP
Element 1
Element 4
Pillar 1 risks
External factors
Element 2
Risk not fully covered under Pillar 1
Element 3
Risks not covered by Pillar 1
Intermediate assessment
Quantitative
assessments
Qualitative assessments
Monitoring and
control
Internal governance
and oversight
49
FSA Pillar 2 Timeline
• Steps are iterative
• Interwoven with Pillar 1 Waiver
Process & Arrow
Internal
Arrow risk assessment interacts with the SREP
• Starting point is the result of the firm’s
ICAAP or the capital resources
requirement (CRR)
Pillar 2 assessment process (SREP)
planning
Submission request
Initial review
Questions/discussion
FSA detailed
initial review
Discuss findings
with firm
FSA panel process
Formal notification
50
Risks under each element
Element 1: Pillar 1 risks
•
Credit risk
Market risk
•
•
Operational risk
Element 2: Risk not fully covered under Pillar 1
•
Residual risk
Securitisation risk
•
Element 3: Risks not covered by Pillar 1
•
•
•
•
Interest rate risk in the
banking book
Concentration risk
Liquidity risk
Business risk (earnings and
costs)
•
•
•
Settlement risk
Reputation risk
Underwriting risk
•
•
•
Pension risk
Transfer risk
Underestimation of credit risk
using standard approach
Element 4: Capital planning
•
Economic and regulatory
environment risk
•
•
Strategic risk
Access to capital
51
Outputs from the SREP
Supervisory Decision
Individual Capital Guidance (ICG)
Individual liquidity guidance
RMPs
Other measures
52
Pillar 2 is part of
53
Overview of Panel Process
• Purpose:
– ensure consistency of approach
– provide effective review and challenge
• Risk Focused
– Planning validation panel
• H impact firms required
• MH / ML impact firms discretion of the RM
• L impact firms – optional
– Final validation panel – all firms
54
Overview of Panel Process
• Timing
– Alignment with ARROW if concurrent
– Planning panel takes place before further
questions of the firm
– Final panel takes place after firm discussions
• Methods
– Panel or independent manager review
– Conclusions must be documented
55
Example: HSBC Pillar 2 Process
• Current Status:
• Pillar 2 Team:
– Ongoing discussions with HSBC
– “Joined up” with Supervisors & Pillar 1 Team
• HSBC:
– Developing/Refining ICAAP
– Currently “Top Down” Capital Assessment
• ECM Tools in Various Centres
• Building out ECM for Group
– Developing Stress Tests
56
HSBC Pillar 2 Process
• “7 Areas of Interest” follow the Pillar 1 “lines in
the sand” with 2 extras:
– Senior Management Understanding
– Use Test
– Stress Testing
– Independent Validation
– Documentation Quality
– Downturn LGD
– Data Quality
57
ICG letter
• Key points to note:
- Letter addressed to authorised firms
- Appendices: including RMP
- Restrictions on disclosure
- Substantive content:
- ICG (Individual Capital Guidance)
- IG on liquidity
- Clear identification of link between Capital and RMP actions
- Explanation of adjustments in broad and quantified terms
58
Home/Host Considerations
• CRD does not specify the form or the content of
ICAAP
• FSA is committed to being flexible and proportionate
• We are prepared in principle to accept ICAAPs based
on:
– Allocation from a Group economic capital models (but this will
require the understanding how the ECM is constructed)
– A ‘Pillar 1 plus’ approach, whereby the local ICAAP uses Pillar 1
as the starting point and then “bolts on” Pillar 2 risks
– Hybrid ‘Pillar 1 plus’ and part ECM allocation
– These questions will be addressed in the context of coordination
between home and host supervisors
59
Home/Host Considerations
• Coordination between home and host supervisors
will be important
– This entails the consolidated supervisor taking a leading role to:
• Synchronise Pillar 2 work across borders
• Communicate home and hosts’ Pillar 2 assessments
• Exchange information both at the pre- and post visit
stages
• Distribute tasks if possible
• Collate conclusions
• Challenges:
– Little direct experience: will gather pace in 2007
– Legitimate variations in national approaches
– Timing differences
•
UK will time P2 assessments to overlap with Pillar 1 model
approval work (partner supervisors may be working to different
timetables)
60
Our Experience to Date
• 59 RRD supported full scope SREPs planned for
2007
• 2 Final validation panels held to date
– 1st firm – a high impact building society - add-ons applied
for concentration risk and stress testing
– 2nd firm – a low impact investment firm – no capital addons – ICG set at 100% of CRR
• In Wholesale Firms Division, approximately 50
streamlined (desk-based) SREPs planned for
2007
61
Final Word
• We will be proportionate & focus on significant
risks
• The ICAAP includes capital planning and
robust stress testing & is embedded in the
firm’s risk management framework
• It is NOT just about capital but assessing risks
and implementing appropriate mitigation
• Need to coordinate, cooperate &
communicate
62
Pillar 3
63
Objectives of Pillar 3 - Disclosure
• Promote market discipline;
• Provide information about the bank’s risk profiles and
levels of capitalisation; and
• Enable market participants to make informed decisions
based on the key information.
64
Risk-based approach to
disclosure
A firm:
• needs to disclose material information; and
• may omit disclosure of information which is regarded as
proprietary or confidential.
• Senior management must determine the material information
and also whether information falls into either the proprietary or
confidential category.
65
What needs to be disclosed?
Firms need to disclose on annual basis qualitative
and quantitative information relating to:
• Risk management objectives & policies;
•
•
•
•
•
•
•
Scope of application;
Capital resources;
Credit and dilution risk and credit risk mitigation;
Market risk;
Operational risk;
Securitization; and
Non-trading book exposure to Interest Rate Risk and Equities.
66