Transcript Document

Financial Crisis and the Implementation
of Basel II:
Potential Economic Impact for Trinidad
and Tobago
Lester Henry and Michelle Majid
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Roadmap of the Paper
• Introduction
• Overview of Basel I & II
• Financial Crisis and Basel II: Are they linked?
• The TnT Financial System
• Some issues of concern to T&T
• The way Forward for T&T
• Summary and Conclusion
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Introduction
• Financial Crisis partly seen as regulatory failure.
• Basel I and Basel II were supposed to prevent such
• Many Caribbean Countries were expected to adopt
Basel II over the next few years (from 1 or 2 in 2007
to 4-6 between 2010 – 2015)
• Examine Basel II’s role in the crisis
• Identify issues arising from possible adopting Basel II
• determine the extent to which Basel II may impact
T&T and by extension the region
• Inform policymakers whether focus should be on
getting Basel I right or introducing Basel II or not
adopting any at all.
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Overview of Basel I
Basel I
Pillar 1:
Regulatory capital
Minimum capital
requirements
Risk-weighted
Assets
(Denominator)
Credit Risk
(1988)
≥ 8%
Risk-weighted assets
Definition of
Capital
(Numerator)
Market Risk
(1996)
Standardized
Approach
Models
Approach
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Shortcomings of Basel I
• Capital required did not mirror a bank’s true
risk profile
• Too simple for advanced banks
• Inflexible against new developments
• Covers only credit and market risks
• Only quantitative in nature
• Limited recognition of collateral
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Basel II in a Nutshell
Basel II
Pillar 1
Pillar 2
Pillar 3
Three
Pillars
Minimum capital
requirements
Supervisory review
process
Risk weighted
assets
Standardized
Approach
Internal
Ratings-based
Approach
Definition of
capital
Operational
risk
Credit risk
Basic
Indicator
Approach
Standardized
Approach
Market
discipline
Market
risks
Advanced
Measurement
Approaches
Standardized
Approach
Core
Capital
Supplementary
Capital
Models
Approach
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Objectives of Basel II
• Greater emphasis on banks’ own assessment of
risk
• Comprehensive framework for credit, market
and operational risk
• Encourages rigorous bank supervision
• Ensures market transparency, disclosure
• More risk sensitive; better align regulatory capital with
actual risk exposure
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Basel II and the Financial Crisis
• I. the average level of capital required by the new
discipline is inadequate and this is one of the reasons
of the recent collapse of many banks;
• II. the new Capital Accord, interacting with fair-value
accounting, has caused remarkable losses in the
portfolios of intermediaries;
• III. capital requirements based on the Basel II
regulations are cyclical and therefore tend to reinforce
business cycle fluctuations;
• IV. in the Basel II framework, the assessment of credit
risk is delegated to non-banking institutions, such as
rating agencies, subject to possible conflicts of interest; 8
Basel II and the Financial Crisis….continued
• V. the key assumption that banks’ internal models for
measuring risk exposures are superior than any other
has proved wrong;
• VI. the new Framework provides incentives to
intermediaries to deconsolidate from their
balance-sheets some very risky exposures
Source: Francesco Cannata Mario Quagliariello (2009)
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In Defense of Basel II
• Only recently implemented
• In US only applies to top tier banks operating
internationally -- most of system is exempted
• Pillar II and Pillar II have been given very little
attention, a careful application would involve;
– Remuneration packages in investment banking and of management
boards;
– Transparency of a bank's risk profile;
– Management's true understanding of both the bank's risk profile and its
risk positions.
• source Van Kemper, Cris (2009)
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Can Basel X work? A Minskyian alternative View
• Can help in some cases but ultimately limited in
preventing crises
• Sources of instability are “built-in” to the system
• During expansions managers competence will be
questioned if they don’t go after higher returns
• In normal times the “three-six-three” rule applies
• During Busts credit supply dries up regardless of any
stimulus policy
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Snapshot of TnT Financial System:
Asset Growth
• Eight commercial banks and 19 NBFIs
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Snapshot of the Financial System:
Capital Adequacy
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20
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Regulatory
capital to RWA
10
Regulatory T ier
I capital to
RWA
5
0
1999
2000
2001
2002
2003
2004
2005 Mar
Source: Financial Sector Assessment Program Report, 2005
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Snapshot of the Financial System:
Asset Quality
NPL to Gross Total loans (% )
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5
4
3
2
1
0
1999
2000
2001
2002
2003
2004
2005 -Mar
Source: Financial Sector Assessment Program Report, 2005
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FSAP (2005): T&T’s deficiencies
• Inadequate financial sector laws
• High-levels of connected exposures across
banking and insurance companies
• BCP Non Compliance with Market Risk, Large
and related exposure limits
• 0% risk weighting all sovereign debt
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Some Areas of Concern
• Credit Risk Assessments
• Macroeconomic Issues
• Capital Requirements
• Distortion of allocation of credit
• Interbank Lending
• Regulators in emerging economies
• Home-host Issues
• Local Banks in T&T
• BCP Compliance
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Credit Risk Assessments
• Shallow credit rating market (reduced to flat
rate)
• Rating linked to level and volatility of capital
flows
• Prohibitive cost and incentive to become rated
• Who will rate the rating agency?
• Potential pro-cyclicality and circularity (Powell,
2002)
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Macroeconomic Issues
• Three factors indicate that tighter regulatory
capital requirements are likely to cause a
domestic credit crunch:
* economies are shallow
* banking sector concentrated
* presence of government in the real economy
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Regulators
• Deficient regulators can be an important
determinant of banking crisis (much more than
adequate capital provisions) (Barth, Caprio and
Levine (2001))
• Increased skills of examiners
• Shift from generalists to specialists (BCBS,
2004)
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Local Banks in T&T
• Banks would need to improve infrastructure for
measuring and monitoring risk – COSTS!!!!
• Foreign-banks within T&T can piggy-back on
parent
• Where does that leave T&T local banks?
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Limitations and Areas of Further
Research
• Limitations:
Lack of data to do QIS
Basel I shortfalls to address
Credit rating assessments
Regional workshop to resolve common issues
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The Way Forward for T&T
• Get the Vision combined with preconditions
right
• Create detailed and specific gap assessments
• Produce detailed plans to address gaps with
sufficient lead times
• Establish a process to oversee and deploy Basel
II implementation
• There is no substitute for extreme vigilance on
the part of regulators
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Selected References
• Francesco Cannata and Mario Quagliariello (2009) “The role of
Basel II in the subprime financial crisis: guilty or not guilty?”,
CAREFIN Working paper 3/09.
• Wray, Randall can Basel II enhance financial stability? A
Pessimistic View”, Working paper 84, Jerome Levy Institute.
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Thank You and enjoy the rest of the
show!!!
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