Transcript The New Capital Accord - International Swaps and

The New Capital Accord
Emmanuelle Sebton
September 2002
International Swaps and Derivatives Association
www.isda.org
Presentation outline
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General considerations
Credit risk
Credit risk mitigation
Operational risk
General Implementation Issues and Beyond
the Accord
ISDA
General considerations
Capital Accord Reform
A brief history of regulation
Capital
0-8% based
on credit risk
equivalents
(also to cover other
risks)
MR Standard
or Model *3plus
plus specific risk
Capital based
on credit risk
- Standard method
- Int. rating based
method
As well as op risk and
Market risk charges
Global risk models
G30 recommendations 1994
Basel risk management guidelines for derivatives
Minimum requirements for trading activities
credit risk treatment
1988
1996
2006/7
2010 ?
ISDA
Capital Accord Reform
Objectives
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Broad coverage of all forms of risk
Risk sensitive capital requirements
Spectrum of approaches
Wide scope : banks and investment firms in
the EU
ISDA
Capital Accord Reform
Milestones
June 1999
Basel Consultative Paper 1
Jan 2001
Basel Consultative Paper 2
Sept 2001
‘CP2½’ (Operational Risk); Disclosure paper
Course of 2001 Various CPs on issues such as future income,
securitisation, collateralised lending etc
Forthcoming
October 2002 QIS 3- EU Commission consults on draft
directive
Spring 2003 Basel Consultative Paper 3 – Further
Commission consultation
End 2003
New Accord is published
Early 2004
Directive is finalised
ISDA
End 2006
Implementation
Basel Committee
Main Working Groups
Basel Committee
Capital Task Force
Models Task Force
Capital Group
Risk Management
Group
Accounting
Task Force
Transparency Group
ISDA
1988 Capital Accord
• One size fits all approach
• Not risk sensitive
• The capital charge is based on a proxy for credit
risk, does not differentiate other forms of risk
• Capital charge is function of nature of
counterparty [sovereign, bank, others] rather than
true credit risk
• Paradigm underpinning the capital requirement is
not explicit
ISDA
1996 Market Risk Amendment
Paradigm becomes explicit
Frequency of
loss

Expected
loss
0
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Unexpected loss

Stress
loss
Amount of loss
ISDA
1996 Market Risk Amendment
• For each risk type [FX, Equity, General interest
rate, Commodity, Specific], a spectrum of
approaches is available [standardised, models]
• Example for general interest rate risk :
– Gap analysis
– Duration
– Models of varying complexity (variance-covariance;
historical; Monte Carlo simulation)
ISDA
Current Review of the Accord
• Systematises the approach followed in the
market risk amendment
• Applies it to other risk forms : credit and
operational risk
5%
5%
30%
60%
Market Risk
Credit Risk
Operational Risk
Other Risks
ISDA
Current Review of the Accord
Structure
Pillar 1: Minimum
Capital Requirements
Credit Risk:
-Standardised
Approach
-Internal Ratings
Based Approach
Pillar 2 :
Supervisory
Review
Pillar 3 : Market
Discipline
Operational risk:
-Basic Indicator
Approach
-Standardised
Approach
-Advanced
Measurement
ISDA
Credit risk
An approach to credit risk
capital based on risk drivers
• Probability of default [assessed via external
or internal rating]
• Loss Given Default [imposed by regulators
or estimated by firms]
• Exposure amount [imposed by regulators or
estimated by firms]
• Maturity [imposed by regulators or
estimated by firms]
ISDA
An evolutionary approach
• Standardised :
All parameters set by regulators, only external
ratings are recognised
• Internal Ratings Based :
– Foundation : regulators set LGD and EAD
– Advanced : firms set LGD and EAD, better
recognition of credit risk mitigation
ISDA
Capital Requirements
• Standardised :
– Simple table of capital requirements as a function of
external rating. E.g. corporates
Credit Assessment
Risk weight
AAA to AA20%
A+ to A50%
BBB+ to BB- Below BB100%
150%
Unrated
100%
• IRB :
– A continuous function of asset type [retail versus
corporate, exposure size, PD, LGD, EAD, maturity]
– Merton model based
– Embedded : 99.9 percentile measure [may be
ISDA
reviewed], 1 year
IRB functions per asset type
• Recognition of different levels of default
correlation
Capital charge
Retail and Corporate IRB curves
(100% LGD- as per CP2)
45
40
35
30
25
20
15
10
5
0
Mortgage retail
Corporate IRB curve
Non-mortgage retail
0
10
20
30
One year PD
ISDA
Calibration of the IRB function
• For information, this is how capital requirements [deflated of EL]
compare for a three year corporate asset under ISDA’s index matrix
and the IRB function, at the same percentile [99.9th]- flattening of the
curve
Capital charge (%)
Comparison of ISDA recalibrated at 99.9
and new IRB charge [100% LGD]
70
60
50
40
30
20
10
0
0
5
10
15
20
25
PD (%)
ISDA
Calibration of the IRB function
• New IRB function has been added for credit cards
• Remaining issues :
– QIS3 will help re-estimate average LGD and EAD
postulated in the Foundation IRB function
• currently LGD set at 50% for senior unsecured debt, 75% for
subordinated debt
• EAD set at 75% of committed undrawn lines
– Procyclicality [Long term PDs, flattening of curve]
– Granularity [Pillar 2]
ISDA
IRB Approach Implementation
• Numerous issues :
– Use test; validation of rating process
– Validation of quantitative ratings and associated PDs:
• Lack of data, mapping, no backtesting possible
• Role of stress testing ?
– Validation of EADs-LGDs under Advanced IRB
– ISDA conducts an Internal Ratings Validation Survey
– ISDA promotes worldwide LGD database
ISDA
Credit Risk Mitigation
Treatment of Collateral
• Improved recognition of collateral:
– Financial : spectrum of approaches, including fixed
haircuts, own haircuts and portfolio VaR measures for
securities financing transactions
– Physical :
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Real estate : up to 20% reduction in capital requirements;
Receivables : same
Other physical collateral : up to 10% reduction
Specialised lending
ISDA
Treatment of GuaranteesCredit Derivatives
• Recognition of unfunded forms of credit
protection still limited.
– Guarantee treatment applies [no recognition of
diversification]
– Arbitrary specific risk offset [80%], insufficiently risk
sensitive
– On-going debate on operational requirements for credit
derivatives viz guarantees [restructuring]
– But : improvement in treatment of maturity mismatches
ISDA
Securitisation
• Complex topic. Rating agencies’ portfolio credit
risk models are implicitly recognised.
• Latest Basel Committee’s proposals : 16 August
2002
• Remaining issues :
– ABS risk weights
– Treatment of super-senior tranches in synthetic
securitisation transactions
– Supervisory formula
ISDA
Operational Risk
Definition of Operational Risk
• Risk of loss resulting from inadequate or
failed internal processes, people, systems or
external events.
• Size : Committee sets it at 12% of minimum
regulatory capital [originally : 20%]
ISDA
Spectrum of Regulatory Approaches
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Stage 1
Stage 2
Stage 3
Basic
Indicator
Approach
Standardised
Approach
Advanced
Measurement
Approaches
One size fits all
No incentives for
better ORM
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Risk based
Incentive to
manage risks
Sound Practices
Simple
Low
Less reflective of actual risk
Simplicity
Sophisticated
Granularity
Risk sensitivity
High
More reflective of actual risk
ISDA
Basic Indicator Approach
• Capital charge equals a percentage of gross
income.
• Percentage currently set at 15% for QIS3
• May be revised post QIS3
ISDA
Standardised Approach
• Capital charge calculated for 8 different
business lines as a percentage of gross
income in the business line [varying
between 12% and 18% depending on the
line], then summed across lines.
• On average, same result as Basic Indicator
Approach
ISDA
AMA approaches
• Recognition by the supervisor of the firms’ own
modelling of operational risk losses, whether
based on historical data analysis, score cards etc.
• Regulators have not specified model parameters
• Data collection framework by business line and
event type must be used.
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ISDA
Operational Risk Mitigation
• Insurance should be recognised for AMA
banks
• Provided insurer is reasonably well rated
• Ceiling on total capital reduction for
insurance [10-25%]
• EU Commission might recognise insurance
more widely
ISDA
Operational Risk Sound Practices
• Ten principles for operational risk
management, centering upon :
– Developing appropriate risk environment
– Management proper : identification,
assessment, monitoring and control/mitigation
– Role of supervisors
– Disclosure
ISDA
General Implementation Issues
and Beyond the Accord
General Basel Implementation
Issues
• Supervisory transparency
• Lead regulation
• Need for consistent implementation of the
Accord - Role of Pillar 2
• Role of the BIS and the EU Commission
– The Basel Committee has established an
Accord Implementation Group
ISDA
Beyond the New Accord
• Portfolio Credit Risk Modelling
• Counterparty risk
ISDA
General Information
ISDA’s risk management and
research activities
• Research
• Data pooling
• Regulatory advocacy :
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Basel Committee
European Commission
OFHEO
Many other regulatory bodies
• Training : risk management seminars in London
and New York
ISDA
Information and contacts
• Emmanuelle Sebton (Global Head/London)
– [email protected]
• David Mengle (Head of Research, NY)
– [email protected]
• Richard Metcalfe (OpRisk, Operations, Collateral/London)
– [email protected]
• Ed Duncan (Counterparty risk+ Pillar 3/London)
– [email protected]
• Tomoko Morita (General/Tokyo)
– [email protected]
• Angela Papesch (ISDA Singapore)
– [email protected]
ISDA
The New Capital Accord
Emmanuelle Sebton
September 2002
International Swaps and Derivatives Association
www.isda.org